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No 3 2003

ISSN 0379-0991

EUROPEANECONOMY

EUROPEAN COMMISSIONDIRECTORATE-GENERAL FOR ECONOMIC

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Public finances in EMU2003

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European Economy appears six times a year It contains important reportsand communications from the Commission to the Council and theParliament on the economic situation and developments ranging from theBroad economic policy guidelines and its implementation report to theEconomic forecasts the EU Economic review and the Public financereport As a complement Special reports focus on problems concerningeconomic policy

Subscription terms are shown on the back cover and the address of thesales offices are shown on the inside back cover

Unless otherwise indicated the texts are published under the responsibilityof the Directorate-General for Economic and Financial Affairs of theEuropean Commission BU1 B-1049 Brussels to which enquiries otherthan those related to sales and subscriptions should be addressed

European Commission

EUROPEANECONOMY

Directorate-General for Economic and Financial Affairs

2003 Number 3

copy European Communities 2003

Printed in Belgium

Public finances in EMU mdash 2003

Abbreviations and symbols used

Member States

BE BelgiumDK DenmarkDE GermanyEL GreeceES SpainFR FranceIE IrelandIT ItalyLU LuxembourgNL The NetherlandsAT AustriaPT PortugalFI FinlandSE SwedenUK United KingdomEUR-12 European area Member States currently participating in the monetary union

(BE DE EL ES FR IE IT LU NL AT PT FI)EU-15 European Union 15 Member States (EUR-12 plus DK SE and UK)

Candidate countries

BG BulgariaCY CyprusCZ Czech RepublicEE EstoniaHU HungaryLV LatviaLH LithuaniaMT MaltaPL PolandRO RomaniaSK Slovak RepublicSI SloveniaTR TurkeyAC-10 Accession countries (CY CZ EE HU LV LH MT PL SK SI)CC-13 Candidate countries (AC-10 plus BG RO and TR)

Currencies

EUR euroECU European currency unitDKK Danish kroneGBP Pound sterlingSEK Swedish kronaCAD Canadian dollarCHF Swiss francJPY Japanese yenSUR Russian roubleUSD US dollar

Other abbreviations

bn billion 1 000 millionCPI consumer price indexEC European CommissionECB European Central BankECSC European Coal and Steel CommunityEDF European Development FundEIB European Investment BankEMCF European Monetary Cooperation FundEMS European Monetary SystemEMU economic and monetary unionERM exchange rate mechanismEuratom European Atomic Energy CommunityEurostat Statistical Office of the European CommunitiesFDI foreign direct investmentGDP (GNP) gross domestic (national) productGFCF gross fixed capital formationHICP harmonised index of consumer pricesILO International Labour OrganisationIMF International Monetary FundLDCs less developed countriesMio millionMrd 1 000 millionNCI New Community InstrumentOCTs overseas countries and territoriesOECD Organisation for Economic Cooperation and DevelopmentOPEC Organisation of Petroleum Exporting CountriesPEP Pre-accession economic programmesPPS purchasing power standardSCP Stability and convergence programmesqoq quarter-on-quarter percentage changeSMEs small and medium-sized enterprisesVAT value added taxyoy year-on-year percentage change not availablendash none

Acknowledgements

This report was prepared in the Directorate-General for Economic and Financial Affairs under the direction ofKlaus Regling Director-General and Servaas Deroose Director for the Economy of the Euro Area and the UnionThe main contributors were Declan Costello Elena Flores Gual Gabriele Giudice Andrea Montanino AlessandroTurrini and Peter Wierts

Specific contributions were prepared by Riccardo Maggi Joatildeo Nogueira Martins and Jan inrsquot Veld The country chap-ters in Part VI were prepared in the Directorate for the Economies of the Member States under the responsibility ofAntonio Joseacute Cabral The contributors were Ronald Albers Georg Busch Joaquim Ayuso Casals Per EckfeldtFrancesco De Castro Heinz Jansen Ulrich Jocheim Harri Kaumlhkonen Martin Larch Karin Abelskov MadeleineMahovsky Laurent Moulin Joatildeo Medeiros Stellios Pantazidis Lucio Pench Elena Reitano Joseacute Luis Robledo FragaMatteo Salto Mirella Tieleman Charlotte Van Hooydonk Keith Vernon Editorial collaboration was provided byIoanna Soulioti Karine Jabet and Marko Mrsnik The statistical annex was prepared by Maarten Van de Stadt (avail-able on the web see at httpeuropaeuintcommeconomy_financepublicationspublicfinance_enhtm)

Comments and suggestions by colleagues in the Directorate-General for Economic and Financial Affairs as well as byother services of the Commission are gratefully acknowledged

Secretarial support was provided by Maria Davi-Pilato and Aliki Drossou

Comments on the report would be gratefully received and should be sent to

Directorate-General for Economic and Financial AffairsPublic Finances Unit with particular reference to the euro zoneEuropean CommissionB-1049 Brussels

or by e-mail to ElenaFloresceceuint

Contents

Summary and main conclusions 1

Part I Current developments and prospects 9

1 Budgetary developments in the euro area and EU Member States 13

11 Short-term developments and prospects for the budget balance and public debt 13

12 Government revenue and expenditure 16

13 The fiscal stance and policy mix 18

2 Overview of the 2002 updates of the stability and convergence programmes 22

21 The medium-term budget targets 22

22 Composition of the budgetary adjustment 26

3 The sustainability of public finances based on the 2002 updates of stability and convergence programmes 31

31 Introduction 31

32 How the sustainability of public finances was assessed 31

321 The quantitative indicators 31

322 The data used 34

323 The results of the quantitative indicators 36

33 Policy conclusions per Member State 39

4 Budgetary developments in candidate countries 44

41 Short-term budgetary developments and prospects in candidate countries 44

42 Overview of the 2002 updates of the pre-accession economic programmes 47

421 Introduction 47

422 Medium-term budgetary developments 48

423 Composition of the adjustment 51

424 Other considerations 52

Part II Evolving budgetary surveillance 55

1 Implementing the Stability and Growth Pact 59

11 Introduction 59

12 The enforcement mechanisms of the SGP 59

121 The preventive part of the Pact 59

122 The dissuasive elements of the Pact 60

13 The use of enforcement mechanisms since spring 2002 62

131 Slippage from budget targets in many Member States 62

132 Portugal 63

133 Germany 65

134 France 67

2 Strengthening the coordination of budgetary policies 69

21 Background to the debate a mandate from the Barcelona European Council 69

22 Commission proposals to strengthen the coordination of budgetary policies 71

221 A diagnosis of the shortcomings of the SGP in the first four years of EMU 71

222 Avoiding pro-cyclical policies and accounting for transitory elements in the assessment 72

223 A minimum annual rate of adjustment for countries still in deficit 75

224 The goals of the Lisbon strategy ensuring that public finances contribute to growth and employment 76

225 Ensuring the sustainability of public finances 78

226 Concrete measures for the enforcement of the Pact 78

23 The agreement of the European Council on strengthening the coordination of budgetary policies 78

3 Public debt and the excessive deficit procedure 80

31 Introduction 80

32 Debt dynamics and compliance with the Treaty requirements 80

33 Debt dynamics in EU countries 81

34 What could constitute a satisfactory pace of debt reduction 82

4 The governance of budgetary statistics in EMU 87

41 Introduction 87

42 The governance of budgetary statistics in the EU 87

421 Main elements 87

422 Other aspects of the governance of budgetary statistics 88

43 Assessing the quality of budgetary statistics 90

431 Reliability 90

432 Transparency and consistency 91

433 Timeliness 91

44 Recent measures to improve the quality of budgetary statistics 92

441 The code of best practice 92

442 Towards quarterly accounts 92

45 Conclusion and challenges for the future 93

Annex A Budgetary surveillance for long-term sustainability in EU Member States 95

Part III Public investment and its interaction with the EUrsquos budgetary rules 99

1 Introduction 103

2 Public investment definition and broad trends 104

21 The definition of public investment 104

22 Broad trends of public investment in industrialised countries 104

3 Public investment its rationale and impact on efficiency 107

31 The rationale for public investment 107

32 Public investment productivity and growth the empirical evidence 108

4 A closer look at public investment in Member States and the interaction with the EU fiscal rules 112

41 The evolution of public and private investment in EU countries 112

411 Trends in recent decades 112

412 Is there a link between changing levels of public and private investment 115

42 Budgetary consolidation in light of EMU and its impact on public investment 115

5 Catering for public investment needs in the Stability and Growth Pact 122

51 How public investment is treated under the existing Treaty and SGP rules 122

52 Public investment and the golden rule 123

521 A rationale for the golden rule 123

522 Limitations and drawbacks 124

523 Practical experiences 125

524 Why a golden rule would not be desirable for EMU 125

53 Public-private partnerships 128

531 Definition taxonomy and recent experiences 128

532 The economics of PPPs 129

533 Publicndashprivate partnerships and budgetary practices in EMU 130

Part IV Can fiscal consolidations in EMU be expansionary 133

1 Introduction 137

2 Can budgetary consolidations be expansionary What the theory says 138

21 Budgetary consolidations the standard view 138

22 Non-Keynesian effects of fiscal consolidation 139

3 Characteristics and effects of fiscal consolidations in the EU evidence from cross-country analysis 143

31 Survey of existing studies 143

32 Were there expansionary fiscal consolidations in the EU A close look at the data 145

321 How to define periods of budgetary consolidation with expansionary effects 145

322 When does a fiscal consolidation occur 147

323 When is a fiscal consolidation expansionary 149

324 Summary of findings 154

4 Assessing ex-ante the effects of fiscal consolidations Simulation results from the QUEST model 158

41 Introduction 158

42 Tax increases 159

43 Expenditure cuts 159

Part V Meeting the EUrsquos budgetary requirements national expenditure rules and fiscal relations across levels of government 167

1 Introduction 171

2 Expenditure rules in EU Member States 172

21 The need for expenditure rules as a means to control public finances 172

22 The design and implementation of expenditure rules 174

221 The design of expenditure rules 174

222 The implementation of expenditure rules 176

223 A taxonomy of expenditure rules 177

23 National expenditure rules 177

231 Main features of expenditure rules within EU Member States 177

232 How have national expenditure rules worked in practice 178

24 Conclusions 186

3 Fiscal relations across levels of government 187

31 Fiscal relations across different levels of government in EU Member States 187

32 Fiscal decentralisation and its interaction with the EUrsquos fiscal rules 190

321 Fiscal decentralisation and the goal of sound and sustainable public finances 190

322 Recent measures in several Member States to coordinate budgetary positions across levels of government in light of EU requirements 193

33 Fiscal decentralisation and automatic stabilisation 195

34 Case studies 199

341 Spain 199

342 Germany 202

Part VI Member State developments 205

1 Belgium 207

2 Denmark 210

3 Germany 214

4 Greece 217

5 Spain 221

6 France 225

7 Ireland 228

8 Italy 232

9 Luxembourg 237

10 The Netherlands 240

11 Austria 243

12 Portugal 247

13 Finland 250

14 Sweden 256

15 United Kingdom 260

Part VII Resources 265

1 Code of best practice on the compilation and reporting of data in the context of the excessive deficit procedure 267

11 Compilation of budgetary data by Member States 267

12 Reporting of budgetary data by Member States to the Commission 267

13 Securing the quality of the actual budgetary data 268

14 Publication of the budgetary data by the Commission 269

2 Glossary 270

3 References 275

4 Useful Internet links 282

Statistical annex 285

Tables

I1 General government budgetary position mdash euro area 1999ndash2004 ( of GDP) 14

I2 Budget balances in EU Member States 2001ndash04 ( of GDP) 14

I3 Composition of changes in government debt ratio in EU Member States 2001ndash04 ( of GDP) 15

I4 Euro area government resources and expenditures 2000ndash04 ( of GDP) 16

I5 Total revenue and expenditure in EU Member States 2001ndash04 ( of GDP) 17

I6 Euro area mdash Growth projections and macroeconomic developments in the 2002 updates and comparison with the 2001 updates and the Commission forecasts 23

I7 GDP growth projections in the 2002 updates 23

I8 Actual budget balances in the 2002 updates and in the Commission forecasts in of GDP 24

I9 Cyclically-adjusted balances in the 2002 updates and in the Commission forecasts

on the basis of the production function method in of GDP 25

I10 Euro area net lending by sub-sectors in the 2002 updates 26

I11 Euro area mdash Gross debt level and changes in the 2001 updates ( of GDP) 27

I12 Debt levels in the 2002 updates of the stability and convergence programmes ( of GDP) 27

I13 Expenditure and revenue ratios in the 2002 updates 28

I14 Euro area Budget developments for the general government 29

I15 Long-run budgetary projections included in the 2002 updates to stability and convergence programmes ( of GDP) 35

I16 Data used to run the sustainability indicators in the lsquoSGP compliance scenariorsquo ( of GDP) 36

I17 Projected evolution of debt levels up to 2050 37

I18 Results of the tax gap indicator 38

I19 Policy conclusions on the sustainability of public finances 41

I20 General government balances in candidate countries ( of GDP) 46

I21 GDP growth in candidate countries ( pa) 46

I22 Macroeconomic projections in the 2002 PEPs 49

I23 General government balances in the 2002 PEPs ( of GDP) 49

I24 General government debt in the 2002 PEPs ( of GDP) 50

I25 General government revenue and expenditure in the 2002 PEPs ( of GDP) 50

I26 Composition of general government expenditure in the 2002 PEPs ( of GDP) 51

I27 Main measures in the PEPs concerning pension reform 53

II1 Comparison of growth and budgetary developments for 2002 between autumn 2002 Commission forecasts and the 2001 updates of the programmes 62

II2 Breakdown of revision of 2001 budget balance of Portugal 64

II3 Average annual percentage change of public debt to GDP ratios 82

II4 Development in debt levels in several EU high debt countries since the mid-1990s 83

II5 Debt dynamic according to different budget balances and nominal GDP growth rates (initial government debt to GDP ratio 100) 84

II6 The implied rate of debt reduction by a constant primary surplus 84

II7 The implied primary surplus by defining a rate of reduction of the debt ratio 85

III1 The effect of public investment on output productivity and growth 111

III2 Public and private investment Granger causality tests 117

III3 The composition of fiscal consolidations general government (1970ndash2002) 119

III4 The determinants of public investment in the EU regression analysis (EU-15 1970ndash2002) 119

IV1 Some puzzling effects of fiscal policy 140

IV2 Cross-country evidence on fiscal consolidations 144

IV3 Expansionary consolidations description of episodes with alternative definitions of consolidation 148

IV4 Size and composition of expansionary consolidations alternative definitions of consolidation 149

IV5 Macroeconomic environment in expansionary consolidations alternative definitions of consolidation 150

IV6 Expansionary consolidations description of episodes with alternative definitions of expansion 151

IV7 Correlation indexes among alternative indicators of expansionary consolidations 152

IV8 Size and composition of expansionary consolidations alternative definitions of expansion 152

IV9 Macroeconomic scenario in expansionary consolidations alternative definitions of expansion 153

IV10 Permanent increase in labour income tax of 1 of GDP 160

IV11 Permanent increase in corporate tax of of 1 of GDP 160

IV12 Permanent increase in VAT of 1 of GDP 161

IV13 Permanent reduction in government purchases of 1 of GDP 161

IV14 Permanent reduction in government transfers to households of 1 of GDP 162

IV15 Permanent reduction in spending on government employment of 1 of GDP 162

IV16 Temporary expenditure cuts (1 of GDP) 163

IV17 Permanent expenditure cuts (1 of GDP) with accommodating monetary stance 164

V1 Trends in public expenditure items in selected EU countries (variation in percentage points between 1998 and 2001) 174

V2 A taxonomy of expenditure rules 177

V3 The features and implementation of expenditure rules within Member States (general targets) 179

V4 The impact of expenditure rules on spending trends 185

V5 Total expenditure targets and spending rules 185

V6 Expenditure and revenues at State and local government level 189

V7 Sub-national government spending by function as a percentage of total local spending 191

V8 The composition of total revenues at state and local level as a percentage of GDP (year 2000) 191

V9 Aggregate budget balances at state level (A B E D) local level (DK FIN S) and output gaps 196

VI1 Composition and balances of general government Belgium (as of GDP) 207

VI2 Key figures of the Belgian stability programme (2003ndash05) 209

VI3 Composition and balances of general government Denmark (as of GDP) 211

VI4 Key figures of the Danish convergence programme (2001ndash06) 212

VI5 Composition and balances of general government Germany (as of GDP) 215

VI6 Key figures of the German stability programme (2002ndash06) 216

VI7 Composition and balances of general government Greece (as of GDP) 218

VI8 Key figures of the Greek stability programme (2001ndash06) 219

VI9 Composition and balances of general government Spain (as of GDP) 222

VI10 Key figures of the Spanish stability programme (2002ndash06) 222

VI11 Main features of recent tax reforms 224

VI12 Composition and balances of general government France (as of GDP) 226

VI13 Key figures of the French stability programme (2002ndash06) 226

VI14 Composition and balances of general government Ireland (as of GDP) 229

VI15 Key figures of the Irish stability programme (2003ndash05) 229

VI16 Composition and balances of general government Italy (as of GDP) 233

VI17 Key figures of the Italian stability programme (2002ndash06) 233

VI18 Composition and balances of general government Luxembourg (as of GDP) 238

VI19 Key figures of the Luxembourg stability programme (2001ndash05) 238

VI20 Composition and balances of general government Netherlands (as of GDP) 241

VI21 Expenditure in the Netherlands mdash relevant ceilings and outcome 242

VI22 Composition and balances of general government Austria (as of GDP) 244

VI23 Key figures of the Austrian stability programme (2002ndash06) 244

VI24 Composition and balances of general government Portugal (as of GDP) 248

VI25 Key figures of the Portuguese stability programme (2003ndash06) 248

VI26 Composition and balances of general government Finland (as of GDP) 251

VI27 Key figures of the Finnish stability programme (2002ndash06) 251

VI28 Difference of budgetary outcomes and expenditure ceilings (excluding interest payment) 253

VI29 Central government expenditure frames 1994ndash2003 253

VI30 Central government expenditure frames 2004ndash07 by the ministeries 255

VI31 Composition and balances of general government Sweden (as of GDP) 258

VI32 Key figures of the Swedish convergence programme (2001ndash04) 258

VI33 Central government expenditure in of GDP 259

VI34 Composition and balances of general government United Kingdom (as of GDP) 261

VI35 Key figures of the United Kingdomrsquos stability programme (2001ndash02 to 2006ndash07) 261

I1 The impact of ageing populations on tax revenues and social contributions 33

I2 Candidate countriesrsquo budgetary data and EU standards 45

I3 The pre-accession fiscal surveillance procedure for candidate countries 47

II1 What constitutes an rsquoexceptional circumstancersquo under the excessive deficit procedure 61

II2 The Convention on the Future of Europe the debate on the coordination of budgetary policies 70

II3 Transitory elements affecting the budgetary position 74

III1 Public investment in national account statistics 105

III2 Empirical evidence on the effects of public investment methodologies and results 109

III3 Public and private investment in EU countries crowding in or crowding out 116

III4 The determinants of public investment in the EU an empirical analysis 120

III5 How would the introduction of a golden rule modify the fiscal architecture of EMU 126

IV1 Expansionary fiscal consolidations and confidence indicators 155

IV2 Fiscal consolidation as catalyst for structural reforms in Germany 165

V1 Key arguments of the theory on fiscal federalism 188

Graphs

I1 Euro area fiscal stance and cyclical conditions 2000ndash04 17

I2 Policy-mix in the euro area 1999ndash02 19

I3 Fiscal stance and cyclical conditions in EU Member States in 2002 20

I4 Policy-mix in EU Member States in 2002 20

I6 Potential and real GDP growth rate and output gaps for the euro area derived from the 2002 updates 22

I7 Contributions to change in budgetary position 2002ndash05 (in points of GDP) 30

I8 A comparison of debt projections for the EU-15 based on the lsquoSGP compliance scenariorsquo and the lsquo2002 starting positionrsquo scenario 38

I9 A comparison of debt projections for four Member States based on the lsquoSGP compliance scenariorsquo and the lsquo2002 positionrsquo scenario 39

I10 Contributions to change in budgetary position 2001ndash05 according to the 2002 PEPs (in points of GDP) 52

II1 Budgetary divergence from target in Portugal 63

II2 Budgetary divergence from target in Germany 66

II3 Budgetary divergence from target in France 68

II4 Compliance with the lsquoclose to balance or in surplus requirement for countries that completed the transition process 73

II5 The budgetary adjustment path of Member States still in transition to the lsquoclose to balance or in surplusrsquo objective 76

II6 Illustration of a small temporary deviation to cater for the intertemporal budgetary effect of a large structural reform 77

II7 Pace of adjustment for the debt ratio 86

III1 Gross fixed capital formation general government of GDP at current market prices 105

III2 Gross public private and total investment of GDP average values for the period 1970ndash2002 113

III3 Net public private and total investment of GDP average values over the period 1974ndash2001 113

III4 Average annual changes in investment shares (1970ndash2002) 114

III5 Cross-country relations between growth rates in public and private investment (average yearly growth rates over the period 1970ndash2002) 114

III6 Interest expenditure and public investment EU-15 1970ndash2002 118

III7 Public invest changes in the 1990s (average yearly growth rate in gross fixed capital formation general government of GDP at current market prices) 118

III8 Nominal budgets structural budgets the SGP and the golden rule 127

IV1 Economic sentiment indicators during expansionary consolidations 155

IV2 Expenditure-based fiscal consolidations and structural reforms effects on GDP ( change from baseline) 165

V1 Trends in different items of public expenditure at EU level 173

V2 Fiscal decentralisation and budgetary situation 192

V3 The contribution of lower levels of government to general government (net lending (ndash) or borrowing (+) in 2002) 193

V4 Germany output gap and changes in the level of real revenues and expenditure at State level 197

V5 Spain output gap and changes in the level of real revenues and expenditure at State level 198

V6 Denmark output gap and changes in the level of real revenues and expenditure at local level 198

Summary and main conclusions (1)

The most difficult period for budgetary policies since the launch of the euro1

The year 2002 and the early part of 2003 has been a dif-ficult period both in terms of actual budgetary develop-ments and as regards the implementation of the EUframework for fiscal surveillance The nominal deficitfor the euro area as a whole increased from 16 ofGDP in 2001 to 22 in 2002 and according to the lat-est Commission forecast it is projected to rise to 25 of GDP in 2003 This aggregate outcome is the result ofstriking contrasts in the performance across Member StatesBy the end of 2002 only six EU countries including foureuro area countries (accounting for some 18 of euroarea output) had achieved budget positions (both in nom-inal and cyclically-adjusted terms) that met the lsquoclose tobalance or in surplusrsquo requirement of the Stability andGrowth Pact whereas two euro area countries (account-ing for half of the euro area output) had deficits abovethe 3 of GDP reference value

The Portuguese authorities succeeded in reducing thenominal deficit from 41 of GDP in 2001 to 28 in2002 although very significant challenges remain if thedeficit is to remain below 3 of GDP in 2003 as muchof this improvement is due to one-off measures whichhave only led to a transitory improvement in the budgetbalance A deficit of 36 of GDP in 2002 has resultedin Germany being placed in an excessive deficit posi-tion while the authorities are taking measures aimed atreducing the cyclically-adjusted budget deficit only avery limited improvement in nominal terms is expectedin 2003 as growth conditions deteriorate Despite clearevidence of budgetary slippage emerging in early 2002the French authorities did not take corrective measuresand a deficit of 31 of GDP occurred in 2002 resultingin the excessive deficit procedure being activated An

even higher deficit of 37 of GDP is forecast by theCommission services for 2003 on the basis of currentpolicies Large deficits remain in Italy (23 of GDPin 2002 and in 2003) and by 2004 are projected to riseabove the 3 of GDP reference value (2) budgetaryconsolidation efforts in Italy continue to rely on one-offmeasures rather than on reforms of a structural natureneeded to ensure a permanent improvement in thebudget balance Deficits have also re-emerged in 2002 incountries that had already reached balanced budget posi-tions notably Austria (06 of GDP) the Netherlands(11 ) and the UK (13 )

Higher nominal deficits are only partly due to the economic cycle

At first sight these developments compare relativelyfavourably with previous economic downturns when def-icits reached much higher levels and debt ratios enteredrapidly increasing trajectories In addition governmentshave not pursued fine-tuning policies and while fiscalpolicies were slightly looser monetary conditions haveeased thanks mainly to low real interest rates

However a closer consideration of underlying budgetarytrends reveals that the deterioration in nominal deficitsalso results from high and rising cyclically-adjusted def-icits in several countries This indicates a discretionaryloosening of the fiscal stance by some Member Statesover the past two years brought about by a combinationof unfunded tax cuts discretionary expenditure increasesand failures as regards budgetary execution While theoutcome of the euro area in 2002 was unchanged com-pared to 2001 it should be noted that the cyclically-adjusted budget balance for 2001 has recently beenrevised upwards to 21 of GDP from 15 of GDPimplying that the deterioration in the underlying budgetbalance in that year was considerably worse than earlier

yen1part The summary and main conclusions of this report have been adopted bythe College of Commissioners in the form of a communication from theCommission to the Council and the European Parliament lsquoPublic financesin EMU mdash 2003rsquo COM(2003) 283 adopted on 21 May 2003

yen2part European Commission spring 2003 forecast 2004 figures are based on theassumption of no policy change

P u b l i c f i n a n c e s i n E M U 2 0 0 3

estimates showed moreover the cyclically-adjustedbudget balance includes the impact of one-off budgetarymeasures which only have a transitory effect on budgetpositions The deterioration has been particularly pro-nounced in Germany (where the CAB increased to 32 of GDP in 2002) and France (to 33 ) In Italy it remainshigh at 21 of GDP

In a medium-term perspective the latest updates of thestability and convergence programmes contain a targetby most Member States to reach budget positions oflsquoclose to balance or in surplusrsquo by 2005 or 2006 How-ever it should be noted that the medium-term targets ofMember States are based on growth assumptions whichin light of developments in recent months now appearto be optimistic In countries where large cyclically-adjusted deficits remain the time frame for reaching thelsquoclose to balance or in surplusrsquo objective has beenpushed back to 2006 or 2007 even this date will only bemet if additional consolidation measures are undertaken

Commission proposals to strengthen the coordination of budgetary policies

The deterioration in budget positions has placed consid-erable stress on the EUrsquos framework for fiscal surveil-lance and three Member States have been placed inexcessive deficit positions In response to these develop-ments and in line with a mandate from the BarcelonaEuropean Council conclusions the Commission adopteda communication on strengthening the coordination ofbudgetary policies (1) It identified a number of short-comings with the implementation of the SGP in the firstfour years of EMU and outlined a strategy based onMember States reassuming political ownership of thePact Inter alia it called for more account to be taken ofunderlying economic conditions when assessing budget-ary positions an interpretation of compliance with SGPrequirements that would (depending on country-specificcircumstances) cater for the budgetary impact of reformsthat enhance growth and employment increasing theemphasis placed on the sustainability of public financesand outstanding debt positions and improving theimplementation of the SGP including stricter and moretimely recourse to the existing enforcement instrumentsAt the same time the Commission adopted proposals toimprove the governance of budgetary statistics whichprovide the foundations for effective surveillance

The European Council of March 2003 endorsed key conclusions of the Ecofin Council

The spring European Council of March 2003 endorseda report of the (Ecofin) Council which shared many ofthe Commissionrsquos proposals on strengthening the coor-dination of budgetary policies It confirmed that theachievement of a budget position of lsquoclose to balance orin surplusrsquo is in the economic self-interest of MemberStates both individually and collectively In the shortrun it provides room for the automatic stabilisers tooperate freely and cushion the effect of economicshocks in the medium run it creates room for budgetarymanoeuvre to either cut taxes or divert expenditures tomore productive items such as investment and RampD inthe long run compliance will help Member States meetthe budgetary costs of ageing population while securingadequate and accessible pensions and healthcare

In addition to re-stating their commitment to the goal ofthe SGP the Council agreed that compliance with thelsquoclose to balance or in surplusrsquo requirement should beassessed in cyclically-adjusted terms with due accounttaken of one-off budgetary measures which only have atransitory impact on budget positions For euro-areacountries agreement was reached that Member Stateswith deficits should achieve an annual improvement inthe cyclically-adjusted budget deficit of at least 05 ofGDP until the lsquoclose to balance or in surplusrsquo require-ment is reached It underlined the need for automatic sta-bilisers to operate symmetrically over the economiccycle and the particular importance of avoiding a pro-cyclical loosening of fiscal policies in good times TheCouncil also confirmed the importance of running downpublic debt at a satisfactory pace towards the 60 ofGDP reference value and that the existing provisions ofthe Treaty (ie the debt criterion of the excessive deficitprocedure) can contribute to achieving this goal

An opportunity to ensure consistent and transparent budgetary strategies

To ensure that the agreement of the European Councilrepresents a real progress towards a consistent and trans-parent implementation of SGP it is essential that the pol-icy guidelines endorsed by the European Council andthe specific budgetary commitments given by MemberStates in their updated stability and convergence pro-gramme are respected

To this end policies adopted at national level need torespect the budgetary goals agreed at EU level Indoing so budgetary consolidation strategies need to be

yen1part Communication from the Commission lsquoStrengthening the coordination ofbudgetary policiesrsquo COM(2002) 668 final of 27 November 2002

S u m m a r y a n d m a i n c o n c l u s i o n s

designed in a way that tackle and do not exacerbatestructural weaknesses leading to slow growth and missedemployment opportunities This requires careful designas regards the balance between measures on the revenueand expenditure side and choices on the composition ofpublic expenditures Contrary to what is often arguedthe existing framework for budgetary surveillance cansimultaneously achieve a consistent approach that bal-ances the need for budgetary consolidation re-ignitingthe recovery and strengthening growth potential

Significant advances have been made in the framework for budgetary surveillance

This yearrsquos report on Public finances in EMU mdash 2003highlights three areas where substantial progress hasbeen made in the framework for budgetary surveillanceover the past year (i) the integration of candidate coun-tries into the EUrsquos fiscal surveillance framework (ii) anincreased focus on the sustainability of public financesand (iii) an improvement in the governance of budgetarystatistics These advances show that tangible progresscan be made to the benefit of Member States and the EUas whole when there is a political will to do so It alsoshows that the framework for budgetary surveillance iscapable of evolving in the light of growing experienceand new policy challenges

Integrating acceding and candidate countries into the EUrsquos fiscal surveillance framework

With 10 countries set to join the EU in 2004 a majorpolicy challenge is to prepare for their integration into theEU economic policy framework in particular for budget-ary surveillance A key requirement has been to developreliable government accounts and economic forecasts ona par with existing EU countries At the same time theEU surveillance of budgetary developments needs todevelop so that appropriate account is taken of the impor-tant structural and institutional changes underway inaccession countries These are partly due to the comple-tion of the transition from a command to a market econ-omy and partly due to the additional effects which EUmembership will entail (associated with the need toupgrade public infrastructure and the commitment toimplement the acquis communautaire)

Clear strides have been taken in recent years althoughbudgetary data are still neither fully comparable acrosscountries nor completely in line with EU definitionsData reported by the candidate countries and forecastsprepared by the Commission services indicate that budg-etary developments are closely mirroring those in the

EU with nominal and cyclically-adjusted budget deficitsin 2002 rising in most countries Looking ahead to 2003and 2004 the Commission forecast of spring 2003 envis-ages an improvement in the budgetary balances of ninecountries with marked deficit reductions forecasted inHungary Slovakia and Turkey and to a more limitedextent in Malta However very limited improvements inbudget balances are projected in the Czech RepublicPoland and Cyprus

An important step to integrate the candidate countriesinto the existing surveillance process was completed inNovember 2002 when the second set of pre-accessioneconomic programmes (PEPs) submitted by candidatecountries were examined The annual programmes out-line the medium-term policy framework including pub-lic finance objectives and structural reform prioritiesand moreover provide an opportunity for candidatecountries to develop their institutional and analyticalcapacity The 2002 updates revealed an improved effortto develop a consistent and credible medium-termmacroeconomic framework although further analyticalcapacity building is called for

The sustainability of public finances received increased prominence in the assessment of sustainability and convergence programmes

Progress has also been made as regards placingincreased emphasis on the sustainability of publicfinances in the SGP as requested by the 2001 StockholmEuropean Council For the second time an assessment ofthe sustainability of public finances was carried out onthe basis of budgetary targets and measures announcedin the 2002 updates to stability and convergence pro-grammes leading to firm policy conclusions by theCouncil The policy conclusions which are based onquantitative indicators and long-run budgetary projec-tions prepared by the Economic Policy Committee andnational authorities are worrying

Even assuming that all Member States achieve thebudget targets for 2006 set down in their stability or con-vergence programmes there is a risk of unsustainablepublic finances emerging in about half the EU MemberStates especially Belgium Germany Greece SpainFrance Italy Austria and Portugal To ensure sustaina-ble public finances Member States with deficits firstneed to achieve and sustain the SGP goal of budget posi-tions of lsquoclose to balance or in surplusrsquo Furthermorepreliminary estimates by the Commission show that anadditional permanent budgetary adjustment of between

1 and 2 percentage points of GDP is needed in MemberStates where the sustainability of public finances is aconcern To close this financing gap governmentsshould try to avoid raising taxes (especially on labour)and concentrate efforts on reducing (in terms of ratio toGDP) age-related expenditure by reforming of pensionand healthcare systems andor reducing non-age-relatedprimary spending while increasing employment ratesand fostering growth

Progress has been made on the governance of budgetary statistics

The quality of economic statistics is crucial to ensure anadequate understanding of the economic situation andeffective policy making Budgetary statistics are thefoundation of the EU fiscal surveillance tools and theirquality has improved considerably over the last decadeGovernment accounts are now more reliable completetransparent and detailed and are published in a muchmore timely fashion than when the excessive deficit pro-cedure was set up However some weaknesses remainin several countries data on government deficit and debtratios are not yet as reliable as they should be and aresubject to large revisions Furthermore the governmentaccounts of several Member States are not fully transpar-ent and there have been problems in terms of theirtimely submission These concerns are clearly amplifiedwith the perspective of enlargement

To address outstanding challenges the (Ecofin) Councilrecently agreed to implement a code of best practice (1)From the Member Statesrsquo side this involves increasingthe transparency of government accounts in particularfor the lower government subsectors the strict respect ofdeadlines an overall increase in the data quality but alsoa clarification of the independence statute of the nationalstatistical offices as the main compilers of governmentdata The Commission (Eurostat) is aiming at reinforc-ing its ability to scrutinise the Member Statesrsquo govern-ment accounts in more detail and accelerating thedecision-making process for deciding upon the record-ing of government transactions The new steps to com-pile quarterly budgetary statistics is a major challengefor statisticians but also for economists policy-makersand budgetary policy analysts that will need to interpretquarterly data with due care since these will necessarily

be more volatile and perhaps less transparent than annualdata

The Commission role in upgrading the analysis of economic and budgetary policies

In its communication on strengthening the coordinationof budgetary policies the Commission committed itselfto upgrading the analysis of economic and budgetarypolicies To this end a number of detailed studies arecontained in the report Public finances in EMU mdash 2003as follows

bull Firstly the report examines the impact of budgetaryconsolidation on growth It considers whether theassertion that budgetary consolidation has a nega-tive impact on output is always valid or whether fis-cal consolidations in EMU under certain conditionscan have a positive effect on output

bull Secondly and as part of the effort to focus on thequality of public finances the report analyses publicinvestment It examines the reasons why publicinvestment as a share of GDP has fallen in recentdecades and whether this is in part due to the processof budgetary consolidation and the development offiscal rules at EU level It also analyses the linkbetween public investment and productivity andconsiders the merits and feasibility of developingspecific provisions for public investment within theEUrsquos framework for budgetary surveillance

bull A third chapter examines various aspects of the chal-lenge facing national authorities in ensuring soundpublic finances It reviews the experience of Mem-ber States in using expenditure rules as an instru-ment to better manage public finances and improvetheir quality In addition the chapter examines howthe allocation of public finance functions across dif-ferent levels of governments influences the capacityof Member States to fulfil their budgetary commit-ments at EU level This analysis is a good exampleof the role of the Commission in undertaking com-parative cross-country analyses that enable MemberStates to learn from the experiences and best prac-tices of other countries

Is fiscal consolidation always contractionary

While there is a broad consensus among both academicsand policy-makers on the need for fiscal discipline toensure the smooth functioning of EMU and provide

yen1part Conclusions of the 2 485th Council meeting Economic and FinancialAffairs Brussels 18 February 2003

conditions conducive to growth and employment crea-tion concerns have been expressed that budgetaryconsolidation could have a negative effect on output inthe short run This issue is relevant given the need forseveral Member States to reduce large cyclically-adjusted budget deficits especially against the currentbackground of slow economic growth

An empirical analysis of the experiences of EU MemberStates however demonstrates that roughly half of theepisodes of fiscal consolidation undertaken in the pastthree decades have been accompanied by an accelerationin economic growth These findings appear to be consist-ent with theories that identify a positive impact of budg-etary consolidation on consumer expectations of lowertaxes in the future inducing them to raise their consump-tion plans andor on business expectations of higherprofitability enabling them to raise investment Confi-dence factors may play a more prominent role in thefuture in the light of large unfunded pension liabilities

Simulations using the QUEST model confirm that ifappropriately designed budgetary consolidation cancontribute significantly to the goal of the Lisbon strategyin terms of raising output and employment in themedium term Budgetary consolidation has a slightcontractionary effect on output in the short run depend-ing on the composition of the budgetary adjustmentHowever budgetary consolidation has a positive impacton output in the medium run if it takes place in the formof expenditure retrenchment rather than tax increasesMoreover the effect of budgetary consolidation on out-put could be reinforced and even positive in the shortrun if fiscal consolidation is combined with structuralreform of factor and product markets and accompaniedwith an accommodating monetary stance Indeed budg-etary consolidation often acts as a catalyst for structuralreforms

Public investment

Public investment as a share of GDP has fallen in mostindustrialised countries in recent decades It has beenclaimed that the budgetary requirements of the Treatyand SGP result in public investment expenditures beingat excessively low levels and that a sustained growth inpublic investment expenditures would improve the EUrsquosgrowth potential However an analysis shows that thedecline in public investment rates is a long-run tendencythat started already in the 1970s and affected all indus-trialised countries and not just EU Member StatesDeclining levels of public investment as a share of GDP

have been attributed to factors such as increased levels ofeconomic development (with developed countries alreadyhaving a high stock of physical capital and the emphasisswitching towards investment in human capital (1)) andthe changing boundaries between public and privateinvestment (in part linked to the process of privatisa-tion) Some of the decline in public investment levelsappears to be related to efforts to consolidate publicfinances which was necessary irrespective of EMU Acareful analysis of the data however fails to show anyclear-cut link between change in investment ratios andthe provisions of the EUrsquos framework for fiscal surveil-lance Indeed public investment expenditures in manyMember States have stopped falling after the beginningof monetary union

Public investment can make an important contribution tomeet the output and employment goals of the Lisbonstrategy However in considering the links between pub-lic investment and growth it is important to focus on netas opposed to gross investment levels (that is takingaccount of the depreciation of the existing capital stock)and also the interaction between trends in public and pri-vate investment level Existing studies reveal that publicinvestment has a positive impact on output and produc-tivity although the results are not very strong This isexplained by the fact that only a fraction of public invest-ment expenditures are devoted to projects which aim atdirectly raising productivity (for example investment intransport infrastructure) whereas a significant propor-tion of public investment is devoted to projects that pur-sue other objectives such as environmental protection orredistribution across regions which have an indirectcontribution to productivity

The important role of public investment is recognised inthe existing framework for budgetary surveillance forexample Member States are required to specify plannedpublic investment levels in their annual updates to stabil-ity and convergence programmes and the BEPGs fre-quently recommend that an increased share of publicexpenditures be devoted to productive items In brief thebudget balance requirements of Treaty and SGP arecompatible with a high share of public spending beingdevoted to public investment The recent Commissioncommunication on strengthening the coordination ofbudgetary polices sought to cater for the budgetary

yen1part Communication from the Commission lsquoInvesting efficiently in educationand training an imperative for Europersquo COM(2002) 779

impact of large investment projects while at the sametime respecting the commitment to sound and sustaina-ble public finances (1)

Several calls have been made to introduce a so-calledgolden rule into the SGP which would allow govern-ments to borrow to finance investment However thereare strong theoretical and practical arguments against itsintroduction especially in a framework of multilateralsurveillance such as the SGP First a golden rule basedon a national accounts system could lead to a bias inexpenditure decisions in favour of physical capital andagainst spending on human capital (education training)or other productive items (healthcare RampD) which alsocontribute to growth and employment Secondly ifapplied to gross investment depending on the specificdesign and implementation of the reform the adoption ofa golden rule into the SGP framework may imply sub-stantially higher deficits thus compromising the objec-tive of sustainability of public finances Finally the rel-evant concept for the application of the golden rulewould be net investment However it is not always pos-sible to compute reliable comparable and timely data onthis type of investment

There is a growing practice of financing public purposeinvestment projects through publicndashprivate partnerships(PPPs) A large share of the PPPs in the EU financeinfrastructure and supplement public investment (2) Themain implication for public finances of choosing PPPs asopposed to traditional public investment is in fact thatof converting up-front fixed expenditures into a streamof future obligations This practice has a sound micro-economic rationale in that it can lead to increased effi-ciency without compromising public objectives It isimportant however to avoid recourse to PPPs wherethis is solely motivated by a desire to bypass budgetaryconstraints by putting capital spending outside govern-ment budgets This could lead to PPP projects whichentail higher overall costs which would not be in linewith the objective of sustainable public finances Effortsare also required to ensure transparency in nationalaccounts

Efforts at national level to meet EU budgetary requirements expenditure rules and fiscal relations across different levels of governments

Many Member States in recent years have introducedexpenditure rules as a means to improve the manage-ment of their public finances mostly in the form ofex ante targets rather than binding legal obligationsNational expenditure rules can enable Member States tomeet the budget balance requirements of the Treaty andSGP by helping them to better control expenditure itemsthat are subject to overruns The specific design and thestrength of the enforcement mechanisms are key to theireffectiveness Depending on their design they can alsocontribute to other policy objectives such as avoiding apro-cyclical loosening of fiscal policy in good times andimproving the quality of the composition of publicspending

There is a great deal of variety in the design of expendi-ture rules across EU Member States as regards the typesof expenditure covered by a rule the time frameinvolved and the robustness of surveillance and enforce-ment mechanisms Preliminary empirical analysis indi-cates that the existing expenditure rules have not had avisible impact on trends in public spending Howeverjudging compliance with expenditure rules is difficult asin many cases they cover several years and are subject torevisions In some countries expenditure rules are notambitious enough and adherence with them is easilyreached in other cases the rule has been adjusted orabandoned if it is perceived as being too ambitiousOverall even a relatively weak expenditure rule can pro-vide useful guidance and signals to actors involved in thebudgetary process

The Treaty and SGP requirements are defined in terms ofthe budget balance of the general government (that iscentral and localstate governments and social security)although the specific budget targets in stability andconvergence programmes are set by the central govern-ment The challenge in meeting EU budgetary require-ments is therefore affected by the way in which Mem-ber States allocate fiscal functions (both revenues andexpenditures) across different levels of governmentThis is especially the case in federal countries and theMember States where local authorities have considera-ble budgetary autonomy The contribution of sub-centralauthorities to the overall budget position is changing in anumber of countries in light of efforts to devolve certainpublic functions to regionallocal authorities

yen1part The Council has shown some flexibility in interpreting compliance withthe lsquoclose to balance or in surplusrsquo requirement to reflect significantplanned increases in public investment programmes

yen2part See also communication from the Commission lsquoDeveloping the trans-European transport network innovative funding solutions interoperatibil-ity of electronic toll collection systemsrsquo COM(2003) 132 of 24 April 2003

The direct contribution of lower levels of government tothe general government deficit is generally limited sinceall Member States apply restrictions to local governmentborrowing the exception is Germany where net borrow-ing by local and state governments accounts for nearlyhalf of the general government budget deficit in 2002However it should be borne in mind that de facto centralgovernments often have to bear the cost of financing dif-ficulties that emerge at sub-central level To help complywith the EUrsquos fiscal rules the federal Member States andItaly and Spain have recently introduced arrangementsthat aim at coordinating the budgetary position acrosslevels of government (usually referred to as nationalstability pacts) More experience with the implementa-tion of these arrangements is needed before conclusionscan be drawn on their effectiveness in contributing to theobjectives of the EU fiscal framework A priori a strong

legal base and enforcement mechanism would beexpected to contribute to the credibility and effective-ness of the arrangements

The process of decentralising responsibility for somepolicies raises a second issue in the context of EMUnamely the operation of automatic stabilisers Experi-ence shows that in general systems are designed toshield sub-national governments from cyclical varia-tions However empirical evidence for the US and Ger-many suggests some degree of pro-cyclical behaviour atthe level of the states Further research would be usefulto analyse the possible interaction between fiscal decen-tralisation and automatic stabilisation and to identify thebest practices to reconcile the process of decentralisationwith ensuring sound and sustainable public finances

Part I

Current developments and prospects

Summary

Against a background of a prolonged period of lowgrowth 2002 and the early part of 2003 has been a diffi-cult period in terms of actual budgetary developmentsThe nominal deficit for the euro area increased from16 of GDP in 2001 to 22 in 2002 and is forecast torise to 25 of GDP in 2003 according to the latestCommission forecast However this aggregate outcomeis the result of striking contrasts in the performanceacross Member States By the end of 2002 only six EUcountries including four euro area countries (accountingfor under 18 of euro area output) had achieved budgetpositions in both nominal and cyclically-adjusted termsthat respected the lsquoclose to balance or in surplusrsquo require-ment of the Stability and Growth Pact (SGP) in contrasttwo euro area countries accounting for half of the euroarea output had nominal deficits above 3 of GDP

Among the countries recording high deficits Portugalsucceeded in reducing the nominal deficit from 41 ofGDP in 2001 to 27 in 2002 although very significantchallenges remain concerning 2003 as much of thisimprovement is due to one-off measures such as a taxamnesty A deficit of 36 of GDP in 2002 has resultedin Germany being placed in an excessive deficit positionand while the authorities are taking measures aimed atreducing the cyclically-adjusted budget deficit only avery limited improvement is expected in 2003 as growthconditions deteriorate Despite clear evidence of budget-ary slippage emerging in early 2002 the failure ofFrench authorities to take corrective measures resulted ina deficit of 31 of GDP in 2002 recent forecasts showan even higher deficit for 2003 at 37 of GDP and thatthe deficit in 2004 would be 35 in 2004 that is stillabove the reference value of the Treaty Large deficitsremain in Italy (23 of GDP in 2002) and the deficitlevel is projected to remain unchanged in 2003 and beabove the 3 of GDP reference value by 2004 budget-ary consolidation efforts in Italy continue to rely on one-off measures rather than reforms of a structural natureneeded to ensure a permanent improvement in thebudget balance Deficits have also re-emerged in coun-

tries that already had reached balanced budget positionsnotably Austria (06 of GDP in 2002) the Netherlands(11 ) and also in the UK (13 ) These three coun-tries are forecast to record an important deterioration ofthe deficit in 2003

At first sight these developments compare relativelyfavourably with previous economic downturns whendeficits reached much higher levels and debt ratiosentered rapidly increasing trajectories In addition gov-ernments have not pursued fine-tuning policies andwhile fiscal policies were slightly looser monetaryconditions have eased thanks mainly to low real interestrates

However a closer consideration of underlying budget-ary trends reveals that the deterioration in nominal def-icits results from high and rising cyclically-adjusteddeficits in several countries This indicates a discre-tionary loosening of the fiscal stance by some MemberStates brought about by a combination of unfunded taxcuts discretionary expenditure increases and slippagesas regards budgetary execution While the outcome ofthe euro area in 2002 was unchanged compared to 2001it should be noted that the cyclically-adjusted budgetbalance for 2001 has recently been revised upwards to21 from 15 of GDP implying that the deteriorationin the underlying budget balance in that year was consid-erably worse than earlier estimates showed moreoverthe cyclically-adjusted budget balance includes the impactof one-off budgetary measures which only have a transi-tory effect on budget positions The deterioration has beenparticularly pronounced in Germany (where the CABincreased to 32 of GDP in 2002) and France (to 33 )In Italy it has improved but remained high (at 21 )

In a medium-term perspective the latest updates of thestability and convergence programmes contain a com-mitment to reach the target of lsquoclose to balance or in sur-plusrsquo both in actual and structural terms by 2005 or2006 although this is not explicitly stated by all Member

States However it should be noted that the medium-term targets of Member States are based on growthassumptions which in light of developments in recentmonths now appear to be optimistic For countries wherelarge underlying deficits remain the date for reachingthe lsquoclose to balance or in surplusrsquo objective has beenpushed back to 2006 or 2007 and even this deadline willonly be met if additional consolidation measures areundertaken It is vital therefore that all efforts are madeto achieve these goals and maintain sound positions overthe medium term This requires that budgetary consoli-dation resumes vigorously as soon as growth picks up inorder to achieve the agreed objectives by the deadlines inthe programmes Meeting these targets will allow allMember States to let automatic stabilisers operate freelyduring future cyclical downturns thereby mitigating thepolicy dilemma that countries in deficit faced in 2002and 2003

EU budgetary surveillance for the second time includesa systematic assessment of the sustainability of publicfinances on the basis of the updated stability and conver-gence programmes submitted in late 2002 The analysisshows that there is a risk of unsustainable public financesin some half of EU countries notably Belgium Ger-many Greece Spain France Italy Austria and Portu-gal With a fast-closing window of opportunity prior tothe budgetary impact of ageing populations taking holdthe risk of unsustainable public finances will increasesubstantially higher if Member States with large deficitsdo not achieve and sustain the budgetary consolidationplans outlined in their stability and convergence pro-grammes In Spain and Greece a substantial share of therisk of emerging budgetary imbalances is due to a verylarge projected increase in pension expenditure In sev-eral Member States (notably Germany France Austriaand Portugal) the risk of emerging budgetary imbalancesis a combination of factors including a projected increasein public spending on pensions and healthcare a slowingin the pace of debt reduction and relatively low labour-force participation rates of older workers High-debtcountries (Belgium Greece and Italy) face a particularset of challenges because they must be able to sustainlarge primary surpluses over several decades SeveralMember States appear to have sustainable public financesincluding Denmark Luxembourg the Netherlands Fin-

land Sweden and the UK but they nonetheless facebudgetary challenges as a result of ageing populationsfor example the maintenance of high tax ratios at over50 of GDP raises concern about competitiveness inthe long run and in some countries the financial sustain-ability of the pension system depends on the perform-ance of private pensions

The framework for budgetary surveillance at EU level isbeing prepared for the accession of 10 countries to theEU in May 2004 The aggregate general governmentdeficit of these 10 countries widened but is projected toimprove in 2003 and 2004 Despite a significant acceler-ation in growth however the projected reduction in theaggregate deficit of the 10 acceding countries is notsufficient to reverse the deterioration recorded in 2002This suggests that structural rather than cyclical factorsunderlie current budgetary imbalances Concerning the13 candidate countries as a whole the aggregate budgetposition is influenced to a large extent by the exceptionaladvance recorded in 2002 and forecast for the comingyears in Turkey

Looking at the pre-accession economic programmessubmitted by candidate countries an improvement by2005 is envisaged in the large majority of cases Ninecountries plan to reduce their budget deficits by 2005leading to a fall in the average deficit Among the fourremaining countries Bulgaria and Estonia plan to movefrom a small surplus to a balanced budget leaving onlyLatvia and the Czech Republic with a projected increasein the general government deficit over the programmeperiod In 2005 projected budget outcomes would varyfrom a balanced budget in Bulgaria and Estonia to a def-icit of 55 of GDP in the Czech Republic Among thecandidate countries only the Czech Republic Malta andthe Slovak Republic refrained from targeting a deficitbelow 3 of GDP in 2005 According to the programmesgeneral government debt-to-GDP ratios would fall orremain virtually stable in all countries with the excep-tion of the Czech Republic and Poland where the debt-to-GDP ratio is projected to rise considerably by the endof the programme period By 2005 however all candi-date countries with the exception of Malta and Turkeywould have a debt-to-GDP ratio below 60

1 Budgetary developments in the euro area and EU Member States

11 Short-term developments and prospects for the budget balance and public debt

In 2002 the euro-area budget position deteriorated again(see Table I1) The actual deficit reached 22 of GDP06 of GDP higher than the outcome in 2001 a devel-opment which is largely explained by the working of theautomatic stabilisers in a period of slowing growth Theeuro-area cyclically-adjusted budget deficit in 2002remained high at 22 of GDP almost unchanged from2001

At first sight this outcome does not appear to be undulynegative against a background of slow growth Howeverit should be noted that the cyclically-adjusted budget bal-ance figure for 2001 has recently been revised upwards to21 from 15 of GDP implying that the deterioration inthe underlying budget balance in that year was consider-ably worse than earlier estimates showed Moreover thecyclically-adjusted budget balance includes the impact ofone-off budgetary measures which only have a transitoryeffect on budget positions Overall this points to anunderlying budget position of the euro area which is lessfavourable than in 1999ndash2000

The aggregate outcome for the euro area as a whole is theresult of striking contrasts in budgetary performanceacross Member States As shown on Table I2 thebudget positions of Germany France Portugal and Italyremained weak with deficits ranging from 23 of GDPin Italy to 36 of GDP in Germany As a result of thedevelopments in the course of 2002 Germany and Por-tugal have already been placed in an excessive deficitposition (1) and the procedure has been launched against

France (see Part II1 of this report) In contrast six EUMember States and four in the euro area had actualbudget positions in balance or in surplus in 2002 In spiteof the continued slowdown in growth actual budget bal-ances in 2002 did not deteriorate (or did so only margin-ally) compared to the previous year in Belgium GreeceSpain Finland Italy (although this is because of a largeupward revision in the recorded deficit level for 2001)and Portugal (partially as the result of one-off measures)

Looking ahead to 2003 and 2004 the Commission fore-cast of spring 2003 projects that economic growth in 2003will remain below potential The budget balance for theeuro area as a whole is expected to deteriorate further to25 of GDP and to remain at a similar level in 2004

Developments in Member States show that BelgiumSpain Ireland and Luxembourg are expected to moveinto small budget deficit positions in 2003 Under a no-policy change assumption Belgium and Spain are pro-jected to move back towards a position of balance in2004 while in Ireland and Luxembourg the deficitwould deteriorate further to around 1 of GDP

On the basis of current policies the Commission fore-casts that Germany France Italy and Portugal willhave deficit levels above the 3 of GDP referencevalue in 2003 andor in 2004 The budget deficit inGermany is forecast to remain above 3 of GDP in2003 and to move only slightly below the referencevalue in 2004 The situation in France is more worry-ing since the deficit is forecast to increase further in2003 and remain well above 3 of GDP in 2004 incontradiction with the requirements of the excessivedeficit procedure After the large reduction in the Por-tuguese deficit in 2002 the balance is expected to dete-riorate in 2003 and remain above 3 of GDP in 2004The deficit in Italy is projected to breach the 3 ofGDP reference value in 2004 yen1part The latter for the 2001 deficit discovered only late in 2002

Table I1

General government budgetary position mdash euro area 1999ndash2004( of GDP)

1999 2000 (1) 2001 (1) 2002 2003 2004

Total receipts (1) 475 472 465 462 461 459

Total expenditure (2) 489 471 481 484 486 483

Actual balance (3) = (1) ndash (2) ndash 13 01 ndash 16 ndash 22 ndash 25 ndash 24

Interest (4) 42 40 39 37 36 35

Primary balance (5) = (3) + (4) 29 41 23 15 11 11

UTMS proceeds 11 00 00

Cyclically-adjusted balance (6) ndash 17 ndash 18 ndash 21 ndash 22 ndash 20 ndash 20

Cyclically-adj prim balance = (6) + (4) 26 22 18 15 16 15

Change in actual balance 10 14 ndash 17 ndash 06 ndash 03 01

Due to mdash Cycle 03 05 ndash 04 ndash 06 ndash 04 01

mdash UMTS 11 ndash 11

mdash Interest 06 02 01 02 01 01

mdash Cyclically-adjusted primary balance 01 ndash 04 ndash 04 ndash 03 01 ndash 01

(1) Including UMTS receipts UMTS receipts as a of GDP would be equal in 2000 to 25 for DE 01 for ES 12 for IT 07 for NL 04 for AT 03 for PT24 for UK 11 for the euro area and 12 for the EU-15 In 2001 they would be equal to 02 for BE 02 for DK 05 for EL 01 for FR and 0 for the euro area andthe EU-15 In 2002 they would be equal to 0 for FR 02 for IE and 0 for the euro area and EU-15

NB differences are due to rounding

Source Commission spring 2003 economic forecasts

Table I2

Budget balances in EU Member States 2001ndash04 ( of GDP)

Budget balance excluding UMTS

Cyclically-adjusted budget balance

Cyclically-adjusted primary balance

2001 2002 2003 2004 2001 2002 2003 2004 2001 2002 2003 2004

BE 03 01 ndash 02 ndash 01 ndash 04 01 02 00 62 61 57 49

DE ndash 28 ndash 36 ndash 34 ndash 29 ndash 30 ndash 33 ndash 26 ndash 24 03 ndash 01 06 08

EL ndash 19 ndash 12 ndash 11 ndash 10 ndash 23 ndash 18 ndash 18 ndash 19 40 37 34 30

ES ndash 01 ndash 01 ndash 04 ndash 01 ndash 08 ndash 04 ndash 04 ndash 01 23 25 23 24

FR ndash 16 ndash 31 ndash 37 ndash 35 ndash 22 ndash 33 ndash 35 ndash 33 09 ndash 03 ndash 03 01

IE 12 ndash 03 ndash 06 ndash 09 00 ndash 09 ndash 03 01 15 04 12 16

IT ndash 26 ndash 23 ndash 23 ndash 31 ndash 31 ndash 21 ndash 18 ndash 27 33 36 35 24

LU 64 26 ndash 02 ndash 12 41 20 05 ndash 03 44 23 07 ndash 02

NL 01 ndash 11 ndash 16 ndash 24 ndash 10 ndash 10 ndash 04 ndash 11 25 22 26 18

AT 03 ndash 06 ndash 11 ndash 04 00 ndash 06 ndash 10 ndash 04 35 29 25 30

PT ndash 42 ndash 27 ndash 35 ndash 32 ndash 46 ndash 25 ndash 26 ndash 21 ndash 15 05 05 09

FI 51 47 33 30 42 48 37 33 70 70 58 54

EUR-12 ndash 16 ndash 22 ndash 25 ndash 24 ndash 21 ndash 22 ndash 20 ndash 20 18 15 16 15

DK 28 20 18 21 23 19 20 22 63 55 53 54

SE 45 13 08 12 36 09 11 15 68 38 39 42

UK 08 ndash 13 ndash 25 ndash 25 07 ndash 10 ndash 20 ndash 20 31 11 00 00

EU-15 ndash 09 ndash 19 ndash 23 ndash 22 ndash 14 ndash 18 ndash 18 ndash 18 23 16 15 14

NB Concerning UMTS receipts see footnote to Table I1 Cyclically-adjusted figures are computed with the production function method except for Germany SpainLuxembourg and Austria where the HP filter method has been used

P a r t IC u r r e n t d e v e l o p m e n t s a n d p r o s p e c t s

High deficits are forecast in other countries as wellin the UK it is projected to deteriorate to 25 of GDPin 2003 and 2004 while in the Netherlands the deterio-ration would be progressive to reach 24 of GDPin 2004

In cyclically-adjusted terms the deficit of the euro areawould decrease slightly in 2003 to 20 of GDP andremain unchanged in 2004 which underlines the factthat the budgetary consolidation process has stalled inrecent years At national level the cyclically-adjusted

deficit is projected to remain above 3 of GDP inFrance while in Italy it is expected to move close to thatlevel by 2004 Germany and Portugal are forecast tomove below 3 of GDP by that year Six euro-areacountries and eight EU Member States are expected tocomply in cyclically-adjusted terms with the lsquoclose tobalance or in surplusrsquo requirement of the SGP by 2004The negative effect of the cycle on the nominal balancesis expected to diminish progressively in 2004 (seeTable I1) so that by that year nominal budgets in manycountries would be close to balance as well

After stabilising in 2002 the general government grossdebt level of the euro area is expected to increase slightlyin 2003 to just below 70 of GDP (see Table I3) Debtreduction should resume in 2004 but at a very slow pacedue to the large negative contribution of the interest rate-growth rate differential and an insufficiently high pri-mary surplus Stock-flow operations mdash although modestmdash would increase debt ratios

This overall picture conceals very different situationsacross Member States Italy Belgium and Greece

continue to have debt ratios above the 100 of GDP By2004 only Italy should have a debt level above 100 ofGDP In Greece debt increasing financial operations ofthe government as reflected in the large stock-flow com-ponent would offset to a large extent the positive contri-butions of the primary balance and GDP growth A highdeficit and the poor growth performance will impact thedebt developments in Germany where the debt ratiowent above 60 of GDP in 2002 as well as in Franceand in Portugal where the reference value is projected tobe breached in 2003 and 2004 respectively In Austria

Table I3

Composition of changes in government debt ratio in EU Member States 2001ndash04 ( of GDP)

Gross debt

Change in gross debt 2002ndash04

Change in 2002ndash04 due to

2001 2002 2003 2004Primary balance

Interest and growth contribution

stock flow adjustment

BE 1085 1053 1027 989 ndash 63 ndash 101 34 04

DE 595 608 627 630 21 ndash 01 38 ndash 15

EL 1070 1049 1010 970 ndash 79 ndash 80 ndash 43 44

ES 569 540 525 505 ndash 35 ndash 46 ndash 08 19

FR 568 591 618 631 40 07 28 05

IE 368 333 333 333 00 ndash 15 ndash 18 31

IT 1095 1067 1060 1047 ndash 20 ndash 50 23 06

LU 56 53 41 34 ndash 19 11 00 ndash 30

NL 528 526 524 528 02 ndash 20 25 ndash 03

AT 673 687 685 668 ndash 19 ndash 54 30 05

PT 556 581 594 602 21 07 13 01

FI 438 427 423 414 ndash 13 ndash 105 12 80

EUR-12 692 692 699 696 04 ndash 23 24 03

DK 454 452 427 399 ndash 53 ndash 104 32 20

SE 544 526 509 495 ndash 31 ndash 74 12 30

UK 389 384 390 398 13 09 05 00

EU-15 629 627 635 632 06 ndash 20 27 ndash 01

after the continuous increase in the debt level until 2002to almost 69 of GDP debt should move onto a slowdownward path in 2003

12 Government revenue and expenditure

The deterioration in the cyclically-adjusted budgetarybalance in the past two years (resulting in the euro areamoving further way from the SGP goal of lsquoclose to bal-ance or in surplusrsquo) is the result of diverging trends asregards expenditures and revenue ratios As shown inTable I4 the expenditure ratio for the euro area in cycli-cally-adjusted terms remains static over the 2000ndash04period In contrast cyclically-adjusted revenues for theeuro area fell from 465 in 2000 to 461 of GDP in2001 (which contributed to increasing the deficit incyclically-adjusted terms) but started to rise to 464 and466 of GDP in 2002 and 2003 (which contributes tolowering the deficit)

At Member State level the patterns are generally similarto that of the euro area (Table I5) Only in Germany andPortugal are revenue ratios expected to increase over the2002ndash04 period (although this is to a large extent due toan improvement in the cyclical position) Strongdeclines are set to take place in the Netherlands Luxem-

bourg Austria and Finland Outside the euro area reve-nues in Sweden and the UK are set to increase over thenext two years while in Denmark revenues will diminishover the whole period Expenditure ratios over 2002ndash04are set to increase in France Luxembourg the Nether-lands Portugal and in particular the UK where discre-tionary spending measures are planned to improvepublic services and address infrastructure needsBy contrast a marked decrease is expected in GreecePortugal and Denmark

A number of lessons can be drawn from these develop-ments Firstly tax reforms were introduced before Mem-ber States had completed the transition to the lsquoclose tobalance or in surplusrsquo objective of the SGP and therewas insufficient room for the automatic stabilisers tooperate when growth slowed down resulting in deficitsin several Member States breaching the 3 of GDP ref-erence value To prevent deficits from rising furtherseveral countries have had to take measures to raiserevenue ratios either by raising tax rates (such as Portu-gal) or extending tax bases (such as Germany) therebyreversing the effects of earlier reforms Secondly thereis some evidence that the relatively high growth ratesin 1999 and 2000) resulted in a degree of fiscal illusionwhereby authorities in some countries overestimated the

Table I4

Euro area government resources and expenditures 2000ndash04 ( of GDP)

2000 2001 2002 2003 2004

Total resources 472 465 462 461 459

mdash Cyclically-adjusted 465 461 464 466 463

Taxes on imports and production 136 133 134 134 134

Current taxes on income and wealth 130 125 123 120 120

Social contributions 162 161 160 161 160

of which actual social contributions 151 149 149 150 149

Other resources 45 46 46 46 44

Total expenditure 471 481 484 486 483

Collective consumption 82 82 82 83 82

Social benefits in kind 117 117 118 119 118

Social transfers other than in kind 167 166 170 173 172

Interest 40 39 37 36 35

Subsidies 14 14 13 13 12

Gross fixed capital formation 25 25 24 25 25

Other expenditures 25 38 40 39 38

NB Including UMTS receipts see footnote to Table I1

Source Commission 2003 spring forecast

Table I5

Total revenue and expenditure in EU Member States 2001ndash04 ( of GDP)

Revenue Expenditure

2001 2002 2003 2004 2001 2002 2003 2004

BE 498 502 495 492 494 501 497 493

DE 455 450 454 455 483 486 489 484

EL 456 465 460 452 470 477 471 462

ES 392 396 393 395 393 396 398 396

FR 510 505 503 503 525 537 541 538

IE 352 337 335 328 341 337 340 336

IT 458 452 451 443 485 475 474 475

LU 466 481 460 451 402 455 463 464

NL 465 461 459 453 464 472 475 477

AT 523 514 510 507 520 520 521 511

PT 421 435 435 436 463 463 470 469

FI 542 539 528 520 490 492 495 490

EUR-12 465 462 461 459 481 484 486 483

DK 581 570 562 561 550 549 544 540

SE 617 595 599 597 572 582 591 585

UK 407 395 395 397 399 407 419 422

EU-15 461 456 456 454 470 474 478 476

Graph I1 Euro area fiscal stance and cyclical conditions 2000ndash04

2001 2000

ndash 10

ndash 05

ndash 20 ndash 15 ndash 10 ndash 05 00 05 10 15 20

Pro-cyclical fiscal tightening

Pro-cyclical fiscal loosening

Counter-cyclical fiscal tightening

Counter-cyclical fiscal loosening

Cyclical condition (Output gap)

level of structural revenues andor the benefits thatwould result from reforms of the tax system Thirdly taxcuts in 1999 and 2000 were not matched by expendituresavings and indeed expenditure cuts made little or nocontribution to reaching the goal of budget positions oflsquoclose to balance or in surplusrsquo

13 The fiscal stance and policy mix

The fiscal stance and policy mix in the euro area

An appropriate policy mix can be defined as a combina-tion of monetary and fiscal policies that ensures pricestability and keeps economic activity close to its poten-tial level In EMU the policy mix results from a mone-tary policy that is centralised and from fiscal policieswhich are decentralised In the euro area nationalauthorities set fiscal policy at Member State level In sodoing national budgetary policies determine implicitlythe fiscal stance for the euro area as a whole The aggre-gate fiscal stance deserves special attention since itaffects the policy mix at the euro-area level and there-fore is one of the elements taken into account by the ECBin setting monetary policy In turn the policy mix for theeuro area will have a feedback effect on the national pol-icy mix via the common interest rate This implies thatthe policy mix needs to be assessed both from the per-spective of the euro area as a whole and from the per-spective of each Member State

Graph I1 examines the fiscal stance (proxied by thechanges in the cyclically-adjusted primary balanceCAPB) in relation to cyclical conditions (that is the sizeof the output gap (1)) for the euro area In this graph fis-cal behaviour in accordance with the general philosophyof the SGP would be represented by a line parallel to thehorizontal axis In other words countries would achieveand sustain broadly balanced budgets over the economiccycle and run a neutral fiscal policy (lsquotax smoothingrsquo)Hence changes in the output gap would not result inmovements in the CAPB Actual budget balances wouldchange reflecting the working of automatic stabilisers Inthe transition period to the extent that a country has yetto reach the medium-term target of the SGP a restrictivefiscal stance mdash that is a rise in CAPB mdash would beneeded (2)

According to the Commission spring 2003 forecasts thefiscal stance loosened again slightly in 2002 This devel-opment follows two years of a looser-than-expected fis-cal policy (given the revision of budgetary positions con-cerning 2001) Such a stance in the past three yearscoupled with the failure to improve cyclically-adjustedbudget balances when growth conditions were favoura-ble has resulted in the current economic slowdown innominal deficits of some Member States approaching orbreaching the 3 of GDP reference value Despite thelonger-than-expected economic slowdown which ledto the appearance of negative output gaps Graph I1illustrates that Member States are not implementingsizeable counter-cyclical measures This is welcomeas the medium-term losses of relaxing fiscal policywould probably outweigh the uncertain short-termgains (see Part IV on this issue) A broadly neutral fis-cal policy stance is projected for 2003 and 2004

Turning to the policy-mix in the euro area Graph I2plots the fiscal stance on the vertical axis and on the hor-izontal axis the monetary stance proxied by the changein the short-term real interest rates Against a back-ground of a prolonged slowdown of the global economythe monetary stance was loosened in 2001 and to a morepronounced degree in 2002 Overall the policy mix inthe early years of EMU has therefore been broadlyappropriate to provide conditions for economic growthand macroeconomic stability

The fiscal stance and policy mix at the national level

The aggregate fiscal stance for the euro area concealsquite disparate national responses to the economic slow-down Graph I3 shows that most EU countries had anegative output gap in 2002 as a result of growth belowpotential in the 2001ndash02 period

France and Ireland loosened their stance in 2002 despitehaving positive output gaps Given the estimated level ofthe output gap the fiscal stance (in particular in Ireland)appears to have been pro-cyclical however the judge-ment on pro-cyclicality has to take into account theuncertainty of the measure of output gap as well as thepoor economic conditions in 2002 Outside the euroarea Sweden substantially eased the fiscal stance inspite of a slightly positive output gap but in view of itsquick deterioration

Several EU countries loosened their fiscal policies in acontext of negative output gaps However the fiscal

yen1part In line with the Council agreement the output gap used in this section iscomputed with the production function method

yen2part However part of the adjustment towards balanced budgets may be origi-nated by reducing interest payments

stimulus was modest in most of these countries with theexception of the UK where the policy was clearly coun-ter-cyclical Portugal stands out for a clearly pro-cyclicalpolicy in 2002 as it enacted a strong consolidation inorder to bring the deficit below 3 from the level of41 recorded in 2001

As pointed out above for the euro area as a whole thepolicy mix in 2002 has been slightly accommodativewith most Member States experiencing a simultaneousloosening of the fiscal stance accompanied by decliningreal interest rates the real interest rate fell in all countriesexcept Finland and the Netherlands

While Graph I4 shows the changes in the real short-term interest rate its level is also important in assessingthe policy mix After the reductions in the nominalinterest rate decided by the ECB during 2002 the realinterest rate in the euro area (that is the short-terminterest rate corrected by private consumption infla-tion) was around a very low 1 in 2002 However thisaggregate figure for the euro area conceals significantdifferences across countries due to differences in infla-

tion rates across countries In spite of the reduction inshort-term real interest rates in 2002 real interests ratesin Germany France Austria and Finland were justbelow 2 whereas in a number of countries (GreeceSpain Ireland and Portugal) the real interest ratebecame slightly negative

Regarding 2003 the fiscal stance is forecast to bebroadly neutral in most members of the euro area (seeGraph I5) Ireland Germany and the Netherlands areexpected to enact a tightening of the fiscal stance Instark contrast France Portugal and Italy mdash countrieswhich still have high budget deficits mdash are not expectedto make any sizeable progress towards improving theirbudgetary positions in 2003 Finland which is benefitingfrom the past consolidation efforts and consequentlyenjoys a large safety margin is expected to ease the fis-cal stance Some pro-cyclical policy is projected for2003 in Greece Fiscal policy in the three countriesoutside the euro area is expected to be neutral with thenotable exception of the UK where the fiscal stanceagain is set to be loosened

Graph I2 Policy-mix in the euro area 1999ndash2002

20002001

ndash 10

ndash 05

ndash 1 0 1

Fiscalmonetary tightening

Fiscalmonetary loosening

Fiscal loosening monetary tightening

Fiscal tightening monetary loosening

Monetary stance (Change in real short-term interest rates)

Graph I3 Fiscal stance and cyclical conditions in EU Member States in 2002

Graph I4 Policy-mix in EU Member States in 2002

EUR-12

NL BE DKFR

ndash 4

ndash 3

ndash 2

ndash 1

ndash 1 0 1 2 3

Pro-cyclical fiscal easing

Counter-cyclical fiscal easing

Cyclical conditions (Output gap)

ndash 3

ndash 2

ndash 1

ndash 15 ndash 10 ndash 05 00 05 10 15

Fiscal easing monetary tightening

Fiscalmonetary tighteningFiscal tightening monetary easing

Fiscalmonetary easing

EUR-12

Monetary stance (Changes in real short-term interest rates)

EUR-12

ndash 2

ndash 1

ndash 3 ndash 2 ndash 1 0 1 2

2 Overview of the 2002 updates of the stability and convergence programmes

21 The medium-term budget targets

The examination of the latest round of updates of the sta-bility and convergence programmes covering the periodto 200506 was particularly prolonged While for most ofthe countries the assessment was completed betweenJanuary and March the Austrian programme was onlyexamined in May and the Dutch programme was consid-ered as provisional pending the submission of a newprogramme after the formation of the new governmentIt should be underlined that the budgetary obligations of

the Treaty and SGP remain in force during periods whennew governments are being formed

To assess the reliability and ambition of budget targetsset by Member States in stability and convergence pro-grammes it is necessary to examine the underlyinggrowth assumptions on which the budgetary commit-ment is given The updated programmes projected a sus-tained economic recovery in the euro area GDP growthwould resume to 21 in 2003 reach 26 in 2004 andstay at 27 in the following years (see Table I6)

Graph I6 Potential and real GDP growth rate and output gaps for the euro area derived from the 2002 updates (1)

(1) Potential GDP growth and output gaps calculated by the Commission

ndash 10

ndash 05

2002 2003 2004 2005 2006

Output gapReal GDP growth Potential GDP growth

Table I6

Euro area mdash Growth projections and macroeconomic developments in the 2002 updates and comparison with the 2001 updates and the Commission forecasts

Macroeconomic developments 2001 2002 2003 2004 2005 2006

2002 updates of the stability programmes

Real GDP growth pc from previous year 16 10 21 26 27 27

GDP deflator 24 22 19 18 18 18

HICP change 26 22 20 16 15 15

Employment growth 12 03 06 12 12 13

Labour productivity growth 03 07 16 16 16 16

2001 updates of the stability programmes 18 18 27 27

Difference ndash 03 ndash 08 ndash 06 ndash 01

Commission autumn 2002 forecast 14 08 18 26

Difference 02 02 03 00

Commission spring 2003 forecast 15 09 10 23

NB Discrepancies are due to rounding For the 2001 updates GDP growth rates used for Germany and the Netherlands are on the basis of the cautious scenario and ofthe revised scenario respectively Since figures for the HICP were not available in the German programme the Commission forecasts have been used to have a rep-resentative aggregate

Source Commission services

Table I7

GDP growth projections in the 2002 updates

2001 2002 2003 2004 2005 2006 Revision (1)

BE 08 07 21 25 25 ndash 05

DE 06 05 15 225 225 225 ndash 04

EL 41 38 38 40 37 36 ndash 01

ES 27 22 30 30 30 ndash 01

FR 18 12 25 25 25 25 ndash 04

IE 57 45 35 41 50 ndash 10

IT 18 06 23 29 30 30 ndash 08

LU 10 05 12 24 31 ndash 42

NL 13 025 075 275 275 275 ndash 09

AT 07 09 14 20 25 25 ndash 05

PT 16 07 13 27 31 35 ndash 08

FI 07 16 28 26 25 24 ndash 01

EUR-12 16 10 21 26 27 27 ndash 05

DK (2) 10 15 18 21 18 17 ndash 01

SE 12 21 25 25 23 ndash 01

UK (3) 20 15 275 325 30 ndash 01

EU-15 16 11 22 27 27 ndash 04

Standard deviation EUR-12 16 14 09 06 07

(1) Difference with respect to the 2001 updates in average growth over 2002ndash04 (2) Taking account of revised information provided by Denmark For 2006 data provided for 2010 has been used(3) Mid-point of the range provided in the programme

The implied euro-area potential growth would be stableat 24 Based on these assumptions the output gap in2002 would be negative at 09 of potential GDP andwiden further in 2003 to 11 thereafter it would closeand disappear by 2006 (see Graph I6 and Table I7)

This projection contrasts markedly with the oneexpected in the 2001 updates which foresaw a lessmarked slowdown and a less sizeable negative gap sothat the output gap would already close in 2003 thanksto the expected rebound

The growth projections were more favourable than theCommissionrsquos autumn 2002 ones which provided thebasis for the assessment of the Commission and CouncilIn view of the Commission spring 2003 forecasts theGDP growth assumptions in the programmes now seemoverly optimistic especially for 2003 (for a comparisonconcerning the euro area see last row of Table I6)

Based on these growth assumption the programmes pro-jected that the budget balance for the euro area wouldimprove from a projected level of 22 of GDP to below1 of GDP by 2005 and should reach zero in the euroarea by 2006 (see Table I8) The overall improvement inthe budget balance relies strongly on the sizeable budget-ary consolidation projected in the largest Member Statessuch as Germany (a consolidation of 38 of GDP overthe next four years in the actual balance) Italy (22 ) andFrance (18 ) Also Portugal (23 ) and Greece (17 )foresee large improvements in the actual budget balanceThe other euro-area countries also project to improve theirbudgetary position over the next four years the only coun-tries forecasting a deterioration were Finland which wouldstill post significant actual surpluses and Ireland wherethe deficit would increase to above 1 of GDP in 2005Outside the euro zone Denmark and Sweden project tomaintain or slightly improve their surpluses over the pro-jection period while in the UK the deficit would remainhigher than 15 in the financial year 2005ndash06

Table I8

Actual budget balances in the 2002 updates and in the Commission forecasts(in of GDP)

2002 updates of stability and convergence programmes (1)

Commission autumn 2002 forecasts (1) (2)

Commission spring 2003 forecasts (1)

2001 2002 2003 2004 2005 2006 2002 2003 2004 2002 2003 2004

BE 02 00 00 03 05 ndash 01 00 03 01 ndash 02 ndash 01

DE ndash 28 ndash 375 ndash 275 ndash 15 ndash 10 00 ndash 38 ndash 31 ndash 23 ndash 36 ndash 34 ndash 29

EL ndash 12 ndash 11 ndash 09 ndash 04 02 06 ndash 13 ndash 11 ndash 11 ndash 12 ndash 11 ndash 10

ES ndash 01 ndash 02 00 00 01 02 00 ndash 03 01 ndash 01 ndash 04 ndash 01

FR ndash 14 ndash 28 ndash 26 ndash 21 ndash 16 ndash 10 ndash 27 ndash 29 ndash 25 ndash 31 ndash 37 ndash 35

IE (3) 16 ndash 05 ndash 07 ndash 12 ndash 12 ndash 12 ndash 12 ndash 10 ndash 03 ndash 06 ndash 09

IT (4) ndash 22 ndash 21 ndash 15 ndash 06 ndash 02 01 ndash 24 ndash 22 ndash 29 ndash 23 ndash 23 ndash 31

LU 61 ndash 03 ndash 03 ndash 07 ndash 01 05 ndash 18 ndash 19 26 ndash 02 ndash 12

NL 01 ndash 07 ndash 10 ndash 07 ndash 04 01 ndash 08 ndash 12 ndash 09 ndash 11 ndash 16 ndash 24

AT 03 ndash 06 ndash 13 ndash 07 ndash 15 ndash 11 ndash 18 ndash 16 ndash 15 ndash 06 ndash 11 ndash 04

PT ndash 28 ndash 24 ndash 19 ndash 11 ndash 05 ndash 34 ndash 29 ndash 26 ndash 27 ndash 35 ndash 32

FIN 49 38 27 21 26 28 36 31 35 47 33 30

EUR-12 ndash 15 ndash 22 ndash 18 ndash 11 ndash 07 ndash 01 ndash 23 ndash 21 ndash 18 ndash 22 ndash 25 ndash 24

DK (5) 28 16 19 24 24 22 20 20 25 20 18 21

SE 48 17 15 16 20 14 12 15 13 08 12

UK (6) ndash 02 ndash 18 ndash 22 ndash 17 ndash 16 ndash 11 ndash 13 ndash 14 ndash 13 ndash 25 ndash 25

EU-15 ndash 11 ndash 20 ndash 17 ndash 10 ndash 07 ndash 19 ndash 18 ndash 16 ndash 19 ndash 23 ndash 22

(1) Excluding UMTS proceeds amounting in of GDP in 2001 to 01 in Belgium 02 in Denmark 05 in Greece 01 in France in 2002 004 in France and 02 inIreland

(2) Based on pre-budget figures for Ireland and the UK For 2004 on the assumption of unchanged policies(3) The targets for the final two years incorporate lsquocontingency provisions against unforeseen developmentsrsquo mdash their size is 04 of GDP in 2004 and 08 in 2005(4) Including lsquofuture measuresrsquo amounting to 16 of GDP in 2004 14 of GDP in 2005 and 08 of GDP in 2006(5) Including revised information provided by Denmark in the supplementary note For 2006 used data relative to 2010 (6) Financial years for data in the convergence programme Figures based on assumptions for output growth which are more prudent than those presented in Table I7

The comparison between the projections made by theMember States (left panel of Table I8) and by theCommission forecast for 2003 and 2004 made in bothautumn 2002 and spring 2003 (1) (right panels) showsthat in most cases the projections in the programmes forthe budget balance are more favourable than the Com-mission ones This is mostly due to the more optimisticgrowth assumptions presented in the national pro-grammes The only exceptions are Finland and to amuch smaller extent Ireland reflecting their more cau-tious growth assumptions The differences in projectedbudget balances already noticeable for 2003 wouldincrease considerably in 2004 for the euro-area averageThis partly appears to be due to some Member Statesincorporating planned though not-yet-enacted policymeasures in their projections

Most countries provided figures for the cyclically-adjusted budget balance (CAB) in their programmes(see the left panel of Table I9) The central panel ofTable I9 shows the cyclically-adjusted balances com-puted by the Commission and used in the individualassessment of the programmes According to these fig-ures the cyclically-adjusted balance of the euro areawhich deteriorated to 19 of GDP in 2002 is projectedto increase by roughly of GDP per year over thecoming years This is clearly more optimistic than whatwas forecast by the Commission in autumn 2002 (2)

According to the Commission calculations of the ninecountries showing a cyclically-adjusted budget deficit in2002 in the euro area four are projecting to be in deficitin 2006 (Germany France Austria and Portugal) The

yen1part For 2004 based on the assumption of unchanged policies yen2part For 2004 on the assumption of unchanged policies

Table I9

Cyclically-adjusted balances in the 2002 updates and in the Commission forecasts on the basis of the production function method

(in of GDP)

2002 updates of the programmes (1)

Commission calculations based on the 2002 updates (2)

COM autumn 2002 forecasts (2)

COM spring 2003 forecasts (2)

2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 2002 2003 2004 2002 2003 2004

BE 05 06 08 08 03 03 02 02 02 02 01 01 02 00

DE ndash 30 ndash 20 ndash 10 ndash 10 ndash 05 ndash 31 ndash 20 ndash 09 ndash 07 00 ndash 33 ndash 24 ndash 19 ndash 33 ndash 26 ndash 24

EL ndash 15 ndash 16 ndash 08 00 00 ndash 16 ndash 15 ndash 12 ndash 08 ndash 06 ndash 17 ndash 18 ndash 20 ndash 18 ndash 18 ndash 19

ES ndash 03 ndash 01 00 01 03 ndash 01 ndash 02 00 ndash 04 ndash 04 ndash 01

FR ndash 21 ndash 19 ndash 14 ndash 09 ndash 05 ndash 28 ndash 26 ndash 21 ndash 16 ndash 10 ndash 27 ndash 28 ndash 24 ndash 33 ndash 35 ndash 33

IE ndash 10 ndash 04 ndash 02 01 ndash 10 ndash 06 ndash 06 ndash 04 ndash 14 ndash 08 ndash 02 ndash 09 ndash 03 01

IT ndash 12 ndash 05 00 00 00 ndash 14 ndash 09 ndash 02 00 01 ndash 18 ndash 16 ndash 25 ndash 21 ndash 18 ndash 27

LU 21 12 19 20 05 ndash 03

NL ndash 05 03 03 02 04 ndash 06 00 03 ndash 10 ndash 04 ndash 11

AT ndash 04 ndash 09 ndash 04 ndash 13 ndash 11 ndash 04 ndash 09 ndash 04 ndash 13 ndash 11 ndash 17 ndash 15 ndash 14 ndash 06 ndash 10 ndash 04

PT ndash 28 ndash 18 ndash 13 ndash 07 ndash 03 ndash 24 ndash 16 ndash 11 ndash 05 ndash 01 ndash 30 ndash 19 ndash 15 ndash 25 ndash 26 ndash 21

FI 35 25 20 26 29 36 27 24 31 35 37 33 36 48 37 33

EUR-12 ndash 17 ndash 11 ndash 06 ndash 04 ndash 01 ndash 19 ndash 13 ndash 08 ndash 05 ndash 01 ndash 20 ndash 17 ndash 15 ndash 22 ndash 20 ndash 20

DK (3) 21 22 22 22 22 16 19 22 25 21 21 25 19 20 22

SE 23 19 17 11 09 10 13 13 15 09 11 15

UK ndash 12 ndash 15 ndash 13 ndash 15 ndash 15 ndash 12 ndash 14 ndash 14 ndash 15 ndash 16 ndash 06 ndash 09 ndash 10 ndash 10 ndash 20 ndash 20

EU-15 ndash 15 ndash 11 ndash 07 ndash 05 ndash 03 ndash 16 ndash 12 ndash 08 ndash 06 ndash 03 ndash 16 ndash 14 ndash 12 ndash 18 ndash 18 ndash 18

NB Footnotes to Table I8 apply here (1) Germany Austria and Portugal provided figures based on the HP filter method (2) On the basis of the PF method except in the case of Germany Spain and Austria where the HP filter method has been used (3) Commission calculations based on data from programme and information provided in the supplementary note The latter did not provide revised cyclically-

adjusted balances

data show that the deficit countries plan to have anadjustment in cyclically-adjusted terms of at least 05 of GDP per year over the next years (1) France andGreece however would only start the adjustment in2004 Outside the euro area the UK is expected to recorda cyclically-adjusted deficit of 14 of GDP in 2003 setto increase slightly until 2006

The developments in the general government balancecan be decomposed by sectors of government (seeTable I10) (2) For the euro area as a whole the budgetdeficit of the general government in 2002 is the resultof a large deficit of the central government sector (over2 of GDP) and a smaller deficit in the local govern-ment roughly compensated by the small surplus in thesocial security sector The local sector is projected toeliminate its deficit by 2004 and in 2006 should con-tribute with the social security sector to broadly bal-ance the deficit of the central government projected toremain at 07 of GDP in that year

The gross debt-to-GDP ratio in the euro area after theincrease recorded in 2002 is set to resume its gradualdecline in 2003 to arrive to just above 65 in 2006(see Table I11) This is again slower than projected inprevious updates and is due to smaller primary sur-pluses and nominal GDP growth contributions espe-cially for 2002

Table I11 also shows that the estimated stock-flow com-ponent contributes to increase the debt ratio on average

over the period (3) This could either stem from plans tobuild up financial assets (for example in public pensionreserve funds which are invested in non-governmentalassets) or simply indicate that a certain degree of cautionhas been used when setting the targets for debt

Table I12 shows that all Member States will be belowthe 60 of GDP ceiling in 2005 with the exception ofBelgium and Greece where the debt ratio should fallbelow 90 of GDP in 2006 (4) of Italy where it shouldstill be above 95 of GDP in 2006 and of Austriawhere it should decrease very slowly and remain slightlyabove 60 in 2006 In the EU the debt level in 2006 islikely to be below 50 in seven Member States (SpainIreland Luxembourg the Netherlands Denmark Swe-den and the United Kingdom) of which four (IrelandLuxembourg Denmark and the United Kingdom) willhave debt ratios below 40

22 Composition of the budgetary adjustment

The updated programmes show that both revenue andexpenditure ratios are expected to decline over theprojection period (see Table I13) The euro-area totalreceipts are projected to fall by almost 1 of GDPbetween 2002 and 2005 to slightly below 46 of GDPin 2005 This is more than compensated by reductions

Table I10

Euro area net lending by sub-sectors in the 2002 updates (1)

of GDP 2002 2003 2004 2005 2006

General government ndash 22 ndash 18 ndash 11 ndash 07 ndash 01

Central government ndash 20 ndash 18 ndash 16 ndash 13 ndash 07

State plus local governments ndash 04 ndash 03 00 00 02

Social security funds 02 03 03 03 03

(1) Discrepancies are due to rounding and to the non-attribution to a specific sector of future measures in the Italian (for the years 2004ndash06) and German (for 2004)programmes

yen1part In accordance to the pace of adjustment endorsed by the European CouncilSee Part II2)

yen2part To simplify the presentation Table I10 presents the two sectors of stateand local government in one row given that the state government sector isrelevant only for four countries

yen3part As in the previous round of updates very large positive contributions of thestock-flow over the period are identified for Greece (but this time the yearlyaverage is around 2 of GDP rather than 5 of GDP implied in the previ-ous update) Finland Sweden and Ireland (on average around 2 ) andSpain (on average around 1 ) In other countries the stock-flow operationsseem to compensate over the period In Italy they are over 2 of GDP inthe last two years of the programme

yen4part For Belgium assuming that in 2006 nominal GDP growth and the budgetbalance are the same as in 2005

Table I11

Euro area mdash Gross debt level and changes in the 2001 updates (1)( of GDP)

2001 2002 2003 2004 2005 2006

Gross debt level 695 697 687 668 654 635

Change in gross debt 03 ndash 11 ndash 18 ndash 14 ndash 19

Previous updates of the programmes 691 674 657 636

Contributions to change in gross debt

Primary balance ndash 15 ndash 19 ndash 25 ndash 28 ndash 33

Interest payments 37 37 35 35 34

Nominal GDP growth ndash 22 ndash 28 ndash 31 ndash 30 ndash 29

Other factors influencing the debt ratio (2) 03 ndash 01 03 08 08

(1) Discrepancies are due to rounding(2) The programmes do not always contain enough information to identify directly the contribution from different factors to the development of the euro-area debt ratio

Therefore it has been necessary in some cases to identify the contribution from nominal GDP growth (GDP deflator plus real GDP growth multiplied by the debtratio) In this way the stock-flow adjustment is derived as a residual

Source 2002 updates of the stability and convergence programmes

Table I12

Debt levels in the 2002 updates of the stability and convergence programmes ( of GDP)

2001 2002 2003 2004 2005 2006

BE 1086 1061 1023 979 936

DE 595 610 615 605 595 575

EL 1070 1053 1002 961 921 879

ES 571 552 531 510 490 469

FR 573 587 591 589 583 570

IE 367 341 340 345 349

IT 1099 1094 1050 1004 984 964

LU 53 51 41 38 29

NL 528 519 512 490 474 453

AT 673 678 670 651 638 621

PT 554 588 587 575 553 527

FI (1) 434 425 419 419 414 407

EUR-12 695 697 687 668 654 635

DK (2) 447 439 421 392 367

SE (1) 566 536 509 493 480

UK (3) 382 379 388 389 389 391

EU-15 628 629 621 606 595

(1) Revised national accounts data for 2001 refer to a debt ratio of 435 of GDP for Finland and of 543 of GDP for Sweden(2) Figures for 2002ndash04 may not be consistent with those in the tables for GDP growth and budget balances as they have not been revised by the supplementary note(3) Financial years

in the expenditure ratio which over the same periodwill amount to 20 of GDP Both revenue andexpenditure ratios are reduced in most countriesStrong reductions in revenue are projected in FinlandIreland Greece Italy (1) Belgium the Netherlands andLuxembourg and outside the euro area SwedenFrance Denmark and Sweden still have revenue ratiosabove 50 of GDP in 2005 (2) The UK is set toincrease revenues by 2 of GDP between 2002 and2005 Such an increase should finance the almostequivalent increase in total expenditure which remainsamong the lowest in the EU All the other countries areset to decrease total expenditure In several countries(that is Germany Greece Italy France and Portugal)this ratio is expected to be reduced by around 2 percent-age points of GDP or more

Although the information provided in the programmeson the budget components is not always complete (3) itwould seem that the reduction in taxes which has takenplace in most countries in the euro area in 2001 and in2002 (on average ndash 08 of GDP see Table I14) (4) isnot expected to continue thereafter as the ratio wouldremain constant around 251 until 2006 Sizeablereductions are expected in Finland and to a smallerextent Italy while Germany would increase the ratio byone point by 2004 Outside the euro area the tax to GDPratio in Sweden would remain constant after the largereduction in 2002 mdash due to the reduced revenues fromhigh capital income and corporate taxes mdash while it

Table I13

Expenditure and revenue ratios in the 2002 updates

Total revenues Total expenditures

2002 2005 2002ndash05 2002 2005 2002ndash05

BE 495 484 ndash 11 495 480 ndash 15

DE 450 445 ndash 05 485 455 ndash 30

EL 457 444 ndash 13 468 442 ndash 26

ES 398 398 00 401 397 ndash 04

FR 512 506 ndash 06 540 522 ndash 18

IE (1) 348 329 ndash 19 351 341 ndash 10

IT (2) 460 448 ndash 12 481 463 ndash 18

LU 466 456 ndash 10 470 456 ndash 14

NL 464 453 ndash 11 471 457 ndash 14

AT 515 495 ndash 20 521 510 ndash 11

PT 437 436 ndash 01 466 447 ndash 19

FI 513 490 ndash 23 475 464 ndash 11

EUR-12 462 455 ndash 08 484 464 ndash 20

DK (3) 551 542 ndash 09 529 518 ndash 11

SE (4) 565 554 ndash 11 548 538 ndash 10

UK (5) 380 400 20 389 408 19

EU-15 452 449 ndash 03 470 457 ndash 13

NB Discrepancies are due to rounding The improvement in net lending implied by this table may be different from the one resulting from other tables This is due toinconsistencies across tables in the programmes

(1) 2002 figures reflect corrected treatment of UMTS proceeds (2) Not including for 2005 future unspecified measures amounting to 14 of GDP(3) Figures for 2002ndash04 may not be consistent with those in the tables for GDP growth and budget balances as they have not been revised by the supplementary note(4) 2004 and 2002ndash04(5) Financial years

yen1part In the case of Italy future unspecified measures amounting to 14 ofGDP in 2005 have not been distributed across budgetary items

yen2part However as no adjustment is made for differences in institutional rules thecomparability of tax ratios is limited across countries

yen3part No information was given by France and Luxembourg only partial infor-mation by Spain and complete data but only up to 2004 by Sweden Insome cases erroneous classifications in the figures provided have beenidentified

yen4part With the notable exceptions of Austria where taxes increased by 18 ofGDP and in more limited measure the Netherlands where the progressiveincrease in taxes is due to the tax reform which shifts revenue from socialcontributions to taxes and reduces social contributions over time

should decrease between 2002 and 2006 by about 1 in Denmark and increase by the same amount in the UKSocial contributions would be reduced further in thecoming years by around of GDP in the euro area(see Table I14) At national level Germany would com-pensate the increase in taxes by a reduction of a similarsize in social contributions although in different yearsItaly and to a smaller extent Belgium are also expectedto reduce the ratios somewhat Other revenues areexpected to decrease slightly over the period

Graph I7 presents the contribution to the change in thebudgetary position of four budget components primarycurrent expenditures interest payments gross fixed cap-ital formation and total revenues A number of generalconclusions can be drawn

Firstly the development of expenditure components overthe time frame of the programmes appears to be influ-enced by the initial budgetary and cyclical position Mostcountries showing deficits in 2002 plan to reduce substan-tially the expenditure ratios while most countries showingsubstantial surpluses expect lower revenue Germany andPortugal which plan to improve the balance substantiallyover the period expect to do so essentially via cuts in cur-rent primary expenditure However Portugal would alsoreduce public investment while Germany also plans to

implement further tax cuts Italy Greece and Francewhich plan to improve the balance by around 1 to 2 ofGDP would use part of the large reductions in primarycurrent expenditure and in interest payments to finance taxcuts and increased investment (1) Secondly after a slightreduction in 2002 and 2003 gross fixed capital formationis set to increase at the euro area level to 24 of GDPThis would reflect the large increase expected in publicinvestment in Spain and to a smaller extent in Greecewhich would more than offset the reduction expected inFinland and in Portugal (2) Germany would maintain theinvestment ratio constant although at 15 of GDP alevel almost 1 percentage point lower than the euro-areaaverage The UK projects to increase public investment by07 of GDP between 2002 and 2005 to 21 of GDPstill below the EU average In Ireland the reduction inrevenues is compensated by cuts in public investment andreduction in primary current expenditure (3)

yen1part The increase of public investment in Italy between 2002 and 2005 is to alarge extent due to an accounting effect (see also footnote 17)

yen2part The level of public investment in 2002 and 2003 has also been affected bythe accounting treatment of the sales of real assets by the Italian govern-ment in those years sales which were recorded as a reduction in invest-ment This effect should cease by 2004

yen3part However contingency provisions are made in the Irish programme whichare not included in these calculations

Table I14

Euro area Budget developments for the general government

of GDP 2001 2002 2003 2004 2005 2006

Components of revenues

Taxes 255 251 251 252 251 251

Social contributions 154 153 153 150 149 149

Interest income

Other 41 42 41 39 38 38

Total receipts 466 462 460 458 455 455

Components of expenditures

Collective consumption

Social transfers in kind 147 148 145 141 138

Interest payments 40 37 37 35 35 34

Subsidies 14 13 13 13 13

Gross fixed capital formation 24 23 22 24 24 24

Other 31 32 32 31 31

Total expenditures 481 484 479 470 464 458

NB Totals might not correspond to the sum of the components while for totals information is available for all countries several countries are not included in the aggre-gation concerning budgetary components which affects the ratio of the components

Thirdly there are a number of countries which whileimproving the balance marginally expect to reduce thesize of the public sector This is most notably the case of

Luxembourg the Netherlands and in a smaller measureSpain and Belgium Outside the euro area this is the caseof Sweden and Denmark

Graph I7 Contributions to change in budgetary position 2002ndash05 (in points of GDP)

Source 2002 updates of the stability and convergence programmes A positive value indicates a positive contribution to net lending A positive value in total variation of budgetary position (value is presented on top of columns) implies an improvement of the balance For SE data refer to 2002ndash04 For FR and LU values of primary current expenditures refer to primary expenditure Net lending for Italy includes unspecified measures totalling 14 of GDP in 2005 Revised figures for net lending for Denmark do not specify the impact of the revision on budget items

ndash 35

ndash 25

ndash 15

ndash 05

BE DK DE EL ES FR IE IT LU NL AT PT FI SE UK

28 12 ndash 09 03 17 ndash 12 ndash 01

Variation of budgetary

position (in points of GDP)

13 02 030805 02 19 ndash 09

Revenues

Gross fixed capital formation

Interest payments

Primary current expenditure

3 The sustainability of public finances based on the 2002 updates of stability and convergence programmes

31 Introduction

In recent years growing attention has been paid to theneed to extend EU budgetary surveillance beyond thethree or four year time horizon of stability and conver-gence and to consider whether public finances aresustainable in the long run This largely stems fromconcerns about the potential impact of ageing popula-tions on public finances The importance of securingsustainable public finances is not unique to EMU butthere are additional implications in a monetary unionAn unsustainable public finance position in a partici-pating Member State may complicate the implementa-tion of the single monetary policy and possibly resultin interest rates being higher than they would other-wise be

Since the launch of the euro in 1999 the Commissionhas addressed the issue of the sustainability of publicfinances along a number of lines (1) In particular theCommission has sought to integrate an examination ofthe sustainability of public finances into the existing EUframework for the surveillance of Member Statesrsquo eco-nomic and budgetary policies in line with the conclu-

sions of the Stockholm (March 2001) and Barcelona(March 2002) European Council meetings

The chapter presents the second assessment of long-termsustainability carried out by the Commission and theCouncil on the basis of the 2002 updated stability andconvergence programmes which followed a similarapproach to that followed in the first exercise (see Euro-pean Commission 2002a)

32 How the sustainability of public finances was assessed

321 The quantitative indicators

In the absence of an agreed definition a pragmatic defi-nition of what constitutes a sustainable public financeposition was used namely whether on the basis of cur-rent policies Member States will continue to complywith the budgetary requirements of EMU and in partic-ular the Treaty requirement to keep debt levels belowthe 60 of GDP reference value (2) At the same timehowever it was recognised that sustainability of publicfinances is a multifaceted policy challenge Aside fromavoiding deficits and debt accumulation sustainabilityin addition requires that tax burdens remain at reasona-ble levels and that other non-age-related expenditures(infrastructure RampD) are not squeezed out In recogni-

yen1part Firstly projections for age-related expenditures were published for eachMember State up to 2050 additional projections covering the impact ofageing on public spending on education and unemployment transfers willbe published in mid-2003 Secondly on 4 and 5 March 2003 the Directo-rate-General for Economic and Financial Affairs coorganised a conferencewith the Centre for Strategic International Studies (CSIS) on lsquothe economicand budgetary implications of global ageingrsquo The conference papers areavailable on the web site of DG ECFIN at httpeuropaeuintcommeconomy_financeevents2003events_brussels_0303_enhtm Thirdly the impactof demographic changes on growth has been analysed (see Chapter 4 inEuropean Commission (2002b)) Fourthly the need to ensure the financialsustainability of pension systems has been addressed as part of the open-method of coordination on pensions

yen2part This definition based on compliance with pre-determined and arbitrarybudgetary aggregates can be justified on the grounds that continued com-pliance with the SGP and in particular the lsquoclose to balance or in surplusrsquorequirement would de facto lead to the virtual disappearance of public debtin the long run under reasonable assumptions on growth and interest ratesBalassone and Franco (2000a) also review the various approaches to defin-ing the sustainability of public finances

tion of this the Commissionrsquos assessment examinedboth quantitative and qualitative information

On the basis of the work of the Economic Policy Com-mittee (2001) two groups of indicators were used toquantify the sustainability of public finances

The first indicator consisted of extrapolating debt devel-opments up to 2050 so as to verify whether continuedcompliance with the debt requirements of the Treaty canbe expected on the basis of current policies Under anlsquoSGP compliancersquo scenario the starting position interms of the current budget balance level of debt pri-mary spending and tax revenues are the figures reportedby the Member States for the final year of their 2002updated stability or convergence programme for mostMember States this is 2005 or 2006 The Commissionthen extrapolated the evolution of the budget balanceand debt levels up to 2050 assuming that (i) the tax bur-den and non-age-related primary expenditures remainconstant as a share of GDP at the 200506 level over theprojection period (ii) the interest-growth rate differen-tial converge towards an EU average level of around 2 in 2010 (1) and (iii) age-related expenditures evolve inline with the projections of the EPC or alternativenational projections It is then possible to verify whetherthe projected level of debt respects the requirement tostay below 60 of the GDP reference value for publicdebt at all times (2) Failure to do so would a priori indi-cate that there may be a risk of budgetary imbalancesemerging in light of ageing populations and that meas-ures may be required to place public finances on a moresustainable footing

It should be noted that the lsquoSGP compliancersquo scenarioassumes that Member States actually achieve thebudget targets set down in their programmes whichfor several Member States implies a successful process

of budgetary consolidation to the lsquoclose to balance orin surplusrsquo requirement However such an outcomeis by no means assured since several Member Statesstill have to complete the consolidation A lsquo2002positionrsquo scenario is therefore run in the same way asthe lsquoSGP compliancersquo scenario excepting that thestarting budget position is different Debt levels areextrapolated from 200506 to 2050 assuming that nobudgetary changes occur during the programme periodthat is the primary balance in 200506 is the same asthe 2002 level The purpose of this scenario is todemonstrate the long-term impact on debt develop-ments and consequently on the sustainability of publicfinances of a failure to achieve the lsquoclose to balance orin surplusrsquo requirement of the Pact for those countriesstill in deficit in accordance with the timetable setdown in the Member Statesrsquo stability or convergenceprogrammes

For both scenarios the tax gap has been measured It pro-vides a gauge of the scale of budgetary adjustment whichwould be required for a Member State to reach a sustain-able public finance position It measures the differencebetween the current tax ratio and the constant tax ratioover the projection period necessary to achieve a pre-determined debt level at some date in the future A posi-tive tax gap indicates that there is a financing gap toreach such an objective

The choice of both the targeted debt ratio and the lengthof the projection period is arbitrary and the Commissiontherefore calculated three different tax gaps as follows

bull T-1 measures the difference between the currentand constant tax ratio required to reach the samedebt level in 2050 that would result from running abalanced budget position over the entire projectionperiod By definition the debt ratio would convergetowards zero but the level reached in 2050 will dif-fer across countries depending on the starting debtlevel This approach has the advantage that the debttarget to be achieved is consistent with the budget-ary framework of the SGP and the fact that the EPCprojections for age-related expenditures cover theperiod up to 2050

bull T-2 recognises that a requirement for debt levels toconverge towards zero is an overly strict definitionto ensure the sustainability of public finances Ittherefore measures the difference between the cur-

yen1part Real growth is based on the projections included in the report of theEPC(2001) that is GDP growth convergence to some 175 by 2030 inmost Member States reflecting the assumption on labour force participationrates and in particular a prudent assumption on the rate of productivitygrowth An identical nominal interest rate was assumed for all countriesThe interest rate is defined as the sum of the inflation target of the ECB(2 ) the real growth rate of the EU (converging to 175 by 2030) plusthe differential of two between the nominal interest rate and nominal GDPgrowth This leads to assume a nominal interest rate close to 6 To avoida discrete jump in the debt projections it is assumed that the implicit inter-est rate on debt in the final year of the stabilityconvergence programmeconverges towards the common nominal interest rate over 10 years in a lin-ear fashion

yen2part For countries with debt ratios still above 60 it must convergetowards the reference value and stays below it for the remaining periodof projection

rent and constant tax ratio required to reach a debtlevel of 40 of GDP in 2050 (1)

bull T-3 is a measure which is close to tax gap measuresfound in the economic literature based on the presentvalue budget constraint It indicates the change intax revenues as a share of GDP that would guaranteethe respect of the intertemporal budget constraint ofthe government that is that equates the actualised

Box I1 The impact of ageing populations on tax revenues and social contributions

Government revenues can be decomposed into four main categories according to the tax base labour capital consumptionand social contributions Revenues for each of these categories are simply the product of the respective effective tax rateby the tax base In the case of social contributions it is the product of wages (the tax base) by the contribution rate Anageing population can have a direct effect on tax revenues through a modification of a tax base

Few studies analyse the consequences of ageing populations on government revenues Goudswaard and Ven de Kar (1994)show that income tax revenues in the Netherlands would increase because of a rising share of older workers in the labourforce as these are the highest paid group for seniority reasons However in the long run wages are driven by labour pro-ductivity more than by seniority and the impact of ageing on labour productivity could therefore be negative Auerbech etal (1989) argue that the capacity to adapt to new technologies is lower for older workers and that technological innovationcan render their human capital obsolete Older workers are also less mobile (both geographically and within sectors andlabour tasks) and this implies a lower capacity of economic systems to adjust to structural changes However CambridgeEconometrics (1997) argues that the evidence that at any given time older workers are paid more implies that they shouldalso be more productive Alternatively it would determine lsquoa shift from profits to wages in national income without anyobvious reason that justifies thisrsquo

Ageing also affects consumption and thus savings If consumption increases as a consequence of a higher propensity toconsume amongst elderly people savings will decrease according to the life-cycle model and this will negatively affectlong-term economic growth and revenues Rosevaere et al (1996) argue that national savings both governmental and pri-vate will decline In particular it is estimated that an increase of the old-age dependency ratio in OECD countries of 20 in the next 30 years will reduce private savings by 6

Martinez-Mongay (2000) shows that the evolution of revenues has been driven mainly by the need to finance increasedlevels of public expenditure In particular revenues have adjusted to the evolution of social transfers He shows thatbetween 1970 and 1998 implicit tax rates on labour increased while the tax base (total wages as a percentage of GDP)decreased In contrast tax rates on consumption did not change sharply According to this study demographic changeswould affect tax revenues only to the extent that they lead to additional expenditure

In any case it is rather difficult to isolate the direct effect of ageing on revenues without taking into account the indirecteffect through changes in income levels and distribution There is an endogeneity problem as economic growth is affectedby ageing and this will determine tax bases and revenues But taxation together with social contribution rates affectsemployment and its structure with relevant consequences on participation rates and on the general level of income as wellas its distribution This makes it difficult to carry out any projection on the impact of ageing on tax revenues

To summarise there is a great uncertainty over the effect of ageing populations on revenues Several factors can lead to anincrease in government revenues for example a better-paid workforce (due to seniority effects) an increase in consump-tion and participation rates However several factors could lead to a decline in tax revenues for example a fall in labourproductivity due to an older workforce and a decline in aggregate savings Therefore in making any long-run projectiona very detailed knowledge of income distribution and its evolution is required (since this can change the tax bases for directand indirect taxes) and account needs to be taken of the indirect effect of taxation on labour participation and on incomelevels However past experience already shows that the level of public spending is the main determinant of tax revenuesas a share of GDP

yen1part Interestingly the UKrsquos sustainable debt rule requires that net debt does notexceed 40 of GDP

flow of revenues and expenses over an infinitehorizon (1) As such there is no target for the debtratio what happens is that this will convergence to arelatively low level Moreover there is no cut-offdate in 2050 and this requires the assumption thatage-related expenditures remain constant as a shareof GDP at the projected level in 2050

It is important to interpret the results of these quanti-tative indicators with caution The projected evolutionof debt levels are not a forecast of possible or evenlikely outcomes Instead they are a tool to facilitatepolicy debate and at best provide rough indication ofthe timing and scale of emerging budgetary chal-lenges that could occur on the basis of lsquono policychangersquo In practice it is likely that governmentswould respond to either explosive debt trajectories orthe implosion of debt leading to the accumulation oflarge net assets

A further limitation of both sets of indicators is thatthey provide little guidance on what is the appropriatebudget target which Member States should aim for inthe light of the expected costs of an ageing populationand indeed other contingencies which may affect pub-lic finances in the future Moreover a positive tax gapdoes not imply that tax rates should be raised but ratherthat a financing gap exists which needs to be closed bya variety of means including raising tax revenues cut-ting non-age-related expenditures andor introducingreforms to curb the growth in age-related expendituregrowth The results are also sensitive to underlyingassumptions on parameters such as interest rates andgrowth rates as well as the starting budget position Tosome extent account can be taken of this by running avariety of sensitivity tests but these provide no esti-mate of the risk or probability of various budgetary sce-narios emerging

Finally the utility of the exercise depends heavily on thequality and comparability of the long-run budgetary pro-

jections If greater weight is to be attached to the sustain-ability of public finances in the EU surveillance processand in particular if the Commission and Council wish toprovide clearer recommendations on policy responsesthen considerable efforts should be made to upgrade theprojections

322 The data used

The code of conduct on the content and presentation ofstability and convergence programmes requires MemberStates to address the issue of sustainability and on a vol-untary basis include long-run budgetary projections AllMember States included a specific section on the sus-tainability in their 2002 programmes and there was amarked improvement in the terms of the quality and cov-erage of information compared with the 2001 pro-grammes

Table I15 summarises the budgetary projectionsincluded in the programmes of Member States Twelveof the 15 programmes included budgetary projectionsfrom national sources whereas three Member Statesreferred to the EPC projections A trade-off exists asregards the choice of which projections to use TheEPC projections were made using common demo-graphic scenarios and agreed assumptions on keylabour market and macroeconomic parameters andwere subject to a peer review exercise by the Commis-sion and Member States However national projectionsmay encompass the impact of recent reforms they mayalso capture in more detail the institutional complexityof national tax and benefit systems

Table I16 presents the projections used by the Commis-sion in running its quantitative indicators A number ofimportant choices taken when doing the projections areworth highlighting

bull The Commission as a general rule used the nationalprojections when they consisted of updates based onthe EPC approach For the most part the differencesbetween the EPC and national projections weremodest and would not influence policy conclusionsHowever Spain Germany and Austria submittedrevised projections for spending on public pensionswhich indicated a much smaller increase in spendingover the projection period The revised projectionfor Spain indicated that spending on pensions willincrease by some 5 percentage points of GDP by2050 compared with 8 percentage points in the EPCprojections and the difference is due to a revised

yen1part The applied formula is the following

where τ is the actual share of revenues on GDP (assumed to remain constant)pg is the share of primary expenditures on GDP (assumed to stay constantafter 2050) is the stock of gross debt on GDP at time t while r and nare respectively the discount rate and the nominal growth rate of the econ-omy (assumed to be constant)

τr nndash----------- 1 TG

τ--------+

pgi 1 n+( )i

sum1 r+( )i

------------------------------------pg

r nndash( )----------------

1 n+1 r+------------

45+ +=

demographic scenario (1) The revised projectionmade by Germany takes account of the 2001 reformof the pension system and indicates that spendingon pensions would be 2 percentage points of GDPlower than in the EPC exercise The Austrian projec-tion indicates that age-related spending by 2040 willincrease by 18 percentage points of GDP less thanwhat was projected by the EPC and is due to the useof an alternative demographic scenario Of this dif-ference 1 percentage point relates to public spend-ing on pensions and 07 percentage points to lowerspending on acute healthcare It should be noted that

none of these national projections have been subjectto peer review at EU level and their use results in aconsiderably more favourable profile for debt devel-opment compared to what would have occurred onthe basis of EPC projections

bull EPC projections for spending on healthcare and long-term care were included in the calculations even ifthey were not mentioned in the stability or conver-gence programme Also to ensure consistency theCommission excluded projections for non-age-relatedprimary expenditures indicated by some MemberStates (for example Sweden and the UK) Finallyprojections for changes in the tax ratio were includedfor three Member States (Denmark Netherlands UK)as these can largely be attributed to the deferred taxrevenue contributions to funded pension systems aswell as accumulated earnings prior to disbursement

Table I15

Long-run budgetary projections included in the 2002 updates to stability and convergence programmes ( of GDP)

Source

PensionsHealth

and long-term careOther age-related

expenditureTax revenues

Net impact

2005Change by 2050

BE national 87 27 62 20 73 ndash 16 31

DK national 47 25 74 19 541 22 22

DE national 111 38 60 11 177 13 36

EL national 124 102 50 16 444 46 72

ES national 79 51 na na 51

FR EPC 121 37 69 20 57

IE EPC 38 39 61 17 56

IT national 139 02 59 17 19

LU EPC 74 19 na na 19

NL national 83 53 73 31 23 29 55

AT national 146 18 58 21 39

PT national 133 20 na na 20

FI national 107 37 62 29 537 ndash 21 87

SE national 91 18 98 46 319 ndash 16 531 25 23

UK national 50 ndash 02 70 28 61 08 399 ndash 15 49

NB BE the starting data refers to 2000 Other expenditures include family allowances unemployment and early retirement transfers work-related accidents and sick-ness and residual regimes DK of the change in tax revenues the net tax on pension payouts increased by 24 pp of GDP from 2005 and 2050 Also pensionassets are projected to increase from 119 of GDP in 2005 to 206 of GDP in 2040 DE the starting data refers to 2010 Pension projections were made by theBMGS (statutory pension insurance and public service workers pension) Healthcare projections only cover acute healthcare and were made by the EPC Tax reve-nues only concern taxation of payments to private households and was made by the German Institute for Economic Research EL Healthcare only concerns acutehealthcare FR starting date is 2000 and change refers to the period 2000 to 2040 IE data in programme was reported as a of GNP It was converted to GDPassuming a constant differential of 17 over the projection period NL revenues projections refer to income tax revenues on pensions PT starting data refers to2001 FI starting year is 2000 SE expenditure projections include a breakdown covering childcare primary and secondary education adult education other trans-fer payments (ill health childrenstudies labour market transfer payments to firms transfer payments abroad) and public investment

Source 2002 updates of stability and convergence programmes

yen1part This is based on the recent census which indicates that the existing popula-tion size is considerably higher than estimated by Eurostat and also impor-tant differences as regards inward migration The upshot is that thepopulation of working age is considerably higher in the revised projectionthan assumed by the EPC

bull The concept used in the EU surveillance of MemberStatesrsquo budgetary positions is general governmentgross debt It measures the amount of existing finan-cial debt the government will have to service andreimburse The only asset taken into account is gov-ernment debt held within the government sectorother financial assets such as holdings of shares andequity and real assets do not contribute to lower therecorded level of debt It has been argued that whenassessing long-term sustainability there is also a casefor looking at net debt figures However this wouldentail a number of practical measurement problems asa large part of government assets are of a non-finan-cial nature Real assets are typically not easy to valueand moreover it is questionable to what extent theseassets can be used to redeem outstanding debt or sub-stitute for other revenues In running the quantitativeindicators for Finland and Sweden (1) however the

Commission took on board information on financialassets (other than government bonds) in designatedpension funds as well as information on financialassets specifically designated for privatisation andthus available for future debt reduction It wasassumed that the yield on assets is the same as ondebt

323 The results of the quantitative indicators

The results of the quantitative indicators (both theextrapolation of debt and the tax gap indicators) are pre-sented in Table I17 and Table I18 The need to interpretthe results with caution is again underlined and in par-ticular to avoid drawing mechanical policy conclusionsNotwithstanding the caveats the indicators clearly illus-trate that ageing populations pose a very significantbudgetary challenge and the following broad conclu-sions can be drawn

First even assuming that all Member States achieve theirbudget targets for 2006 (SGP compliance scenario)which in most cases represents a position of lsquoclose to bal-ance or in surplusrsquo there is a risk of unsustainable public

Table I16

Data used to run the sustainability indicators in the lsquoSGP compliance scenariorsquo ( of GDP)

Level in 20056 (1) Change by 2050

Net borrowing

DebtTotal

revenues

Total non-age-related spending

PensionHealth-

Other age-related

expenditures

Tax revenues

Net change

BE 05 94 484 210 29 16 ndash 11 00 34

DK 22 26 536 266 20 20 02 00 42

DE 00 58 445 243 35 13 00 00 48

EL 06 88 443 218 102 16 00 00 118

ES 02 47 398 235 51 16 00 00 67

FR ndash 10 57 505 290 34 11 04 00 49

IE ndash 12 35 329 227 39 17 00 00 56

IT 01 89 446 194 02 17 00 00 19

LU ndash 01 3 456 380 19 00 00 00 19

NL 01 45 453 274 35 34 05 37 37

AT ndash 11 61 494 271 18 13 08 00 39

PT ndash 04 53 430 242 21 08 00 00 29

FI 28 ndash 17 489 260 30 10 15 00 55

SE 17 18 554 149 18 14 17 ndash 09 58

UK ndash 16 39 399 214 ndash 02 28 08 15 49 (2)

(1) Denmarkrsquos levels are for 2010(2) The net change for UK includes the change in the total non-age-related spending of ndash 14 of GDP

yen1part According to the last set of stability and convergence programmes grossgovernment debt in Sweden in 2001 was 523 of GDP while the net debttaking pension fund financial assets into account was ndash 31 of GDP Inthe Finnish programme gross interest payments in 2001 was 28 of GDPwhile net interest payments was 07 of GDP

finances (measured against the 60 of GDP referencevalue) emerging in some half of EU Member States andindeed for the EU as a whole (see Graph I8) Hence cur-rent policies are not sustainable and further policy meas-ures are needed

Secondly the risk of unsustainable public financesincreases considerably if all Member States do notachieve the SGP goal of budget positions of lsquoclose to bal-ance or in surplusrsquo An indication of this can be seen bycomparing the projected debt levels under the lsquoSGPcompliance scenariorsquo with the lsquo2002 positionrsquo scenariofor the EU-15 the failure to reduce the deficit for its2002 levels of some 2 of GDP would result in debtbeing some 100 of GDP higher in 2050 In particularGraph I9 compares debt developments under both sce-narios for the four euro area countries with highest defi-cits in 2002 ie Germany France Italy and Portugal

Thirdly debt developments for most Member Statesfollow a U-shaped pattern In the coming decade or20 years debt levels are projected to decrease thanks tothe running ofa balanced budget position however thistrend would start to reverse once the budgetary impact ofageing starts to take hold with the largest increase inmost countries expected between 2020 and 2030 There

is therefore a limited but fast closing window of oppor-tunity to reduce debt levels

Fourthly the tax gap indicators provide some order ofmagnitude to the budgetary adjustment needed to ensuresustainable public finances In addition to consolidationefforts to correct the 2002 aggregate underlying deficitof some 2 of GDP the tax gap under the lsquoSGP com-pliance scenariorsquo indicates that an additional permanentbudgetary adjustment of between 1 and 2 percentagepoints of GDP is needed in Member States where thesustainability of public finances is a concern A budget-ary adjustment of this magnitude would be between onethird and one half the size of consolidation achieved aspart of the Maastricht process since 1995 However thescale of budgetary adjustment efforts could be evengreater if age-related spending increases faster than inthe baseline EPCnational projections andor if accountis taken of the stated budgetary objectives of some Mem-ber States such as a reduction in the tax ratio Also andas stated above this does not suggest that taxes should beincreased but rather that an appropriate combination isneeded of tax increases reducing the level of non-age-related primary spending andor reform of pension andhealthcare systems to curtail the impact of ageing onexpenditure growth The scale of such a budgetary chal-lenge is presented in Table I18

Table I17

Projected evolution of debt levels up to 2050

SGP compliance scenario 2002 budget position scenario (1)

2010 2030 2050 2010 2030 2050

BE 70 ndash 21 ndash 108 66 ndash 41 ndash 154

DK 26 ndash 23 ndash 51 9 ndash 79 ndash 172

DE 49 56 89 75 186 384

EL 70 48 160 70 64 201

ES 38 17 89 33 4 59

FR 54 107 248 62 144 335

IE 33 85 220 22 52 153

IT 77 17 ndash 38 88 72 91

LU 2 16 51 4 18 52

NL 39 48 99 37 43 91

AT 59 88 123 61 39 19

PT 46 51 107 61 120 281

FI (2) ndash 25 ndash 48 ndash 39 ndash 42 ndash 135 ndash 225

SE (2) 3 2 ndash 35 3 2 ndash 57

UK 38 43 78 39 49 90

(1) As calculated assuming primary balance constant at the level of 2002(2) Government debt net of financial assets

Table I18

Results of the tax gap indicator

SGP compliance scenario 2002 budget position scenario

T1 T2 T3 T1 T2 T3

BE ndash 17 ndash 20 01 ndash 24 ndash 27 ndash 05

DK ndash 09 ndash 13 01 ndash 27 ndash 31 ndash 20

DE 10 06 32 48 45 69

EL 20 17 48 26 23 55

ES 11 07 24 10 06 24

FR 37 35 46 48 45 57

IE 34 29 51 24 18 40

IT ndash 08 ndash 10 03 09 06 19

LU 12 02 25 10 03 26

NL 12 07 46 10 06 45

AT 26 21 34 10 06 19

PT 13 10 20 37 33 43

FI ndash 06 ndash 11 ndash 05 ndash 32 ndash 37 ndash 08

SE ndash 06 ndash 11 02 ndash 09 ndash 14 ndash 01

UK 19 14 12 13 08 14

NB T1 indicates the constant difference between projected revenues and the revenues required to reach in 2050 the same debt-to-GDP ratio as the close to balance posi-tion holds for the whole projection period T2 indicates the constant difference between projected revenues and the revenues required to reach in 2050 a debt-to-GDP ratio equal to 40 T3 indicates the change in tax revenues as a share of GDP that guarantees the respect of the intertemporal budget constraint of thegovernment that is that equates the actualised flow of revenues and expenses over an infinite horizon

Graph I8 A comparison of debt projections for the EU-15 based on the lsquoSGP compliance scenariorsquo and the lsquo2002 starting positionrsquo scenario

EU ndash non-compliance SCPs 2002 EU baseline

debtGDP

60 reference value

33 Policy conclusions per Member State

The policy conclusions in the Commissionrsquos recommen-dations for Council opinions on updated stability and con-vergence programmes were drawn on the basis of qualita-

tive as well as quantitative analysis They addressed threepolicy questions as follows

bull In the light of projected budgetary implications ofageing populations is it likely that the SGP require-ments will continue to be respected on the basis ofcurrent policies

Graph I9 A comparison of debt projections for four Member States based on the lsquoSGP compliancersquo scenario and the lsquo2002 positionrsquo scenario

ndash 50

France

Germany Portugal

bull Are the medium-term budget target and other policymeasures outlined in the updates compatible withimproving the sustainability of public finances (1)

bull What is the main policy challenge facing MemberStates and what reform measures should be envisaged

Table I19 below summarises the conclusions on each ofthese questions based on the Commissionrsquos assessmentof the 2002 updated programmes and the respectiveCouncil opinions The risk of unsustainable publicfinances is evident in some half of EU countries notablyGermany Greece Spain France Italy Austria andPortugal There are also particular circumstances forBelgium and Ireland which influence the quantitativeindicators of the sustainability of public finances andunderline the need to avoid a mechanical interpretationof results It is possible to group countries according tothe source of potential budget imbalances and the seri-ousness of the risk as follows

bull In two Member States (Spain and Greece) a largeshare of the risk of emerging budgetary imbalancesis due to the very large projected increase in pensionexpenditure According to the EPC public spendingon pensions alone is projected to grow by 8 of GDPbetween 2000 and 2040 in Spain and 12 of GDP inGreece the highest projected increase of all EU coun-tries although both countries have submitted revisedprojections showing substantially lower increasesSpain has already achieved a budget position of lsquocloseto balance or in surplusrsquo and Greece aims at doing soin the coming two years To ensure sustainability themain challenge is to reform the public pension systemso as to contain any increase in spending as a result ofageing populations

bull In several Member States (notably Germany FranceAustria and Portugal) the risk of emerging budgetaryimbalances is a combination of factors First public

spending on pensions and healthcare in these countriesis projected to grow at or above the average rate of theEU in coming decades Secondly the pace of debtreduction is slow due to persistent and large underly-ing deficits Finally they have a relatively poor labourmarket performance and in particular low employ-ment rates of older workers and a low effective retire-ment age Addressing sustainability therefore requiresa more ambitious and comprehensive approach tack-ling all these challenges rather than the unambiguousand piecemeal approaches evident today

bull High debt countries (Belgium Greece and Italy) facea particular set of challenges in ensuring the fastreduction of debt levels At first sight the quantitativeindicators suggest that these countries appear to be rel-atively well placed to meet the costs of ageing popula-tions But the favourable development in debt levels(and consequently on interest payments) hides adegree of fiscal illusion based on an implicit assump-tion that high debt countries are able to sustain largeprimary surpluses over a long period Running theactual budget surpluses implied by such assumptionsover time may be difficult to ensure for the govern-ment as they will be faced with competing budgetarypressures for tax cuts andor increased public expendi-tures (2) In addition the debt may evolve more slowlythan planned because of stock-flow adjustments Onthis aspect the Council expressed concern about theslow pace of debt reduction in Greece and Italy since1999 due to large and persistent financial operationsbesides the unfavourable growth conditions and slip-page from budget balance targets (3)

bull Several Member States appear to have sustainablepublic finances (Denmark Luxembourg the Neth-erlands Finland Sweden and the UK) They have

yen1part The conclusion of the Stockholm European Council did not alter the goalor purpose of the SGP that is to ensure that Member States have medium-term budget positions that are lsquoclose to balance or in surplusrsquo The Com-mission and Council did not attempt to quantify what constitutes an appro-priate budget position for a Member State in light of the budgetary costs ofageing population Whether countries should set more ambitious budgettargets (including surpluses) in the coming years prior to the budgetaryimpact of ageing populations taking hold is clearly a policy issue which theECOFIN Council must address in the future Indeed several MemberStates already go beyond budget positions of lsquoclose to balance or in sur-plusrsquo and are running large surpluses with the explicit purpose of preparingfor the budgetary costs of ageing populations However the obligation onMember States under the SGP remains unchanged

yen2part An indication of this additional budgetary effort can be gauged by lookingat the required primary surplus needed to sustain a balanced budget posi-tion The Commission has calculated this using the same projected increasein age-related spending and assuming that countries achieve the budget tar-get set down in their stability and convergence programme On averageBelgium is estimated to require an average primary surplus of 3 of GDPover the 2010 to 2020 period whereas Greece and Italy would require pri-mary surpluses of 36 and 37 of GDP respectively This compares withan estimated required primary surplus of between 1 and 2 of GDP inmost other Member States with debt levels below the 60 of GDP refer-ence value

yen3part Moreover for Italy the Commission and Council noted that the relativelysmall projected increase in spending on public pensions is based upon anassumption that the reforms enacted in the 1990s are implemented in full(especially the indexation of the entitlement to prices and the adjustment ofbenefits to increases of life expectancy) and on the basis of the assumptionof a significant increase in labour force participation rates in coming dec-ades

sound budget positions and in most cases pastreform of their pension systems have strengthenedthe link between contributions and entitlementsNotwithstanding the favourable conclusion ageingpopulations will pose budgetary challenges for thesecountries The maintenance of high tax ratios at over50 of GDP in a number of Nordic countriesrequires continued public support and raises concernabout competitiveness there is also a risk that taxbases may become more mobile in the future whichmay make it more difficult for countries to raise rev-enues For the Netherlands the Council consideredthat some additional measures may be needed if theDutch authorities are to achieve the stated aim ofeliminating public debt within one generation Lux-embourg has to provide pensions to a large numberof non-residents financial sustainability will beinfluenced on the number of cross-border workersRegarding the UK the Council concluded that muchof the financial sustainability of the pension systemdepends on the performance of private pension pro-viders If private provision produces significantlyless than the anticipated coverage or level of pen-

sions future governments may face increasedclaims of means-tested benefits

bull In Ireland the indicators point a policy challengethat sooner or later needs to be addressed despitethe improvement in public finances in recent yearsA financing gap may emerge if public spending onpensions and healthcare in Ireland converge towardslevels in other EU countries and if the tax ratio as ashare of GDP remains unchanged (1)

Table I19

Policy conclusions on the sustainability of public finances

yen1part A number of important qualifications need to be made First and as recog-nised in the Commissionrsquos assessment of Irelandrsquos stability programme themedium-term budget position may be substantially better than indicated bythe programmesrsquo targets as it includes an annual transfer of 1 of GNP tothe National Pensions Reserve Fund and a contingency reserve of some06 of GNP The projected evolution of debt levels would be different ifan adjustment was made for these items Secondly there is considerableuncertainty as to what constitutes the potential growth rate of Ireland andthe time frame over which it could be expected to converge to levels seen inother EU countries The growth assumptions used in the sustainability indi-cator are prudent based on recent experience in Ireland Thirdly it shouldbe borne in mind that the tax ratio in Ireland is the lowest of all EU coun-tries and thus there is greater scope to raise taxes if necessary

Are public finances sustainable

Do the budgetary measures in the programme improve sustainability

What are the key policy measures required

BE Appears to be sustainablebut conditional upon sustain-ing large primary surpluses inthe coming decade or more

Policy of sustaining high primary surpluses shouldlead to a fast pace of debt reduction But thisneeds to be complemented with measures toraise employment rates especially amongst olderworkers as the effective retirement age is oneamongst the lowest of all EU countriesSome progress made as regards draft legislationfor setting up the framework for supplementarypensions

Sustaining high primary surplus over the long runwill be a challenge At the same time it is impor-tant that the budgetary cost of structuralreforms notably those involving tax and non-taxburden reduction be kept consistent with thetargeted budgetary adjustment and the reduc-tion of the government debt ratio be ensured

DK Appears to be sustainable Yes Comprehensive approach benefiting fromthe running of budget surpluses and a projectedaccumulation of large net assets in both pensionfunds and the government sector

The tax ratio will remain high compared to otherindustrialised countries and consideration couldbe given to further reductions in a framework ofsound public finances

DE Clear risk of emerging budg-etary imbalances

If achieved a balanced budget position by 2006would help reduce debt at a faster pace Pensionreform of 2001 has helped improve sustainabilitybut the need for further reforms cannot be ruledout

To ensure sustainability compliance with SGP assoon as possible is essential This needs to beaccompanied with far-reaching reforms to raiseGermanyrsquos very low growth potential Urgentreforms are needed not only in the labour mar-ket but also in social security and benefit systemsin general and for a reduction in the regulatoryburden of the economy

(Continued on the next page)

Table I19 (continued)

EL Clear risk of emerging budg-etary imbalances

Projected move towards a position of budget bal-ance is welcome But programme does notaddress the core issue of pension reform

Further reforms are required to the pension sys-tem to avoid an unsustainable increase in publicspending The Greek authorities are encouragedto promote supplementary privately-funded pen-sion schemes and to take measures to raise partic-ipation rates and to control the evolution of age-related expenditures

ES Clear risk of emerging budg-etary imbalances

Programme contains commitment to sustain abalanced budget position and provides informa-tion on measures to increase employment ratesMeasures to improve incentives for active ageingand private pension schemes were taken

Risk of unsustainable public finances largelystems from the projected increase in spending onpensions (despite the recent downward revisionon estimate) Reform of the pension systemplanned for in 2004 needs to address the issue offinancial sustainability

FR Clear risk of emerging budg-etary imbalances

Overall approach and in particular a failure toreach a position of lsquoclose to balance or in surplusrsquoby the end of the programme is not consistentwith a commitment to sustainable public financesSome progress however has been made asregards structural measures designed to curbexpenditures in the health sector and the actionsaiming at improving the control of budgetaryexecution in the State sector Also the Frenchauthorities announced their intention to reformpension and healthcare systems

To ensure sustainability compliance with SGP assoon as possible is essential Need to pursue theplanned reform of pension system

IE Outlying country Some riskof emerging budgetary im-balances given projected in-creases in spending on pen-sions and healthcare butthere should be scope tomeet financing challengegiven low tax rates and lowlevels of government debt

Some concern as regards projected move to deficitin coming years However when assessing sustain-ability due account should be taken of a contin-gency provision of 08 of GDP in the deficit ofthe final year of the programme and of the even-tual completion of a large programme of publicinvestment Also the gradual build up of assets inthe National Pension Reserve Fund (annual contri-bution of 1 of GNP) will help bear the budget-ary costs of an ageing population

In a good position to meet the costs of ageingpopulations given high degree of funding of pen-sions and the relatively low tax burden Howevera long-term financing challenge may arise asspending on pensions and healthcare as a shareof GDP approach levels in other EU countries

IT Clear risk of emerging budg-etary imbalances

Strategy to prepare for ageing populations givescause for concern There is a need to implement asustained path of budgetary consolidation withone-off measures replaced with structural oneson the expenditure side Council is especially con-cerned that the risks to the programme deficittargets might imply too slow a pace of reductionin the debt ratio The slowdown in the rate ofdebt reduction projected toward the end of theprogramme period also in connection with somelsquobelow the linersquo operations Italyrsquos ability to copewith the budgetary consequences of ageing isbased on implementation of the major pensionreforms adopted in the 1990s and a large increasein the participation rate

To ensure sustainability compliance with SGP assoon as possible is essential It will be necessarygiven Italyrsquos high debt to sustain primary sur-pluses in the order of 5 of GDP for many yearsAlso the goal of reducing the tax burden canonly be safely and effectively achieved within acomprehensive reform plan on both the expendi-ture and the revenue side Italian authorities areencouraged to adopt further measures to pro-mote supplementary privately-funded pensionschemes and to address the outstanding criticalissue in the public pension system namely thelong transition period to the new contributions-based system This should be coupled with themeasures necessary to raise participation ratesand to control the evolution of age-relatedexpenditures

LU Appears to be sustainable Yes comprehensive approach outlined withmeasures announced to improve the attractive-ness of third pillar private pensions

Sustainability is sensitive to the number of cross-border workers

NL Appears to be sustainable Yes comprehensive approach outlined althoughadditional measures may be needed if the Dutchauthorities are to achieve the stated aim of elimi-nating public debt within one generation Theconclusion on sustainability relies on projectedincreases in the tax ratio although in part this isdue to increases in the deferred taxes on pensionincome

The strategy hinges upon achieving a large andsustained reduction in the debt ratio which mayprove challenging during economic downturnsand in the face of competing pressures to pursueother budgetary objectives While the stabilityprogramme envisages additional savings beingmade so as to absorb the projected increase inage-related expenditures there is a lack of clarityon the precise measures which will be taken toachieve this goal

AT Clear risk of emerging budg-etary imbalances

The Council welcomes the intentions of the Aus-trian authorities to reform pension and health-care systems in light of ageing populations How-ever a greater degree of budgetary ambition isrequired and Austria should complete the transi-tion to a position of budget balance in line withSGP requirements without delay

Need to sustain sound public finances and possi-bly consider further reform of pensions It is vitalto put into operation the planned pensionreform since the measures outlined in the updateaddress many of the key problems

PT Clear risk of emerging budg-etary imbalances

The programme sets down an ambitious pro-gramme for budgetary consolidation which ifsuccessful would make a significant improve-ment to the sustainability of public finances

To ensure sustainability compliance with SGP assoon as possible is essential Also essential to pro-ceed with reforms to achieve a better control ofpublic expenditures at all levels of governmentand in particular in the healthcare system

FI Appears to be sustainable Yes comprehensive approach outlined benefitingfrom the sustained running of budget surplusesand a reformed pension system that has a highdegree of pre-funding Programme also containsinformation of reforms both planned and under-way which aim at raising employment rates ofolder workers

The tax ratio in Finland is high compared withother industrialised countries A major challengewill be to carry out the planned tax reformswhile safeguarding the achievements of the pastdecade of placing public finances on a sustainablefooting

SE Appears to be sustainable Yes comprehensive approach outlined benefitingfrom the sustained running of budget surplusesof 2 of GDP up to 2015 and a reformed pen-sion system that automatically limits futureexpenditure growth

Policy aim of running large surpluses may provedifficult over a long time period A challenge willbe to complete the tax reform while safeguard-ing the achievements of the past decade of plac-ing public finances on a sustainable path

UK Appears to be sustainable The deficit targets in the programme raise someconcern as regards the sustainability of publicfinances A budgetary position of a limited deficitin the medium term would help avoid any risk ofemerging budget imbalances in the context ofageing populations and give greater assurance tothe programme view that lsquothe public financesbased on current policies are sustainable in thelong-termrsquo

Much of the financial sustainability of the pen-sion system depends on the performance of pri-vate pension providers If private provision pro-duces significantly less than the anticipatedcoverage or level of pensions future govern-ments may face increased claims of means-testedbenefits

Source Based on the policy conclusions in the Commissionrsquos assessment of the 2002 updates to stability and convergence programmes and the respective opinions of the Council

4 Budgetary developments in candidate countries

41 Short-term budgetary developments and prospects in candidate countries

In 2002 the aggregate budget position of the 13 candi-date countries (CC-13) (1) improved but only due to theexceptional advance recorded in Turkey (see Table I20) (2)The aggregate general government deficit of the 10 coun-tries set to become EU members in May 2004 (AC-10)widened This deterioration occurred despite the fact thataggregate growth for the AC-10 continued at roughly thesame pace as in 2001 (3)

Aggregate budget positions are projected to improve forall country groupings in 2003 and 2004 Despite a signif-icant acceleration in growth however the projectedreduction in the aggregate deficit of the AC-10 is not suf-ficient to reverse the deterioration recorded in 2002 Thissuggests that structural rather than cyclical factorsunderlie current budgetary imbalances

Due caution however should be taken when interpret-ing budgetary trends for the CC-13 Despite significantprogress budgetary data for these countries are still notfully comparable across countries nor completely in linewith EU definitions (see Box I2) Significant revisionsin the budget positions of these countries are still possi-

ble and from a methodological point of view aggregat-ing country figures is only possible to a limited degree

Aggregate figures tend to hide the differences amongindividual countries Outcomes for 2002 range from adeficit of 137 of GDP in Turkey to a surplus of 13 of GDP in Estonia (see Table I20) Relative to 2001 thebudgetary position worsened in seven countries mdash andby more than 1 of GDP in the majority of cases Themost noticeable improvement was recorded in the caseof Turkey followed by Romania and Estonia

Among the seven countries undershooting the budgetarytargets for 2002 set out in their pre-accession economicprogrammes (PEPs) of 2002 Cyprus Malta and aboveall Hungary missed their objectives by a rather largeamount (see Table I20) (4) Five countries on the otherhand overachieved their targets most notably Estoniawhich further increased its surplus position despite hav-ing originally planned to run to a small deficit

In most cases country-specific factors rather than gen-eral macroeconomic trends seem to lie behind countriesrsquobudgetary performance relative to targets Electoraldynamics for instance appear to have played a relevantrole in the case of some of the countries missing theirPEP targets such as Hungary Latvia and the SlovakRepublic Statistical reclassifications and one-off meas-ures also played a part most notably in the case ofHungary (5)

yen1part The CC-13 are Bulgaria Cyprus the Czech Republic Estonia HungaryLatvia Lithuania Malta Poland Romania the Slovak Republic Sloveniaand Turkey The AC-10 exclude Bulgaria Romania and Turkey

yen2part Accounting factors underpin this improvement At 137 of GDP Tur-keyrsquos general government deficit remained very high in 2002 but nearlyhalved relative to 2001 when expenditures were boosted on a one-off basisby the inclusion (in a single year) of the large transfers to the agriculturalsector that had been channelled through the banking system in previousyears

yen3part The sources for all figures used in this section are the 2002 pre-accessioneconomic programmes the 2002 fiscal notification and the Commissionforecast of spring 2003 Given the cut-off data for the preparation of thisreport new and revised budgetary data reported to the Commission in thecontext of the 2003 fiscal notification exercise could not be taken intoaccount

yen4part Following elections the new government of the Slovak Republic formallyrevised upwards its PEP deficit targets prior to the finalisation of the Com-missionrsquos assessements The Slovak Republic is projected to have compliedwith its revised deficit target for 2002 which was 32 of GDP higherthan in the original PEP submission

yen5part Reclassifications also contributed to the upward revision of the PEP deficittarget of the Slovak Republic

Growth on the other hand did not influence budgetaryperformances uniformly across countries For instanceof the eight countries for which growth in 2002 turnedout higher than envisaged in the PEP framework (seeTable I21) only five achieved a better than targetedbudgetary balance (1)

Looking ahead to 2003 and 2004 the Commissionspring 2003 forecast envisages an improvement in thebudgetary balances of eight countries with particularlymarked deficit reductions in the cases of TurkeyHungary the Slovak Republic and to a more limitedextent Malta (see Table I20) With Estonia projected tomove from a surplus to a small deficit position a rela-tively small deterioration is also expected in the case ofLithuania and Latvia Relative to 2002 country positionswould become less diverse with deficits ranging from06 of GDP in the case of Estonia to 69 in Turkey

Box I2 Candidate countriesrsquo budgetary data and EU standards

The data utilised in this section approximate ESA95 definitions for the general government statistics as much as possibleHowever due to methodological and data availability problems this is only partially possible As the harmonisation ofstatistics progresses significant revisions of general government deficits may be needed Problems of comparability alsoaffect data on the level of total expenditure and revenue and their components

In estimating the data used in this section the Commission services relied upon the government deficit and debt figuresreported in the 2002 fiscal notifications Candidate countries have been formally notifying fiscal statistics to the Commis-sion since 2001 using the same format and aiming at producing the same data as the notifications provided by the MemberStates in the framework of the excessive deficit procedure By completing this exercise candidate countries are becomingfamiliar with the technical and quantitative requirements they will have to apply as soon as they become Member States

The April 2002 fiscal notifications showed that a majority of countries were well advanced in the application of the EUmethodology However further work was still required in all cases and progress remained uneven In particular Estoniashowed a degree of good practice the Czech Republic Hungary Latvia Malta Poland the Slovak Republic and Sloveniawere well advanced in the application of the EU methodology and significant work was still necessary in Bulgaria CyprusLithuania Romania and Turkey

The following issues raised particular concerns

bull While the exhaustiveness of general government statistics had been improved by integrating the activities of privatisationagencies and debt consolidation institutions as well as the quasi-fiscal activities of public enterprises and financial institu-tions further work was still necessary to verify that reclassified revenue and expenditure items were completely and correctlytaken into account

bull Despite a more extensive reliance on accrual figures these often constituted only preliminary estimates In many casesthe correct statistical treatment of large tax and social contribution arrears posed a particular challenge

bull There remained a need to determine with greater precision the component of budgetary support to the enterprise sectorthat constituted a transfer element

bull The classification of compulsory pension funds either within the social security sub-sector of the general governmentor within the insurance sector remained an open question

Candidate countries notified new figures in April 2003 This new set of fiscal notifications is expected to show furtherprogress in the quality and comparability of CC-13 government deficit and debt figures However this report could nottake them into account as their assessment by the Commission services was still ongoing at the time of publication

yen1part These were Bulgaria Estonia Lithuania Romania and the Slovak Repub-lic A diverse picture also emerges if one compares budgetary performancewith the difference between actual and projected nominal GDP growth

Table I20

General government balances in candidate countries ( of GDP)

Actual Forecast PEP target

2001 2002 2003 2004 2002 2004

CY ndash 30 ndash 35 ndash 40 ndash 35 ndash 26 ndash 06

CZ ndash 55 ndash 65 ndash 63 ndash 59 ndash 64 ndash 57

EE 05 13 ndash 05 ndash 06 ndash 02 00

HU ndash 42 ndash 91 ndash 49 ndash 37 ndash 57 ndash 30

LV ndash 19 ndash 25 ndash 29 ndash 26 ndash 18 ndash 22

LH ndash 23 ndash 18 ndash 19 ndash 20 ndash 19 ndash 16

MT ndash 70 ndash 61 ndash 52 ndash 41 ndash 52 ndash 39

PL ndash 31 ndash 42 ndash 42 ndash 40 ndash 41 ndash 33

SK ndash 54 ndash 77 ndash 53 ndash 38 ndash 78 ndash 38

SI ndash 25 ndash 18 ndash 15 ndash 12 ndash 18 ndash 10

AC-10 ndash 37 ndash 53 ndash 44 ndash 39 ndash 47 ndash 34

BG 04 ndash 07 ndash 06 ndash 05 ndash 08 ndash 05

RO (1) ndash 33 ndash 24 ndash 24 ndash 24 ndash 27 ndash 24

TR ndash 289 ndash 137 ndash 98 ndash 69 ndash 131 ndash 29

CC-13 ndash 124 ndash 71 ndash 57 ndash 45 ndash 66 ndash 31

(1) For Romania 2003 spring forecast adjusted to estimated ESA95 balance

Source Commission spring 2003 economic forecasts and 2002 PEPs

Table I21

GDP growth in candidate countries ( pa)

2002 Average 2003ndash04

Forecast PEP Difference Forecast PEP Difference

CY 20 28 ndash 08 29 46 ndash 17

CZ 20 30 ndash 10 33 38 ndash 05

EE 56 43 13 50 58 ndash 08

HU 33 40 ndash 07 39 45 ndash 06

LV 61 50 11 57 56 01

LH 59 47 12 47 54 ndash 06

MT 30 33 ndash 03 34 33 01

PL 13 10 03 31 40 ndash 09

SK 44 38 06 41 42 ndash 01

SI 30 36 ndash 06 36 44 ndash 08

AC-10 24 25 00 35 42 ndash 07

BG 43 40 03 47 51 ndash 04

RO 49 45 04 49 54 ndash 04

TR 78 39 39 41 50 ndash 09

CC-13 43 31 12 39 46 ndash 07

Source 2002 PEPs and Commission services

According to the projections six countries among theAC-10 would have a general government deficit above3 of GDP in 2004

As a result of the trends outlined above the Commissionforecasts that all countries will miss the 2004 targets setout in the 2002 PEPs with the exception of BulgariaRomania and the Slovak Republic (see Table I20)Targets would be missed by a particularly significantamount in the cases of Turkey Cyprus and to a muchmore limited extent Hungary and Poland Various fac-tors drive these developments including the slippagefrom the targeted adjustment path accumulated by sev-eral countries in 2002 and the worsening of economicprospects (1) Moreover in some cases like Latvia gov-ernments have modified their medium-term budgetarytargets following the submission of the 2002 PEPsFinally in the case of Turkey less optimistic assump-tions on the projected decline of interest rates explain alarge part of the divergence between the Commissionforecast and the PEP targets More information on thelatter is provided in the following section

42 Overview of the 2002 updates of the pre-accession economic programmes

421 Introduction

The examination of the second set of pre-accession eco-nomic programmes (PEPs) submitted by candidate coun-tries within the framework of the pre-accession fiscalsurveillance procedure (see Box I3) was completed inNovember 2002

Compared to the PEPs submitted for the first time bycandidate countries in 2001 the 2002 updates revealed agood and improved effort to develop a consistent andcredible medium-term macroeconomic framework Theprogrammesrsquo information content and their comparabil-ity across countries was greatly enhanced by the presen-tation of data through standardised tables based uponthose envisaged under the code of conduct for currentMember States as well as by the provision of detailedestimates of fiscal variables in principle according toESA95 methodology (2)

yen1part For all countries except Latvia and Malta the average growth rate over the2003ndash04 period is projected to fall below that envisaged in the 2002 PEPs(see Table I21)

yen2part The only exception was Turkey which provided budgetary data based uponGFS methodology Apart from Cyprus Lithuania and Romania all countriesupdated the estimates presented in the fiscal notification of April 2002

Box I3 The pre-accession fiscal surveillance procedure for candidate countries

In line with the call for the establishment of an annual fiscal surveillance for the candidate countries contained in the 1999and 2000 accession partnerships the so-called pre-accession fiscal surveillance procedure was established in 2001 ThePFSP aims at preparing the candidate countries for the participation in the multilateral surveillance and economic policycoordination procedures currently in place in the EU as part of economic and monetary union

As explained in European Commission (2002a) the PFSP has three components

1 The notification of budget positions mdash requires candidate countries to report data on their general government def-icits and debt in the same format as that used by existing Member States Notifications are then evaluated by the Com-mission services in order to monitor the countryrsquos fiscal positions determine compliance with ESA95 standards andassess their quality as a basis for fiscal analysis

2 The pre-accession economic programmes mdash are submitted on an annual basis by each candidate country for theCommissionrsquos evaluation PEPs have two main aims First to outline the medium-term policy framework includingpublic finance objectives and structural reform priorities needed for EU accession Second they offer an opportunityto develop the institutional and analytical capacity necessary to participate in EMU with a derogation from the adop-tion of the euro upon accession particularly in the areas of multilateral surveillance and coordination of economicpolicies

While all programmes reflected the main challengesahead for the acceding countries the degree of detailedanalysis differed across countries and policy areas as didthe specificity and credibility of the medium-term eco-nomic and fiscal scenarios A rather common problemwas that the costs of structural reforms were insuffi-ciently quantified and integrated in the budgetary frame-work More generally further analytical capacity-build-ing still seemed required for all countries More detailedinformation on the sources of fiscal risks the budgetarycosts of on-going reforms the long-term sustainabilityof public finances and cyclically-adjusted budget bal-ances also appeared to be needed

422 Medium-term budgetary developments

The medium-term macroeconomic framework for the2002 PEPs covers the period 2001 to 2005 For mostcountries the framework envisages accelerating growthdeclining inflation and persisting external imbalances(see Table I22) Although growth projections were gen-erally revised downwards relative to the 2001 PEPs inview of the deterioration in the international economicenvironment growth is generally expected to acceleratein the period 2002ndash05 relative to 2001 (1)

Against this background and taking as a starting pointthe 2001 general government balances most budgetaryplans presented in the 2002 PEPs envisage an improve-ment by 2005 with nine countries planning to reducetheir budget deficits by 2005 thus leading to a fall in theaverage deficit for both the CC-13 and the AC-10 (seeTable I23) Among the four remaining countries Bul-

garia and Estonia plan to move from a small surplus to abalanced budget leaving only Latvia and the CzechRepublic with a projected increase in the general govern-ment deficit over the programme period In the case ofthe Czech Republic in particular the budget deficit wasprojected to increase from 5 of GDP in 2001 to 55 of GDP in 2005 after peaking at 64 in 2002 In 2005projected budget outcomes would vary from a balancedbudget in Bulgaria and Estonia to a deficit of 55 ofGDP in the Czech Republic Among the AC-10 only theCzech Republic and Malta refrained from targeting adeficit below 3 of GDP in 2005

Primary balances are also projected to improve over theprogramme period both on average and for the majorityof individual countries After being projected to worsenin eight cases over 2002 in fact by 2005 primary bal-ances are targeted to improve relative to 2001 for eightcountries The Czech Republic and Latvia would then bethe only countries left running a primary deficit

Compared to the 2001 PEPs eight countries presentedless ambitious budgetary paths in the 2002 updates lead-ing to a deterioration in the average deficit target for theAC-10 over the 2002ndash04 period Among the factorsunderpinning these revisions the reassessment of eco-nomic growth prospects does not seem to have played aconsistently relevant role (2) Contrary to what one mayexpect in fact lower growth projections are met byhigher deficit targets in only five cases out of nine (andto a significantly different degree in each of these)

Box I3 (continued)

3 The discussions in a multilateral context mdash allow present and prospective Member States to jointly debate the fiscalnotifications the PEPs and their evaluation by the Commission Discussions take place in two steps First at a high-level meeting between the member of the Economic and Financial Committee and their counterparts from candidatecountries Secondly at a yearly ministerial meeting between Ecofin and their counterparts

In this context on 5 November 2002 ministers concluded inter alia that lsquosound and credible fiscal policy is crucial notonly for coping with difficult economic policy choices but also for enhancing confidence in the stability of the macro-economic policy framework The weak fiscal positions of several acceding countries argue strongly for taking decisivesteps towards sustainable fiscal consolidation in line with the EUrsquos fiscal surveillance procedures inter alia so as to createroom for private investment Effective public expenditure management and efficient tax collection should be central ele-ments of any consolidation programme Long-term challenges due to ageing populations have also to be factored inrsquo

yen1part Even when a deceleration is expected as in the cases of Latvia Lithuaniaand Romania the average rate of growth is projected to remain above 5

yen2part Other potential factors include a worse starting position than originally tar-geted in the 2001 PEPs methodological changes in the statistics for thegeneral government sector and of course changes in the political willing-ness to pursue the budgetary targets originally set out in the 2001 PEPs

Table I22

Macroeconomic projections in the 2002 PEPs

Real GDP growth(Annual percentage change)

Consumer price inflation (Annual percentage change)

Current account balance(percentage of GDP)

2001 2002ndash05 (1) Revision (2) 2001 2005 2001 2005

CY 40 42 ndash 06 20 20 ndash 43 ndash 14

CZ 33 37 ndash 03 47 34 ndash 46 ndash 35

EE 50 55 ndash 06 58 35 ndash 61 ndash 64

HU 38 46 ndash 12 92 30 ndash 22 ndash 33

LV 77 55 ndash 03 25 30 ndash 97 ndash 67

LH 59 53 03 13 41 ndash 48 ndash 70

MT ndash 08 34 01 29 24 ndash 50 ndash 24

PL 10 36 ndash 03 55 31 ndash 41 ndash 57

SK 30 43 00 71 45 ndash 86 ndash 42

SI 33 44 ndash 05 84 46 ndash 04 02

AC-10 25 40 ndash 04 59 33 ndash 43 ndash 46

BG 40 49 ndash 14 74 35 ndash 60 ndash 52

RO 53 51 ndash 02 345 80 ndash 59 ndash 35

TR ndash 74 47 na 544 98 23 ndash 08

CC-13 ndash 01 43 na 228 56 ndash 26 ndash 34

(1) Annual average over the period 2002ndash05 (2) Difference between the average rate of growth over the period 2002ndash04 in the 2001 and 2002 PEPs

Source 2001 and 2002 PEPs Commission services

Table I23

General government balances in the 2002 PEPs ( of GDP)

Nominal balance Primary balance Cyclically-adjusted balance (3)

2001 2005 Change Revision (2) 2001 2005 Change 2001 2005 Change

CY ndash 30 ndash 03 27 ndash 09 26 48 22 na na na

CZ ndash 50 ndash 55 ndash 05 ndash 15 ndash 38 ndash 36 02 ndash 53 ndash 56 ndash 03

EE 02 00 ndash 02 06 05 03 ndash 02 na na na

HU ndash 41 ndash 25 16 17 02 07 05 na na na

LV ndash 16 ndash 20 ndash 04 ndash 13 ndash 10 ndash 11 ndash 01 ndash 19 na na

LH ndash 19 ndash 15 04 ndash 02 ndash 02 00 02 na na na

MT ndash 70 ndash 31 39 ndash 01 ndash 34 02 36 ndash 68 ndash 27 41

PL ndash 35 ndash 22 13 ndash 08 ndash 06 15 21 ndash 36 ndash 26 10

SK (1) ndash 54 ndash 20 34 ndash 04 ndash 20 04 24 ndash 39 ndash 27 12

SI ndash 25 ndash 08 17 ndash 07 ndash 05 09 14 ndash 18 09 27

AC-10 ndash 38 ndash 27 11 ndash 05 ndash 11 03 14 na na na

BU 04 00 ndash 04 08 41 32 ndash 09 na na na

RO ndash 34 ndash 24 10 05 07 02 ndash 05 ndash 31 ndash 23 08

TR ndash 151 ndash 05 146 na 86 78 ndash 08 na na na

CC-13 ndash 66 ndash 19 47 na 19 24 05 na na na

(1) Figures for the Slovak Republic refer to the first draft of its 2002 PEP because its officially revised draft did not include a full set of figures The revised deficit targetfor 2005 equals 33 of GDP

(2) Difference between annual averages over the 2002ndash04 period in the 2001 and the 2002 PEPs(3) Countriesrsquo own estimates as presented in the 2002 PEPs

Shedding more light on this issue would require relia-ble indicators of cyclically-adjusted balances but onlya few countries provided some preliminary estimates inthis regard in their 2002 PEPs Moreover these figuresstill need to be interpreted with considerable cautionThe institutional capacity to estimate cyclically-adjusted balances in fact is still being developed whileshort time series and strong structural changes make itdifficult to isolate structural relationships With thesole exception of the Slovak Republic however theestimates provided would indicate that the budget defi-cits recorded in 2001 were generally equal to the struc-tural deficits With the cyclical component of thebudget playing a relatively small role in the plannedadjustment structural changes in revenue and expendi-ture would be required to achieve the targets set out inthe 2002 updates

In line with decreasing deficits and high nominal GDPgrowth (see Table I24) most countries expect theirgeneral government debt-to-GDP ratios to fall andsharply so in the cases of Turkey and Bulgaria Theonly significant exceptions are the Czech Republic andPoland where the debt-to-GDP ratio is projected to riseconsiderably by the end of the programme period Nev-ertheless according to the projections presented in thePEPs by 2005 all countries would have a debt-to-GDP

ratio below 60 except Malta and Turkey In both ofthese cases however the ratio would be on a decliningtrend

Table I24

General government debt in the 2002 PEPs ( of GDP)

2001 2005 Change

CY 546 512 ndash 34

CZ 236 347 111

EE 48 37 ndash 11

HU 530 500 ndash 30

LV 159 180 21

LH 231 231 00

MT 653 611 ndash 42

PL 387 456 69

SK 430 381 ndash 49

SI 275 244 ndash 31

AC-10 369 409 ndash 41

BU 663 463 ndash 200

RO 233 260 27

TU 1228 730 ndash 498

CC-13 599 483 ndash 116

Source 2002 PEPs and Commission services For the Slovak Republic first ver-sion of the 2002 PEP

Table I25

General government revenue and expenditure in the 2002 PEPs ( of GDP)

Revenue Expenditure

2001 2005 Change 2001 2005 Change

CY 405 422 17 435 425 ndash 10

CZ 421 413 ndash 07 471 468 ndash 03

EE 386 384 ndash 02 384 384 00

HU 461 425 ndash 36 502 450 ndash 52

LV 414 386 ndash 28 430 406 ndash 24

LH 342 361 19 361 376 15

MT 374 358 ndash 17 444 388 ndash 56

PL 418 422 04 453 445 ndash 08

SK 412 398 ndash 14 466 418 ndash 48

SI 431 425 ndash 06 456 433 ndash 23

AC-10 421 415 ndash 06 459 442 ndash 17

BU 406 350 ndash 56 403 350 ndash 53

RO 367 346 ndash 21 401 370 ndash 31

TU 421 401 ndash 20 572 406 ndash 166

CC-13 415 402 ndash 13 482 422 ndash 60

Source 2002 PEPs and Commission services For the Slovak Republic first PEP version

423 Composition of the adjustment

The 2002 PEPs show that most countries plan to reducethe size of the general government sector in terms of bothrevenue and expenditure ratios (see Table I25) Averag-ing some 13 of GDP the planned reduction in reve-nues appears particularly sharp in the cases of BulgariaHungary and Latvia Only Cyprus Lithuania and Polandforesee an increase in revenues over the programmeperiod As regards the composition of these changes anumber of countries including Bulgaria HungaryLatvia and Lithuania expect a significant cut in taxreceipts often due to sizeable reductions in direct taxesand company taxation in particular Being bound by spe-cific acquis provisions the changes in indirect taxes aremore limited (1)

With the planned reduction in the revenue ratio tending toincrease budget deficits the targeted improvements inbudgetary balances generally hinge upon a relatively

sharper reduction in the expenditure ratio (see Table I25)All countries programme a reduction in their expenditureratio with the exception of the two with the lowest ratio in2001 that is Estonia and Lithuania Reduction targetsappear particularly ambitious in the case of BulgariaHungary Malta and the Slovak Republic mdash each aimingto cut outlays by some 5 of GDP mdash and Turkey

Turkey however constitutes a special case as theplanned cut in the expenditure ratio by nearly 17 percent-age points of GDP is almost fully accounted for by thedramatic fall in interest payments expected to follow thenormalisation of its macroeconomic situation In theother countries instead planned budgetary retrenchmentis driven in most cases by cuts in current expendituresand collective consumption in particular (see Table I26and Graph I10)

Most of the PEPs also envisage a gradual reduction insubsidies but only marginally in the Czech RepublicHungary and Poland that is three of the five countrieswhere in 2001 subsidies amounted to more than 2 ofGDP With the sole exception of Poland and to a lesser

yen1part Most of the adjustments required by the acquis in the area of VAT havealready been made whereas in many countries there is still further need foradjustment in the area of certain excise duties (such as for tobacco)

Table I26

Composition of general government expenditure in the 2002 PEPs ( of GDP)

Social transfers SubsidiesGross fixed capital

formationOthers including

interest

2001 2005 Change 2001 2005 Change 2001 2005 Change 2001 2005 Change 2001 2005 Change

CY 97 78 ndash 19 149 157 08 16 06 ndash 10 37 37 00 136 147 11

CZ 81 81 00 245 245 01 28 26 ndash 02 50 47 ndash 03 68 70 02

EE 202 193 ndash 09 111 109 ndash 02 08 10 02 34 43 09 29 29 00

HU 101 82 ndash 19 214 234 20 29 24 ndash 05 51 39 ndash 12 107 71 ndash 36

LV 84 na na 229 na na 11 na na 41 na na 65 na na

LH 72 81 09 227 233 06 07 07 00 22 28 06 33 27 ndash 06

MT na na na na na na na na na na na na na na na

PL 72 66 ndash 06 251 235 ndash 16 25 24 ndash 01 26 25 ndash 01 79 95 16

SK 100 80 ndash 20 186 194 08 12 10 ndash 03 27 22 ndash 05 140 118 ndash 23

SI 81 74 ndash 06 180 173 ndash 07 14 13 ndash 01 25 24 00 157 149 ndash 09

AC-10 (1) 83 76 ndash 08 231 227 ndash 04 24 22 ndash 02 34 31 ndash 03 88 88 00

BU 98 82 ndash 16 142 142 00 24 13 ndash 11 35 29 ndash 06 104 84 ndash 20

RO 63 53 ndash 10 99 99 00 21 16 ndash 05 32 40 08 186 162 ndash 24

TU 175 162 ndash 13 91 90 ndash 01 09 10 01 42 43 01 ndash 317 ndash 305 12

CC-13 (1) 107 97 ndash 10 176 173 ndash 03 19 17 ndash 02 36 35 ndash 01 ndash 13 ndash 13 00

(1) Weighted averages excluding Latvia and Malta

extent Slovenia social transfers (1) would not be cut sig-nificantly in any country and would actually increasequite markedly in Hungary Apart from the latter publicinvestment would be mostly shielded from expenditurecuts with the (unweighted) average public investmentratio remaining around 35 of GDP (2) Over the2002ndash05 period the average ratio of government grossfixed capital formation to GDP would be above 4 inthe case of the Czech Republic Estonia Hungary andTurkey

424 Other considerations

When viewed against the rigidity of primary expenditurerecorded in the past (3) the fall in expenditure ratiosrequired to achieve the deficit and revenue reduction tar-gets of the 2002 PEPs highlight the difficult task facedby the authorities in implementing their fiscal plansCompounding this challenge and arguably weakening

the programmesrsquo credibility expenditure cuts are back-loaded in a large majority of the PEPs In only threecases expenditures are expected to be already cut in2002 and only Hungary Malta and Romania aim toachieve a large share of total expenditure adjustment in2003 In seven cases half or more of the total expendi-ture cuts would have to be implemented in 2004 and2005 In addition as shown in Section 12 the Commis-sion 2003 spring forecast indicates that 11 countries outof 13 would fail to meet the PEP budgetary goals for2004 An even larger adjustment than planned in the2002 PEPs would therefore have to be implemented in2005 to achieve the programmesrsquo end-targets

Quite apart from the possibility of partial implementa-tion a wide range of risks to countriesrsquo budgetary plansare identified in the 2002 PEPs most of which stress thedanger posed by governmentrsquos off-budget liabilities Interms of overall stocks of guarantees these seem to berelatively high in Malta and Romania moderate inCyprus the Czech Republic Hungary Lithuania andSlovenia and relatively low in the other countries forwhich information is provided Of course the assess-ment of underlying fiscal risks cannot rely solely on thelevel of the existing stock of guarantees Yet only a few

Graph I10 Contributions to change in budgetary position 2001ndash05 (1) (in points of GDP)

(1) Source 2002 updates of the pre-accession economic programmes A positive value indicates a positive contribution to the change in budgetary positionA positive value for the total variation of the budgetary position (figure presented in bold) implies an improvement of the balance For LV primary cur-rent expenditure refers to total expenditure as no data were provided for interest payment and gross fixed capital formation in 2005 For MA no dataavailable on gross fixed capital formation

yen1part In kind and other than in kindyen2part In Hungary cuts in gross fixed capital formation (from 51 of GDP in

2001 to 39 of GDP in 2005) would account for nearly a quarter of theplanned reduction in the expenditure ratio However Hungaryrsquos publicinvestment ratio was the highest among accession candidates in 2001 andwould remain above the (unweighted) average for the group in 2005

yen3part See World Bank (2002)

countries provided information on the estimated annualbudgetary impact stemming from these contingent liabil-ities making this a key area for the provision of furtherinformation in the next PEP updates (1)

This also applies to the assessment of the long-term sus-tainability of acceding countriesrsquo public finances For thefirst time in 2002 countries were asked on a voluntarybasis to provide data in this regard along the format pro-vided for Member Statesrsquo convergence and stability pro-grammes Only very few countries however provided(incomplete) data

Almost all countries however identified the reform ofthe pension system as one of the key domestic policyareas linked to medium-term fiscal sustainability Inmost cases in fact long-term demographic projectionssuggest that the first (compulsory non-funded) pillar ofthe pension system would become overburdened thusconstituting a source of medium-term budgetary risks Inview of this trend all countries either intend to reformtheir first pillar or have recently done so notably bymatching individual benefits more closely to individualpast contributions and in same cases by raising theretirement age or by adjusting pension indexation rulesAbout half of the candidate countries have introduced amulti-pillar pension system with several others planningto do so (see Table I27) (2)yen1part As for the other identified risks these appeared to be more country-spe-

cific Lithuania for instance highlighted additional risks linked to hard-to-predict remaining costs of the transition process such as those stemmingfrom the restitution of savings and real estate ownership rights the debts ofState-owned enterprises and the decommissioning of the Ignalina nuclearpower plant Restitution issues could also represent a significant share ofGDP under the most pessimistic scenarios presented in the Polish PEPRomania identified policy failures linked to the non-elimination of quasi-fiscal deficits or to additional bank bailouts as the main fiscal risk

yen2part Healthcare reform is another area high on the agenda in most countrieswith considerable implications for the long term sustainability of publicfinances Planned and on-going reforms often include the introduction of amixed publicndashprivate model for insurance and health services provision

Table I27

Main measures in the PEPs concerning pension reform

Introduction of mandatory funded-pillar

Planned reforms

Bulgaria radic Balance 1st pillar by 2007Increase contribution compliance

Cyprus radic Increase contribution to 1st pillar in framework of tax reform

Czech Republic times Reform planned but no details in PEP

Estonia radic None new lower estimates of costs of introduction of 2nd pillar scheme on 1st pillar scheme

Hungary radic Increase contribution rate to 2nd pillarMake 2nd pillar compulsory for new entrants

Latvia radic Increase retirement age further

Lithuania times Introduction of 3 pillar system planned in 2004

Malta times Reform 1st pillar planned

Poland radic Administrative and legal changes to 1st pillar and interaction with 2nd pillar

Romania times Introduction of 3 pillar system is being discussed

Slovak Republic times Parametric reforms of 1st pillarIntroduction of 3 pillar system planned privatisation revenue planned to fund transition cost

Slovenia times None

Turkey times None

Part II

Evolving budgetary surveillance

Summary

The year 2002 and the early part of 2003 has been a dif-ficult period as regards the implementation of the EUframework for fiscal surveillance With nominal deficitsbreaching the 3 of GDP reference value Germany andPortugal have been placed in excessive deficit positionsAn early-warning was issued to France in January 2002but subsequent data revealed that a nominal deficit of31 of GDP was recorded in 2002 and the Commis-sion has consequently recommended that France beplaced in an excessive deficit position

A number of lessons can be drawn from these first expe-riences with the enforcement mechanisms of the Treatyand SGP Firstly the credibility in the rules-basedframework was not aided by the Councilrsquos failure toissue an early-warning in February 2002 to Germany andPortugal the recent experience with France furtherunderlined the need for early-warnings to be sent wellbefore nominal deficits are close to 3 of GDP Sec-ondly the repeated upward revisions of deficits under-lined the importance of strengthening the process of col-lection and verification of budgetary statistics Thirdlyand on a positive note surveillance at EU level (with itsbinding deadlines for reporting data and the role of theCommission in providing a neutral assessment of com-pliance with agreed budgetary targets) has prompteddebates at Member State level on the need to face up todifficult budgetary policy challenges In the case of Por-tugal and Germany action at EU level has arguablyfacilitated the introduction of painful reforms necessaryto prevent public finances from entering unsustainablepaths the French authorities however have to datefailed to take measures to address the growing budgetaryimbalances despite these becoming apparent already inmid-2002

In response to these developments and in line with amandate from the Barcelona European Council conclu-sions the Commission adopted a communication onstrengthening coordination of budgetary policies Itidentified a number of shortcomings with the implemen-

tation of the SGP in the first four years of EMU and out-lined a strategy that called for more account to be takenof underlying economic conditions when assessingbudgetary positions an interpretation of compliancewith SGP requirements which would (depending oncountry-specific circumstances) cater for the budgetaryimpact of reforms that enhance growth and employmentincreasing the emphasis placed on the sustainability ofpublic finances and outstanding debt positions andimproving the implementation of the SGP includingstricter and more timely recourse to the existing enforce-ment instruments At the same time the Commissionadopted proposals to improve the governance of budget-ary statistics

The spring European Council of March 2003 endorseda report of the (Ecofin) Council which shared many ofthe Commissionrsquos proposals on strengthening the coor-dination of budgetary policies It confirmed that theachievement of a budget position of lsquoclose to balance orin surplusrsquo is in the economic self-interest of MemberStates both individually and collectively In addition theCouncil agreed that compliance with the lsquoclose to bal-ance or in surplusrsquo requirement should be assessed incyclically-adjusted terms with due account taken of one-off budgetary measures which only have a transitoryimpact on budget positions For euro-area countriesagreement was reached that Member States with deficitsshould achieve an annual improvement in the cyclically-adjusted budget deficit of at least 05 of GDP until thelsquoclose to balance or in surplusrsquo requirement is reached Itunderlined the need for automatic stabilisers to operatesymmetrically over the economic cycle and the particu-lar importance of avoiding a pro-cyclical loosening offiscal policies in good times The Council also confirmedthe importance of running down public debt at a satisfac-tory pace towards the 60 of GDP reference value andthat the existing provisions of the Treaty (that is the debtcriterion of the excessive deficit procedure) can contrib-ute to achieving this goal

A debt-to-GDP ratio below 60 (or on a decreasingpath) is warranted to ensure that public finances are on asustainable footing in the light of the projected budget-ary impact of ageing populations In addition the reduc-tion of government debt will create room to pursue othereconomic and social goals in particular to enhance eco-nomic growth High debt levels also leave the creditstanding of the country vulnerable to unfavourable eco-nomic circumstances The challenge now is to operation-alise the debt criterion of the EDP When assessing debtdevelopments careful attention should be devoted to allthe factors which determine its dynamics so as to evalu-ate to what extent debt developments are due to factorsoutside the immediate control of governments It isindeed essential to avoid a too mechanistic approach toassess compliance with the debt criterion

Budgetary statistics are the foundation of the EU fiscalsurveillance tools and their quality has improved consid-erably over the last decade Government accounts are nowmore reliable complete transparent and detailed and arepublished in a much more timely fashion than when theexcessive deficit procedure was set up However someweaknesses remain in several countries data on govern-

ment deficit and debt ratios are not yet as reliable as theyshould be and are subject to large revisions Furthermorethe government accounts of several Member States are notfully transparent and there have been problems in termsof their timely submission These concerns are clearlyamplified with the perspective of enlargement To addressoutstanding challenges the (Ecofin) Council recentlyagreed to implement a code of best practice From theMember Statesrsquo side this involves increasing the transpar-ency of government accounts in particular for the lowergovernment subsectors the strict respect of deadlines andan overall increase in data quality but also a clarificationof the independence statute of the national statisticaloffices as the main compilers of government data TheCommission (Eurostat) is aiming at reinforcing its abilityto scrutinise the Member Statesrsquo government accounts inmore detail and accelerating the decision-making processfor deciding upon the recording of government transac-tions The new steps to compile quarterly budgetary statis-tics is a major challenge for statisticians but also for econ-omists policy-makers and budgetary policy analysts whowill need to interpret quarterly data with due care sincethese will necessarily be more volatile and perhaps lesstransparent than annual data

1 Implementing the Stability and Growth Pact

11 Introduction

The fiscal framework of EMU aims at combiningbudgetary discipline with flexibility through two mainrequirements These are the Treaty requirement to avoidexcessive deficit positions (measured against referencevalues for deficits and debt of 3 and 60 of GDPrespectively) and the requirement of the SGP to achieveand maintain a budgetary position lsquoclose to balance or insurplusrsquo over the cycle Compliance with the lsquoclose tobalance or in surplusrsquo requirement secures fiscal disci-pline and the sustainability of public finances and thuscontributes to maintaining an economic environment inwhich monetary policy can effectively pursue price sta-bility It also provides the necessary room for manoeuvreto allow the automatic stabilisers to play freely Therules-based framework of the Treaty and SGP consists ofboth preventive and dissuasive elements both of whichare backed up with enforcement procedures

The deterioration in the budget positions has required theCommission and Council to apply the various enforcementmechanisms of the Stability and Growth Pact (SGP)against several Member States during 2002 and the earlypart of 2003 Against a background of slow economicgrowth this has led to considerable tension in the CouncilThe discussions on the implementation of the SGP gener-ated negative reactions in the press and markets and in partmotivated the Commission proposals to strengthen thecoordination of budgetary policies in November 2002 (1)

The remainder of this chapter summarises the debate onthe implementation of the SGP since spring 2002 (2)

Section 2 describes the enforcement mechanisms pro-vided for in the Treaty and the SGP regulations (3)Section 3 examines the specific cases of the three Mem-ber States (Portugal Germany and France) where theCouncil has already taken action in the framework of theexcessive deficit procedure

12 The enforcement mechanisms of the SGP

121 The preventive part of the Pact

Under the preventive arrangements of the Pact Mem-ber States submit annual stability or convergence pro-grammes in which they set down their short andmedium-term budgetary strategies to reach and sustainbudget positions that are lsquoclose to balance or in sur-plusrsquo The programmes are subject to peer review andmonitoring by the Commission and Council with aview to identifying any lsquosignificant divergencersquo eitherfrom the medium-term budget target or the adjustmentpath towards it This surveillance not only consists ofverifying whether nominal budgetary targets are met italso involves a close examination of the underlyingbudget position taking account of cyclical economicconditions

If the Council identifies such a significant divergencefrom a budget target it shall address a recommendationto the Member State concerned with a view to give anearly warning in order to prevent the occurrence of anexcessive deficit The Council recommendation isadopted by qualified majority on the basis of a Commis-sion recommendation following the procedure outlinedin Article 99(4) of the Treaty and Articles 6 and 10 of

yen1part COM(2003) 668 final See Chapter II for a discussion of the communicationyen2part Part II2 in last yearrsquos report summarises the debate on the Commissionrsquos

recommendation of February 2002 for lsquoearly-warningsrsquo to be sent toGermany and Portugal

yen3part For a more detailed description see Cabral (2001) Costello (2001) andFischer and Giudice (2001)

Council Regulation (EC) No 146697 (1) A second rec-ommendation to take prompt corrective measures can beaddressed to the Member States concerned if the Counciljudges that the divergence is persisting or worsening

Council Regulation (EC) No 146697 does not definewhat constitutes a lsquosignificant divergencersquo from budget-ary targets or the conditions under which the early-warn-ing mechanism is to be activated To ensure consistencythe Commission has developed and used the followingthree factors in deciding whether to activate the early-warning mechanism

bull the size of the budgetary slippage that is the extentto which budget positions diverge from the targetsset down in stability or convergence programmes

bull the reason for the budgetary slippage that iswhether the divergence of actual balances from thetarget can be explained by cyclical or discretionaryfactors

bull the risk of an excessive deficit position that iswhether there is a risk of breaching the 3 of GDPreference value

These criteria distinguish between slippage from budget-ary targets in nominal and cyclically-adjusted terms andreflect whether or not a country has reached the medium-term target of the SGP In brief more leeway is affordedto countries with sound budget positions An early-warn-ing however can be issued even if the nominal deficit issome way below the 3 of GDP reference value Todate recourse has only been made to the early-warningmechanism when deficits were well above 2 of GDPand experience with Portugal Germany and France hasshown that this is likely to be too late to prevent deficitsfrom going above 3 of GDP

122 The dissuasive elements of the Pact

The dissuasive elements of the SGP are set down in Arti-cle 104 which requires all Member States to avoid exces-sive government deficits (2) Under the excessive deficitprocedure (EDP) the Commission monitors budgetary

developments and examines compliance with budgetarydiscipline on the basis of two criteria that is lsquowhetherthe ratio of the actual or planned government deficit togross domestic product exceeds a reference value [3 of GDP]rsquo and lsquowhether the ratio of government debt togross domestic product exceeds a reference value [60 of GDP] unless the ratio is sufficiently diminishing andapproaching the reference value at a satisfactory pacersquo

The EDP is a complicated procedure involving severalsteps Article 104(3) states lsquoIf a Member State breachesone or both of the these criteria the Commission shallprepare a reportrsquo This report shall lsquotake into accountwhether the government deficit exceeds governmentinvestment expenditure and take into account all otherrelevant factors including the medium-term economicand budgetary position of the Member Statersquo After theCommission adopts such a report the EFC must give itsopinion thereon within two weeks As of this point threepossible courses of action are possible

bull the Commission could decide that there is neither arisk nor existence of an excessive deficit positionand the procedure would then stop

bull the Commission could address an opinion on the riskof an excessive deficit position in accordance withArticle 104(5) The Treaty does not specify the pre-cise conditions as to what constitutes a risk of anexcessive deficit but the most clear-cut scenario is aforecast (either Commission or of the nationalauthorities) projecting a deficit level above 3 ofGDP reference value (3) The Council is not requiredto vote on the Commissionrsquos opinion and the proce-dure comes to a halt at this stage It would only bereactivated if subsequent outcome data confirmsthat the 3 of GDP reference value has indeed beenbreached

bull the Commission could adopt an opinion in accord-ance with Article 104(5) on the existence of anexcessive deficit position The Council is thenrequired to vote by qualified majority on whether anexcessive deficit position exists in accordance withArticle 104(6) To be placed in an excessive deficit

yen1part OJ L 209 281997 In addition to these legal obligations on the early-warning mechanism the Commission Member States and Council gave astrong political commitment to the lsquostrict and timelyrsquo implementation ofthe SGP in the resolution of the Amsterdam European Council on theStability and Growth Pact (OJ C 236 281997)

yen2part Under the provisions of its opt-out protocol the UK is not required to avoidexcessive deficit positions but rather must endeavour to do so

yen3part However a forecast deficit above the 3 of GDP reference is not a prereq-uisite requirement for the activation of the EDP Article 104(3) states thatlsquoThe Commission may also prepare a report if notwithstanding the fulfil-ment of the requirements under the [deficit and debt] it is of the opinionthat there is a risk of an excessive deficit positionrsquo

P a r t I IE v o l v i n g b u d g e t a r y s u r v e i l l a n c e

position outcome data must show that the referencevalues have indeed been breached The rationalebehind waiting for the outcome data is that beingplaced in an excessive deficit position has poten-tially serious consequences for a Member State forexample the possibility of negative reactions bymarkets resulting in a higher risk premium on debtit could prevent a country from joining the eurozone it could eventually lead to the imposition of

financial sanctions on euro-area countries in breachof its obligations

At the same time as it decides upon the existence of anexcessive deficit position the Council must also adopt arecommendation to the Member State concerned (inaccordance with Article 104(7)) with a view to bringingthe situation to an end within a given period Article 3(4)of Council Regulation (EC) No 146797 specifies that

Box II1 What constitutes an lsquoexceptional circumstancersquo under the excessive deficit procedure

A nominal deficit above 3 of GDP does not imply a country is automatically placed in an excessive deficit positionas the Treaty and SGP regulations provide some room for interpretation to take account of lsquoexceptional circumstancesrsquoArticle 104(2) of the Treaty states that a Member State with a deficit to GDP ratio over 3 is in an excessive deficitposition unless lsquohellip the excess over the reference value is only exceptional and temporary and the ratio remains close tothe reference valuersquo Against the background of the current economic slowdown and the effects of war in the Gulf thequestion has been raised as to whether countries could make recourse to this exceptionality clause to avoid being placedin an excess deficit position

Before addressing this question directly it should be noted that any breach must be at the same time exceptional and tem-porary and close to the reference value that is the conditions are cumulative and thus recourse to this Treaty provision isrestricted to a very limited number of cases Moreover the issue of exceptional circumstances only arises when the Com-mission and Council are deciding upon the existence of an excessive deficit position in accordance with Article 104(6) ofthe Treaty There is no scope for the Council to give an ex ante exemption to any Member State allowing to breach the 3 of GDP reference value for deficits Neither could it be applied retroactively to countries such as Portugal and Germanywhich are already in excessive deficit positions

Article 2(1) of Council Regulation (EC) No 146797 provides some further clarification on what constitutes an exceptionalcircumstance The excess of a government deficit over the reference value shall be considered exceptional when lsquoresultingfrom an unusual event outside the control of the Member State concerned and which has a major impact on the financialposition of the general government or when resulting from a severe economic downturnrsquo

A priori the direct costs of participation in a military conflict could be regarded as an lsquounusual event outside the control ofthe Member State concernedrsquo together with costs of additional security measures However it would need to be backed upwith evidence that these have had a lsquoa major impact on the financial position of the general governmentrsquo and thus are amajor contributory factor to the deficit level rising above 3 of GDP Clearly this argument would not apply to deficitsgoing above 3 of GDP in 2002

A more pertinent issue is whether the economic situation constitutes a lsquosevere economic downturnrsquo Article 2(1) ofCouncil Regulation (EC) No 146797 establishes a general rule whereby a severe downturn is considered exceptional iflsquothere is an annual fall of real GDP of at least 2 rsquo The Member State concerned can demonstrate that even a fall ofannual real GDP of less than 2 is lsquonevertheless exceptional in the light of further supportive evidence in particularon the abruptness of the downturn or on the accumulated loss of output relative to past trendsrsquo In the resolution of theEuropean Council on growth and employment Member States committed not to invoke the exceptional clause if GDPfall is less than ndash 075

Based on the spring 2003 Commission forecast a loss in output of 075 is not projected in any Member State and there-fore there is currently no case for considering recourse to the exceptionality clause However it could become relevant ifgrowth in some countries turns out to be substantially lower than is currently forecasted

this recommendation must contain two deadlinesFirstly a deadline of four months at the most must beestablished for the Member State to take effective actionIn addition a deadline must be established for the correc-tion of the excessive deficit position which lsquohellip shouldbe completed in the year following its identificationunless there are special circumstancesrsquo It is worth high-lighting the fact that the initial requirement on the Mem-ber State concerned is to take corrective action ratherthan in achieving immediate results As such the will-ingness of the Member States to respond to the repri-mand of the Council is of critical importance The failureto take corrective actions would trigger the next stage ofthe EDP and move the Member State closer to the stagewhen it may receive sanctions

13 The use of enforcement mechanisms since spring 2002 (1)

131 Slippage from budget targets in many Member States

Throughout 2002 concern grew about the deteriorationin budget positions in several Member States participat-ing in the euro area Table II1 compares the budget out-comes for 2002 projected by the Commission in autumn

yen1part For documents concerning these procedures see the section on fiscal sur-veillance on the web site of the Directorate-General for Economic andFinancial Affairs httpeuropaeuintcommeconomy_financeaboutactiv-itiessgpprocedures_enhtm

Table II1

Comparison of growth and budgetary developments for 2002 between autumn 2002 Commission forecasts and the 2001 updates of the programmes

GDP growth in 2002 ( pa)

Budget balance in 2002 (excluding UMTS) ( of GDP)

Difference from SPCP budget target ( of GDP) due to

of GDP SPCP COM

forecastSPCP target

EDP notification

COM forecast

Difference COM

ndash SPCP

Impact of cyclical conditions

in 2002

Non-cyclical factorsin 2002

pmcyclical and non-cyclical

factors in 2001

1 2 3 4 5 6 = 5 ndash 3 7 8 = 6 ndash 7 9

BE 13 07 00 00 ndash 01 ndash 01 ndash 01 01 02

DE 08 04 ndash 25 ndash 29 ndash 38 ndash 13 ndash 01 ndash 12 ndash 03

EL 38 35 08 08 ndash 13 ndash 21 00 ndash 21 ndash 18

ES 24 19 00 00 00 00 ndash 02 02 ndash 01

FR 15 10 ndash 18 ndash 26 ndash 27 ndash 09 ndash 01 ndash 08 ndash 01

IE 39 33 07 ndash 01 ndash 12 ndash 19 ndash 02 ndash 17 02

IT 23 04 ndash 05 ndash 11 ndash 24 ndash 19 ndash 07 ndash 12 ndash 11

LU 53 01 28 13 05 ndash 23 ndash 19 ndash 03 20

NL 13 02 04 ndash 05 ndash 08 ndash 12 ndash 06 ndash 05 ndash 06

AT 13 07 00 ndash 13 ndash 18 ndash 18 00 ndash 17 02

PT 18 07 ndash 18 ndash 28 ndash 34 ndash 16 ndash 03 ndash 13 ndash 20

FI 16 14 26 36 36 10 ndash 02 12 01

EUR-12 18 08 ndash 11 ndash 17 ndash 23 ndash 11 ndash 05 ndash 06 ndash 04

DK 17 17 19 21 20 01 00 02 02

SE 24 16 21 18 14 ndash 07 ndash 03 ndash 04 02

UK 23 16 ndash 11 ndash 10 ndash 11 00 ndash 04 04 09

EU-15 18 09 ndash 10 ndash 14 ndash 19 ndash 09 ndash 04 ndash 05 ndash 02

NB SPCP = stabilityconvergence programmes submitted in Autumn 2001 EDP notification = September 2002 COM = autumn 2002 Commission forecasts Impactof cyclical conditions shortfall = ndash bonus =

Source European Commission

2002 with the targets set down in the 2001 updates ofstability and convergence programmes that is the infor-mation which was available to ministers in late 2002when key decisions on the implementation of the SGPhad to be taken Significant slippage from budget targetswas evident in a large number of countries although theconcern was focused on countries where deficits emergedEventually the Council took action against three coun-tries (Germany France and Portugal) although the defi-cits in Greece Italy and Austria also gave cause forconcern

As shown on column 8 of Table II2 approximately halfof the deterioration in budget positions projected for2002 was due to the automatic stabilisers in response toeconomic cycle Non-cyclical factors such as unfundedtax cuts discretionary expenditure increases and spend-ing overruns also contributed to the slippage This indi-cates a reversal in some Member States of budgetaryconsolidation efforts In several Member States how-ever most of the deviation from the 2002 target resultedfrom the slippage that had already occurred by the end of2001 (see column 9)

132 Portugal

On 5 November 2002 the Council decided that an exces-sive deficit existed in Portugal the first time the EDPwas applied since the launch of the euro in 1999 (1)Budget difficulties in Portugal had been apparent forsome time (2) and in January 2002 the Commissionadopted a recommendation that an early-warning be sentto Portugal for having missed its budget target for 2001by a wide margin At that time the Commission (on thebasis of its autumn 2001 forecast) was projecting a defi-cit of 22 of GDP for 2001 compared with a target of11 of GDP set down its stability programme seeGraph II1 The Ecofin Council at its meeting of 12 Feb-ruary 2002 however decided not to endorse the Com-mission recommendation for an early-warning Thisfollowed commitments given by the Portuguese authori-ties to endeavour to prevent the deficit from going abovethe 3 of GDP reference value in 2002

yen1part Council Decision 2002923EC OJ L 32230yen2part See Part II2 in European Commission (2002a)

Graph II1 Budgetary divergence from target in Portugal

ndash 5

ndash 4

ndash 3

ndash 2

ndash 1

2000 2001 2002 2003 2004 2005 2006

Reference value

2001 programme 2002 programme

Spring 2002 forecastAutumn 2002 forecast

On 25 July 2002 the Commission received officialconfirmation from the Portuguese authorities that thegeneral government deficit in 2001 was to be revisedupwards from 22 of GDP (reported in February 2002EDP notification) to 41 of GDP an upward revisionof 19 percentage points of GDP (1) This revision fol-lowed the submission of a report by a special task forcecalled the Commission for the Analysis of PublicAccounts established by the Portuguese Governmentunder the direct responsibility of the Governor of theBank of Portugal This task force set up following thenon-acceptance by Eurostat of budgetary data notified inMarch 2002 was made up of representatives from theMinistry of Finance Bank of Portugal and the NationalInstitutes of Statistics

The size of this ex-post revision and the delay in it com-ing to light underlined serious deficiencies in the collec-tion and processing of general government statisticaldata in Portugal A breakdown of the revised outcomefor data for 2001 shows that the difference of 19 per-centage points of GDP was due in almost equal parts tothe reclassification of certain items in governmentaccounts (2) to bring them in line with the Eurostat defi-nitions and due to a slippage in budgetary execution

A deficit of 41 of GDP in 2001 was confirmed in thePortugalrsquos submission by 1 September 2002 under thesemi-annual reporting of government deficits and debtlevels and the Commission activated the EDP by prepar-ing on 24 September 2002 a report in accordance withArticle 104(3) of the Treaty In this report the Commis-sion drew attention to the failure on the part of Portugalto achieve budgetary consolidation since the mid-1990sand that the deterioration in the budget balance could notbe explained by the cycle as the cyclically-adjustedbudget deficit had risen from 3 of GDP in 1999 to45 of GDP in 2001 (using the HP filter method) Onthe revenue side the shortfall derives from the lossesimplied by the reform of direct taxes implemented in2001 and lower-than-projected efficiency gains in tax

collection and administration At the same time currentprimary expenditures continued to grow faster than nom-inal GDP with the public sector wage bill and socialtransfers repeatedly surpassing targets set by the govern-ment The Commission also concluded that the breach ofthe 3 of GDP reference value could not be attributedto a severe economic downturn (that is the exceptional-ity clause could not apply) Moreover the increase in thedeficit in 2001 could not be attributed to public invest-ment as this remained constant at some 4 of GDP overthe 1999 to 2001 period

The Economic and Financial Committee confirmedthese findings and on the basis of an opinion and a rec-ommendation proposed by the Commission adopted on16 October 2002 the Council decided upon the existenceof an excessive deficit It also adopted a recommenda-tion with a view to bringing the situation to an end (3) Asrequired two deadlines were set down in this recommen-dation (i) a deadline of 31 December 2002 was set forthe Portuguese authorities to take measures to correct theexcessive deficit position (ii) a deadline for the correc-tion of the excessive deficit position which should becompleted in the year following its identification this isunderstood as being the end of 2003

The response of the Portuguese authorities began beforethe Council had decided upon the existence of an exces-sive deficit position (for more details see Part VI12 onPortugal) The newly elected government enacted arectifying budget which became law in June 2002 It

yen1part The impact of this upward revision for 2001 on the budgetary position for2002 is evident on column 9 of Table II1 above

yen2part Regulation EC25162000 requires that taxes and social contributionsrecorded in the accounts may be derived from two sources amounts evi-denced by assessment and declarations or cash receipts If assessments anddeclarations are used the amounts shall be adjusted by a co-efficientreflecting assessed and declared amounts never collected If cash receiptsare used they must be time-adjusted so that the cash is attributed when theactivity took place to generate a liability The Portuguese authorities optedfor the cash method with slight time adjustments notably as regards the col-lection of VAT taxes Portugal was granted a derogation from this provisionup to 30 June 2002

Table II2

Breakdown of revision of 2001 budget balance of Portugal

Reclassification of some operations as subsidies instead of capital injections 02

Recording of expenditure arrears from commitments made in 2001 03

Application of regulation EC25162000 06

Recording of receipts associated with EC structural funds ndash 01

New information on budgetary execution 09

Total 19

Source Portuguese Commission for the Analysis of public Accounts

yen3part See the Directorate-General for Economic and Financial Affairs web sitefor the relevant documents httpeuropa euintcommeconomy_financeaboutactivitiessgpprocedures_enhtm

included consolidation measures equivalent to 06 ofGDP notably via an increase in the standard VAT ratefrom 17 to 19 It also included measures such as afreeze on the hiring of civil servants and the end of inter-est rate subsidies on new mortgage loans

In addition a firm commitment was given to reduce thedeficit to 28 of GDP in 2002 that is below the 3 of GDP reference value already in the same year thusahead of the formal deadline required under the EDPregulations Additional measures have been taken in anattempt to meet this goal a task made more difficultby deteriorating growth conditions According to theMarch 2003 semi-annual notification the deficit in 2002fell to 27 of GDP an outcome which relied heavilyon one-off measures especially a tax amnesty

Against a background of slow growth and the termina-tion of one-off measures Portugal will face a considera-ble challenge in keeping the nominal deficit below the3 of GDP reference value The Council will shortlyhave to decide whether in accordance with Article 104(11)to abrogate the decision on the existence of an excessivedeficit

Both negative and positive conclusions can be drawnfrom this first experience with the EDP in Stage III ofEMU It underlined the importance of strengthening theprocess of collection and verification of budgetary statis-tics that underline the fiscal rules of EMU On the posi-tive side however the discrepancies in the statisticalreporting framework were picked up albeit with anunsatisfactory delay and the resulting peer pressure hasfacilitated the introduction of painful but necessaryreforms to prevent public finances continuing on whatwas an unsustainable path

133 Germany

On 21 January 2003 the Council decided that an exces-sive deficit exists in Germany (1) Significant divergenceof the budgetary position from targets had becomeapparent already in late 2001 and in January 2002 theCommission adopted a recommendation for an early-warning to be sent to Germany At that time the Com-mission (on the basis of its autumn 2001 forecast) wasprojecting a deficit of 26 of GDP for 2001 comparedwith a target of 15 of GDP set down its stability pro-gramme see Graph II2 The Council decided the Com-

mission recommendation would not be put to vote and toclose the early-warning procedure This followed com-mitments from the German authorities to endeavour toensure that the 3 of GDP reference value for the gen-eral government deficit would not be breached in 2002and to reach a close to balance position by 2004 in linewith previous commitments

Following general elections on 22 September 2002the re-elected federal government on 24 Septemberbelatedly submitted the autumn notification of budg-etary data showing a deficit of 29 of GDP andconfirming a debt ratio of 606 for 2002 Subse-quently on 16 October 2002 the Minister for Financepublicly stated that the deficit for 2002 was likely toexceed the Treatyrsquos reference value On the basis of itsautumn 2002 forecast projecting a deficit of 38 ofGDP for 2002 the Commission activated the EDP bypreparing a report in accordance with Article 104(3) ofthe Treaty

The report drew attention to the very weak growth per-formance of Germany over the past decade Howeverthe deterioration in the budget balance can only in part beattributed to the effects of the economic cycle as thecyclically-adjusted budget deficit which had fallen con-tinuously since 1995 started to increase as of 2000 andgrew to some 32 in 2002 The origins of this budget-ary slippage can be found in the 1998ndash2000 periodinsufficient efforts were made to strengthen the underly-ing budgetary position when growth conditions werefavourable Indeed the cyclically-adjusted deficit startedto rise again as from 2000 not least due to strongerexpenditure growth at the regional level Based on anassumption of continued strong economic growth and aso-called lsquodividendrsquo for public revenues the governmentopted for the carrying-forward to 2001 of the 2002 stageof the tax reform and for a back-loading of the necessarybudgetary consolidation efforts Thus with the advent ofthe business cycle slowdown there was insufficient lee-way for the operation of automatic stabilisers while atthe same time preventing the deficit from rising abovethe 3 of GDP reference value

Although dramatic for the people involved the floodswhich occurred in August 2002 are not expected to haveconstituted a serious drag on public finances in 2002Commission calculations show that the 2002 overall def-icit-raising effect should not be higher than one tenth ofa percentage point of GDP (that is around EUR 2 bil-lion) given that the bulk of repair works would start onlyyen1part Council Decision 200389EC OJ L 3416

in 2003 this was implicitly recognised by the fact thatthe special fund set up by the federal government offi-cially began its operations on 1 January 2003 As in thecase of Portugal the general government deficit hadbeen clearly higher than public investment althoughhigher public investment induced by the flood damagesand the projected decline in the general government def-icit should narrow the gap in 2003

Outcome data for 2002 confirmed a deficit of 36 ofGDP and the Council on 21 January 2003 decided uponthe existence of an excessive deficit position andadopted a recommendation with a view to bringing thesituation to an end It should also be noted that the debtlevel in 2002 reached 608 of GDP which is in excessof the Treaty reference value and on the basis of currentgrowth forecasts it is expected to increase further in2003 Two deadlines were set in the Council recommen-dation (i) a deadline of 21 May 2003 was set for the Ger-man authorities to take measures to correct the excessivedeficit positions (ii) a deadline for the correction of theexcessive deficit position which should be completed inthe year following its identification this is understood asbeing the end of 2004 Germany however was invitedto bring the deficit below 3 of GDP already in 2003

as planned in the updated stability programme if thegrowth conditions projected in the update (GDP growthof 1 ) would materialise The Council also recom-mended that the German authorities ensure that the risein the debt ratio is brought to a halt in 2003 and reversedthereafter

Based on the latest growth prospects a correction of theexcessive deficit situation in 2003 appears uncertainConcerning 2004 the full implementation of the coali-tion agreement and the achievement of the targets setdown in the updated stability programme (see Part VI3on Germany) would ensure a substantial decline in theactual and cyclically-adjusted deficit provided GDPgrowth turns out as expected Even in the event ofgrowth picking up further into 2004 the budgetary roomfor manoeuvre is set to remain limited in view of the fur-ther steps of income tax cuts envisaged A sustainedimprovement in the budgetary position will thus requiregovernment expenditure to remain under firm control

Important lessons can be drawn from the application ofEDP to Germany the largest economy in the euro areaand a leading proponent of the SGP The credibility inthe rules-based framework was not aided by the Coun-

Graph II2 Budgetary divergence from target in Germany

ndash 5

ndash 4

ndash 3

ndash 2

ndash 1

2000 2001 2002 2003 2004 2005 2006

cilrsquos failure to issue an early-warning in February 2002nor the subsequent ratcheting up of projections for thedeficit level throughout 2002 This called into questionthe reliability of budgetary statistics and forecasts under-lying the EU surveillance process and indicated a lack ofcapacity and willingness on the part of Member States todeal with growing budgetary imbalances However italso indicated that a debate on difficult budgetary policychallenges could not be avoided on account of bindingdeadlines in the SGP even for large countries duringelectoral campaigns Arguably the debate on the early-warning ensured that the issue of sound public financesplayed a prominent role in the electoral campaign andhas been facilitating discussions on difficult policychoices and trade-offs

Ultimately however the debate on the SGP has shownthat the rising budget deficit is the symptom but not thecause of Germanyrsquos economic problems The key policychallenge is the growth performance during the last dec-ade with an average annual GDP growth rate of 13 between 1992 and 2002 Unless the causes of slowgrowth are tackled at source deficits in Germany willremain high posing continuous stress on the SGP

134 France

On 21 January 2003 the Council adopted a recommen-dation giving an early-warning to France in order to pre-vent the occurrence of an excessive deficit This is thefirst time that an early-warning has been issued by theCouncil and occurred because there was a significantdivergence from the budget target set down in its stabil-ity programme (see Graph II3)

In its 2001 update of the stability programme France pro-jected a general government deficit at 14 and 13 ofGDP in 2002 and 2003 respectively under the assump-tion of an increase in real GDP by 25 in both years (1)The Commission in its autumn 2002 forecast projected adeficit of 27 and 29 of GDP for 2002 and 2003 respec-tively An early warning was merited on account of

bull the size of the slippage from target some 13 per-centage points of GDP for 2002

bull the source of the budgetary slippage According toCommission services calculations at most one half

of the total slippage can be attributed to cyclical fac-tors The cyclically-adjusted government deficitstable at around 2 of GDP between 1999 and2001 has increased in 2002 to slightly above 2

bull the risk of a breach of the 3 of GDP referencevalue given the perilously close margins that wereprojected at that time

In its March 2003 reporting of data the French authori-ties indicated that the deficit in 2002 was 31 (2) clearlyin excess of the reference value considering also its fore-cast for 2003 of a deficit still above 3 of GDP Itshould be noted that this further deterioration in thebudget balance compared with the autumn 2002 forecastcannot be attributed to effects of deteriorating growthconditions and instead is the result of a disappointingbudgetary execution The Commission therefore acti-vated the EDP and on 7 May 2003 recommended to theCouncil to decide on the existence of an excessive deficitin France and to address a recommendation to France toput an end to the present excessive deficit situation asrapidly as possible and by 2004 at the latest

The experience with the early-warning mechanism toFrance has been far from smooth for three reasonsFirstly the fact that the deficit level in 2002 turned out tobe above 3 of GDP and that the EDP was activatedsome eight weeks after the Council had issued an early-warning forcefully illustrates that the mechanism is notproviding an advance signal to Member States on theneed for corrective action Early-warnings to be effectivewould need to be sent well before deficit levels are veryclose to 3 of GDP a point made in the Commissioncommunication of November 2002 on strengthening thecoordination of budgetary policies (see Chapter II2)

Secondly the debate on the early-warning was charac-terised by repeated revisions in budget projections for2002 coupled with strong but unfulfilled commitmentsto avoid excessive deficits position In February 2002the French authorities adjusted their objective for the2002 general government deficit upwards from 14 to18 of GDP reflecting the impact of deterioratingcyclical factors This revision took place very shortlybefore the discussion of the French update in the EcofinCouncil which created inconveniences with respect to

yen1part France subsequently revised its deficit target for 2002 to 18 of GDP asreported in Table II1

yen2part The government deficit for 2002 has been revised from 30 of GDP (asnotified by the French authorities) to 31 of GDP as a consequence of theinclusion in the deficit of the capital injection by the French State to Reacuteseauferreacute de France (RFF) See Press Release STAT0330 of 17 March 2003

the preparatory work made by the Commission and theEFC In May 2002 after the presidential elections thenew government launched an audit on public financeswhich estimated the general government deficit in 2002within a range 23ndash26 of GDP the revision broughtabout by the audit was due to the consideration of thecyclical effect on tax revenues and unemploymentexpenditures following the deceleration in economicactivity estimated at 03ndash04 of GDP and also due toan overrun in expenditures particularly in the State andthe health sectors estimated at 06ndash07 of GDP InJuly 2002 the French authorities presented a correctivebudget bill for 2002 aimed at adjusting the governmentbudgetary forecasts in line with the results of the audit onpublic finances and at implementing a cut in the incometax by 5 In this corrective budget bill the Frenchauthorities decided to target a general government deficitof 26 of GDP in 2002 which is the highest value ofthe range of the auditorsrsquo projections thus not correctingthe observed slippage in the budgetary situation Asnoted above the autumn 2002 forecast and subsequentreporting of data under the EDP has led to a further sub-stantial upward revision

Thirdly and unlike the Portuguese and German authori-ties which did not contest the application of the SGP the

French authorities have to date failed to take any measuresto address the growing budgetary imbalances despitethese already becoming apparent in mid-2002 Moreoverthey have failed to engage in a constructive dialogue at EUlevel on the pace of budgetary consolidation towards thelsquoclose to balance or in surplusrsquo requirement (see the nextchapter for a discussion on these issues) In particularFrance was the only euro area country which did notaccept to pursue a continuous adjustment of the underly-ing balance by at least 05 of GDP per year startingalready in 2003 as agreed by all other ministers at theEurogroup meeting of 7 October 2002 (see Section II21)

The French authorities continue to fail to start taking cor-rective measures in 2003 This was demonstrated in thebudget targets of their 2002 stability programme whichprovided for an improvement of only 02 percentagepoints of GDP in its cyclically-adjusted budget balanceThe Council in its opinion urged lsquohellip the French author-ities to seek an improvement in the underlying budgetposition in each yearhelliprsquo The start of the process ofbudgetary consolidation cannot be postponed indefi-nitely as the Council recommendation (in accordancewith Article 104(7)) on measures to correct an excessivedeficit position includes a deadline of no more than fourmonths for taking corrective actions

Graph II3 Budgetary divergence from target in France

2000 2001 2002 2003 2004 2005 2006

ndash 5

ndash 4

ndash 3

ndash 2

ndash 1

Reference

2 Strengthening the coordination of budgetary policies

21 Background to the debate a mandate from the Barcelona European Council

The Treaty supplemented by secondary legislation hasbestowed on the Union a unique institutional architec-ture for the conduct of economic and monetary policiesThe uniqueness of the framework resides in the fact thata single monetary policy is entrusted to an independentEuropean Central Bank whilst the responsibility foreconomic policies (budgetary and structural policies)remains decentralised in the hands of national (or sub-national) authorities but subject to some common rulesIn particular Member States remain fully responsible fortheir tax and expenditure policies but within a frame-work at EU level to monitor and where necessaryensure that countries pursue the common goal of soundand sustainable public finances

The appropriate degree and instruments of economic pol-icy coordination cannot remain static or be subject to anoverly rigid literal interpretation of rules and proceduresTo remain effective it must evolve over time so as to takeaccount of changing economic circumstances andor theconvergencedivergence of political preferences It isespecially important in the aftermath of a major regimechange such as the launch of EMU that a learning-by-doing approach be followed so that shortcomings arecorrected and the lessons of experience are drawn

On the basis of the experience accumulated in the earlyyears of EMU the Commission in February 2001adopted a communication on strengthening economic pol-icy coordination within the euro area (1) This led to sev-eral positive developments including better and moretimely statistics covering the euro area a quarterly report

on the euro area prepared by the Commission the estab-lishment of a Eurogroup working party attached to theEconomic and Financial Committee (EFC) to help pre-pare debates and regular communiqueacutes (so-called terms ofreference) from the Eurogroup on important policy issuesIn addition an important agreement had been reached onthe streamlining of policy measures in the BEPGs

Subsequently the Barcelona European Council ofMarch 2002 concluded that the euro area needed to makefurther progress with policy coordination and invitedthe Commission to present proposals to reinforce eco-nomic policy coordination in time for the 2003 springEuropean Council

The initial response of the Commission to this mandatewas to suggest that all euro-area countries adhere to com-mon standards for the conduct of economic policies in theeuro area The objective of common standards would beto clarify the respective role of economic policies in threedomains (1) preserving macroeconomic stability (2)enhancing the economic growth potential of the euro areaand (3) responding to economic shocks that affect indi-vidual Member States or the euro area as a whole

Concerning their format and status the intention was forcommon standards to complement the existing Treatyprovisions and Stability and Growth Pact regulationswith non-binding guidelines on the policy stanceexpected of authorities in various circumstances that isa so-called lsquoreaction functionrsquo The aim was to facilitatediscussions amongst ministers on policy challenges asthey emerged and thereby contribute to a more consist-ent policy stance over time and across Member StatesMoreover the Commission argued that setting downbroad ex ante guidelines on the conduct of economic andbudget policies would help demonstrate that the EU andthe euro area have a well-defined economic strategy withmedium-term orientationyen1part COM(2001) 82 final of 7 February 2001

Based on analytical work of the Commission servicesthe Eurogroup in July and September 2002 discussedpossible elements to be included in common standardson the conduct of economic policies in the euro areaHowever these discussions became overshadowed bythe deterioration in budget positions in several Member

States described in Chapter II1 and the challenges in theimplementation of the SGP This forced a major re-con-sideration on the part of the Commission on how torespond to the mandate of the Barcelona EuropeanCouncil The intended approach of adopting commonstandards on the conduct of economic and budgetary pol-

Box II2 The Convention on the Future of Europe the debate on the coordination of budgetary policies

In the two communications to the Convention adopted in the course of 2002 (1) the Commission has put forward specificsuggestions in the area of economic and notably budgetary policy coordination

First the Commission proposes to reinforce the Community dimension of the policy-coordination process To this effectthe instruments of economic policy coordination should be drafted on the basis of proposals from the Commission ratherthan mere recommendations from which the Council may depart by qualified majority As far as Article 99 of the Treatyis concerned this change would notably have an impact on the adoption procedure of the BEPGs on the adoption by Coun-cil of its opinions on the stability and convergence programmes and on the Council recommendations to a Member Statewhich is pursuing economic policies which are not consistent with the BEPG or with the Stability and Growth Pact

Moreover when the economic policies pursued by a specific Member State are not consistent with the broad guidelines orrisk jeopardising the proper functioning of EMU the Commission should be able to issue warnings directly to the MemberState concerned For example the Commission could decide to issue a lsquodirectrsquo early warning to any Member State with abudgetary position which is significantly diverging from the budgetary target set out in its stability or convergence pro-gramme At the same time it would preserve the possibility under Article 99(4) to invite the Council to make the necessaryrecommendations to the Member State concerned As already explained above the Councilrsquos decision would be based ona Commission proposal as opposed to a recommendation These different measures will reinforce the Community dimen-sion of the economic policy coordination framework by allowing the Commission to play its role as a representative of thecommon interest and as the lsquorefereersquo who ensures that the rules of the game are being observed

The Commission furthermore proposes to facilitate decision-making within the euro area While the informal Eurogroupwould continue to exist a lsquoeuro arearsquo Ecofin Council would also be established in order to allow the Member States belong-ing to the euro area to take certain decisions which are mainly or exclusively relevant for participating countries This insti-tutional change would have important consequences for a number of decisions taken in the framework of the excessivedeficit procedure and the SGP (for example early warnings adopted by the Council) particularly when participating Mem-ber States are concerned

The Convention has closely examined the functioning of the EMU framework A Working Group on Economic Govern-ance chaired by Mr K Haumlnsch was established in order to examine a list of different issues falling under three headingsmonetary policy economic policy and institutional issues As far as the Stability and Growth Pact is concerned a majorityof the Group agreed that the Commission should be allowed to issue first warnings on excessive deficits directly to theMember State concerned Some members also agreed with the need to transform Commission recommendations into pro-posals and supported the exclusion from the vote of the Member State concerned for example in the case of an early warn-ings issued by the Council or in relation to decisions on the existence of an excessive deficit The Working Groupconsidered that the Stability and Growth Pact is a political instrument to implement the Treaty provisions and that it shouldtherefore not be integrated into the Constitution The results of the Working Group were discussed by the plenary on7 November 2002 which largely confirmed the main views expressed by the Group The Praesidium has indicated that afirst draft of Part II of the Constitution which will describe the different policy areas and the Conventionrsquos proposals inrelation to each of them will be made available in the course of May 2003

(1) lsquoA project for the European Unionrsquo (COM(2002) 247 of 22 May 2002) and lsquoFor the European Union peace freedom solidarityrsquo (COM(2002) 728 of4 December 2002)

icies in the euro area was dropped in favour of muchfocused efforts to improve the functioning of the SGP (1)

On 24 September 2002 Commissioner Solbes with theagreement of President Prodi issued a communicationsuggesting a strategy for dealing with pressing budgetarychallenges in the euro area (2) It underlined the impor-tance of the SGP but recognised the need to avoidsetting budget targets that would require very largeimprovements in underlying budget positions in econo-mies suffering from cyclical weakness To this end theysuggested that the medium-term objective of the SGPshould incorporate explicit references to cyclical consid-erations Also countries which have not yet reached the(cyclically-adjusted) lsquoclose to balance or in surplusrsquoobjective should be required to undertake every year aminimum adjustment of 05 of GDP of their cycli-cally-adjusted deficit

The Eurogroup meeting of 7 October 2002 producedlsquoTerms of references on the budgetary developments inthe euro arearsquo very close to the approach of the Commis-sion and which marked an important policy shift asregards the implementation of the Pact In particularlsquoministers re-affirmed their commitment to the Treatyobligation to avoid excessive deficits and to the Stabilityand Growth Pact objective to achieve and maintainbudgetary positions close to balance or in surplus overthe economic cycle Ministers and the ECB concurredtherefore with the Commission that those countrieswhich have not yet reached that objective need to pursuecontinuous adjustment of the underlying balance by atleast 05 of GDP per year All ministers but one[France] accept this to start no later than in next yearrsquosbudgetrsquo

The efforts described in this chapter on measures tostrengthen the coordination of budgetary policies shouldnot be confused with the broader debate underway in theConvention on the Future of Europe The need for abroader and deeper debate on the future of the Unionbecame apparent at the European Council in Nice(December 2000) see Declaration 23 to the Treaty ofNice One year later the European Council meeting inLaeken decided to convene a Convention to examine thefundamental questions raised by the future developmentof the Union The different questions put forward in the

Laeken Declaration mainly relate to the definition of thepowers of the Union the simplification of the Unionrsquosinstruments (legislative instruments implementationmeasures etc) the enhancement of democracy transpar-ency and effectiveness (for example appointment proce-dures for Commissioners and for the Commission Presi-dent EP powers and elections role of the Council roleof the national parliaments etc) and the preparation of aEuropean Constitution The Convention is chaired byMr Giscard drsquoEstaing and is composed of 105 memberswhich represent the different Heads of State or Govern-ment the national parliaments the European Parliamentand the Commission Its work is prepared by the Praesid-ium which is composed of 12 members The Conven-tion started its work in February 2002 and will presentthe results of its work in mid-2003 An intergovernmen-tal conference will be convened either in 2003 or in2004 in order to formally amend the Treaty and proposeit for ratification to the different Member States Box II2provides details on the proposals of the Commissionrelated to the coordination of budgetary policies and thesubsequent debate within the Convention

22 Commission proposals to strengthen the coordination of budgetary policies

221 A diagnosis of the shortcomings of the SGP in the first four years of EMU

The Commission adopted on 27 November 2002 acommunication on strengthening the coordination ofbudgetary policies (3) While arguing that the coordina-tion of budgetary policies is essential for the smoothfunctioning of EMU and that the SGP goal of budgetpositions of lsquoclose to balance or in surplusrsquo remains aneconomically valid objective (4) it provided a candiddiagnosis of significant shortcomings in its implementa-tion as follows

bull political ownership of the SGP by Member Stateshas diminished with a divergence between budget-ary commitments and concrete actions to achievestated targets and unwillingness to acknowledge theimplication of EMU on the conduct of fiscal policyat national level More generally Member Statesfailed to play their role in exerting peer pressure oncountries that miss budgetary targets by a wide mar-gin via the enforcement mechanisms of the SGP

yen1part For a review of problems and challenges concerning the SGP see Giudiceand Montanino (2002)

yen2part SEC(2003) 10096 of 25 September 2002

yen3part COM(2002) 668 finalyen4part For an assessment of Maastrichtrsquos fiscal rules see Buti and Giudice (2002)

bull it has been difficult to establish clear and verifiablebudget objectives which take account of underlyingeconomic conditions While the targets for budgetbalances are set down in stability and convergenceprogrammes in nominal terms the effect of the eco-nomic cycle on the budget position has to be takeninto account when assessing compliance with budg-etary commitments and in particular the adjustmentpath to lsquoclose to balance or in surplusrsquo This proveddifficult in the absence of an agreed method to cal-culate cyclically-adjusted budget balances and alsobecause the nominal deficit targets in the pro-grammes of Member States were sometimes basedon optimistic growth assumptions and with budget-ary adjustment efforts back-loaded towards the endof the time horizon of programmes Measuring com-pliance with budgetary commitments set down inprogrammes has therefore not been straightforwardand this in turn weakened the enforcement mecha-nisms of the SGP

bull the framework for the collection and assessment ofbudgetary statistics has experienced a number ofdifficulties Of greatest concern are the reportinganomalies detected in some Member States whichin the case of Portugal led to a very large upwardrevision of deficit levels Concern was expressedabout the fact that ex post revisions of budgetarydata are getting larger and the discrepancy betweendeficits recorded on accrual basis and debt issuancein cash terms in some Member States Finally thedecision making processes of Eurostat on the classi-fication of certain budgetary operations could bespeeded up

bull some Member States did not run sound budgetarypolicies in good times A failure to pursue budgetaryconsolidation in 1999 and 2000 when growth condi-tions were favourable led to a deterioration in under-lying budget positions and inadequate room for theautomatic stabilisers to operate in the subsequenteconomic slowdown This failure to allow the auto-matic stabilisers to operate symmetrically over theeconomic cycle illustrates inadequate surveillanceand enforcement mechanisms to deal with unwar-ranted pro-cyclical loosening of the fiscal stance

bull the enforcement procedures of the SGP have beenfound wanting at critical junctures In particularthe early-warning mechanism was not effective indealing with significant slippage from budget tar-

gets set down by Member States in their stability andconvergence programmes

bull the SGP has struggled to develop into an effectivecoordination framework for dealing with country-specific circumstances in a consistent manner assur-ing the long-term sustainability of public financeswhile supporting structural reforms that are designedto enhance employment and growth potential

bull it has been difficult to communicate effectivelywith the press markets and the public on thebenefits of achieving and sustaining sound publicfinance positions and also how the SGP worksThis is partly due to the fact that it takes time foreconomic agents to adjust to the new policy frame-work in place since the launch of the euro and alsobecause the institutional procedures of the SGP arecomplex In addition effective communication hasbeen hampered by conflicting statements on theappropriate conduct of budgetary policies

The communication then set out a number of proposalsto tackle these shortcomings It should be noted that theyimplied no change whatsoever to the existing Treaty pro-visions or SGP regulations that is the existing frame-work would be unchanged and no additional procedureswere envisaged On the one hand they consisted of pro-posals to clarify the interpretation of key SGP provisionsso as to strengthen the economic rationale underpinningthe policy decisions On the other hand there were pro-posals to strengthen the implementation of SGP includ-ing the enforcement procedures The main elements ofthe Commission proposals are described below

222 Avoiding pro-cyclical policies and accounting for transitory elements in the assessment

The Commission proposed that in establishing budget-ary objectives at EU level and in carrying out the surveil-lance of Member States budgetary positions dueaccount should be taken of the economic cycle In partic-ular the Commission suggested that the lsquoclose to bal-ance or in surplusrsquo requirement of the SGP would bedefined in underlying terms throughout the economiccycle To this end it is necessary to isolate the impact oftransitory factors on the budget position and in particu-lar the effects of the economic cycle

The underlying budget balance is the actual balance netof transitory elements The main transitory elementtaken into account is the cyclical component However

other transitory elements beyond the cyclical componentalso have impact on the budget positions (both positivelyand negatively) and thus need to be considered whenassessing the underlying position so as to avoid wrongpolicy conclusions this issue is examined in detail inBox II3 In other words the economic cycle is one butnot the only transitory element that has an importantbudgetary impact Consequently the cyclically-adjustedbudget balance (CAB) is not the same concept as theunderlying budgetary position

To illustrate how the Commissionrsquos proposal wouldwork in practice (and in particular the relevance of thecyclically-adjusted budget balances) Graph II4 illus-trates the budgetary position expected of MemberStates in order to be in compliance with the lsquoclose tobalance or in surplusrsquo requirement of the SGP over theeconomic cycle (1) It refers to a country that has com-pleted the transition to the medium-term goal of thePact and assumes that there are no other transitory

effects on the budget balance other than the effect of thecycle mdash that is the CAB corresponds to the underlyingbudget balance

The underlying budget balance is represented in Graph II4by the bold line which remains unchanged over theeconomic cycle However the nominal budget balance(blue line) fluctuates according to the output gap (darkline) The degree of the fluctuation depends on thecyclical sensitivity of the budget on average an outputlevel that goes 1 below the potential implies anincrease in the nominal deficit of 05 of GDP How-ever automatic stabilisation should show its effects tooduring upturns as automatic stabilisers should operatesymmetrically over the economic cycle this impliesrunning nominal budget surpluses when growth condi-tions are favourable A degree of caution must be usedwhen interpreting changes in cyclically-adjustedbudget balances especially on an annual basis (2)

yen1part Buti and Giudice (2002) illustrate the benefits of focusing on cyclically-adjusted balances for output stabilisation

yen2part See Part II3 of European Commission (2002a)

Graph II4 Compliance with the lsquoclose to balance or in surplusrsquo requirement for countries that completed the transition process

CAB (underlying

budget balance)

of GDP

Nominal balance

Output gap

3 refence value

Box II3 Transitory elements affecting the budgetary position

The surveillance of budgetary positions aims at the maintenance of sound public finances and at ensuring their long-termsustainability In this respect what is important to understand is what the underlying budgetary positions are beyond theimpact of the economic cycle and other transitory effects In the context of the EU rule-based fiscal framework the sur-veillance carried out by the Commission and the Council should take into account the role of measures with only transitoryeffect on the budget As concluded by the Brussels European Council (21 March 2003) lsquoin making an assessment [of theimprovement of the cyclically-adjusted budgetary position] one-off measures will be considered on their own merits on acase-by-case basisrsquo

What could qualify as a one-off measure According to Milesi-Ferretti (2001) lsquoa measure implying an improvement in thefiscal balances is considered to be creative accounting if it does not imply an improvement in the intertemporal budgetarypositionrsquo lsquoCreative accountingrsquo is used in the economic literature as meaning measures with temporary effect or one-offmeasures It is difficult to identify clearly what is transitory or permanent as this depends on what is the reference pointand the degree of country- and situation-specificity is large In the context of EU surveillance the Commission and theCouncil have inevitably a margin of discretion to decide what measures to take into account in order to make the bestpossible assessment However it is important that there is consistency to the degree possible across countries in the dis-tinction between purely transitory elements and other more permanent trends Some examples of transitory elements thatcould be explicitly taken into account are as follows

On the expenditure side large individual sales of real assets such as real estate and the UMTS receipts provide good exam-ples On the revenue side a possible candidate is tax amnesties Here of course what is lsquonormalrsquo in the country concernedis an important reference point since some measures can be exceptional in one country while taking place regularly inanother Other elements may be linked to lsquounusualrsquo events Here size is clearly important as each year there are lsquounusualeventsrsquo Possibly the short-term emergency costs from flooding could be an example Large revenues or expenditures dueto specific court rulings could be another

Along the same line the Congressional Budget Office of the United States produces an estimation for the so-called stand-ardised budget that nets the actual budgetary position from the cyclical component and other temporary factors (see lsquoACBO report the standardised and cyclically-adjusted budgetsrsquo March 2003) It includes in these temporary measures thefollowing unusually large discrepancies between tax payments and liabilities swings in collection of capital gains taxeschanges in the inflation component of the governmentrsquos net interest payments temporary legislative changes in the timingof revenues and outlays asset sales and receipts from auctions of licences to use portions of the electromagnetic spectrum

However the availability of fiscal data on measures with a transitory effect is limited given the difficulties of measurementand the degree of arbitrary Some countries as done by Danish and Swedish authorities in their updated convergence pro-gramme (2002) use of a refined cyclically-adjusted budget balance More specifically by correcting the budget balancefor the deviation of several special factors (that are by definition country-specific) to their calculated trend Large clearlyidentifiable transitory items can be taken into account when assessing underlying budget developments However furtherwork in this area is necessary to upgrade the quality of the analysis

The question of measures that have only a transitory effect (one-off measures lsquocreative accountingrsquo) on the budget positionis also relevant in terms of compliance with the fiscal rules The economic literature proves that the imposition of numericalbudget rules by an outside agent encourages the use of lsquocreative accountingrsquo (see for example Easterly (1999) Eichen-green and Wyplosz (1998) Kopits and Craig (1998)) Policy makers can be induced to explore ways to fulfil budgetarytargets through creative accounting even when the rule results from an agreed commitment and not from an externalconstraint The simple reason to recourse to creative accounting is to avoid the implicit (reputational) or explicit (pecuni-ary) sanctions that occur when the rule is breached In the context of the EU rule-based fiscal framework creative account-ing may contribute to limit reputational sanctions that appear with the lsquoearly-warningrsquo andor with the start of the excessivetends to disappear in the long run due to its temporary nature it is less likely that it can be helpful in avoiding eventual

223 A minimum annual rate of adjustment for countries still in deficit

The Commission communication built upon the agree-ment of the Eurogroup that countries with underlyingdeficits would be required to achieve an annual improve-ment in the underlying budget position of at least 05 of GDP each year until the lsquoclose-to-balance or surplusrsquorequirement of the SGP has been reached This proposalmakes clear that Member States with underlying deficitsmust make continuous progress towards the medium-term goal of the Pact and thus tackles the problemwhereby targets are being rolled over indefinitely in suc-cessive updates of stability or convergence programmesMoreover it recognises that account must be taken ofeconomic conditions when setting the pace of budgetaryconsolidation

An example of what this proposal implies in practice isillustrated in Grapg II5 The starting position shows thatthe Member State has not completed the transition to thelsquoclose to balance or in surplus requirementrsquo of the SGPNote that there is an assumption of no other transitoryeffects on the budget balance other than the effect of thecycle that is the cyclically-adjusted budget correspondsto the underlying budget balance at all times

The country is required to achieve an annual improve-ment in its underlying budget position of at least 05 of GDP until the medium-term target of the Pact hasbeen reached this minimum rate of underlying budget-ary consolidation should be achieved irrespective ofgrowth conditions (see adjustment path illustrated by thebold line) However this does not imply that the nominal

budget balance must improve every year by an equiva-lent amount There may be some scope to allow the auto-matic stabilisers to operate as illustrated by the deterio-ration in the nominal budget balance during thedownturn when growth falls below its potential rate(between t0 and t1) however a safety margin must beprovided at all times so as to ensure that the nominalbudget deficit does not risk breaching the 3 of GDPreference value

The communication also states that the lsquohellip rate ofimprovement in the underlying budget position shouldbe higher in countries with high deficits or debt Also amore ambitious annual improvement in underlyingbudget positions should be envisaged if growth condi-tions are favourablersquo The latter requirement is illus-trated by a kink in the line representing the cyclically-adjusted budget balance when the output gap starts toimprove As shown between t1 and t2 the output gapstarts to increase and it closes in t2 The requested rate ofadjustment is higher than in the previous period and thenominal budget balance improves at a faster rate than thecyclically-adjusted budget position reflecting the sym-metric operation of the automatic stabilisers As illus-trated in Graph II5 reaching a position of balance innominal terms would not necessarily represent compli-ance with the lsquoclose to balance or in surplusrsquo require-ment The consolidation continues between t2 and t3when the nominal budget becomes positive and theclose to balance position in underlying terms is reachedFrom t3 onwards the transitional period is finished andthe nominal and underlying budget balance are expectedto behave as in Graph II4

Box II3 (continued)

pecuniary sanctions implied by the EDP If nominal budget unbalances is only temporary (due for example to aneconomic shock) the recourse to one-off measures avoids overemphasising the imbalance rightly correcting this temporarysituation as a temporary budgetary measure

But using creative accounting also has costs First fiscal adjustment can be illusory because it temporarily lowers thebudget deficit or the public debt but it does not improve the public sectorrsquos net worth This can imply future measures tocompensate the insufficient structural adjustment that becomes necessary once transitory measures end their effect on thebudgetary position Second the use of creative accounting entails a lack of transparency that could lead to a loss of confi-dence by public opinion in respect of government actions Loss of confidence could also affect financial markets and there-fore the country concerned could face higher risk premium Third these transitory measures can cause distortions in themarkets For example a huge sale of real estate concentrated in a short period of time to reducing the deficit level can havea destabilising impact on prices in the housing market

224 The goals of the Lisbon strategy ensuring that public finances contribute to growth and employment

Perhaps the most innovative elements of the communi-cation concern the proposal to introduce a more flexibleapplication of the lsquoclose to balance or in surplusrsquo require-ment in light of the achievement of the goals of the Lis-bon strategy In particular it is argued that there is a needto lsquohellip cater for the intertemporal budgetary impact oflarge structural reforms (such as productive investmentor tax reforms) that raise employment or growth poten-tial in line with the Lisbon strategy andor which in thelong term improve the underlying public finance posi-tionsrsquo The Commission did not consider it appropriateto develop a list or catalogue of reforms which justify ormerit an exemption This should be judged on a case-by-case basis but it referred to major structural reformsidentified in the BEPGs or as part of the Lisbon strategythat have a clearly identifiable negative impact on thebudget in the short run (for example a reform of the taxsystem pension reform substantial increase in net pub-lic investment) but a positive return in the medium tolong term on growth and the budgetary position

In making this proposal the Commission was aware thatthis initiative could easily be interpreted as a weakeningof the commitment to sound public finances or the corebudgetary goals of the SGP To avoid the impression thatprovisions of this nature would weaken the Pact numer-ous safeguards were outlined in the communication Adistinction was drawn between deviations from thelsquoclose to balance or in surplusrsquo requirements of a lsquotem-poraryrsquo and lsquomore permanent naturersquo

Regarding the former the communication stated that lsquoasmall temporary deterioration in the underlying budgetposition could be envisaged only if the Member Stateconcerned has already made substantial progresstowards the lsquoclose to balance or in surplusrsquo requirementand if general government debt is below the 60 ofGDP reference valuersquo The Commission did not specifya numerical rule as to what would constitute lsquosubstantialprogressrsquo the key issue is to ensure that an adequatesafety margin exists to limit the risk of the nominal def-icit breaching the 3 of GDP reference value and thiswould imply that the underlying budget deficit should bewell below 1 of GDP

Graph II5 The budgetary adjustment path of Member States still in transition to the lsquoclose to balance or in surplusrsquo objective

CAB (underlying BB)

Nominal balance

of GDP

3 reference value

Output gap

t 1 t 2 t 3

The communication added additional safeguards as fol-lows lsquoIn assessing the programme the Commissionmust ascertain that there is a clear and realistic deadlinefor returning to a position of ldquoclose to balance or in sur-plusrdquo within the time horizon of the stability or conver-gence programme Budgetary projections must be basedon a sound and prudent macroeconomic scenario to beverified against those of the Commission with dueaccount taken of the need to avoid inappropriate pro-cyclical policies An adequate safety margin must beprovided at all times to prevent nominal deficits frombreaching the 3 of GDP reference value Finally theMember State concerned should pre-announce correc-tive measures that would be introduced in the event of afailure to stick to the adjustment path for returning to abudget position of lsquoclose to balance or in surplusrsquo

An example of what this implies in practice is illustratedin Graph II6 The starting position shows a MemberState with an identical nominal (continuous line) andcyclically-adjusted budget deficit (bold line) again it isassumed that there are no other transitory effects on thebudget balance other than the effect of the cycle that is

the cyclically-adjusted budget corresponds to the under-lying budget balance at all times

From that starting position in t1 the Member State imple-ments a major structural reform that initially has a nega-tive impact on the cyclically-adjusted budget balancethis is evident from the downward slope in the CAB lineThere may be some scope to allow the automatic stabi-lisers to operate in the event of a slowdown in growthan even larger increase occurs in the nominal deficit(continuous line) However an adequate safety marginmust be provided at all times so as to ensure that thenominal budget deficit does not risk breaching the 3 of GDP reference value The nominal and the CAB areequal when the output gap is zero (t2) and the MemberState concerned must return to a position of lsquoclose to bal-ance or in surplusrsquo within the time horizon of the pro-gramme (say in t3)

The communication also sought to reflect differencesbetween the sustainability of public finances acrossMember States It therefore proposed that a lsquosmall devi-ation from the ldquoclose to balance or in surplusrdquo require-

Graph II6 Illustration of a small temporary deviation to cater for the inter-temporal budgetary effect of a large structural reform

CAB (underlying BB)

Nominal balance

3 reference value

Start of the reform

Output gap

of GDP

t 1t 2 t 3

ment of a longer-term nature could be envisaged forMember States where debt levels are well below the60 of GDP reference value and when public financesare on a sustainable footing This will require a carefulassessment to be made of outstanding public debt con-tingent liabilities (such as implicit pension obligations)and other costs associated with ageing populations Anadequate safety margin must be provided at all times toprevent nominal deficits from breaching the 3 of GDPreference valuersquo

225 Ensuring the sustainability of public finances

The communication also proposed that the sustainabilityof public finances should become a core policy objectiveat EU level and this requires that greater weight isattached to government debt ratios in the budgetarysurveillance process Countries with high debt levelswould be required to set ambitious long-term debt-reduction strategies in their stability and convergenceprogrammes Also the Commission suggested that thehigh-debt countries should be required to achieve a sat-isfactory pace of debt reduction towards the 60 ofGDP reference value and that a failure to do so shouldresult in the activation of the debt criterion of the exces-sive deficit procedure Overall these proposals wereconsidered necessary as the sustainability of publicfinances cannot be assured simply by looking at a three-or four-year time horizon of programmes Chapter II3considers how in practice the debt criterion of theexcessive deficit procedure could be made operational

226 Concrete measures for the enforcement of the Pact

In addition to suggestions on how to interpret certainprovisions of the SGP the communication set downdetailed proposals to improve its practical implementa-tion of how Member States needed to reaffirm theirpolitical commitment to the Pact

Firstly to ensure that Member States assume politicalownership of the SGP the communication called for thespring 2003 European Council to adopt a resolution onstrengthening the coordination of budgetary policiesThe reason for seeking support at the highest politicallevel is that achieving and sustaining the goal of budgetpositions of lsquoclose to balance or in surplusrsquo is extremelychallenging and requires full commitment of all govern-ment departments and all levels of government from thefederal authorities to local councils Substantive conclu-sions of the European Council were deemed helpful for

finance ministers in their difficult task of negotiatingwith spending ministries and representatives of sub-cen-tral governments

Secondly the communication recognised the need toimprove the quality of budgetary statistics and to thisend proposed that all parties mdash Member States and theCommission itself mdash commit themselves to a code ofbest practice on the compilation and reporting of budget-ary statistics (see Part II4 of this volume)

Finally the communication underlined the fact that fis-cal rules need to be backed up with effective and credibleenforcement procedures To this end the Commissionproposed to clarify the criteria to be used when decidingwhether to activate the early-warning mechanism TheCommission also proposed that the interpretation of thedebt criterion of the excessive deficit procedure shouldbe clarified in particular what would constitute a lsquosatis-factory pacersquo of debt reduction towards the 60 of GDPreference value

23 The agreement of the European Council on strengthening the coordination of budgetary policies

The Ecofin Council on 7 March 2003 (1) adopted a reporton strengthening the coordination of budgetary policeswhich was fully endorsed by the European Council of21 and 22 March 2003 The Council agreed that therewas no need to change the current fiscal rules of the EUand that improvements could be made to ensure an effec-tive application of the Stability and Growth Pact

In its report the Ecofin Council endorsed most of theproposals of the Commission It considered that compli-ance with the close to balance or in surplus requirementof the Stability and Growth Pact should be assessed incyclically-adjusted terms and that countries with deficitsmust improve their cyclically-adjusted budget positionand in the case of euro-area countries by a minimumannual reduction of 05 of GDP

The Council also called for automatic stabilisers to oper-ate symmetrically over the cycle and to this end Mem-ber States should avoid pro-cyclical policies especiallywhen growth conditions are favourable

yen1part Ecofin Council report on lsquoStrengthening the coordination of budgetary pol-iciesrsquo 7 March 2003 687703 (Press 61)

The suggestion of the Commission to allow for devia-tions from the lsquoclose to balance or in surplus requirementrsquoof the SGP was subject to intense debate Concerns wereraised about the practical feasibility of making such aproposal operational while at the same time safeguardingthe commitment to sound public finances In the end theEcofin Council agreed lsquohellip to pay particular attention tocountry-specific circumstances in particular to (i) thelong-term sustainability of public finances (ii) sufficientsafety margins at all times including an allowance forautomatic stabilisers to operate fully without breachingthe 3 of GDP reference value and (iii) the coherencebetween the evolution and quality of the public finances

in the stability and convergence programmes and theclose to balance or in surplus requirementrsquo

Finally the Ecofin Council agreed to pay greater atten-tion to the longer-term sustainability and the quality ofpublic finances with a view to increasing the growthpotential of the EU economies in conformity with theLisbon agenda It recognised that the pace of decline inpublic debt plays an important role in budgetary sur-veillance especially in highly indebted countries Inconformity with the Treaty provisions the excessivedeficit procedure should contribute to ensuring a satis-factory pace of debt reduction

3 Public debt and the excessive deficit procedure

31 Introduction

As part of the recent debate on strengthening the coordi-nation of budgetary policies a consensus was reached onthe need to pay increased attention to debt developmentsand the sustainability of public finances One step to thisend is to enhance the assessment of the sustainability ofpublic finances on the basis of stability and convergenceprogrammes (see Part I3 of this report)

The European Council of March 2003 also concludedthat lsquoThe pace of decline in public debt plays an impor-tant role in budgetary surveillance especially in highlyindebted countries In conformity with the Treaty provi-sions the excessive deficit procedure should contributeto ensuring a satisfactory pace of debt reductionrsquo Bothcriteria defined in the Maastricht Treaty (the deficit crite-rion of the 3 reference value and the debt criterion) arerelevant to ensure sound public finances A nominal def-icit-to-GDP ratio below 3 allows automatic stabilisersto smooth (at least partially) the cycle without compro-mising long-term budgetary positions It also helps mon-etary policy to keep inflation under control and to sustainthe economy during slowdowns A debt-to-GDP ratiobelow 60 (or on a decreasing path) is warranted toensure that public finances are on a sustainable footing inthe light of the projected budgetary impact of ageing pop-ulations In addition the reduction of government debtwill create room to pursue other economic and socialgoals in particular to enhance economic growth Highdebt levels also leave the credit standing of the countryvulnerable to unfavourable economic circumstances (1)

So far neither the excessive deficit procedure nor therisk of excessive deficit have been launched for breach-

ing the debt criterion alone The challenge is now toensure that the commitment of reducing debt levelsbelow 60 of GDP is implemented

32 Compliance with the Treaty requirements

Member States have a Treaty obligation to avoid exces-sive deficit positions To this end Article 104(2) of theTreaty states that lsquoThe Commission shall monitor thedevelopment of the budgetary situation and of the stockof debt in Member States with a view to identifying grosserrors In particular it shall examine compliance withbudgetary discipline on the basis of the following twocriteria

(a) whether the ratio of the actual or planned governmentdeficit [hellip]

(b) whether the ratio of government debt to gross domes-tic product exceeds a reference value [60 of GDP]unless the ratio is sufficiently diminishing and approach-ing the reference value at a satisfactory pacersquo

Article 104(3) states that lsquoIf a Member State does not fulfilthe requirements under one or both of the these criteriathe Commission shall prepare a reportrsquo This report is thefirst step in the process that eventually could lead to aCouncil decision on the existence of an excessive deficitposition

To make the debt criterion of the EDP operationalrequires clarifying the conditions under which a debtratio above 60 of GDP lsquohellipis sufficiently diminishingand approaching the reference value at a satisfactorypacersquo yen1part See Bank of America Corporation Economic Research 7 February 2003

A key question to consider is whether a Member Statecould be in an excessive deficit position for not respect-ing the debt criterion even if the nominal deficit levelremains below 3 of GDP A priori the answer is yessince the Treaty gives the same relevance to both criteria

The focus on government debt in the EUrsquos budgetary sur-veillance process is not new In its decision on MemberStates to adopt the euro (Council Decision of 3 May1998) the Council stated that several countries with agovernment debt-to-GDP ratio still above 60 respectedthe convergence criteria on both the deficit and the debtsince the latter was diminishing at a satisfactory pace

Furthermore the lsquoDeclaration of 1 May 1998 by theEcofin Council accompanying the Councilrsquos recommen-dation on Member States adopting the EMUrsquo stated thatlsquoThe higher the debt-to-GDP ratios of participatingMember States the greater must be their efforts toreduce them rapidly To this end in addition to maintain-ing appropriate levels of primary surpluses in compli-ance with the commitments and the objectives of theStability and Growth Pact other measures to reducegross debt should be put in placersquo As a result high debtcountries remained committed to reduce their govern-ment debt-to-GDP ratios towards the reference valueFor instance Ireland committed to reduce its govern-ment debt-to-GDP ratio to 70 by 1999 (60 deemedachievable early in the 21st century) Italy stated that thegovernment debt-to-GDP ratio would fall below 100 in 2003 and thanks to a constant primary surplus itwould continue to fall in the following years Similarcommitments were taken by the Belgian authorities

33 Debt dynamics in EU countries (1)

Table II3 shows the average annual percentage changeof public debt-to-GDP ratios over the past 10 years intwo sub-periods 1992ndash97 (the so-called period of lsquofiscalconsolidationrsquo) and the years of the Stability and GrowthPact (1998ndash2002) Over the whole period the rate ofvariation has been negative (on average) in only onethird of EU members and among those countries with agovernment debt-to-GDP ratio still above 60 onlyBelgium showed a declining path (ndash 22 on averageeach year) Thanks to the reduced deficit levels and the

further implementation of the Stability and Growth Pactrequirements the debt-to-GDP ratio has had a moreaccentuated declining path during recent years How-ever in those countries that did not comply with the SGPrequirement andor with very high levels of debt thespeed of debt reduction has been slower than in othercountries Six out of 15 countries have had a rate ofreduction of less than 3 each year between 1998 and2002 and among these countries there are the three big-gest EU economies mdash Italy France and Germany mdash thatrepresent more than 60 of total EU public debt in 2002

The pace of debt reduction depends upon both factorsthat can be shaped by government policies (primary bal-ance privatisation) and factors which lie outside theirimmediate control (interest rate changes growth andinflation rates exchange rate movements) Factors out-side the immediate control of the government whosecombined effect is commonly known as the lsquosnowballeffectrsquo are as follows

The interest rates on government debt They includeexpected inflation and a (diversificationdefault) riskpremium A lower interest rate decreases the amount ofinterest payments making the reduction of the debt ratioeasier Ceteris paribus the market interest rate is likelyto decrease the more credible the economic policy is

Real GDP growth A faster rate of real GDP growthincreases the denominator of the debt-to-GDP ratio Italso affects revenues and therefore improves the budget-ary position

Inflation rate As the denominator of the debt-to-GDPratio is expressed in nominal terms a faster inflation ratereduces the value of the stock of debt The inflation ratehas also an impact on government revenues and expen-ditures and in general tends to improve the nominalbudgetary position Contrary to the past given the clearmandate of the ECB to maintain price stability and itsindependence this factor can no longer be expected tocontribute substantially to debt reduction However dif-ferences in inflation across Member States could ceterisparibus be reflected in the pace of reduction of the stockof the debt

The factors more under governmental control are asfollows

The primary balance This factor is determined bygovernment policies (apart from cyclical components)

yen1part The definition of government debt is the one contained in the Protocolannexed to the Maastricht Treaty lsquodebt means gross debt at nominal valueoutstanding at the end of the year and consolidated between and within thesectors of general governmentrsquo

Other things being equal a primary surplus improves thegovernment debt-to-GDP ratio (or limit the deterioration)

Stock-flow adjustments These result primarily fromfinancial operations for example debt issuance policy tomanage public debt privatisation receipts impact ofexchange rate changes on foreign denominated debt (1)In general these should tend to cancel out over timeHowever large and persistent stock-flows (especially ifthey always have a negative impact on debt develop-ments) should give cause for concern as they may be theresult of the inappropriate recording of budgetary opera-tions and can lead to large ex post upward revisions ofdeficit levels Also the debt ratio may fluctuate consid-erably because of changes in the governmentrsquos portfolioof financial assets For instance if the social securitysector decides to shift its reserves from governmentpaper into private securities the government debt asdefined in the Protocol annexed to the Maastricht Treatyincreases

Table II4 shows how the above-mentioned factorsaffected debt development in high debt countries sincethe mid-1990s The impact of interest rates and nominalGDP growth is represented by the so-called lsquosnowballrsquoeffect measured as the difference between the twoSince 1998 beside lsquopurersquo public finance variables thebehaviour of the stock of debt has been negativelyaffected by stock-flow adjustments in all three high-debtcountries

34 What could constitute a satisfactory pace of debt reduction

Table II5 shows the expected debt dynamic for a countrywith a starting government debt-to-GDP ratio of 100 under different nominal GDP growth conditions (therange is between 3 and 5 ) and when the lsquoclose to bal-ance or in surplusrsquo requirement is always respected (2) Asshown the government debt-to-GDP ratio is expected toreach the reference value in maximum 17 years unlessgrowth conditions remain very adverse over the wholeperiod (that is below 3 in nominal terms)

Respect of the lsquoclose to balance or in surplusrsquo require-ment will clearly ensure a fast pace of debt reductionHowever for the purpose of operationalising the debtcriterion of the EDP a minimal requirement of whatconstitutes a lsquosatisfactory pacersquo of debt reduction couldbe defined to be used as a reference in the assessment ofdebt developments This operational indicator should berelated to the level of the debt ratio with a faster pace ofreduction required in countries where debt levels arewell above the 60 of GDP reference value It shouldalso be consistent with the overall policy frameworkThe indicator should be strict enough to allow debtreduction below the reference value in a reasonablenumber of years but not be over-demanding

A number of different methods can be used to measure asatisfactory pace of debt reduction Depending on howparameters of the rule are fixed the speed of debt reduc-tion towards the reference value can be very different Afirst set of operational indicators can refer to the budgetbalance position either in terms of required primary sur-plus or required budget balance An example of how thisindicator could work in practice for a stylised countrywith initial government debt at 100 of GDP is shown

Table II3

Average annual percentage change of public debt-to-GDP ratios

1992ndash2002 1992ndash97 1998ndash2002

Countries with debt ratio above 60 in 2002

BE ndash 22 ndash 11 ndash 32

DE 37 74 ndash 01

EL 21 47 ndash 06

IT 00 23 ndash 23

AT 18 26 09

Countries with debt ratio below 60 in 2002

DK ndash 35 ndash 12 ndash 58

ES 18 77 ndash 41

FR 42 85 ndash 01

IE ndash 103 ndash 82 ndash 124

LU 03 58 ndash 52

NL ndash 38 ndash 21 ndash 55

PT 08 18 ndash 02

FI 12 69 ndash 45

SE ndash 40 ndash 15 ndash 56

UK 00 55 ndash 54

EUR-12 12 41 ndash 17

EU-15 ndash 08 21 ndash 25

yen1part Exchange rate developments may affect the flow of interest payments andhence the implicit interest rate paid on debt when part of the latter isdenominated in a foreign currency yen2part Nominal implicit interest rates are set up at 6

in Table II6 for different combinations of nominalgrowth and primary surpluses (1)

The exact minimum primary surplus required woulddepend on the pace of debt reduction which would beconsidered necessary and feasible A main conclusion tobe drawn from the table is the critical influence of thenominal GDP growth rate If nominal growth rates are

low then the pace of debt reduction slackens considera-bly for a given primary surplus For example if the nom-inal growth rate would be 3 instead of 4 it wouldtake 26 as opposed to 17 years for debt to fall below thereference value with a primary surplus of 4 of GDPWhile primary surplus is the policy variable that drivesdebt reduction over which the government has mostcontrol the budgetary effort becomes higher the lowerthe debt-to-GDP ratio is In fact the implied rate ofreduction of the debt-to-GDP ratio increases the lower isthe debt-to-GDP ratio

Table II4

Development in debt levels in several EU high-debt countries since the mid-1990s

Belgium 1995 1996 1997 1998 1999 2000 2001 2002

Debt level ( GDP) 1340 1302 1248 1196 1149 1096 1085 1053

Change in debt level ndash 19 ndash 38 ndash 54 ndash 52 ndash 47 ndash 53 ndash 11 ndash 32

Due to Primary deficit (1) ndash 49 ndash 50 ndash 60 ndash 68 ndash 65 ndash 69 ndash 70 ndash 61

Snowball effect 45 57 19 31 17 13 36 29

Stock-flow adjustment ndash 15 ndash 45 ndash 12 ndash 15 01 03 23 00

Implicit interest rate on debt 71 68 64 63 61 62 62 58

Real GDP growth (pa ) 24 12 36 20 32 37 08 07

GDP deflator (pa ) 13 12 13 17 14 13 20 23

Greece 1995 1996 1997 1998 1999 2000 2001 2002

Debt level ( GDP) 1087 1113 1082 1058 1051 1062 1070 1049

Change in debt level 08 26 ndash 31 ndash 24 ndash 07 11 08 ndash 21

Snowball effect ndash 05 07 ndash 25 ndash 09 06 ndash 05 ndash 12 ndash 22

Stock-flow adjustment 23 50 36 39 41 68 69 44

GDP deflator (pa ) 98 74 68 52 30 34 34 37

Italy 1995 1996 1997 1998 1999 2000 2001 2002

Debt level ( GDP) 1232 1221 1202 1163 1149 1106 1095 1067

Snowball effect 23 40 41 31 31 07 15 23

Stock-flow adjustment 11 ndash 07 06 ndash 18 06 08 11 ndash 18

GDP deflator (pa ) 50 53 24 27 16 21 27 27

(1) The primary surplus include UMTS proceeds which amounted to 12 of GDP in Italy in 2000 02 of GDP in Belgium and 05 of GDPin Greece in 2000

yen1part Nominal implicit interest rates are set up at 6

Alternatively the lsquosatisfactoryrsquo pace of debt reductioncan be defined looking directly at the rate of reduction ofthe debt ratio For instance this can fall by a fixed per-centage of the debt ratio each year (Table II7a) or as afixed percentage of the distance between the actual debt-to-GDP ratio and the 60 reference value (Table II7b)Note this approach is defined in terms of a specified per-centage of reduction in the debt-to-GDP ratio each yearand not in terms of a fixed reduction of debt as a share ofGDP

Table II7a shows the required primary surplus at thebeginning and at the end of the adjustment period (forexample first three years and last three years beforereaching 60 ) according to different annual rate ofreduction and nominal growth assumptions when a fixed

rate of reduction is set up (1) For instance a reduction inthe debt ratio of 3 each year would bring the debt levelfrom 100 to 60 of GDP within 17 years If nominalGDP growth is assumed constant at 5 this wouldrequire an average primary surplus of 38 of GDP inthe first three years of the consolidation process As debtlevels fall over time a lower primary surplus would beneeded to achieve a constant reduction in the debt ratioof 3 each year in the last three years of the consolida-tion process an average primary surplus of 33 ofGDP would be sufficient

Table II7b shows the debt development when the rate ofreduction of the debt ratio is based on the distance of the

debt ratio from 60 As the debt ratio declines towards60 the further reduction that is required becomessmaller and approaches zero the closer it gets to 60 (2)

Throughout a fixed rate of debt reduction the MemberState reaches the reference value of 60 in a reasonablenumber of years without the rule being over-demandingat the beginning of the adjustment path However itcould be too stringent for countries with a governmentdebt-to-GDP ratio below 65 but still above 60 Conversely a percentage of debt reduction that decreaseas the debt approaches 60 of GDP makes a clear dis-tinction between very high and high debt countries

Table II5

Debt dynamic according to different budget balances and nominal GDP growth rates (initial government debt-to-GDP ratio 100 )

Nominal GDP growth rate

Budget balance Years to reach 60

Years to reach 60

0 10 13 17

ndash 05 12 15 22

ndash 10 14 19 30

ndash 15 17 25 53

Table II6

The implied rate of debt reduction by a constant primary surplus(starting point 100 of government debt-to-GDP ratio)

Nominal GDP growth

Average primarysurplus

Annual rate of reduction

Years to reach 60

3 GDP 02 gt30 11 29 21 19

4 GDP 12 26 22 17 32 13

5 GDP 23 16 33 13 44 10

NB The table shows the average annual reduction in debt levels as pp of GDP in the first five years of a budgetary consolidation programme for different combinationsof a constant primary surplus and interest-growth rate differential It also shows the number of years required to bring debt levels from 100 to 60 of GDP

yen2part The formula to be applied is the following bt = bt ndash 1 ndash x (bt ndash 1 ndash 60) where btis government debt-to-GDP ratio at time t bt ndash 1 is government debt-to-GDPratio at time t ndash 1 x is the fixed percentage of reduction ie 0 lt x le 1

However the debt ratio would approach 60 at adecreasing speed without ever reaching it (1) In addi-tion to achieve the reference value within a reasonableperiod of time the required adjustment at the beginningof the period could become unsustainably high in termsof the required primary surplus

Graph II7 compares the implied debt dynamic of thethree described approaches with the expected path if acountry complies with the Stability and Growth Pactrequirement of a budget balance lsquoclose to balance or insurplusrsquo The three approaches are set in order to deliverthe same rate debt reduction in percentage points of GDP

during the first year for a stylised country with initialgovernment to GDP ratio of 100 (2) Once the param-eters are fixed the approach is then maintained over theyears

To summarise the pace of debt reduction depends uponboth factors that can be shaped by government policies(primary balance privatisation) and factors which lieoutside their immediate control (interest rate changesgrowth and inflation rates exchange rate movements)When assessing debt developments careful attentionshould be devoted to each of these factors so as to eval-uate to what extent unfavourable debt developments are

Table II7

The implied primary surplus by defining a rate of reduction of the debt ratio

(a) Implied primary surplus by a constant rate of debt reduction(starting point 100 of government debt-to-GDP ratio)

Nominal GDP growth

Years to reach 60

First 3 years Last 3 years First 3 years Last 3 years First 3 years Last 3 years

3 17 56 48 47 41 38 33

4 13 65 43 56 37 46 31

5 10 72 50 63 44 55 38

NB The table shows the implied primary surplus in the first and last three years of a budgetary consolidation process necessary to achieve a constant annual reductionin debt levels as a of GDP Implicit interest rates constant at 6

(b) Implied primary surplus by a fixed percentage of debt reduction based on distance from 60 reference value(starting point 100 of government debt-to-GDP ratio)

Nominal GDP growth

Fixed percentage of debt reduction

Years to reach 60 (1)

75 39 56 21 47 15 38 09

10 29 64 22 55 16 46 10

15 19 77 24 69 18 60 12

(1) Since the rule is asymptotic to 60 it never reaches the reference value Therefore the table shows the number of years to approach the reference value (ie toreach 62 of government debt-to-GDP ratio) The table shows the implied primary surplus in the first and last three years of a budgetary consolidation process bya fixed percentage of debt reduction Implicit interest rate is constant at 6

yen1part To avoid the asymptotic problem at 60 it could be proposed to move thetarget to a value lower than 60 say 40 when the country has alreadyreduced its debt-to-GDP ratio to a value well below 100 but still far from60 eg 80

yen2part The implied reduction in the first year is 3 percentage points of GDP iegovernment debt-to-GDP ratio falls from 100 to 97 Primary surplus at4 constant rate of reduction at 3 fixed percentage of reduction at75 Implicit interest rate at 6 Nominal GDP growth at 5

due to factors outside the immediate control of govern-ments Also the year-on-year development of the debt-to-GDP ratio can be influenced by the volatility of somevariables and for this reason the dynamic of the debt

should also take into account government debt develop-ments in previous years It is indeed essential to avoid atoo mechanistic approach to assess compliance with thedebt criterion

Graph II7 Pace of adjustment for the debt ratio

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 24years

reference value

(1) Fixed primary surplus CTB

(2) Fixed rate of reduction(3) Reduction based on distance from 60

4 The governance of budgetary statistics in EMU

41 Introduction

The quality of economic statistics is crucial to ensure anadequate understanding of the economic situation and tocontribute to effective policy making Low quality statis-tics may lead to poor economic analysis mistaken con-clusions about the behaviour of economic agents andeven to inappropriate policy decisions The quality of thebudgetary statistics of Member States is particularlyimportant given that these statistics are the foundation ofthe budgetary surveillance framework

The quality of budgetary statistics is used here as a verygeneric term It includes the appropriateness of theaccounting rules compliance of data with the account-ing rules the reliability credibility completeness time-liness across-time and across-country comparabilityconsistency and transparency of data

The quality of the statistics depends primarily on theirgovernance Governance includes the accounting princi-ples rules procedures and behaviour of institutions onthe compilation and publication of figures on the distri-bution of responsibilities among different institutionsand on the mechanisms to resolve technical difficultiesor even to mediate conflicts

Throughout the last decade since the Maastricht Treatycame into force there has been considerable progressin the budgetary statistics in the EU Governmentaccounts are now more reliable complete transparentand detailed and are published in a much more timelyfashion than when the excessive deficit procedure (EDP)was set up Moreover the governance of statistics has alsoimproved with the respective roles of the Member Statesand of the Commission being progressively clarified

However some weaknesses can be still identified in thecompilation and publication of government accounts bythe Member States In several countries the governmentdeficit and debt ratios are not yet as reliable as theyshould be and are subject to large revisions Further-more the government accounts of several countries arenot fully transparent and there have been some problemsin terms of timeliness and of inappropriate politicalpressure on the national statistical institutes All theseconcerns are clearly amplified with the perspective ofenlargement since most acceding countries have statis-tical systems that are less developed than in currentMember States and some of them have serious budgetaryimbalances (see Part I2)

The next section of this chapter describes the main ele-ments of the governance of budgetary statistics in EMUSection 3 assesses the quality of the main budgetaryindicators the government deficit and debt in terms ofreliability transparency and timeliness Section 4 is onrecent progress to improve the quality of budgetary sta-tistics the first steps towards the compilation of govern-ment accounts with a quarterly frequency and the code ofbest practice recently endorsed by the Ecofin CouncilSection 5 concludes and describes the challenges for thefuture

42 The governance of budgetary statistics in the EU

421 Main elements

The main elements of the governance of budgetary sta-tistics in EMU were established already in 1992 in theprotocol on the excessive deficit procedure annexed tothe Maastricht Treaty The authors of the MaastrichtTreaty were already mindful that an effective implemen-tation of the budgetary surveillance in the EU depended

on the quality of statistics and that the latter should besupported by good governance

ESA as the accounting reference The protocol statesthat the data for the budgetary surveillance should becompiled according to the objective and well-definedaccounting rules of the European system of integratedeconomic accounts (ESA) A main advantage of an eco-nomic accounting system like ESA (1) is that transac-tions and policy measures are recorded in a meaningfuland suitable way for economic analysis forecasting andpolicy making In addition the ESA accounts try toreflect the economic reality irrespective of the legal andadministrative arrangements and therefore lead to com-parable results even if the Member States have quitedifferent institutional settings

There is a wide agreement that ESA is an appropriatetool to assess economic developments The usefulness ofESA for budgetary surveillance is also widely acceptedalthough the accounting system was not developed spe-cifically for budgetary surveillance purposes

The Commission authority The protocol also helps toensure sound governance by stating that the statisticaldata to be used for the implementation of the excessivedeficit procedure are to be provided by the CommissionThis implies that the Commission is the statisticalauthority in this domain This principle is understanda-ble and logic Since the budgetary data will be used bythe European institutions to check whether MemberStates adhere to fiscal discipline it is sensible that thesedata are officially provided by an impartial institutionand not by the Member States themselves The provisionof the budgetary data by the Commission ensures thatsuch statistics are properly checked their quality is per-manently monitored and that they are comparable amongMember States

However this does not mean that the budgetary data arecompiled directly from basic sources by the Commissionservices That would clearly be an inefficient option Thecompilation of government accounts involves collecting

data on millions of transactions by thousands of govern-ment units by the central government including theState and several other public units such as publicautonomous funds and services public hospitals univer-sities and other education units by the regional and localgovernments and by the social security Clearly theCommission does not have the means to compile thegovernment accounts of each Member State Accordingto the principle of subsidiarity this task belongs to eachMember State However the statistics compiled byMember States are then reported to the Commissionwhich validates them after a thorough examination

422 Other aspects of the governance of budgetary statistics

Besides the basic elements of governance of budgetarystatistics contained in the protocol there are some otherimportant aspects that were developed in secondarylegislation or that evolved over the last decade Theseinclude the rules on the reporting of EDP-related data tothe Commission the rules on the transmission to theCommission of more complete budgetary statistics andthe role of Eurostat as the Commission service that exer-cises the Commissionrsquos role as statistical authority

EDP reporting Given the Commission task of officiallyproviding the statistical data for the excessive deficitprocedure there was a need to organise the transmissionor reporting of data by Member States This was done ina Council regulation of 1993 (2) Member States reporttheir deficit and debt figures twice a year for 1 Marchand 1 September

This twice a year reporting is adequate The first report-ing allows the Commission to get a first estimate of theoutcome of the budgetary implementation in the previ-ous year so that the formal implementation of the exces-sive deficit procedure can be put in motion shortly afterthe end of the year The second reporting confirms orrevises the estimate with data that are much more stableand reliable

The reporting tables contain important information tocheck whether the deficit and debt data comply with theaccounting rules Namely Member States should reportinformation that explains the adjustments made to thecash-basis deficit to transform it into the ESA definition

yen1part The version of ESA that was in force in 1992 was ESA79 This system wasreplaced in 2000 with the European system of national and regionalaccounts or ESA95 The adoption of ESA95 as the accounting frameworkfor the budgetary surveillance in Europe in 2000 was a major step in thecompilation of national accounts and in particular of governmentaccounts ESA95 is a modern system of national accounts which has astrong legal basis in the form of a legally binding regulation while the pre-vious accounting system was simply an administrative document

yen2part Council Regulation (EC) No 360593 This regulation was slightly revisedin 2000 and 2002

of government deficit Member States should also trans-mit information on the contribution of the governmentdeficit and the other relevant factors to the variation inthe government debt level that is the so-called stock-flow adjustment In practice this consists of transmittinginformation on the government financial transactions(such as privatisation loans etc) that affect the govern-ment debt but are eligible to be excluded from the gov-ernment deficit

Transmission of other budgetary statistics The EDPreporting covers the data that are strictly indispensablefor the surveillance of the budgetary situation in the EUand that are specifically mentioned in the Treaty asconvergence criteria That is the government deficit anddebt However there are plenty of other elements thatare relevant when analysing budgetary policy and thedevelopments in the fiscal position of Member States

In fact Member States transmit many other budgetarystatistics to the Commission These other statistics aretransmitted according to the transmission programme ofnational accounts and include

bull the complete government account which is transmit-ted thrice a year at the end of March end of Augustand end of December This is detailed informationon tax revenue and on all other government receiptson salaries paid on purchases of goods and serviceson investment and on all other government expend-iture categories The data transmission of Decemberis even broken down by sub-sector (central Stateand local government and social security)

bull the government financial account which is transmit-ted at the end of September This is information ontransactions on financial assets such as the sales andpurchase of enterprisesrsquo shares loans granted by thegovernment and on all government liabilities

bull the government financial balance sheets which aretransmitted at the end of September This is informa-tion on the stocks of assets and liabilities owned orowed by government

bull details on taxes and social contributions collected bythe general government and each of its sub-sectorswhich is transmitted in December for the previousyear

bull the breakdown of government expenditure by func-tion which is also transmitted in December for theprevious year

All this information is disseminated by Eurostat

Although these other statistics are compiled under alegal context other than EDP they may be used for eco-nomic analysis in the context of the budgetary surveil-lance and for cross checking the deficit and debt figuresreported for 1 March and September

The role of Eurostat In the internal organisation of theCommission the statistical authority role is exercised byEurostat The aim of this delegation of powers was thatthe accounting and statistical issues are treated inde-pendently by an impartial and technically competentbody that guarantees the quality of data and lends credi-bility to the whole process

The tasks of Eurostat in this field have developed alongtwo lines The first has been checking and validating thedata reported by Member States This work has beendone on the basis of the reporting tables on other infor-mation transmitted by Member States when reportingtheir EDP data and on regular technical meetings withthe national authorities in charge of compiling the deficitand debt figures

In practice Eurostat has become progressively moreactive and stricter when checking the data transmittedby the Member States Several times notably duringthe last two years the control of data by Eurostat led theMember States to amend the reported figures MoreoverEurostat has itself amended the reported government sta-tistics figures and publicly expressed reservations aboutthe quality of data reported by a few Member States thuscontributing to the transparency and credibility of budg-etary surveillance

The second part of the Eurostat task has been in clarify-ing the application of the accounting rules wheneverthere were doubts over how specific measures and trans-actions should be recorded In fact despite the high levelof detail of the ESA accounting rules there are govern-ment transactions for which the accounting treatment isnot straightforward This owes to the specificity of eachcountry as the same accounting system is applied bycountries with fairly different institutional arrangementsto the diversity and multitude of operations performedby government each year and also to the increasing

sophistication of government transactions To guaranteethat data reported by each country are comparable thereis a need to interpret the accounting rules in these cir-cumstances

The accounting issues with relevance for the governmentdeficit and debt that had so far to be considered by Euro-stat can be classified in four broad groups

bull issues about the delimitation of general governmentthat is whether a specific publicly owned or control-led unit is government or whether it should beclassified outside general government as a publicenterprise in the corporate sector

bull issues about the nature of specific transactions thatis to know whether a specific government transac-tion has any direct impact on the government deficitIn more technical terms this means that one shoulddecide whether a transactions has a financial or anon-financial nature In the former case the transac-tion has no direct impact on the deficit while in thelatter case the deficit improves or deteriorates

bull issues about the time of recording of transactionsThis issue is particularly relevant since in ESAtransactions are recorded on an accruals basis Theaccruals basis imply that transactions are recordedwhen economic value is created transformed orextinguished or when claims and obligations ariseare transformed or extinguished which does notnecessarily coincide with a cash disbursement

bull issues about the calculation of the government debtEurostat had to decide about the inclusion in thegovernment debt of unusual financing instrumentssuch as share-convertible and share-exchangeablebonds of bonds issued by the government specifi-cally for the financing of public enterprises and ofbonds issued by special purpose vehicles in the con-text of securitisation

The Eurostat decisions have been very important toensure comparable results In some cases they have hadsubstantial impact on the accounts of some MemberStates

Multilateral discussion and accountability Given thatthe accounting decisions on specific transactions mayhave significant consequences on the government deficitand debt ratios of Member States Eurostat has taken its

decisions as openly as possible after discussion with thestatistical authorities of all Member States and the con-sultation of the CMFB (1) Although the CMFB opinionis not binding Eurostat always takes the utmost accountof the opinions expressed by the CMFB In practice inmost cases Eurostat follows the opinion expressed bythe majority of CMFB members whenever it was aquestion of deciding on the accounting treatment of gov-ernment transactions Furthermore the Eurostat deci-sions and the CMFB opinions on the recording of gov-ernment transactions and the respective rationale aremade public thus ensuring accountability

43 Assessing the quality of budgetary statistics

The section above described governance of budgetarystatistics In particular the distinction between theCommission and the Member Statesrsquo role is widely rec-ognised as adequate and contributing to the quality ofbudgetary statistics However the quality of statisticsmust be assessed directly that is whether the budgetaryfigures in particular the deficit and the debt ratiosreported by Member States are reliable transparentconsistent and timely

431 Reliability

The reliability of statistics is difficult to measure andeven to define The concept of reliability that is used hererefers to the successive revisions in data Are the deficitand debt ratios reported in March each year reliable inthe sense that they are only slightly revised after sixmonths or later or are deficit and debt figures subject tolarge revisions after the publication of the first estimate

Over the last three and half years (that is since 2000when ESA95 replaced ESA79 as the accounting frame-work for the compilation of government accounts) theaverage absolute revision in the deficit ratios of MemberStates has been 015 of GDP after six months 022 after one year and 026 after 18 months (2) This is avery small figure if one considers that the EU average of

yen1part The CMFB or Committee on Monetary Financial and Balance of PaymentStatistics gathers senior statisticians and national accountants from thenational statistical institutes and national central banks of all MemberStates as well as Commission and ECB representatives

yen2part This indicator is the GDP-weighed average of the absolute differencebetween the deficit (or debt) ratio for year t reported in March t+1 and thedeficit (or debt) ratio for the same year reported in September t+1 andMarch t+2

government total revenue and expenditure that lead tothe deficit is around 47 of GDP

However in some cases the revisions in the governmentdeficit ratios were unacceptably high For example thedeficit to GDP ratio for 2001 as reported by Portugal wasrevised upwards by 2 points from spring 2002 tospring 2003 by Greece by 15 and by Italy by 12 The government surplus of Luxembourg for 2001 wasalso revised upwards by 14 of GDP

Concerning the debt ratios the average absolute revisionin data has been 031 038 and 041 of GDP aftersix 12 and 18 months The largest revisions in the debtratio in recent years took place in Greece and Austria (1)

In most cases the revisions in the deficit and debt ratiosare because the national statistical institutes receivedbetter data from their basic sources However in otheroccasions the revisions were because Eurostat requestedcountries to amend their data since the accounting ruleshad not been fully respected or following a clarificationof such rules In some cases the revision in the GDP fig-ures also played a role in the revision of deficit and debtratios

Therefore while the deficit and debt ratios reported byMember States have been generally reliable there werevery large revisions in a few countries Although allcountries may still improve the reliability of their datathis issue is particular relevant for the countries forwhich the deficit and debt data were recently signifi-cantly revised

432 Transparency and consistency

All Member States publish complete governmentaccounts that is they publish not only the governmentdeficit figures but also details about their expenditureand revenue even if in most cases such informationappears around one month after the transmission of thedeficit data In this sense government accounts are

transparent as one may understand what is behind anymovement in the deficit ratio (in terms of increase ordecrease in specific revenue and expenditure categories)from one year to the other

For the sake of consistency it is also important that a linkis established between the ESA government deficit andthe cash-based public accounts deficits This is impor-tant because the cash-based balances are easier to com-pile and to monitor as they are directly observable Inaddition the public accounts deficits are scrutinised bythe national institutions like the national parliaments andcourts of auditors Therefore if one is able to explain thelink between the two deficit concepts the ESA govern-ment accounts profit from the scrutiny made at the levelof the public accounts

All countries transmit to the Commission data on the linkbetween the cash basis figures and the ESA governmentdeficit for central government However for severalcountries this information is relatively confusing or notcomplete or there are important statistical discrepanciesMoreover only one Member State (Spain) has transmit-ted detailed information on the link between the cash fig-ures and the ESA accounts for the lower subsectors(regional and local authorities and social security) Thisis clearly an area where there is still much progress to bemade

433 Timeliness

Most countries always transmit their data to the Com-mission within the reporting deadlines However somecountries consistently report their data to the Commis-sion several weeks after the established deadlines Inmost cases these delays are because of technical diffi-culties in compiling the government accounts in time forthe reporting deadline However in a few occasionsMember States have also postponed the transmission ofdata on purpose for political reasons such as the proxim-ity of elections

These delays may hinder an effective and expeditedimplementation of the budgetary surveillance mecha-nisms both for the concerned countries but even for allother countries Moreover delays in the transmission ofdata by Member States lead to delays in the publicationof the EU aggregates and impede a proper validation ofdata by Eurostat

yen1part From spring 2002 to spring 2003 the Greek government debt ratio for 2001was revised upwards by 73 of GDP mainly because of the inclusion inthe debt of bonds issued in the context of securitisation of share-exchange-able bonds and of share-convertible bonds In Austria the debt ratio wasrevised upwards by 41 of GDP mainly because of the inclusion in thegovernment debt of bonds issued by the federal government for the financ-ing of public enterprises (Rechtstraumlgerfinanzierung)

44 Recent measures to improve the quality of budgetary statistics

441 The code of best practice

The Ecofin Council of 18 February 2003 endorsed acode of best practice on the compilation and reporting ofEDP data The aim of the code which follows the Com-mission communication on the need and the means toupgrade the quality of budgetary statistics of 27 Novem-ber 2002 (1) is to streamline procedures both at MemberStates and Commission level that may contribute toimproving the quality of budgetary statistics

The main elements of the code of best practice (the fulltext of the code of best practice as endorsed by the Coun-cil can be found in the annex) are the following

bull the authority of the Commission (and of Eurostat onbehalf of the Commission) in assessing the qualityof reported data and in interpreting the accountingrules is clarified and reinforced

bull the Member Statesrsquo responsibility to compile andreport data to the Commission and their commit-ment to strictly respect the accounting rules and thereporting deadlines

bull the need to ensure transparency and consistency inbudgetary statistics and to report figures that are asupdated as possible

bull the reporting tables will be revised as experiencehas shown that more precise and detailed informa-tion is needed (2) while each Member State willprovide an inventory of methods procedures andsources (3)

bull Member States are encouraged to address account-ing issues at the earliest stage when there are doubtson the correct accounting treatment of a government

measure Eurostat should be formally consulted onthe recording of specific transactions

bull the procedure leading to the Eurostat decisions onaccounting issues is streamlined and accelerated Asa rule no accounting issue should be left pending atthe time of the EDP reporting of 1 March and 1 Sep-tember Moreover as a general rule the Eurostatdecisions should be taken within six weeks (4) aftera formal request has been received

bull Eurostat is entitled to examine in depth the ESAgovernment accounts of each Member State tocheck compliance with the accounting rules toexpress reservations to the reported figure and toamend such figures if need be

In the above-referred communication of 27 November2002 the Commission concluded that lsquoan improvementin the quality of budgetary statistics requires effort andstrong commitment from all parties The Commissionbelieves that the reliability of budgetary statistics wouldprofit from a clarification and streamlining of proceduresfollowed both by the Member States and by the Commis-sion This clarification and streamlining should take theform of a code of best practice that all concerned partiescommit themselves to implementrsquo

442 Towards quarterly accounts

EU budgetary surveillance is based on annual data Thismeans that data that are relevant for deciding whether acountry is complying with the SGP requirement ofbudget positions of lsquoclose to balance or in surplusrsquo orwhether such a country is in an excessive deficit positionare the deficit and debt ratios for each year Given thatthe government budgets are adopted by the politicalinstitutions of each country and implemented in a yearlyfrequency it would not make any sense to implement theEDP and SGP on a basis other than annual

However quarterly accounts for general government canbe very important for budgetary surveillance for severalreasons First quarterly government data allow thebudgetary policy analysts to better understand the inter-action between the fiscal positions of countries and theeconomic activity Second quarterly data allows policymakers to better calibrate their measures within each

yen1part COM(2002) 670 finalyen2part This concerns in particular the lower government subsectors given that the

central government is already relatively well covered The new reportingtables will be prepared by the Commission in cooperation with the CMFBand will be implemented from March 2004

yen3part Such an inventory is a kind of document that the national statistical insti-tutes have already prepared in other circumstances It is an important toolto check that deficit and debt figures are compiled according to the account-ing rules and that the data sources and estimation methods are appropriateThe inventory requested by the Council in the code of best practice shouldbe ready for each Member State by the end of 2004

yen4part Please note that this deadline of six weeks does not appear specifically inthe code as there is a cross reference to the CMFB rules of procedure

year whenever any deviation from plans becomes evi-dent Third the budgetary efforts made by any countrycan be better and more quickly appreciated by the Coun-cil and the Commission Moreover experience fromother statistics shows that the compilation of data with ahigher frequency (quarterly or monthly figures) has afavourable impact on the quality of statistics with alower frequency (annual data)

The compilation of quarterly statistics for general gov-ernment is still at an early stage and should be under-stood as a medium-term project The quarterly govern-ment accounts are governed by three legal acts

First according to Regulation (EC) No 2642000 allMember States are required to transmit to the Commissionquarterly data on taxes and social contributions and onsocial benefits other than in kind since mid-2000 Thesedata are transmitted with a three-month lag after the end ofthe respective quarter Such data have not yet entered theusual rhythm of regular publication as their quality is stillbeing assessed by both the Commission and the MemberStates However one expects that the publication of thesefigures would start later in 2003 Although the variablescovered by Regulation (EC) No 2642000 represent a rel-atively small part of the complete government accountand do not allow the compilation of a quarterly govern-ment deficit they have the potential of becoming very rel-evant indicators as they are the government account itemsthat are most sensitive to economic activity

Second according to Regulation (EC) No 12212002Member States should compile and transmit quarterlydata for all other items of the government account lead-ing to the compilation of a quarterly government deficitMost countries are already compiling these figures andall of them will do so by mid-2004 However as in thecase with the data on taxes social contribution and socialbenefits such figures will be subject to a quality assess-ment period and the publication of data per country is notexpected before the end of 2005

Third the compilation of quarterly statistics on the gov-ernment financial transactions and of the governmentfinancial balance sheets is being envisaged The relevantlegal acts still have to be adopted by the European Par-liament and the Ecofin Council but the plans are thatthese data will be compiled from 2003 or 2004 on

For the time being there is no legal act on the compilationof the government debt with an infra-annual frequencyalthough a few Member States do compile such figures

45 Conclusion and challenges for the future

This chapter described the main elements of the govern-ance of budgetary statistics in Europe The main ele-ments of the governance mdash well-defined accountingrules and a clear distinction of roles between the Com-mission and the Member States mdash have shown to be nec-essary adequate and have contributed to the increase inthe quality of budgetary statistics in the EU

However there is still scope to improve the reliabilitythe transparency and timeliness of budgetary statistics inmany countries A strict implementation of the recentlyagreed code of best practice will also give a majorcontribution to the quality of budgetary statistics Fromthe Member Statesrsquo side this requires increasing thetransparency of government accounts in particular withrespect to the government subsectors a stricter respect ofdeadlines an overall increase in the data quality as wellas a reinforcement of the independent role of the nationalstatistical institutes as the main compilers of governmentdata From its side the Commission needs to reinforceits ability to scrutinise the Member Statesrsquo governmentaccounts in more detail Moreover it should acceleratethe process to decide whenever there are doubts howspecific government transactions are recorded in theaccounts

ESA has performed well as the accounting reference andits usefulness as a budgetary surveillance tool has notbeen challenged However one should acknowledge thatit is an extremely complex system which is not alwaysproperly understood by policy makers and that the com-pilation of the ESA government deficit and debt is noto-riously difficult lengthy and costly This is partiallybecause the foundations of the accounting system weredeveloped in a context other than budgetary surveillanceand before EDP and SGP were set up

Moreover in a context of evolving surveillance theaccounting rules need to be further developed to take dueaccount of innovative transactions or the changingnature of government units (1) The accounting systemshould remain consistent provide policy makers with

yen1part For example the reform of the public pension schemes the development ofthe securitisation of government assets or of the partnerships between thepublic and private sectors for the construction of public infrastructures andthe provision of public services etc

reliable data and the adequate set of incentives to remainthe appropriate tool for budgetary surveillance

The compilation of quarterly budgetary statistics is amajor challenge for the next years The challenge ismainly for the statisticians who will compile the datasince the quarterly data are notoriously more difficult tocompile than annual figures However it is also a chal-

lenge for economists policy-makers and budgetary pol-icy analysts who will need to learn how to read quarterlydata since these will necessarily be more volatile sub-ject to more revisions and perhaps less transparent thanannual data Anyhow whilst quarterly data will give asignificant contribution for the public finance analysisthe formal budgetary surveillance mechanisms willremain on a yearly basis

Annex A Budgetary surveillance for long-term sustainability in EU Member States

Part I3 of this report described how the sustainabilityof public finances is assessed on the basis of annualupdates to stability and convergence programmes andexplained that the Economic Policy Committee is con-tinuously working on the production of more compara-ble long-run projections on the budgetary impact ofageing populations on public expenditures As part ofits work on the sustainability of public finances theworking group on ageing populations attached to theEconomic Policy Committee (EPC) recently carriedout a questionnaire survey on whether and how thesustainability of public finances is systematicallyaddressed as a part of the budgetary-setting process inMember States

This annex presents a short summary of the results Thequestionnaire was divided into two main parts A firstsection examined how Member States carried out thelong-run budget projections A second part of the surveyexamined how such projections are used in the budget-ary-setting process and in particular whether considera-tions on the sustainability public finances are taken onboard in the setting of short- and medium-term budget-ary priorities

Long-term projections coverage and updating

All Member States currently produce long-term projec-tions for at least some expenditure or revenue items Pen-sions and healthcare represent the most relevant publicexpenditures affected by ageing and they are generallyfully covered in the projections exercise mainly thanks

to the common projections carried out by the EPC at theend of 2001 see Table II9) (1)

The coverage of revenue projections is more limited dueto methodological difficulties Any projection of taxrevenues should make assumptions on development oftax rates as they tend to adjust to the level of publicexpenditures (2) It also requires a detailed knowledge ofincome distribution and its evolution since this canchange the tax bases for direct and indirect taxes More-over the indirect effect of taxation on labour participa-tion and on income levels should be assessed to projectthe likely impact of ageing on revenues

A key issue is the demographic scenarios used toperform the projections of age-related expenditures andrevenues All Member States run several projections totake account of different possible scenarios to take intoaccount uncertainty over long-term demographic devel-opments The demographic scenarios are not fully con-sistent across countries since in many cases they arebased on national projections and not on Eurostat dataHowever the use of national scenarios makes it easier totake on board the latest demographic projections whichtake account of fast-changing variables such as migra-tion flows

In most Member States long-term projections are regu-larly updated to take into account at least changes in theeconomic environment andor the demographic scenarioIn Denmark the UK and Sweden they are updated more

yen1part The information provided below comes from a survey across MemberStates carried out by the Economic Policy Committee of the EuropeanUnion

yen2part See Martinez-Mongay C (2000)

often than once a year in Belgium Germany and Italyprojections are updated annually (1) Longer time spansare considered in Ireland (two years) Austria (threeyears) and the Netherlands (four years) Irregular updat-ing is being done in France Finland and Portugal InGreece a lsquoNational Actuary Authorityrsquo has just beenestablished and it will produce long-term projections ona regular basis in the coming years

The process of producing long-term budgetary projectionsgenerally involves several actors In most cases the finalresponsibility for producing the projections is within a gov-ernmental body mainly the TreasuryFinance Ministry orthe LabourSocial Affairs Ministry Social partners inde-pendent experts and social security institutions are fre-quently involved at some stage in the preparation of techni-cal assumptions and in the feedback of the first wave ofresults In many Member States there are ad hoc public bod-ies (committees and working groups) composed of officialsfrom the public administration and external experts socialpartners and representatives of the national Parliament

For instance in Germany consultation is a regular fea-ture of each annual update a workshop on methodologyand the main assumptions that involve the Pension Insur-ance Institutions (VDR) and the Federal Ministry ofHealth and Social Affairs is organised Other institutionsare also consulted and at the end of the process a special

advisory board assesses the results and forwards theassessment to the Federal Parliament In Austria a con-sultant body to the federal government composed of min-istry representatives social partners and researchers dis-cusses projections and it presents subsequently a report tothe government In Portugal there is an interministerialworking group on ageing that discusses technical aspectsof the projections An ad hoc group is also established inthe Irish Finance Ministry (the Long-Term Issues Group)and in Belgium (Comiteacute drsquoetudes sur le vieillissement)In France a body attached to the Prime Ministerrsquos Officecoordinates the consultation with many different actors(social partners Parliament Ministry of Finance etc)

The use of projections in budgetary procedures

All Member States use long-term projections at somestage of the budgetary process reflecting a shift in recentyears from budgetary procedures that only focused onshort-term targets to procedures that incorporate morelonger-term considerations

Currently long-term projections are used in SwedenFinland the Netherlands Belgium and Denmark as atool in setting the medium-term budgetary targets of thegovernment

Long-term projections are also used in the majority ofcountries at the design stage of major reforms in partic-

yen1part In the case of Germany this applies to projections performed for the gen-eral statutory pension scheme

Table A ndash Long-term public expenditures development covered by national projections

BE DE EL ES FR IE IT LU NL AT PT FI DK SE UK

Pensions of public employees X X X X X X na X X X X X X

Pensions of private employees X X X X X X X na X X X X X X

Pensions of employers X X X X X X X na X X X X X

Second pillar pensions X na X X

Third pillar pensions na X X

Healthcare X X X X na X X X X X X

Education X X na X X X X

Others (1) X X X na X X X X X X X

(1) IE Other areas of social welfare such as child benefit and unemployment benefit payments NL All other expenditure items (for example defence general gov-ernment transfers abroad) FI Services long-term care child day care Benefits family allowances unemployment benefits sickness insurance allowances hous-ing allowances living allowances etc DK unemployment benefits labour market- and maternity leave cash benefits early retirements benefits pension benefitspayable between early retirement and normal retirement (efterloslashn) child care and residential support for elderly SE All public sector expenditures UK All spend-ing for example long-term care non-pension social benefits (for example child benefit incapacity benefit housing benefit) net transfers abroad etc IT age-related lump sums other than pensions will be projected in the coming years AT contributions and federal transfers PT long-term care projections available inDecember 2003 BE all social security expenditures are included sickness and disability Family allowances unemployment early retirements

ular those related to pensions or tax systems Projectionsare generally used as additional information for prepar-ing specific provisions of legislation In some countriesthere is a legal obligation for each new law or amend-ment to be accompanied by a technical report on thelong-term budgetary effects for which the use of projec-tions is indispensable For instance in Italy the long-term (10 year) impact of a pension reform must beassessed and annexed to the law proposal In the UKindividual reforms are generally assessed for their long-term fiscal sustainability before policies are imple-mented In Germany such projections were used whenthe 2001 pension reform was devised

The assessment of long-term sustainability of public finances

The assessment of long-term sustainability of publicfinances is conducted primary by ministries of financeeconomy but there are cases where the SocialLabourMinistries or other public institutions are involved(Table B)

A key issue is the definition of long-term sustainabilityof public finances It can refer to debt dynamics or to abudget balance position In the Netherlands and Den-mark public finances are considered sustainable if debtis not on an lsquoexplosive pathrsquo implying a constant debt-to-GDP ratio over the long term Other countries refer tothe Treaty requirement of 60 in the debt-to-GDP ratioas in Sweden where a sustainable debt path is one whichnever exceeds the Treaty reference value In Italy thereare currently two ways to assess long-term sustainabilityof public finances One has been developed in the 2002updated stability programme for the first year and refers

to a debt reduction towards 60 of GDP A second def-inition of sustainability refers to the impact of differentdebt structure scenarios on the cost of debt and on realGDP growth rates This analysis is then used to projectthe evolution of the debt-to-GDP ratio in a long-termperspective

Belgium and Austria refer more explicitly to the defini-tion given by the EPC that is each year to maintain abudget position which is balanced or in surplus A ratherdifferent definition is the one used in the UK where sus-tainability is defined as meeting the governmentrsquos sus-tainable investment rule which says that net debt shouldremain below 40 of GDP over the economic cycle

On the basis of the above-mentioned definitions of long-term sustainability countries use a number of indicators

bull budget balance the country is not sustainable if thebudget balance cannot be maintained for the wholeperiod covered by the projections

bull fiscal gaps tax ratios (whether the current tax ratiois sustainable)

bull increase of expenditure and revenue which are sen-sitive to changes in the composition of the popula-tion (mainly pension expenditures)

bull economic dependency ratios

bull a measure of generational fairness where benefitsfrom government expenditure enjoyed by a genera-tion minus taxes paid by this generation should besimilar across generations

Table B ndash Who makes the assessment of long-term sustainability

Ministry of FinanceTreasuryEconomy X X na X na X X X X X X X

Ministry of Health X na X na

Ministry of Social AffairsLabour X na na X

Others (1) X X na na X X

(1) BE Conseil Supeacuterieur des Finance - public research institute NL Netherlands Bureau of economic policy analysis DK independent institutions DE Ministry ofthe Interior (if the civil servantsrsquo pension scheme is assessed)

Part III

Public investment and its interaction with the EUrsquos budgetary rules

Summary

Public investment as a share of GDP has fallen in the EUin recent decades and currently public investmentexpenditures are relatively low compared with otherindustrialised areas There is a widespread perceptionthat the process of budgetary consolidation (both beforeand after the launch of the euro) and the application ofthe EUrsquos fiscal rules has contributed to excessively lowlevels of public investment it is claimed that a sustainedgrowth in spending would improve the EUrsquos growthpotential in accordance with the Lisbon strategy

However data analysis shows that the decline in publicinvestment rates is a long-run tendency that had alreadystarted in the 1970s and affected all industrialised coun-tries and not just EU Member States Declining levels ofpublic investment as a share of GDP have been attributedto factors such as economic development and structuralchange (with developed countries already havingacquired a high stock of physical capital) and the chang-ing boundaries between public and private investment(in part linked to the process of privatisation) Some ofthe decline in public investment levels appears to berelated to efforts to consolidate public finances whichwas necessary irrespective of EMU A careful analysisof the data taking account of other explanatory variableshowever fails to show any clear-cut link betweenchanges in investment ratios and the provisions of theEUrsquos framework for fiscal surveillance Indeed publicinvestment expenditures in many Member States havestopped falling since the beginning of monetary union

Public investment can make an important contribution tomeet the output and employment goals of the Lisbonstrategy However in considering the links between pub-lic investment and growth it is important to focus on netas opposed to gross investment levels (that is takingaccount of the depreciation of the existing capital stock)and also the interaction between trends in public and pri-vate investment levels Existing studies reveal that pub-lic investment has a positive impact on output and pro-ductivity although the results are not very strong and

depend quite crucially on the analytical methodologiesemployed This is explained by the fact that only a frac-tion of public investment expenditures are devoted toprojects which aim directly at improving the allocationof resources and raising productivity (for exampleinvestment in transport infrastructure) a significant pro-portion of public investment is devoted to projects thatpursue other objectives such as environmental protectionor redistribution across regions which only indirectlycontribute to output

Understanding and measuring the links between publicand private investment is also crucial to assessing theoverall impact of public investment on the economy andits growth potential A priori both a complementarity ora substitution relationship can be expected between pub-lic and private investment depending on whether crowd-ing-out effects via reduced savings and increased interestrates are compensated by higher productivity of privatecapital associated with enhanced public infrastructure Inrecent decades both public and private investment rateshave declined in the EU as a whole although there aresignificant differences across countries In some coun-tries such as Greece Ireland Luxembourg and Portugalboth public and private investment have been risingConversely both type of investments have been fallingin other countries such as France Germany Italy andthe Netherlands Finally in other countries such as Aus-tria Denmark and the UK the fall in public investmenthas been coupled with a moderate increase in privateinvestment The analysis of the data shows that publicinvestment has a poor explanatory power on the dynam-ics of private investment the effect is generally not sig-nificant with the exception of the UK where there issome evidence of crowding-out and that of Portugal andSpain where instead the evidence indicates a crowding-in effect In summary the hypothesis that a generalisedincrease in public investment expenditures in the EUwould contribute to growth via higher private investmentreceives little empirical support

The important role of public investment is recognised inthe existing framework for budgetary surveillance forexample Member States are required to specify plannedpublic investment levels in their annual updates to stabil-ity and convergence programmes and the BEPGs fre-quently recommend that an increased share of total pub-lic expenditures be devoted to productive items such asinvestment In brief the budget balance requirements ofthe Treaty and SGP are compatible with a high share ofpublic spending being devoted to public investment Therecent Commission communication on strengthening thecoordination of budgetary policies sought to cater for thebudgetary impact of large investment projects while atthe same time respecting the commitment to sound andsustainable public finances

Several calls have been made to introduce a so-calledgolden rule into the SGP which would allow govern-ments to borrow to finance investment However thereare strong theoretical and practical arguments against itsintroduction especially in a framework of multilateralsurveillance such as the SGP First a golden rule basedon a national accounts system could lead to a bias inexpenditure decisions in favour of physical capital andagainst spending on human capital (education and train-

ing) or other productive items (healthcare and R amp D)which also contribute to growth and employment Sec-ond if applied to gross investment the adoption of agolden rule into the SGP framework may imply substan-tially higher deficits thus compromising the objective ofsustainability of public finances Finally to be effectiveit would need to apply to net investment however dataon net investment is neither reliable nor timely

There is a growing practice of financing public purposeinvestment projects through publicndashprivate partnerships(PPPs) The main implication for public finances ofchoosing PPPs as opposed to traditional public invest-ment is in fact that of converting up-front fixed expen-ditures into a stream of future obligations While thispractice has a sound microeconomic rationale (increasedefficiency without compromising public objectives)there is the risk that the recourse to PPPs is increasinglymotivated instead by the purpose of putting capitalspending outside government budgets in order to bypassbudgetary constraints If this is the case then it may hap-pen that PPPs are carried out even when they are morecostly than purely public investment Efforts are alsorequired to ensure a transparent recording of PPP trans-actions in national accounts

1 Introduction

Public investment as a share of GDP has fallen in mostindustrialised countries in recent decades promptingmany commentators to argue that this is having negativeconsequences on productivity In the EU context it hasbeen claimed that the deficit targets of the Treaty andSGP may contribute to keeping public investmentexpenditures at excessively low levels and that consid-eration should be given to allowing for a special budget-ary treatment for public investment

This part of the report analyses and discusses the issue ofpublic investment in the framework of the EUrsquos fiscalrules Public investment is analysed from a long-runmacroeconomic perspective Issues related to sectoralpatterns or microeconomic efficiency (for example cost-benefit analysis) are therefore left aside and the focus ison the aggregate trends in public investment and theirdeterminants and on the impact of public investment onoutput growth and private investment

While the effects of public investment on output andgrowth have been extensively studied empirically in thepast decade there is little work investigating systemati-cally how public investment relates to private investmentin EU countries New empirical analysis is thus carriedout to investigate this issue Original analysis is alsoundertaken to study the relationship between public andprivate investment in EU countries and the impact of theadvent of EMU on the evolution of public investment

Chapter 2 provides a definition of public investment anddescribes the broad trends in public investment level indeveloped economies in recent decades

Chapter 3 examines the economic rationale for publicinvestment and its potential impact on productivity Inparticular it surveys the main empirical findings on thismatter

Chapter 4 takes a closer look at developments as regardspublic investment in EU Member States It focuses onthe relationships between public and private investmentlevels in EU countries and also considers whether publicinvestment levels have been affected by the Treaty andSGP budgetary requirements both before and after thelaunch of the euro While this section focuses on the linkbetween budgetary consolidation and investment itshould also be borne in mind that a reverse causationcould exist as transparent public procurement proce-dures can contribute to budgetary savings (1)

Chapter 5 is forward looking and examines the pros andcons of proposals to modify the existing EU fiscal rulesto include a golden rule for public investment It alsopresents the main features and the budgetary implica-tions of publicndashprivate partnership agreements forundertaking public investments

yen1part OECD (2003a)

2 Public investment definition and broad trends

21 The definition of public investment

Through public investment governments increase andimprove the stock of capital employed in the productionof the goods and services they provide It is important tonote that the term lsquopublic investmentrsquo used in this chap-ter refers to a rather unique definition used in nationalaccount statistics and thus excludes certain expenditureswhich typically might be considered as constitutinginvestment (Box III1) It includes the relevant transac-tions that lead to changes in the stock of physical capitalbut excludes a large amount of expenditures related to theaccumulation of human capital For example the construc-tion of research laboratories or the purchase of computersoftware is included in the definition of public invest-ment but wages paid to researchers and scientists arenot in national account statistics this type of spending isclassified as current expenditures of the public sector inspite of the fact that the labour services provided by theseprofessional categories contribute to the accumulation ofhuman capital Equally investment in knowledge (edu-cation training or R amp D) also enhances productivityperformance in the long run by favouring more knowl-edge-intensive higher value-added job creation but thisis not captured by the national account definition (1)

With regard to the contribution of the stock of publiccapital a distinction should also be drawn between grossand net investment by the public sector Only the con-cept of net investment takes into account depreciation(that is the loss of economic value of the current capitalstock due to usage or obsolescence) and as such is thecorrect measure of the actual change in value of the stockof public capital However the available statistics on netinvestment are the result of estimation methods and are

of limited reliability It is therefore common to refer tothe statistical aggregate lsquogross fixed capital formation ofthe general governmentrsquo to obtain country-level infor-mation on public investment

22 Broad trends of public investment in industrialised countries

In most OECD countries (gross) public investment hason average been below 5 of GDP in the past 30 yearsa fraction about five times lower than private investmentFrom the 1970s onwards public investment rates havebeen falling significantly in a number of OECD coun-tries although the picture is quite differentiated acrosscountries (see for example Roubini and Sachs 1989Oxley and Martin 1991) (2)

Focusing on the EU US and Japan Graph III1 showsthat gross public investment as a share of GDP fell visi-bly in the US and in the EU during the 1970s and the firsthalf of the 1980s whereas in Japan the trend was broadlypositive (3)

yen1part European Commission (2002d)

yen2part A downward trend in public investment as a share of GDP is quite substan-tial in non-EU OECD countries such as Norway Canada Australia Icelandand New Zealand In Switzerland the share of public investment on GDPhas instead remained quite stable The main exceptions among OECDcountries are Japan and South Korea where on average the role of publicinvestment has been growing

yen3part In the whole analysis data to Germany in the years before unification referto West Germany only Moreover in this part of the report ESA95 grosspublic investment data are linked with those referring to the previous clas-sification systems system according to the following criterion

where the subscript lsquoFormerrsquo refers to the classification used before ESA95This linking methodology assumes that the growth rates in the variables arethe same irrespective of the accounting system employed and has the advan-tage of avoiding lsquojumpsrsquo in time series in correspondence with the year inwhich the accounting system changes

Xt Xt 1ndash 1Xt Xt 1ndashndash

Xt 1ndash----------------------

FORMER

P a r t I I IP u b l i c i n v e s t m e n t a n d i t s i n t e r a c t i o n

w i t h t h e E U rsquo s b u d g e t a r y r u l e s

Graph III1 Gross fixed capital formation general government of GDP at current market prices

Box III1 Public investment in national account statistics

US Japan EU-15

In national account statistics investment is defined as expenditures in fixed assets for example in items that last for morethan one year So while for instance teachersrsquo wages are classified as current expenditures buildings or furniture used inthe education sector enter the definition of investment The most common statistical definition of public investment is thegross fixed capital formation of the general government Since the general government is the relevant institutional unitthis definition includes investments carried out by the central government and by local authorities but excludes invest-ments by public enterprises classified as market units

In the ESA95 system of accounts (see Council Regulation (EC) No 222396) gross fixed capital formation consists of lsquores-ident producersrsquo acquisitions less disposals of fixed assets during a given period plus certain additions to the value of non-produced assets realised by the productive activity of producer or institutional units Fixed assets are tangible or intangibleassets produced as outputs from processes of production that are themselves used repeatedly or continuously in processesof production for more than one yearrsquo

Some remarks concerning the above definition are warranted First gross fixed capital formation does not take necessarilypositive values Negative values may be recorded if the public capital stock is reduced through sales of assets Secondchanges in inventories are excluded meaning that the stock of items other than fixed assets that can be cumulated and car-ried over (for example materials and supplies used as intermediate inputs in production) are not part of gross fixed capitalformation Third fixed assets are not necessarily physical Intangible assets like patents or software enter in fact the def-inition of gross fixed capital formation Finally it should be noted that some types of military expenditures such as thelsquopurchase of military weapons and their supporting systemsrsquo are not included in the category of gross fixed capital forma-tion whereas all military expenditures with a possible civilian use (for example hospitals) are included This is a majordifference with respect to the accounting system previous to ESA95

Public investment as a share of GDP in the EU continuedto fall throughout most of the 1990s but started to rise inlater years In contrast public investment in the US hadstarted to rise already by the mid-1980s and by the endof the 1990s it had surpassed the EU

A large body of studies has identified several factors thatcould explain this downward trend in public investmentlevels (1) First there are reasons linked to economicstructural development The supply of public capital(public infrastructure especially) depends upon the levelof economic development of a country At very low lev-els of development the supply of public infrastructuresis limited by the availability of financial (savings) andtechnical resources At intermediate levels of develop-ment the limiting role of these factors weakens and thecontribution of public infrastructure to the economybecomes more important At high levels of developmentthe marginal productivity of public physical capital startsdecreasing while the role of knowledge and human cap-ital becomes more important In brief public investmentlevels are likely to be highest in countries at intermediatelevels of economic development

Second there are reasons related to the changingboundaries between the public and private sector asregards the provision of overall investment in the econ-omy In recent decades the private sector has increas-ingly replaced the government in the realisation of riskylong-term projects due to the development of more effi-cient capital markets and better possibilities of hedgingrisk via market instruments Also many industrial andindustrialising countries in the 1980s and 1990s have

been characterised by privatisation practices throughwhich activities owned and managed by the public sectorhave been transferred totally or partially to the privatesector (2) Moreover in a number of countries a growingshare of investments in public interest have been carriedout through the operation of publicndashprivate partnershipagreements (PPPs) Frequently investments carried outin this way are not registered as government investmentin national account statistics (see Section 53 of thischapter)

Finally there are reasons related to the need to consoli-date public finance positions From the 1980s onwardsmany industrial countries especially in Europe werefaced with rising public deficits and debts In manyinstances governments found it easier to achieve a partof the consolidation of public finances by reducing pub-lic investment

Overall the trend towards falling levels of public invest-ment has led to an extensive debate as to whether this isin part responsible for lower productivity and growthrates This issue is examined in the next section of thischapter There has been an added dimension to this pol-icy debate in the EU namely whether the need to respectthe budgetary requirement of the Treaty and SGP hasaffected the level of public investment an issue which istaken up in Section 4

Box III1 (continued)

The concept of net fixed capital formation takes into account the flow of resources that are used up during the year in main-tenance operations (repairing or substituting capital goods) and the depreciation of existing fixed assets of the public sectorThe quantification of net fixed capital formation is obtained by subtracting capital consumption from gross fixed capitalformation In available national account statistics capital consumption figures are the result of an estimation method Inthe ESA95 system of classification the suggested estimation method is based on the value of the stock of fixed assets(obtained through the perpetual inventory method) and the probable average economic life of the different capital items

yen1part For empirical evidence on this issue see for instance de Haan Sturm andSikken (1996)

yen2part Privatisation practices may result in falling public investment figuresbecause of two reasons The first is that the sales of non-financial assetsowned by the general government enters with a negative sign in the defini-tion of government investment statistics The second is that after privatisa-tion the investments related to the transferred activities (for example toimprove or expand their services) stop being undertaken by the governmentand exits from public investment statistics

3 Public investment its rationale and impact on efficiency

31 The rationale for public investment

Public sector economics identifies a number of reasonswhy governments should undertake public invest-ment (1) In many instances the promotion of economicgrowth is not the main (or even minor) rationale for agovernment to undertake a particular public investmentand therefore the link between public investment andefficiency (productivity) is very often only of an indirectnature

A first reason for public investment is the supply of pub-lic goods that is goods for which there is no rivalry inconsumption and that would be under-supplied by theprivate sector alone A typical example would be publicinvestment in transport infrastructures such as roadsharbours or railways In general these are intermediatepublic goods that is they produce their benefits asinputs in the production process rather than as finalgoods and have an important impact on the efficiency ofthe private sector investments However not all govern-ment investment on public goods is likely to have adirect impact on productivity For example investmentin infrastructures to ensure clean air and water whileessential for the general welfare of citizens may onlyindirectly feed through to efficiency

A second rationale for public investment comes from thepresence of various sources of market failures Invest-ments in infrastructures with environmental purposesserve to deal with pollution or other types of environ-ment-related externalities Investment in the educationsector can be justified on the ground of human capitalexternalities and knowledge spillovers Due to such phe-

nomena the social marginal productivity of educationwould exceed the private one In the absence of publicintervention under-investment in schooling and educa-tion-related activities would arise (2)

Another category of market failures that justifies publicintervention in the provision of infrastructures comesfrom the presence of increasing returns and naturalmonopoly-type arguments The provision of networkinfrastructures (in energy distribution or telecommunica-tion for instance) could be subject to increasing returnsassociated with so-called network externalities resultingin a natural tendency towards monopolisation In suchindustries public intervention through the direct supplyof services or the regulation of the sector is desirable toovercome the inefficiencies associated with the under-supply by the private sector Since public utilities pro-vide important intermediate inputs in private sector pro-duction their efficient provision has an impact on over-all productivity However it should be pointed out thatdue to technological and institutional innovation (forexample international liberalisation of air transport andpublic utilities) in recent decades the role of naturalmonopolies has been shrinking thereby enabling gov-ernments to leave the provision of such goods and serv-ices to the private sector

A third argument in favour of public investment is thatof missing markets for capital or insurance that resultfrom asymmetric information problems In the absenceof properly functioning capital and insurance marketsprivate firms may not be willing to undertake riskyprojects or projects that can be recovered only over avery long time horizon In these cases the only alterna-

yen1part For a general treatment of the rationale for public sector activity see forexample Atkinson and Stiglitz (1990) See also European Commission(2002a)

yen2part It should be noted however that only spending on education infrastruc-tures (such as school buildings etc) is recorded as public investment innational account statistics whereas spending on teachersrsquo salaries isrecorded as current expenditures

tive to have such type of projects carried out is throughthe public sector

Summarising there are several reasons that justify thedesirability of public investment in terms of a more effi-cient allocation of resources It should be noted thoughthat in many cases the principal rationale for a particularpublic investment is not to increase efficiency in the sup-ply of goods and services that enter production statistics(GDP) but rather to pursue some other policy objectivethat raises overall welfare for example protection of theenvironment or a fair distribution of resources This isalso the case for investment related to the provision ofseveral types of welfare state services (for example hos-pitals public housing hellip) (1) Hence a priori a stronglink between government investment productivity andgrowth should not be expected

In principle public investments are desirable until thesocial marginal benefit of public capital exceeds itssocial marginal cost Social marginal benefits exceedingsocial marginal costs indicate that public capital is inshort supply and that higher public investment wouldimprove social welfare In practice however the supplyof public capital can be far from the welfare maximisinglevel for several reasons

A basic reason has to do with the lack of information ofthe policy-makers about the costs and benefits of publicinvestment The outcome of the actual economic evalu-ations of policy-makers concerning public investment(for example though cost-benefits analysis) is subject topotentially large errors related to limited information onthe technical characteristics of projects and on citizensrsquopreferences (free-riding problem) The potential dis-crepancy between the outcome of actual cost-benefitanalyses and the lsquotruersquo social marginal costs and benefitsbecome evident by considering that an appropriate esti-mate of social costs should refer to the concept of oppor-tunity cost (which requires an estimation of the benefitsfrom alternative uses of public funds) and should takeinto account the cost of alternative means of financingpublic investment including an assessment of the impactof distortionary taxation

Political economy considerations may also lead toinvestments which are not welfare increasing for thesociety as a whole A basic reason is that public invest-ments such as infrastructures tend to concentrate thebenefits among a clearly identifiable and relatively smallsubset of the population while the costs tend to spreadamong a larger and more diffused group Such types oflsquopork-barrelrsquo projects may end up being over-providedby the public sector (see for example Drazen 2000 onthis subject) (2)

In sum for a number of reasons public capital may eitherbe in short or in excess supply Understanding whetherpublic investment is socially desirable in a particularcountry or region is most often an empirical matter

32 Public investment productivity and growth the empirical evidence

In the 1990s a large amount of research was carried outwith the aim of measuring the contribution of publiccapital in terms of increased production possibilitiesreduced costs for the private sector or enhanced growthprospects In spite of the different approaches and meth-odologies followed and different measures of public cap-ital employed (for example total public investment fromnational account statistics estimates of the net publiccapital stock estimates of the stock of public infrastruc-tures or estimates of transport infrastructure only) allthese analyses assume that public capital is a productionfactor of a particular type

Aschauer (1989a) found a significant and strong positiveimpact of public investment on aggregate output for theUS case whereby a 1 percentage point increase in thepublic capital stock would raise aggregate output byalmost 04 percentage points This result generated avivid debate in academic and policy circles Empiricalwork proliferated investigating alternative datasets (dif-ferent periods or countries) and following new method-ologies In these subsequent analyses not only is theestimated impact of public investment on output smallerbut quite often the results are insignificant or even nega-tive (see Box III2 and Table III1)

yen1part By definition such investments will not necessarily have a direct positiveimpact on overall efficiency However by contributing to social cohesionthey may improve a countryrsquos lsquosocial capitalrsquo and to its long-run productivepotential an efficient allocation of resources

yen2part This does not mean that political economy factors lead to a bias of publicexpenditure in favour of investment expenditure Political economy reasons(existence of political clienteles and pressure groups) may equally explainsa bias towards excessive current public expenditure

While results do not seem to depend crucially upon theparticular country or period considered the level ofaggregation of the dataset and the way dynamic rela-tions among the variables are modelled seem to matterSome work (for example Bernd and Hansson 1991Conrad and Seitz 1994 La Ferrara and Marcellino2000) compare estimates of the social marginal benefits(proxied by shadow prices) with estimates of the socialmarginal costs of public capital with the aim of deter-mining whether public capital is in short or in excess

supply (1) Quite often the results are not supportive ofthe view that public capital is under-supplied

Box III2 Empirical evidence on the effects of public investment methodologies and results

In recent empirical analyses different methodologies have been followed to analyse the impact of public investment oneconomic activity A first strand of studies follows the so-called lsquoproduction function approachrsquo The aim is that of esti-mating the parameters of an aggregate production function in which public capital enters as a separate productive factorThe obtained estimate of the marginal productivity of public capital is thus chosen as a measure for the benefits of publicinvestment This approach has been followed for the first time in the seminal work of Aschauer (1989a) The analysis fol-lowing this approach generally finds quite ambiguous results (see Table III1) Results appear to depend quite crucially onthe level of aggregation of the dataset and the way dynamic relations among the variables are modelled In general studiesusing panel datasets disaggregated at the state or regional level find a weaker or insignificant impact of public investmentConcerning dynamics once proper techniques are used to obtain stationary series (thus avoid estimating possible spuriousrelations between public capital and output) results tend to become ambiguous

In other studies a different approach has been followed Instead of production functions cost or profit function of privatesector firms have been estimated The idea is that public capital affects the costs and profits of firms as an unpaid fixedinput This approach has the advantage of imposing less restrictions on the equations to be estimated and allowing for theestimation of the shadow price of public capital In most of the cases public capital is found to reduce the costs of privatesector firms However in several studies (for example Berndt and Hansson 1991 La Ferrara and Marcellino 2000) it isfound that public capital is in excess supply since its social marginal productivity (proxied by its shadow price) is lowerthan its social marginal cost

Some analyses followed an atheoretical approach Instead of deriving measures of the contribution of public capitalfrom the estimation of production or cost function equations these studies investigate the dynamic relationship betweenpublic investment and other aggregate variables (output private investment etc) through vector auto regressions (VAR)analysis Under this approach no a priori assumptions are made concerning causal relations all variables are jointlydetermined In most of this work measures of public investment are found to increase aggregate output but there areexceptions (see Table III1) (1)

A different strand of studies analyses the impact of public capital on the growth potential of countries or regions The ideais that public capital (transport or communication infrastructure for instance) has an impact on the accumulation possibil-ities of the economy rather than on the level of output The empirical methodology to test this hypothesis is that of cross-section growth regressions Growth rates in per-capita income over a given time period for a collection of countries orregions are regressed on initial conditions and a list of conditional variables (for example measures of human capitalstock) including the stock of public capital Results from these studies appear to be very fragile Depending on the set ofcountries and regions considered the impact of public capital may or may not be significant

(1) Such results are obtained by means of Granger causality tests

yen1part The shadow price of public capital measures the impact on private sectorfirmsrsquo costs of a unitary increase in the stock of public capital This meas-ure is thus an adequate proxy of the social marginal productivity of publiccapital under the assumption that the main role of public capital is as anintermediate input Estimates of public capital shadow prices are com-monly used in cost-benefit analysis and project evaluation Measures forthe social cost of public capital are based on estimates of the public invest-ment deflator rates of return and depreciation rates

Overall a majority of studies indicate that public capitalhas a positive impact on output productivity or growthHowever results appear to be quite weak and fragileWhen positive the estimated impact in most of the stud-ies is not a strong one and there are cases in which theimpact is insignificant or even negative A certain con-sensus is emerging that public investment is not asimportant for growth as other factors such as invest-ments in human capital (see for example Barro andSala-i-Martin 1998)

These results are mainly explained by the fact that thepurpose of a non-negligible share of public investmentexpenditures is not that of (static or dynamic) efficiencybut rather that of supporting the provision of welfareservices and affecting the distribution of income Dataon the sectoral distribution of public investment in EUcountries indicate that the investment projects directlyaffecting overall productivity and growth potential are

hardly the majority (1) Even if the most important cate-gory is transport infrastructure (roads and bridges in par-ticular) which accounts by itself for almost one third ofthe gross fixed capital formation of the general govern-ment in the EU the rest is devoted to purposes not nec-essarily related to productivity and growth A sharebetween 10 and 15 of public investment is absorbedby fixed expenditures for education and health (forexample construction and maintenance of school build-ings and hospitals) while the provision of public hous-ing and community amenities (for example water andsewers) accounts for roughly 10 of public investmentThe remaining share is mainly devoted to general publicservices (for example administration) defence andsecurity

yen1part Matha et al (2000)

Table III1

The effect of public investment on output productivity and growth

Study Data Results

1 Production function approach

Aschauer (1989a) US time series 1949ndash85 Positive effect of public capital on output

Sturm and De Haan (1995) US time series 1949ndash85 Positive effect of public capital on output insignificant effects using time differences

Evans and Karras (1994) US panel data on 48 states 1970ndash86 Insignificant effect of public capital on output

Baltagi and Pinnoi (1995) US panel data on 48 states 1970ndash86 Insignificant effect of public capital on output

Garcia Milagrave et al (1996) US panel data on 48 states 1970ndash83 Insignificant effect of public capital on output

Aschauer (1989c) G-7 panel data 1966ndash85 Positive effect of public capital on output

Ford and Poret (1991) 11 OECD countries time series 1960ndash89 Significant positive effect in Belgium Canada and Germany

Merriman (1990) Japan panel data on 9 regions 1954ndash63 Positive effect of public capital on output

Bajo-Rubio and Sosvilla-Rivero (1993) Spain time series 1964ndash88 Positive effect of public capital on output

Dalamagas (1995) Greece time series 1950ndash92 Ambiguous effects

Kavanagh (1997) Ireland time series 1958ndash90 Insignificant effect of public capital on output

Ligthart (2000) Portugal time series 1965ndash95 Positive effect of public capital on output

La Ferrara and Marcellino (2000) Italy regional panel 1970ndash94 Negative effect of public capital on output

2 Cost or profit function approach

Berndt and Hansson (1991) Sweden time series 1960ndash88 Reduction in costs Public capital in excess supply

Conrad and Seitz (1994) Germany panel on three sectors 1961ndash88 Reduction in costs Public capital in short supply during 1961ndash79 in excess supply during 1980ndash88

Dalamagas (1995) Greece time series 1950ndash92 Reduction in costs

Lynde and Richmond (1993a) UK time series 1966ndash90 Reduction in costs

Lynde and Richmond (1993b) US time series 1958ndash89 Increase in output

Morrison and Schwartz (1996a) US panel on 48 states 1970ndash87 Infrastructures have a negative impact on costs

Morrison and Schwartz (1996b) US panel six New England states 1970ndash78 Public infrastructure reduces costs but less than private investment

Seitz and Licht (1995) Germany panel on 11 states 1971ndash88 Reduction in costs

La Ferrara and Marcellino (2000) Italy regional panel 1970ndash94 Insignificant effect on costs Public capital in excess supply for Italy as a whole

3 VAR studies

Clarida (1993) US France Germany UK time series 1964ndash89

TFP and public capital are cointegrated but direction of causality is unclear

Sturm et al (1999) Netherlands time series 1853ndash1913 Public infrastructure Granger-causes output

Otto and Voss (1996) Australia time series 1959ndash82 No significant relation between public capital and output

Ligthart (2000) Portugal time series 1965ndash95 Public investment Granger-causes output

4 Cross-section growth regressions

Barro (1991) 76 countries 1960ndash85 No effect of public investment on per capita GDP growth

Easterly and Rebelo (1993) 100 countries 1970ndash88 Insignificant effect of public investment on per capita GDP growth significant effect of transport and communication spending

Crinfield and Panggabean (1995) 282 US metropolitan areas 1960ndash77 Ambiguous or insignificant effects of local and federal public capital on per capita GDP growth

Host-Eakin and Schwartz (1994) 48 US states 1971ndash86 Insignificant effects of public capital on per capita GDP growth

Mas et al (1994) 17 Spanish regions 1955ndash91 Not always significant effects of public capital on per capita GDP growth

Matha et al (2001) EU countries 1960ndash97 Positive effect of public investment on per capita GDP levels negative on output growth

La Ferrara and Marcellino (2000) Italian regions 1970ndash94 (panel structure) Positive effect of public infrastructure investment on TFP growth

4 A closer look at public investment in Member States and the interaction with the EU fiscal rules

41 The evolution of public and private investment in EU countries

411 Trends in recent decades

The EU has been characterised by a prolonged down-ward trend in public investment rates in recent decadesThere is a quite widespread view that such a tendencymay have contributed to reducing the productive poten-tial of EU countries However since what matters foroutput and growth is the accumulation of overall capitalrather than that of public capital only to support thisargument one needs to assess how the decline in publicinvestment shares relates with trends in private invest-ment in EU countries

On average gross public investment in the EU in the1970ndash2002 period has been slightly above 3 of GDPOver the same period private investment averaged about19 of GDP in the 1970ndash2002 period The differencebetween public and private investment is less markedwhen using net fixed capital formation figures The shareof net public investment in GDP was about 14 ofGDP over the same period while that of net privateinvestment is just above 6 This smaller difference ismainly explained by the fact that as on average the stockof private capital is higher than that of public capital alarge part of the investment is devoted to maintenance

Graph III2 provides a breakdown of average gross pub-lic private and total investment-GDP shares over the1970ndash2002 period for each Member State Regardingpublic investment the lowest shares are recorded forItaly Germany and the UK while the highest are thoseof Ireland Luxembourg and Sweden

Evidence concerning net investment is reported inGraph III3 (1) Net investment shares are generally lessthan one half of gross investment shares In Denmarkaverage net public investment during the 1974ndash2001period has been particularly low compared with grossinvestment being slightly negative At the opposite endin Ireland Spain and Portugal net public investment hasbeen relatively high in comparison with gross figuresThese differences across countries between gross and netinvestment figures reflect primarily differences in thesize and composition of the capital stock but may alsobe related to non-uniform practices for imputing depre-ciation

Graph III4 reports average annual changes in the shareof gross private public and total gross fixed capital for-mation during the period 1970ndash2002 For the EU-15 areduction is observed in both the public and private com-ponent of investment resulting in a reduction of the totalinvestment share of about half a percentage point peryear The average annual reduction is stronger for thepublic component which is above 16 percentage pointsper year

Overall the evidence shows that investment sharesdiffer quite widely across countries Differences ininvestment shares seem mainly to reflect differences inper-capita income and levels of economic develop-ment Cohesion countries (Greece Ireland Portugaland Spain) registered relatively high overall investmentshares and both public and private investment rates

yen1part Data are reported for the 1974ndash2001 instead of 1970ndash2002 due to missingvalues

Graph III2 Gross public private and total investment of GDP average values for the period 1970ndash2002 (1)

(1) Gross fixed capital formation

Graph III3 Net public private and total investment of GDP average values over the period 1974ndash2001 (1)

(1) Net fixed capital formation(2) Excluding Greece and Luxembourg

EU-15 BE DK DE EL ES FR IE IT LU NL AT PT FI SE UK

Gross fixed capital formation general governmentGross fixed capital formation private sector Gross fixed capital formation total economy

ndash 2

EU-13 (2) BE DK DE ES FR IE IT NL AT PT FI SE UK

Net fixed capital formation general government Net fixed capital formation private sectorNet fixed capital formation total economy

Graph III4 Average annual changes in investment shares (1970ndash2002) (1)

Graph III5 Cross-country relations between growth rates in public and private investment (average annual changes in shares 1970ndash2002)

ndash 4

ndash 3

ndash 2

ndash 1

EUndash 15BE DK DE

EL ES FRIE

NLAT PT

FI SEUK

Gross fixed capital formation general governmentGross fixed capital formation private sectorGross fixed capital formation total economy

UKy = 00534x ndash 00828

R2 = 00626

ndash 10

ndash 08

ndash 06

ndash 04

ndash 02

ndash 40 ndash 30 ndash 20 ndash 10 00 10 20 30

Gross fixed capital formation general government

have generally been growing in these countries (1)Conversely investment rates have been generally rela-tively low and falling in countries with relatively highper-capita income This is particularly evident by look-ing at changes in public investment rates with strongnegative values observed for countries such as AustriaBelgium Germany and Sweden characterised by per-capita income higher than the EU average

Another factor that helps to explain cross-country differ-ences in the evolution of public investment rates is theoccurrence of changes in the ownership structure of pro-ductive assets The reduction in the investment activity ofthe public sector is partly the result of privatisation initi-atives especially in the UK Austria and Germany (2)

412 Is there a link between changing levels of public and private investment

A relevant question is the following how does the fall inpublic investment relate with changes in private invest-ment A clear a priori effect of public investment on pri-vate investment is not evident On the one hand as withother types of public expenditure public investmenttends to crowd out private investment via reduced avail-able savings and higher interest rates Public investmentmay also crowd out private investment if the publicsector engages in activities that are strictly substitutedwith those normally carried out by the private sector(for example productive investment by publicly ownedenterprises) On the other hand public investment mayexert a positive effect on private investment (crowdingin) via increased productivity of private sector firmshigher expected profits and better investment opportuni-ties This is typically the case of public infrastructuresthat are used as common inputs in private sector firmsrsquoactivities (for example transport and communicationfacilities)

In Graph III5 growth rates in private investment areregressed against growth rates in public investment

across countries The relationship appears to be positivealthough weak indicating that the countries experienc-ing bigger reductions in public investment are morelikely to also experience bigger reductions in privateinvestment Such an analysis however does not provideany information on the direction of causality so that it isnot possible to say if it is public investment causing pri-vate investment if it is the opposite or if there is a thirdfactor that is simultaneously affecting both public andprivate investment To investigate this issue further timeseries analyses have been performed separately for eachcountry with the aim of assessing the effect of changesin public investment on future developments in privateinvestment (see Box III3 and Table III2) Results areweak and vary considerably across countries In mostcountries public investment did not play a significantrole Crowding-in effects are found for Spain and Portu-gal while for the UK there is evidence of crowding-out

In sum there is no evidence that changes in publicinvestment had a relevant or systematic impact on pri-vate investment developments in EU countries

42 Budgetary consolidation in light of EMU and its impact on public investment

Among the factors that may have contributed to explainthe downward trend in public investment has been theefforts by Member States especially during the mid-1990s to consolidate public finances in light of mount-ing public debt which was accompanied by a consequentincrease in interest expenditure While budgetary con-solidation was necessary in any event the prospect ofstage III of EMU and the entry into force of EU budget-ary rules may also have played a role With the entry intoforce of the Maastricht Treaty Member States commit-ted to avoid excessive deficits and high debt levels (anentry condition for joining the euro area) An additionalbudgetary requirement came into force with the launchof the euro in 1999 namely the objective of the Stabilityand Growth Pact to achieve budget positions of lsquoclose tobalance or in surplusrsquo

The purpose of this section is to examine the impact ofbudgetary consolidation on public investment rates inEU countries It should be stressed that this analysisexamines the relationship between budgetary consolida-tion in terms of deficit levels and changes in public

yen1part An additional reason why public investment shares may have been in gen-eral higher and growing in cohesion countries is the availability of Commu-nity structural funds However this should not be considered as a structuraldeterminant and the size and direction of structural funds will change afterthe accession of new Member States

yen2part The shift of ownership concerned mainly energy and telecommunicationinfrastructure As a result of privatisation public investment in these coun-tries became even more concentrated into fewer sectors such as transportinfrastructure health and education (OECD 1998) In the UK case afterthe privatisation of telecom and energy companies and of airports and rail-ways about 15 of UK gross fixed capital formation was transferred out-side the general government sector (Pollitt 2000)

Box III3 Public and private investment in EU countries crowding in or crowding out

The purpose of this analysis is to assess which impact public investment had on private investment in EU countries Acommon methodology followed in time-series analyses to test whether one variable has a significant impact on anothervariable (or set of variables) is through Granger causality tests This test permits the understanding of whether the pastvalues of the variable to be tested (public investment in this case) adds explanatory power to an existing relationshipbetween one variable (private investment) and its lags (1)

Granger causality tests are performed for all 15 current EU countries Yearly data are used ranging from 1970 to 2002 Thechosen specification to perform Granger causality tests is the simplest possible and it is the same for all countries Privateinvestment at time t is assumed to depend upon its own value at time t-1 and upon public investment at time t-1 This formu-lation permits to save degrees of freedom given the limited number of time series observations Variables are expressed asfirst differences of their logarithm This transformation permits to obtain stationary time series so that ordinary least squaresestimation methods can be used The logarithmic transformation permits the interpretion of the variables employed in theregressions as growth rates of the underlying variables Formally the equations to be estimated are as follows

where (resp ) is the difference between the log of private (resp public) investment at time t and time t-1 while is a random term

Testing whether public investment has an impact on private investment (Granger causes) in the above specification simplyamounts to test whether the parameter γ is significantly different from zero A significantly negative value for γ indicatescrowding out a positive value would be associated with crowding in

Results are reported in Table III2 for all EU-15 countries The coefficient of public investment normally turns out to benot significant with the exception of three countries Spain Portugal and the UK For Spain and Portugal the estimatedimpact of public on private investment is positive conversely for the UK it is negative A possible interpretation of theresults for Spain and Portugal can be related with decreasing returns in public capital Spain and Portugal are character-ised by a relatively low publicprivate investment ratio during the period considered (see Graph III2) For these coun-tries since the stock of public capital is relatively low (and thus its marginal productivity relatively high) an increase inpublic capital results in higher productivity for the private sector and then in enhanced profits and better investmentopportunities for private firms (2) In the case of the UK a possible explanation comes from the process of privatisationof the 1980s and 1990s and the growing involvement of private sector firms in the realisation of projects of public interestDue to changing ownership of assets from the public to the private sector falling public investment in the UK may havecoincided to a certain extent with a corresponding increase in investment by the private sector Something else to noteis the negative and almost significant coefficient for public investment in the case of Sweden In this country the publicprivate investment ratio is higher compared with the rest of EU countries This may indicate a relatively low marginalproductivity of public capital so that an increase in public investment would mainly crowd out private investmentthrough reduced available savings and higher interest rates (3)

(1) In existing studies on the relation between public investment and private investment using Granger causality tests results depend on the particular coun-tries and periods analysed and on the specific methodology followed (for example Aschauer 1989c Eremburg 1993) Flores de Frutos et al 1998 findevidence of crowding-in while Monadjemi et al 1998 Lightart 2000 and Voss 2001 find support of the crowing-out hypothesis) Among the existingstudies there is none analysing systematically all EU countries

(2) The result for Spain is consistent with those found in previous studies (for example Flores de Frutos et al 1998) while Lightart (2000) finds noevidence of crowding-in in the case of Portugal

(3) This interpretation for the Swedish case is consistent with existing work estimating that the stock of public capital in Sweden is above the optimal one(Berndt and Hanson 1991)

∆itp α β∆it 1ndash

p γ∆it 1ndashG εt+ + +=

∆itp ∆it

investment rather than a detailed examinations of spe-cific provisions of the EU framework for budgetary sur-veillance (1)

Graph III6 shows that in EU countries public investmentand interest expenditure followed quite opposite tenden-cies during the past decades It shows that the share ofinterest expenditure reached its maximum in the mid-1990s and declined in subsequent years Public invest-ment reached its minimum level around 1997 and stayedbroadly constant afterwards Table III3 presents evi-dence consistent with the hypothesis that fiscalconsolidations induced by high debt levels and the needto satisfy the Maastricht criteria coincided with rela-tively larger cuts in public investment For each Euro-pean country the average annual change occurred ingovernment revenues total primary expenditures andpublic investment (shares on GDP) during consolidationperiods is reported With the exception of Greece andPortugal public investment in all countries dropped dur-ing phases of consolidation and in general did so moremarkedly than total primary expenditures

Table III3 also reports the average annual change ingovernment revenues total primary expenditures andpublic investment for the EU-14 aggregate separately forthe overall period for consolidations periods only andfor consolidation periods occuring after 1985 only Pub-lic investment cuts during consolidations occurredthroughout the whole period but were on average deeperduring consolidations that took place after 1985 whichwere concentrated on the expenditure side

Graph III7 reports the average annual change in publicinvestment shares in each EU country and in the EUaggregate during the 1990s distinguishing several sub-periods The first sub-period (1991ndash93) coincides withphase I of EMU The second sub-period (1994ndash98) cor-responds to phase II of EMU It is in those years that theMaastricht calendar for monetary unification exercisedthe strongest pressure on governments urging them tokeep their budget deficits below 3 of GDP as a condi-tion for entering EMU Between 1994 and 1998 publicinvestment in the EU registered the largest drop How-ever it can be noted that during this period publicinvestment also fell in all the countries that chose not tojoin the single currency (2) The third sub-period (1999ndash2002) coincides with the years of operation of the euroIn spite of the fact that in this period the Maastricht

Table III2

Public and private investment Granger causality tests

Dep Variable N obs

Adj R squared

BE 0213(0189)

ndash 0114(0137)

31 00385

DK 0194(0183)

0101(0161)

30 ndash 00118

DE 0473 (2)(01749

ndash 0024(0117)

31 0159

EL 0063(0204)

006(0173)

31 ndash 00577

ES 0491 (3)(0152)

0158 (1)(0081)

31 0271

FR 0449 (2)(0165)

0012(0141)

31 0155

IE 025(0191)

ndash 0084(0155)

29 ndash 0063

IT 0287(0179)

ndash 0076(0106)

31 0036

LU ndash 0153(0199)

0122(0264)

31 ndash 0047

NL 0301(0177)

ndash 0137(0149)

31 0066

AT ndash 0002(0178)

ndash 0026(0121)

31 ndash 0069

PT 039 (2)(016)

0262 (1)(0138)

31 0227

FI 06 (3)(0154)

005(0182)

31 032

SE 0438 (2)(0163)

ndash 0246(0176)

31 0223

UK 0377 (2)(0161)

ndash 0144 (2)(007)

31 0234

NB Estimation method OLS constant term included (3) (2) (1) denoterespectively significance at 1 5 10 level Coefficient standard devia-tions are reported in parentheses is the difference between the (log of)real gross fixed capital formation of the private sector at time t and at timet-1 is the difference between the (log of) real gross fixed capital for-mation of the general government at time t and at time t-1 The deflatorused is that of gross fixed capital formation total economy

Data source AMECO database

yen1part The EU framework for budgetary surveillance is presented in previousissues of this report See European Commission (2000 2001 and 2002a)

∆itp

∆it 1ndashp ∆it 1ndash

∆itp

∆itG

yen2part While in Denmark and Sweden this reduction was not particularly strongthe UK is the European country registering the largest drop in publicinvestment in this period The reduction of UK public investment in thisperiod concerned mostly central government investment in health educa-tion and defence (Clarke Elsby and Love 2001)

Graph III6 Interest expenditure and public investment EU-15 1970ndash2002

Graph III7 Public invest changes in the 1990s (average annual changes in GDP shares) (1)

(1) Gross fixed capital formation general govenment

Interest expenditure general government ( of GDP at current market prices)Gross fixed capital formation general government ( of GDP at current market prices)

ndash 15

ndash 10

ndash 5

EUndash 15

BE DK DE

requirements for fiscal discipline (integrated with the pro-visions contained in the Stability and Growth Pact) contin-ued to operate the share of public investment in GDPstopped falling in the EU aggregate (1) In several countriespublic investment shares actually rose (Ireland especially)

On the basis of the data it appears that public investmentin EU Member States has been cut especially during theperiods of fiscal consolidation occurring in the late1980s and in the 1990s These dynamics may be partlyexplained by the fact that in periods of financial distresspublic investment is often more likely to be cut than cur-

rent public expenditure since the former is made of fixedexpenditures which can be delayed or moved to futureperiods with relatively low political costs The evidencealso seems to suggest that the effects of the fiscal disci-pline provisions of EMU were quite different before andafter the introduction of the euro The years precedingthe introduction of the euro coincided with a particularlystrong reduction in public investment shares in mostcountries Conversely and also thanks to the progressmade in reducing interest expenditure the introductionof the euro coincided with a halt in the downward trendin public investment that characterised the EU since theearly 1970s Interestingly the trends are similar in coun-tries that do not form part of the euro zone

Results of regression analysis presented in Table III4(see also Box III4) suggest that the requirements of fis-cal discipline associated with EMU have produced botha direct and an indirect effect on public investment withopposite signs

Table III3

The composition of fiscal consolidations general government (1970ndash2002)

Total revenues

Total primary

expenditure

Gross fixed capital

formation

EU-14 average

Overall period 09 0977 ndash 098

Consolidation periods

152 ndash 086 ndash 413

Consolidation periods after 1985

Individual countries during consolidation periods

BE 059 ndash 075 ndash 600

DK 078 ndash 214 ndash 234

DE 089 ndash 006 ndash 683

EL 260 ndash 045 373

ES 050 ndash 100 ndash 630

FR 194 091 170

IE 291 ndash 217 ndash 532

IT 244 ndash 031 ndash 478

NL 246 ndash 140 ndash 235

AT 161 050 ndash 800

PT 053 112 145

FI 014 ndash 243 ndash 428

SE 173 ndash 290 ndash 446

UK 210 ndash 095 ndash 1070

NB Figures refer to average annual changes in shares on GDP Cross-coun-try averages are unweighted The years of fiscal consolidation in each EUcountry are those reported in European Commission (2000) p 20 for the1990s while for the remaining period are those reported in IMF (1996)p 57

yen1part For the EU aggregate public investment shares are constant at 23 GDPpercentage points for the 1999ndash2001 period and equal to 22 percentagepoints in 2002

Table III4

The determinants of public investment in the EU Regression analysis (EU-15 1970ndash2002)

RPCGDP(t-1) ndash 0112 (3)(0011)

ndash 0145 (3)(0013)

ndash 0172 (3)(0014)

RLIR(t-1) ndash 0036 (2)(0014)

ndash 0022(0014)

ndash 0021(0014)

CAB(t-1) ndash 0038 (3)(0013)

ndash 0057 (3)(0013)

ndash 0064 (3)(0013)

DEBT(t-1) ndash 0021 (3)(0002)

0025 (3)(0002)

ndash 0024 (3)(0002)

TOTGREV(t-1) 0051(0012)

0051 (3)(0012)

0055 (3)(0012)

EMU 0566 (3)(0122)

0881 (3)(0149)

EMUCAB(t-1) 0115 (3)(0032)

R squared within groups

044 047 048

NB Dependent variable Gross fixed capital formation general government( of GDP)

Estimation method fixed effects panel regressionCountry effects coefficients are not reported Hausman tests rejected random effects in linear panel regressions(3) (2) (1) denote respectively significance at 1 5 and 10 confidence Coeffi-cient standard deviations are reported in parenthesesRPCGDP(t-1) Real per capita GDP lagged one year RLIR(t-1) Real interest rate on 10 year government bonds lagged one yearCAB(t-1) Cyclically-adjusted budget balance of GDP) lagged one yearDEBT(t-1)Gross nominal public debt of GDP) lagged one yearTOTGREV(t-1) Total revenue general government of GDP) lagged one yearEMU dummy variable equal to 1 for years following 1993 and for EMU countries

bull on the one hand EMU is associated with higher pub-lic investment shares keeping other factors constantThis direct effect may be associated to changed gov-ernmentsrsquo expectations concerning the state of theirpublic finances induced by the framework for fiscalstability The expectation of lower future deficits anddebts may have induced governments to increaseexpenditures devoted to public investment

bull on the other hand EMU appears to have reduced pub-lic investment indirectly by inducing a negative effectof budget deficits on public investment This mayindicate that in order to qualify for the adoption of theeuro countries running relatively large budget deficitshad to reduce their public investment expenditures torespect the EMU requirements of fiscal discipline

The overall effect of monetary unification on publicinvestment expenditures in EU countries is therefore notclear-cut and may be different depending on the countryconsidered While the net effect on countries running rel-atively large budget deficits in the 1990s may have beennegative public investments in countries with relativelylow deficits and debt levels may have instead received astimulus (1)

yen1part Gali and Perotti (2003) in their empirical analysis report evidence consist-ent with these findings They similarly do not find support for the hypothe-sis that the advent of EMU reduced public investment rates in EUcountries Their analysis however shows that with EMU public investmenthas become more pro-cyclical

Box III4 The determinants of public investment in the EU an empirical analysis

The aim of this analysis is to investigate the main factors affecting the evolution of public investment across EU countriesin the past decades with a special focus on the impact of the process of monetary unification To that end panel data regres-sions have been performed The dataset includes all Member States and covers the period 1970ndash2002 (1) The data sourceis the AMECO database

The dependent variable is the share of public investment (gross fixed capital formation general government) on GDP atcurrent market prices As for explanatory variables the real GDP per capita (RPCGDP) captures the different role that pub-lic investment has in different stages of countriesrsquo development Public investment is likely to exert a more prominent rolein countries at intermediate stages of development Since in the European context all countries are at an advanced or inter-mediate stage of development in the period considered the expected effect of RPCGDP on public investment is negative

To take into account the opportunity cost of funds used up in public investment real long-term interest rates (RLIR) areadded in the equation to be estimated This variable also hase an effect on public investment through the current andexpected cost of public debt The expected sign for the coefficient of RLIR is thus negative The fiscal stance is capturedby the cyclically-adjusted budget balance (CAB) It has been found in previous empirical analysis (for example Sturm etal 1996) that budget deficits can be negatively associated with public investment expenditure so that the expected signfor the coefficient of CAB is thus positive (in CAB deficits are negative entries while surpluses are positive entries) Afurther variable is the stock of gross public debt as a share of GDP (DEBT) Other things being equal the larger the stockof accumulated debt the higher the flow of interest payments to be paid by governments Hence the expected sign for thecoefficient of DEBT is negative

To account for the cross-country variation in the scope of government intervention and for its evolution in time the shareof government revenues on GDP (TOTGREV) is included in the equation A higher value for TOTGREV is an indicationof a greater role of the public sector in the economy The expected sign for the coefficient of TOTGREV is positive sincea higher value for TOTGREV is likely to be associated with a higher share of resources devoted to public expenditureincluding public investment To overcome endogeneity (reverse causation) problems all the above-mentioned variables

(1) Due to missing observations for some variable in particular years and countries the total number of observations used in regressions is somewhat lowerthan the maximum of 15 times 33 = 495

have been used with a one-year lag Finally a dummy variable (EMU) equal to one in all EMU countries in all years fol-lowing the start of phase II of EMU (1994) is included to have a measure of the effect played by the fiscal constraints ofmonetary unification on public investment All the remaining idiosyncratic factors that may explain differences in publicinvestment expenditures across countries (for example publicprivate ownership of infrastructures etc) are captured bycountry effects (1)

Results are displayed in Table III4 The first specification tested excludes the EMU dummy All variables have theexpected sign When the EMU dummy is included as a constant term its coefficient is significantly positive and close to05 The interpretation is the following other things being equal EMU is associated with larger public investment by abouthalf a percentage point of GDP Keeping unchanged per capita GDP public debt deficit government revenues and interestrates a country would devote a larger fraction of resources to public investment Under this specification the assumptionis that EMU only has a direct effect on public investment It may be argued however that EMU also produces an indirecteffect on public investment by changing the impact of budget deficits To test for this hypothesis the EMU dummy hasbeen interacted (multiplied) with the CAB variable (EMUCAB) Under this specification the effect on EMU is both directand indirect The impact of CAB outside EMU is captured by the coefficient of the CAB variable when not interacted theone on EMU is given by the sum of this coefficient and that of the CAB variable interacted with the EMU dummy Resultsshow that while outside EMU the impact of CAB is negative in EMU it is significantly positive In fact summing up thecoefficient of CAB and that of EMUCAB yields a positive value It is also to note that EMU still plays a significant directeffect on public investment represented by a significantly positive coefficient for the constant EMU dummy

The overall results can be interpreted as follows The requirements of macroeconomic convergence and fiscal disciplineaccompanying the process of monetary unification appear to have produced both a direct and an indirect effect on publicinvestment On the one hand EMU is associated with a shift of resources towards public investment keeping other factorsconstant This direct effect may be due to reduced interest expenditure but also to changed government expectations con-cerning the state of their public finances induced by the EMU fiscal framework The expectation of lower future deficitsand debts may have induced governments to devote a higher amount of resources to public investment On the other handmonetary unification induced a negative effect of budget deficits on public investment Starting with phase II of EMU therequirement of fiscal discipline was strengthened by specific time deadlines and started to be perceived as binding thistranslated into countries running larger budget deficits making bigger cuts in public investment

(1) The regressions results presented in Table III4 hold qualitatively unchanged under alternative specifications The exclusion of the variable TOGREV(which due to its correlation with CAB leads to multicollinearity problems) does not alter significantly the coefficients of the remaining variables A listof additional explanatory variables affecting the expected benefits of public investment (the net stock of capital over GDP private investment as a shareof GDP) and representing cyclical factors (inflation rate growth rate of real GDP) have also been considered but their coefficients resulted in beinginsignificantly different from zero in all specifications Specifications including a time trend have also been tested In such specifications the time trendturns out to have a significant negative effect on public investment while real per capita GDP and the debt variable result in being insignificant

5 Catering for public investment needs in the Stability and Growth Pact

51 How public investment is treated under the existing Treaty and SGP rules

The Treaty obliges countries to avoid excessive deficitpositions (defined as general government deficit below areference value of 3 of GDP) and the SGP requirescountries to achieve budget positions lsquoclose to balance orin surplusrsquo These requirements imply that most publicexpenditure including those in investment projectshave to be funded from current revenues

While the existing framework provides for no specialtreatment of public investment as regards the definitionof the budget balance (and consequently in terms ofthe budgetary objectives which Member States mustrespect) the framework for budgetary surveillance doeshowever take account of public investment as part of theassessment of Member Statesrsquo fiscal position For exam-ple Member States are required to report public invest-ment levels and plans in their annual updates to stabilityand convergence programmes The Council has shownsome flexibility in interpreting compliance with thelsquoclose to balance or in surplusrsquo requirement to reflectsignificant planned increases in public investment pro-grammes (for example see recent Council opinions onthe stability programme of Ireland and on the conver-gence programme of the UK)

Moreover public investment levels are taken intoaccount in the excessive deficit procedure As describedin Part II2 the Commission activates the EDP by pre-paring a report if the actual or planned deficit goes above3 of GDP Article 104(3) states that when preparingits report the Commission lsquohellipshall also take intoaccount whether the government deficit exceeds govern-ment investment expenditurehelliprsquo

In brief public investment does feature in the existingframework for budgetary surveillance and in particularconcerning the assessment of the budgetary position ofMember States This chapter considers whether there isscope for a more specific treatment of public investmentexpenditures in the EUrsquos framework for budgetary sur-veillance Two specific issues are examined

First it has been suggested by several scholars and pol-icy makers to amend or reinterpret the EU legislation insuch a way as to exclude investment expenditures fromthe deficit ceilings relevant to the EDP that is to intro-duce a lsquogolden rulersquo (1) Section 52 considers the meritsand feasibility of applying a golden rule for publicinvestment in the EUrsquos budgetary rules

Second private sector corporations are increasinglyinvolved in the building and operating of public projectsin EU countries (2) Section 53 examines the rationalefor publicndashprivate partnerships (PPPs) and how these arehandled within the existing framework for budgetarysurveillance

The issue of a more specific and flexible treatment ofpublic investment within the EU framework for budget-ary surveillance is timely In the communicationlsquoStrengthening the coordination of budgetary policiesrsquoadopted on November 2002 (3) the Commission pro-posed to introduce a more flexible application of thelsquoclose to balance or in surplusrsquo requirement to betterachieve the goals of the Lisbon strategy Point 5 (iv) ofthe communication states that there is a need to lsquohellipcater

yen1part For the academic debate on this point see for instance Balassone andFranco (2000b) Blanchard and Giavazzi (2002) Buiter and Grafe (2002)and Buti Effijnger and Franco (2002)

yen2part See for instance European Commission (2003) on alternative proposals tofinance trans-European transport networks including partnerships betweengovernments and private operators

yen3part European Commission (2002c) See also Part II2 of this report

for the intertemporal budgetary impact of large structuralreforms (such as productive investment or tax reforms)that raise employment or growth potential in line withthe Lisbon strategy helliprsquo The Commission made clearthat this should not put in jeopardy the core budgetarycommitment to sound public finances and thereforestated that lsquosmall temporary deteriorationsrsquo in underly-ing budgets position can only apply to countries alreadyhaving made substantial progress towards the lsquoclose tobalance or in surplusrsquo requirement and whose debt isbelow the 60 of GDP In other words the Commissiondid not propose a golden rule per se but rather that on atemporary basis a planned increase in public investmentcould provide grounds for a flexible interpretation of thelsquoclose to balance or in surplusrsquo requirement providedthere was an adequate safety margin ensuring respect ofthe 3 of GDP reference value for deficits

52 Public investment and the golden rule

521 A rationale for the golden rule

The golden rule consists of excluding investment spend-ing from the computation of the deficit measures whichare considered for the definition of fiscal discipline tar-gets This is not a new idea and was debated already inthe 1930s (1) A number of countries (for example Bel-gium the Netherlands and Sweden) adopted this ruleduring the 1950s and 1960s but subsequently aban-doned it The golden rule debate has been revivedrecently partly as a consequence of decisions taken bysome governments (UK Australia and New Zealand) toallow for public borrowing to finance public investment

The idea behind the golden rule is relatively simple Aswith private companies a government should notattribute entirely the full cost of a project that is likely togenerate gains for a long time period to a single yearrsquosaccounts Since public investments normally implyreturns over several years (and in some cases over a verylong time horizon) the cost should be distributed overseveral years as the returns materialise

A proper working of golden rule provisions requiresadopting a dual public budget one budget should onlyinclude current operations a separate budget should bedevoted to capital operations (2) Gross investments would

enter only in the asset side of the capital budget while inthe liabilities side of the capital budget would be regis-tered the cumulative amortisation of the public capitalstock and the deficit of the current budget As for thecurrent budget it would be affected only by the amorti-sation of the capital stock which would be recorded onthe expenditure side (3) Since the balance of the currentaccount equals general government net lendingborrow-ing after subtracting net public investment for countriesadopting a dual-budget system targets for the balance ofthe current budget are equivalent to standard budgetarytargets amended by the golden rule A dual budgetsystem would have the added advantage of improvinginformation on the contribution of public investment tothe net worth of the public sector (see for exampleFottinger 2000)

Several arguments have been advanced in favour ofadopting a golden rule First in the presence of deficitlimits socially desirable public investment projects maynot be undertaken This may happen for several reasons

bull Financing investment from current revenues mayclash with consumption-smoothing objectives ofpolicy authorities If policy-makers are inclined toavoid large variations of consumption possibilitiesover time they may decide not to carry out poten-tially profitable investment projects if this implies asubstantial reduction in current disposable incomeWhen growth prospects and public investmentreturns are high while public borrowing is not toocostly constraints that impose financing all publicexpenses through current revenues may be counter-productive In such conditions in fact profitableinvestments may be rejected under a balancedbudget rule because the additional gains generatedby public investment projects will only materialisein the future mdash when income is expected to be highmdash while current consumption would be furtherreduced by higher taxation Under such conditionsamending the balanced budget constraint by agolden rule may increase profitable investmentssince deficit finance permits current consumptionnot to be compressed

bull A more subtle motive for under-investment arisingfrom deficit ceilings builds on the analysis of

yen1part See for example Musgrave (1939)yen2part As it is currently done in the UK and in the past by Belgium the Nether-

lands and Sweden

yen3part So by construction the balance of the capital budget equals net investmentminus the balance of the current budget

Tabellini and Alesina (1990) who show that govern-ments may have a tendency to run large deficits forstrategic purposes (1) In this setting Peletier Durand Swank (1999) analyse public investment expen-ditures and show that in the presence of deficit ceil-ings governments may be induced to under-investfor strategic reasons The reason is that by reducinginvestment current policy-makers can assure them-selves of a high level of current expenditure of thepreferred type reducing at the same time the amountof resources that will accrue to future governmentsfrom the returns on investment Under such a frame-work a golden rule that excludes investment expend-iture from the deficit ceiling could help to avoid thetendency towards strategic underinvestment

A second reason why potentially desirable investmentprojects may not be carried out in the presence of deficitlimits is the existence of institutional or political constraintsIt has been argued (for example Oxley and Martin (1991)Lane 2002) that cutting public investment is often polit-ically easier to do than to achieve reductions in currentexpenditure or raising taxes Under such circumstancesinvestment may not take place simply as a result offinance constraints of institutional and political origin

A third rationale in favour of a golden rule concernsintergenerational equity As emphasised for instance inBalassone and Franco (2001) the adoption of deficitceilings that do not distinguish between current andinvestment expenditure may redistribute income awayfrom current generations due to the creation of a lsquodoubleburdenrsquo Current generations continue to pay back thedebt accumulated to finance investment undertaken bypast generations (in the form of taxes levied on theirincomes) However budget rules prohibiting deficitfinancing would require them to also pay entirely fornew investments carried out by themselves without thepossibility of deferring their cost to future generationsthrough debt The double burden issue is a transitory onethat continues until all the debt of previous generationsis repaid Once achieved all future generations will onlyhave to pay for their current investment without inherit-ing debt used to finance past investment However thetransition may be very long penalise the generations

alive during the shift in the financing regime and lead toa bias towards excessively low investment levels for aprolonged period

522 Limitations and drawbacks

In spite of the potential benefits of a golden rule thereare also considerable drawbacks and implementationproblems

A first set of basic problems with a golden rule relatesto its desirability effectiveness and relevance As illus-trated in Section 121 there are no strong theoretical orempirical arguments in favour of the view that govern-ments undertake too few public investments If the proc-ess of public decision-making produces a bias towardsexcessive rather than insufficient public investmentthen the adoption of a golden rule may prove counter-productive (2)

A further substantial drawback of the golden rule has todo with possible distortions in resource allocation Theidea of the golden rule is that of distributing over timethe costs of public projects that are likely to generateincome streams across several years This is a principlethat is normally followed in private sector accountingHowever the analogy is very limited since there aremajor differences between the concepts of economicreturns for the public and the private sector While forprivate firms economic returns of investment projectsmust translate into financial returns at least in the longrun this is not necessarily the case for the public sector(such as for instance concerning investment projectswith environmental purposes) Moreover the adoptionof a golden rule is likely to produce an effect on the com-position of productive public expenditure Finance con-straints would be released on investment in fixed assetswith a physical component (normally covered by thedefinitions of public investment from national accountstatistics) while investments in human capital mayremain constrained by deficit ceilings This may lead toa distortion in the allocation of resources in favour of thephysical

A sound application of the golden rule would require thatit should be investment net of amortisation which isexcluded from the computation of the deficit Howeverimplementation problems arise especially with the deter-mination of net investment The calculation of amortisa-yen1part When current governments have a preference over a certain type of current

expenditure but are uncertain about the preferences of future governmentsa bias towards too-high deficits may emerge since by running deficits pol-icy authorities will influence the composition of current expenditure andlimit the spending possibilities of their successors yen2part See for example Fottinger (2001) for a formal development of this argument

tion is subject to technical difficulties and ambiguitiesMoreover the difficulties with the computation of netinvestment may induce opportunistic accounting prac-tices with the consequence of an overestimation ofamortisation rates

523 Practical experiences

Though not a very common practice some form ofgolden rule has been operational in some countries orsub-national jurisdictions In the European context thecountries currently operating some form of a golden ruleare Germany and the UK In both cases the rule isdesigned in such a way that budget deficits should not behigher than some definition of public investment but thecharacteristics of the German and the UK golden rule arequite different (1)

In the German legislation Article 115 of the Constitutionstates that the annual budget deficit of the general govern-ment cannot be higher than gross fixed capital formationin the federal budget Exceptions are permitted to avoidlsquodisturbances to the overall economic equilibriumrsquo Acrucial feature of the German golden rule is that the targetis defined in terms of gross public investment not netinvestment as would be preferable in principle

In the UK since the institution of the Code for FiscalStability in 1997 the general government and thebroader public sector are allowed to borrow only to fundinvestment while current spending must be fullyfinanced from current revenues The compilation of sep-arate current and capital budgets facilitates the distinc-tion between gross and net investment in nationalaccounts Consistently the UK golden rule applies to netinvestment It can also be noted that the UK golden ruleis applied over the budget cycle so that a transitorydecline in revenues would not affect medium-termexpenditure targets Finally it is to be remarked that thegolden rule in the UK is complemented by a rule aimedat guaranteeing that leaving net investment out of defi-cits is not incompatible with sustainable public financesThis is the so-called lsquosustainable investment rulersquo whichrequires the debt-to-GDP ratio to be maintained at belowthe prudential 40 ceiling

Is the golden rule effective in stimulating public invest-ment expenditures by reducing finance constraints Inspite of the fact that a number of countries have experi-enced alternative forms of the golden rule very few sys-tematic analysis of the effects of such rules on publicinvestment exist One notable exception is the analysisby Poterba (1995) who studies the impact of the differentbudgetary rules across states in the US The analysisallows to identify the states that make a budgetary dis-tinction between capital and current expenditures andthose that use pay-as-you-go constraints to finance pub-lic projects The results show that on average separatecapital budgets are associated with higher capital expen-ditures

The cross-section dimension used in the analysis by Pot-erba (1995) for US states is lost when analysing EU coun-tries since only Germany and the UK adopted a goldenrule in recent years By simply looking at the evolution ofpublic investment figures one notes that in spite of thepresence of a golden rule Germany is among the EUcountries in which public investment has been fallingmore markedly in past decades (see Graph III7) As far asthe UK is concerned the evolution of net public invest-ment after the introduction of the golden rule does notseem so far very different from that before its introduction(see the section on the UK in part VI15 of this report)

524 Why a golden rule would not be desirable for EMU

Various proposals have been made to introduce someform of a golden rule into the EUrsquos fiscal rules that isexclude investment expenditures from the measure ofbudget balance This would imply shifting from budget-ary targets and ceilings common to all countries andfixed ex ante in numerical terms to country-specificceilings and targets related to some form of investmentexpenditure planned by national governments The pre-cise effect of such a move would depend on the way thea golden rule is designed and implemented For examplea golden rule could concern the upper ceiling for nomi-nal deficits in the EDP (as in the German golden rule)andor the medium-term target of lsquoclose to balance or insurplusrsquo (as in the UK golden rule) Box III5 examineshow the EMUrsquos fiscal architecture would be affected if agolden rule was introduced along the lines of Germanand UK approaches

Overall and building upon the drawbacks and limita-tions identified in Section 522 above there are severalarguments which suggest that the adoption of the golden

yen1part Note that the working of a golden rule in Germany and the UK is not incon-sistent with the respect of the budgetary requirements of the Treaty and theSGP In both countries deficits are required to be below ceilings defined interms of investment expenditures These ceilings will be binding only ifmore stringent than the Maastricht 3 Moreover these ceilings are notinconsistent with the medium-term goal of lsquoclose to balance or in surplusrsquo

rule in the EMU framework would largely outweigh thepossible benefits as follows

First the likely impact of a golden rule on actual levelsof public investment and its share in total public spend-ing is questionable For example a golden rule whichallows deducting net investments from medium-termbudgetary targets (as in the UK) would probably onlyhave a limited impact An indirect indication of the orderof magnitude can be inferred from past values of netinvestment in European countries During the 1980s and1990s average annual net public investment rates in theEU-15 area were well below 2 of GDP with valuesaround 1 of GDP for countries like Belgium the Neth-erlands the UK and Sweden while the average rate wasnegative for Denmark (see Graph III5)

Second the introduction of a golden rule could undermineefforts to improve the sustainability of public finances if(either because of the way the rule is designed or imple-

mented) the medium-term target for deficits ends upbeing increased by an amount equal to planned grossinvestment rates Simulations show that if governmentsrun constant deficit levels of 2 of GDP over the period2005ndash50 then debt levels would be some 45 percentagepoints of GDP higher in 2050 than what would resultfrom running a balanced budget position over the pro-jection period The difference would amount to some90 percentage points were governments to run constantdeficits of 4 of GDP (equivalent to the gross invest-ment ratio in some Member States) The impact of defi-cits (either temporary or permanent) on the sustainabilityof public finances depends on many factors not least theprojected increase in age-related expenditures in comingdecades As pointed out in Part I4 debt reduction has akey role to play in the strategies of many countries tomeet the costs of an ageing population and the risks ofan unsustainable public finance position is greatlyincreased by a failure to respect the lsquoclose to balance orin surplusrsquo requirement of the SGP

Box III5 How would the introduction of a golden rule modify the fiscal architecture of EMU

The impact of the introduction of a golden rule on the EMU fiscal architecture depends crucially on how the golden ruleis designed The current requirements of the Treaty and the Stability Pact are (i) nominal budget balances below 3 ofGDP at each year t (ii) a budget position lsquoclose to balance or in surplusrsquo Graphically the present state of the EMU fiscalarchitecture can be described as in Graph III8a) The nominal budget balance and the cyclically-adjusted budgets are plot-ted as functions of the output gap Assuming a constant sensitivity of the budget deficit with respect to the output gap thenominal budget balance can be represented by a linear function of the output gap The lsquoclose to balancersquo requirement con-strains the CAB to be non-negative This constraint is represented by the continuous horizontal line in correspondence witha value of zero Deficits must not breach the 3 reference value set by the Treaty this ceiling is represented by the dottedhorizontal line

The application of a golden rule of the German type would prescribe nominal deficits in each year to be lower than theprogrammed gross investmentGDP share Compared with the current situation the only change that would be a revisionof the value for the nominal deficit ceiling that is the SGP objective of lsquoclose to balance or in surplusrsquo would beunchanged As illustrated in Graph III8b) the upper ceiling for a deficit would change from 3 to the planned grossinvestment share at time t denoted by It

Amending the EMU fiscal architecture with a UK-type golden rule would instead change the medium-term target but leavethe 3 of GDP reference value unchanged As illustrated in Graph III8c) the revised lsquoclose to balance or in surplusrsquorequirement would require the CAB to be at most equal to the average net investmentGDP rates planned over the cycle(denoted by NIAV )

It has also been proposed (for example by Modigliani et al 1998 Blanchard and Giavazzi 2002) to modify the EMUfiscal framework by excluding net investments from the definition of deficits both nominal and CAB Such a reform wouldresult in a revision of both the upper ceiling for deficits and the medium-term targets Both would increase by the amountof planned net investment rates In other words the medium-term objective would be the same as in the UK proposal (NIAV)whereas the upper ceiling would be equal to 3 +NIAV

Graph III8 Nominal budgets structural budgets the SGP and the golden rule

CAB (underlying budget balance)

Positive outputgap

Negative outputgap

Positive outputgap

Negative outputgap

Positive outputgap

Negative outputgap

deficit

surplus

Maastricht 3 upperceiling

(SGP medium-run target)

deficit

surplus

deficit

surplus

(revised medium-run target)

Output gap

Nominal balance

Gross investmentGDPprogrammed for year t(revised upper ceiling)

Maastricht 3 upper ceiling

Nominal balance

(a) Current SGP

(b) SGP amended by a German-type golden rule

(c) SGP amended by a UK-type golden rule

Output gap

Third there would be specific implementation problemsin implementing a golden role in a multilateral settingThe crucial distinction is the one between net and grossinvestment As illustrated in Section 321 an applica-tion of the golden rule in accordance with its economicrationale would require using the concept of net invest-ment However EU countries normally do not dispose ofa dual-budget accounting system which would instead berequired for an efficient application of the golden ruleapplied to net investment As stressed previously the cal-culation of amortisation is a complex process whichrequires estimating the economic value of each publiccapital item and its expected life period These difficul-ties would become particularly relevant in a multilateralframework Amortisation rates should be evaluated by allcountries following common methodologies but oppor-tunistic accounting practices may be difficult to avoidwith governments attempting to underestimate amortisa-tion rates Finally a golden rule applied to net investmentin a multilateral framework would discriminate againstthe countries with a larger stock of public capital For agiven amount of gross investment net investment forthese countries will normally be lower since amortisa-tion applies to a larger public capital stock Howevercross-country differences in the magnitude of the publiccapital stock may simply relate to a different allocation ofownership of facilities and infrastructures between thepublic and the private sector so that a larger public capi-tal stock does not necessarily imply a weaker need forpublic investment

53 Publicndashprivate partnerships

531 Definition taxonomy and recent experiences

The involvement of private sector corporations to buildand operate public projects has become an increasinglywidespread practice in EU countries Following theexperience of the UK private finance initiative the con-struction and operations of infrastructures such as roadsbridges or airports are made jointly in a number of coun-tries by the government and private sector enterprisesthat finance the projects through so-called publicndashpri-vate partnership (PPPs) Currently PPPs cover about15 of the finance provided yearly to publicly spon-sored investment projects in the UK (Spackman 2002)In other European countries such as Germany SpainFrance the Netherlands Portugal Austria and FinlandPPP projects have been recently carried out mainly inthe field of transport infrastructure Almost all the otherEU Member States have planned PPP projects

There is no unambiguous definition of what constitutes aPPP Broadly speaking PPPs concern the transfer to theprivate sector of investment projects that traditionallyhave been executed or financed by the public sector (seefor example Grout 1997) Four elements howeverseem required to qualify PPPs

bull the project should concern the construction or theoperation of physical assets in areas characterised bya strong public function (for example transporturban development security etc) and involve thepublic sector (general government) as the principalpurchaser Although PPPs are especially relevant intransport infrastructure examples of publicndashprivatepartnerships can be found in the provision ofdefence health education and cultural services thebuilding and operation of prisons or the area ofwater and waste management

bull the PPP must involve a corporation outside the gen-eral government (normally a private corporation) asthe principal operator that is the agent that carriesout the project

bull the principal finance of the project should not comefrom public debt but from other sources such as pri-vate bonds

bull by way of the partnership the way the project is exe-cuted must change compared with the alternative ofpure public supply This means that in PPPs the pri-vate operator provides significant inputs in thedesign and conception of the project and bears a rel-evant amount of risk

The main distinction between PPPs and alternative pri-vatisation schemes is that the public sector plays a keyrole as purchaser of services While in the case of pureprivatisation (for example of public utilities) the clientsof the private operator are private users in the case ofinfrastructure building realised though PPPs the govern-ment normally pays for the services to be supplied or hasan influence in their specification What instead distin-guishes PPPs from the traditional public procurementmodel is the origin of the funds to accomplish theproject Instead of relying on government borrowingmost PPPs are financed through bonds issued by the pri-vate operator

For accounting and performance evaluation purposes itis useful to classify PPP schemes according to the typeof financial operations involved as follows (1)

Sale of services After having funded and executed theproject what the private operator sells to the purchasinggovernment is the flow of services from a capital asset (forexample a road a bridge a prison) In addition to theservices emanating from the use of the assets additionalservices can be provided by the private counterpart for theregular operation of the asset (for example maintenance)The contracts specify on which conditions the governmentcan access these services This is the most frequent case ofPPP and has been extensively used in the financing build-ing and operation of infrastructures such as prisons rail-ways or roads In a sense PPPs can be assimilated to aform of leasing rather than a case of asset purchase

Financial free standing The private operator designsbuilds finances and operates the asset and recovers thecosts through direct charges to users without direct pay-ments from the government The involvement of thepublic sector is in the provision of licenses in securingconformity of the project with public purposes and inregulating the private operator This scheme has beenused especially in projects concerning transport infra-structures such as bridges and highways Compared withthe classic privatisation schemes the government playsa greater role in contributing to the definition of the char-acteristics of the services to be provided by the asset

Joint ventures In this case the finance to build theproject does not come fully from the private operator butis partially provided by the government

Also relevant for accounting and evaluation purposes arethe characteristics of the private operator involved in thePPP and how the contract is designed The private oper-ator can be either an existing firm or a new firm createdon purpose Its activities can either be multiple anddiversified or confined to those of the PPP contractMoreover the operator may be fully private or partici-pated in by the public sector In particular a number ofrecent PPPs are dealt through operators that are publicenterprises not belonging to the general government sec-tor (so called lsquoproject vehiclesrsquo)

Regarding the design of the contract a crucial aspect isthe specification of the modalities with which paymentsare made to the private operator by the government Pay-ments may be in fixed yearly amounts proportional tosome measure of the cost of the asset provided by theoperator (for example in the case of road building pro-portional to the length of the road) or proportional to theeffective flow of services provided by the asset (forexample still in the case of roads proportional to thenumber of vehicles using the road) The way governmentpayments are specified in the contract are crucial indetermining how risks are shared between the govern-ment and the private operator Also key in determiningthe sharing of risk between the public and the privatecounterparts is the possible presence of guarantees bywhich the government backs the bonds issued by the pri-vate operator to finance the project

Another characterising feature of PPP contracts are theirlong-term nature (due to the fact that the revenues for theprivate operator must be distributed over sufficientlylong time horizons to cover up-front costs) and the pos-sible inclusion of clauses by which the government com-mits to buy back the asset after a given number of years

532 The economics of PPPs

Which is the rationale for using PPP schemes to financeand operate public purpose investment

In the policy debate it is often emphasised that PPPs havethe desirable property of putting capital spending outsidegovernment budgets thus easing the effects of externalbudgetary constraints on public investment Though verypopular this argument has little substance First it doesnot address why PPPs should be preferred to alternativeschemes to finance capital formation with public purposesthat do not imply an increase in government borrowing(for example classical privatisation) Second even if theimpact on current budget balances of PPP schemes is mostlikely to be smaller compared with the alternative of purepublic procurement the long-term impact of PPPs on pub-lic finances is to be assessed carefully

The main implication for public finances of choosingPPPs as opposed to traditional public investment is thatof converting up-front fixed expenditures into a streamof future claims In computing the actuarial value of thegovernment commitments of PFI schemes one has toestimate not only the size and distribution of the regularpayments specified in the contract but also the cost ofthe possible buy-back of the asset and the possibility that

yen1part This taxonomy has been proposed by Pollitt (2000) to classify UK privatefinance initiative projects Note that the taxonomy is not fully exclusivesince PPP cases may have characteristics common to more than one of thecases identified

debt guarantees are exercised Comparing the impact ofPPPs schemes on the actuarial value of public financeswith that which would arise from traditional publicinvestment is thus a complex issue which requires a greatdeal of information The argument that PPP schemes arepreferable to publicly funded investment expendituresfrom the viewpoint of long-term public finance sustain-ability is thus not well grounded The distinguishing fea-ture of PPPs is rather that of permitting to smooth out thecost of public investment This in turn may be effectivein releasing finance constraints on public investment inthe presence of formal ceilings on budget deficits (1)

The rationale for the use of PPP schemes is rather that ofmicroeconomic efficiency Even assuming that competi-tive tenders for the selection of private counterparts arefeasible and efficient pure privatisation schemes may notbe optimal when there are reasons that justify a form ofcontrol on the design of the project by the public sectorThis is the case when the project concerns the delivery ofpure public goods (for example a prison) when external-ities are particularly relevant (for example when projectshave a considerable environmental impact) or when thedistributive consequences of the project are a major con-cern (for example the provision of health facilities) Inthose cases regulation mechanisms may not be sufficientto ensure that public objectives are satisfactorily met Thestandard alternatives are direct public provision or publicprocurement through competitive tenders

In many instances public procurements (contracting out)guarantees higher cost-efficiency than direct public provi-sions (2) In both alternatives however it is the public sec-tor that provides the financial funds to carry out the projectand that exercise the control on the design of the assetPPP schemes offer a third alternative In such a case thefinance of the project is provided by the private sector asin privatisation schemes but the public sector plays a rel-evant role as client of the services provided by the assetIn particular PPP contracts may specify that the privateoperator will be remunerated only if the actual supply ofservices is judged to be successful The fact that the objectof PPP contracts is the supply of services rather than theprovision of the asset can make a major difference with

respect to public procurement schemes Specifying andmonitoring the desired characteristics of services is nor-mally easier than specifying and monitoring those ofassets Thus contracts that have as their object the flow ofservices rather than the building of assets help to reducethe incentives that the private supplier may have to cut onquality while preserving the incentives to contain costs(Grout 1997) (3) The microeconomic rationale of PPPschemes is thus that of shaping incentives in such a way asto achieve cost efficiency without compromising publicobjectives relating to the quality and characteristics of theservices provided by the asset (4)

533 Publicndashprivate partnerships and budgetary practices in EMU

Although there are microeconomic reasons that may jus-tify the use of PPP schemes there is the risk that PPPsare increasingly used by EU governments to evade SGPconstraints on public deficits As already pointed out theimpact of PPPs on long-run public finance sustainabilityas an alternative to traditional public investment dependsupon a complex set of factors and should be assessedcase by case In general when resorting to PPP schemesgovernments should conform to the Eurostat guidelineson accounting practices and to a series of transparencyprinciples

Concerning the treatment of PPP schemes in nationalaccounting Eurostat fixes a set of guidelines that nationalstatistical institutes should respect A crucial issue is thatof evaluating the effective sharing of risk and rewardsbetween the general government and the project operatorassociated with the building and operation of the assetAccording to the Eurostat guidelines whenever there areregular payments made by the government to the opera-tor the asset should be recorded in the balance sheets ofthe contracting party that effectively bears most part ofthe risks and rewards form the project

yen1part The conditions under which external constraints on budget deficits caneffectively reduce public investment have been discussed in Section 521

yen2part The reasons are well-known (see for example Domberger and Jensen(1997) for a survey) In particular bureaucracy theories suggest that gov-ernment officials tend to focus on objectives different from that of costminimisation (eg maximising the size of their budget)

yen3part Hart Shleifer and Vishny (1997) develop an incomplete-contracts model ofpublic procurement and show that compared with direct public provisionsprivate operators will in general have higher incentives to keep costs lowbut lower incentives to keep quality high They provide supporting evi-dence in the context of prisons in the US

yen4part The resort to PPPs to finance trans-European transport infrastructure is alsoconsidered by the Commission in its communication COM(2003) 132 final)There the view is expressed that lsquoUse of publicndashprivate partnerships(PPPs) to supplement public financing may be envisaged for some types ofproject However there are still too many unknowns regarding the projectsto be carried out mdash particularly railway and cross-border projects mdash andregarding transport policy choices The private sector has insufficient confi-dence to commit to financing them Moreover PPPs almost always requiremajor public financial support in the form of subsidies and guaranteesrsquo

Evaluating the sharing of risks in PPP schemes has thusmajor implications for the computation of public deficitsand debts If it is the operator that bears most of the risksthen the budget balance of the government will beaffected only by the regular payments made by the gov-ernment If instead most of the risk lies with the govern-ment then public debts and deficits will be affected bythe full cost of the project Given the uncertainties sur-rounding the appropriate evaluation of risk-sharing inPPP schemes it is desirable that national statisticaloffices exchange (among themselves and with Eurostat)detailed information on the criteria used to make suchevaluations It may also be desirable to have the defini-tion of further operational guidelines concerning riskevaluation on the part of Eurostat

It is also relevant that national statistical institutes con-form to transparency principles concerning the recordingof operations giving origin to so-called contingent liabil-

ities Contingent liabilities normally arise when in PPPcontracts governments offer a guarantee to the debtissued by the private operator to finance the project Pub-lic guarantees do not constitute effective government lia-bilities because there is no certainty that they will trans-late into increased debt in the future However this maybe the case if certain contingencies occur that is in thecase of default of the private counterpart Since withpublic guarantees there is no certainty concerning theimpact on public debt they are recognised only undercash accounting if and when the contingent event (thePPP counterpart default) actually occurs and payment ismade However given the possible relevant debt impactof contingent liabilities the inclusion of information(also quantitative when possible) on each provision giv-ing raise to contingent liabilities in supplementary budg-etary documents is recommended in international codesof fiscal transparency (for example the OECD best prac-tices for fiscal transparency)

Part IV

Can fiscal consolidations in EMU be expansionary

Summary

While there is a broad consensus among both academicsand policy-makers on the need for fiscal discipline toensure the smooth functioning of EMU and to provideconditions conducive to growth and employment creationconcerns have been expressed that budgetary consolida-tion could have a negative effect on output in the short runThis issue is relevant given the need for several MemberStates to reduce large cyclically-adjusted budget deficitsespecially against the current background of slow eco-nomic growth

According to standard macroeconomic models a restric-tive fiscal stance would result in short-run negativeimpact on aggregate demand and then on output andemployment However the indications of the standardmodels approach have not always been supported by thefacts Growing evidence has been accumulated that thevalue of fiscal multipliers is likely to be quite small andfalling over time Moreover there is evidence that in thecase of fiscal consolidations the effects of fiscal policyon short-run growth may be even opposite to those pre-dicted by traditional macroeconomic models Cases havebeen documented of EU countries in which tax increasesor expenditure cuts have been followed by acceleratedgrowth in the short run Through systematic cross-coun-try analysis new evidence is reported in this partshowing that roughly half of the episodes of fiscalconsolidations undertaken in EU countries in the pastthree decades have been followed by an immediateacceleration in growth

Academic research in the past decade focused on theidentification of the most relevant offsetting factors thatmay explain the emergence of possible expansionaryeffects of fiscal consolidations A number of rationalisa-tions have been provided for what are commonly calledlsquonon-Keynesianrsquo effects of fiscal policy Some of thesefactors concern the impact of fiscal policy on privateconsumption In particular it has been shown that thereduction of budget deficits may lead to an increase inaggregate consumption already in the short run through

wealth and confidence effects In this sense the credibil-ity of consolidations is crucial that is fiscal adjustmentshould be perceived to lead to a permanent increase infuture disposable income streams via reduced taxationConsolidations leading to a substantial improvement ofthe budget balance or starting from situations of highdebt-to-GDP ratios are more likely to affect consumersrsquoexpectations and induce an immediate increase in con-sumption through confidence and wealth effects Withthe awareness of the implications of ageing the effectsof fiscal consolidation on confidence may have becomemore important Fiscal consolidations may also affectaggregate supply via the investment channel They maylead to higher-expected profits and then higher invest-ment by reducing the tax burden on firms and inducingwage moderation In this respect the composition of thefiscal adjustment and the institutional characteristics ofthe labour market may play a major role

Consistently with the predictions of theory the empiricalevidence reported in existing studies shows that the sizeand persistence of the fiscal adjustment (as measured bya sufficient degree of improvement in cyclically-adjustedbudget balances) the composition of adjustment (that isthe extent to which it is achieved through tax increases orexpenditure cuts) and the initial state of public finances(mainly the debt-to-GDP ratio) are relevant for episodesof expansionary consolidations

Interpreting cross-country evidence ex-post is subject toa number of problems above all difficulties in isolatingthe effect of concomitant factors (other than fiscaladjustment) that may have acted on growth Model sim-ulations have therefore also been carried out to investi-gate whether fiscal consolidations can actually produceexpansionary effects The policy experiments performedwith the European Commission QUEST model refer tothe German economy and focus on the composition ofthe adjustment They permit the evaluation of the likelyimpact of fiscal retrenchment obtained either through taxincreases or via cuts in different expenditure items con-

trolling for other factors such as the stance of monetarypolicy

The results of simulations using the QUEST model con-firm that if appropriately designed budgetary consoli-dation can contribute significantly to the goal of Lisbonstrategy in terms of raising output and employment in themedium term Budgetary consolidation have a slightcontractionary effect on output in the short run depend-ing on the composition of the budgetary adjustment

However budgetary consolidation has a positive impacton output in the medium run if it takes place in the formof expenditure retrenchment rather than tax increasesMoreover the effect of budgetary consolidation on out-put could be reinforced and even positive in the shortrun if fiscal consolidation is combined with structuralreform of factor and product markets and accompaniedwith an accommodating monetary stance Indeed budg-etary consolidation often acts as a catalyst for structuralreforms

1 Introduction

There is consensus among both academics and policy-makers on the need for fiscal discipline to ensure thesmooth functioning of EMU and provide conditions thatare conducive to growth and employment creation Thisconsensus is reflected in the Treaty requirement to avoidexcessive deficit positions and the goal of the Stabilityand Growth Pact for Member States to achieve andmaintain budget positions of lsquoclose to balance or in sur-plusrsquo With significant cyclically-adjusted budget defi-cits remaining even increasing in several MemberStates (see Part I of this report) the process of budgetaryconsolidations needs to resume if these budgetary goalsare to be achieved

Concerns however have been expressed that budgetaryconsolidation could have a negative effect on output inthe short run and this is particularly relevant against thecurrent background of slow economic growth This sec-tion of the report analyses whether the assertion thatbudgetary consolidation has a negative impact on outputin the short run is always valid or whether it can have apositive effect on output and the conditions under which

this can occur It builds on the work on automatic stabi-lisers and discretionary policy presented in the 2001 and2002 reports on public finances in EMU

Chapter 2 presents a survey of the existing theoreticalexplanations based on consumption-side or investment-side effects through which fiscal consolidation may leadto higher output in the short run

Chapter 3 reviews the empirical evidence from existingstudies on the impact of fiscal consolidations on outputIt then carries out a statistical analysis on the effects ofpast fiscal consolidations in the EU

Chapter 4 presents simulations made using the QUESTmodel investigating the effects on output of varioustypes of fiscal consolidations in a representative EUcountry It examines a variety of consolidation scenarioson both the expenditure and revenue side as well as theimplications of budgetary consolidation through spend-ing cuts being accompanied with an accommodatingmonetary policy response or structural reforms

2 Can budgetary consolidations be expansionary What the theory says

21 Budgetary consolidations the standard view

Following the textbook macroeconomics approach a fis-cal consolidation has a negative impact via the multiplieron domestic demand national output and employmentDisposable income and private consumption would benegatively affected by tax increases while a cut in publicspending would directly reduce aggregate demandGiven that the simple form of the multiplier (the standardKahn-Keynes multiplier) depends on the responsivenessof consumption to income its value is by definitionhigher than one (1)

The models generated by the so-called neo-classical syn-thesis (the IS-LM model and its variants) develop theoriginal Keynesian approach to consider also the effectsof various characteristics of the real and money marketson the fiscal multiplier In these models several factorsare likely to interact with the direct effect of fiscal policyon aggregate demand The final impact of the fiscal con-solidation may be therefore smaller implying that thevalue of the multiplier may be below 1 Several factorshave to be considered for the evaluation of fiscal policymultipliers in complex open-economy neo-Keynesianmodels

Real sector substitution effects and investment crowdingout Substitution effects are likely to reduce somewhatthe multiplier some of the goods or services no longerdemanded by the public sector would be demanded by

the private sector or could be directed towards theexport markets The sensitivity of investment spendingto interest rates and income is also relevant A larger sen-sitivity to interest rates would imply a bigger adjustmentof aggregate demand to reduced interest rates (ie wouldflatten the IS curve) leading to a more extensive offset-ting of the initial fiscal contraction By contrast currentincome could affect investment more than proportion-ally (as in the case of multiplier-accelerator models)which may depress investment more markedly in case ofa fiscal consolidation

The functioning of the money market The lower activ-ity implied by the fiscal consolidation would beaccompanied by a reduced demand for money Thiswould lead to a fall in interest rates which would inturn create an incentive for increased investment off-setting part of the effect of the consolidation on outputThis effect crucially depends on the responsiveness ofmoney demand to income and interest rates If thedemand for money is highly sensitive to income and alittle to interest rates (that is the LM function is steep)the reduced activity will have a strong effect on thedemand for money implying a very large adjustmentin interest rates The effect of fiscal policy wouldeventually be small due to the offsetting behaviour ofprivate investment In such a case most of the initialadjustment would be rapidly absorbed via a change ininterest rates

Wealth effects In lsquomodernrsquo neo-Keynesian models con-sumption is determined not only by current disposableincome but also in some measure by current wealth Thelarger the importance of financial wealth in determiningprivate consumption is the more it is likely that a wealtheffect would offset the contraction in public sector

yen1part This value hinges on the typical assumption that output is determined byaggregate demand this results from excess capacity with rigid prices whichdo not adjust (at least in the short run) to the mismatch between demandand supply

P a r t I VC a n f i s c a l c o n s o l i d a t i o n s i n E M U

b e e x p a n s i o n a r y

demand (1) The wealth effect could be generated bylower interest rates or in an open economy by fluctua-tions in the exchange rates Lower interest rates increasethe value of nominal fixed-rate debt holdings and ofother assets held by households with the size of its effecton consumption depending on the level of debt holdingsand maturity In an open economy a similar effect couldarise following a depreciation or a devaluation of theexchange rates which would affect the nominal value ofassets denominated in foreign currencies

Openness The degree of openness of the economy andthe exchange rate regime affect the way the external sec-tor responds to the fiscal adjustment (this is evident inthe Mundell-Fleming open economy version of theIS-LM model) The more open an economy is the morethe external sector is likely to react to the change in mon-etary conditions induced by the fiscal adjustment Theextent to which fiscal policy will be crowded-out via thecurrent account crucially depends on the exchange rateregime With flexible exchange rates the currency willtend to depreciate after a fiscal contraction as a result ofcapital outflows The currency depreciation in turn stim-ulates net exports which reduces the effect of the fiscalcontraction on output Conversely with fixed exchangerates an automatic monetary policy response to keep theexchange rate constant increases the effectiveness offiscal policy on output (2)

The interaction between the labour and goods marketsThe degree of price flexibility is a crucial factor in thedetermination of the impact of the fiscal consolidationIn the neo-classical synthesis prices are assumed to berigid in the short run Softening this assumption changesthe effects of a fiscal adjustment The reduction in aggre-gate demand caused by the fiscal contraction will befollowed by an adjustment process whereby pricereductions (or a lower inflation) increase demand in thedirection of a new equilibrium Naturally the magnitudeof this effect will depend on the degree to which pricesare assumed to be less rigid in the short run (3)

In general even if according to the standard models inthe Keynesian tradition fiscal multipliers are expected tobe positive there are several instances that can justifysmall fiscal multipliers also within this approach This isespecially the case for economies with a high degree ofopenness Adjusting the real exchange rate would behelpful if fiscal consolidations occur in countries whoseexchange rate floats the output effects of fiscal policywill be offset by an improvement in the current accountbalance In countries adhering to exchange rate regimesthe negative output effects of fiscal consolidations couldbe offset by accompanying devaluation policies Moreo-ver the value of multipliers will be lower the higher therelevance of wealth in determining consumption asopposed to that of current income which in turn dependsupon the availability of financial instruments to smoothincome and the efficiency of financial marketsIncreased openness and financial wealth may explain thefact that the value of estimated multipliers has been fall-ing in the last decades when the pace of economic inte-gration was accelerating and financial markets devel-oped as a result of liberalisation and institutional andtechnological innovation (4)

22 Non-Keynesian effects of fiscal consolidation

While successive developments of the neo-Keynesianapproach explain why the value of fiscal multipliers isfalling they all assume the multiplier to be positiveThe idea that fiscal policy may have short-run effectsopposite to those predicted by the Keynesian modelwas first suggested by Giavazzi and Pagano (1990)who looking at the fiscal consolidation experiences ofDenmark and Ireland in the mid-1980s documented inboth cases an acceleration in growth just after the gov-ernments put in place measures that drastically reducedbudget deficits

Table IV1 shows deficits and debt ratios as well as GDPgrowth rates in Denmark and Ireland during the cited fis-cal consolidation episodes and in Sweden during theearly 1990s when its deficit and debt rose dramaticallyWhile growth accelerated after the Irish and Danishconsolidations the Swedish fiscal stimulus was followedby an output contraction

yen1part These wealth effects are often referred to also as Pigou effects or real bal-ance effects

yen2part Needless to say for individual euro-area countries the impact of exchangerate movements on the fiscal multiplier is absent or negligible

yen3part While in a closed economy price reductions (or a lower inflation) wouldreduce the output effect of the fiscal consolidation in an open economyprice flexibility softens the effects of the exchange rate regime described inthe previous parafigure in a fixed exchange rate regime there will be morecrowding out (that is a lower fall in output) than with price rigidity and in aflexible exchange rate regime the crowding out is less (that is output wouldfall more) than with sticky prices The price-wage loop will determine thespeed and relevance of this factor

yen4part On this issue see European Commission (2002a) For a recent survey on theestimated value of fiscal multipliers see for instance Hemming Kell andMahfouz (2002)

The possibility that fiscal policy may have non-Keynesianeffects has attracted increasing attention among academ-ics Some studies aimed at further investigating empiri-cally the case of expansionary fiscal consolidations (seeChapter 3 of this part) Some of the research was directedat providing a conceptual framework in which non-Key-nesian effects of fiscal policy could be rationalised

Starting from the 1970s the so-called new classicalmacroeconomics paradigm has challenged many of thefounding assumptions of the standard neo-classical syn-thesis models with major implications for the concep-tual grounds for macroeconomic policy-making Amongthe basic tenets of the so-called new classical macro-economics there is the acknowledgement that agentstake their economic decisions from a forward-lookingperspective and that in so doing they will use rationallyall the information available to them

While according to macroeconomic models in the Keyne-sian tradition consumption is essentially a function of cur-rent income in new classical macroeconomics modelsconsumers are assumed to be forward looking that is tobase their consumption decisions upon the expected futurestreams of income (permanent income) (1) Moreover whileplanning consumption decisions consumers are also in the

position to identify the intertemporal budgetary constraintwhich has to be respected by solvent governments

Concerning the modelling of how expectations areformed macroeconomic models before the neo-classicalsynthesis generally were based upon static or adaptiveexpectations The idea was that agentsrsquo expectationsabout the future could not be too dissimilar from theobserved present This view has been challenged innew classical macroeconomics by the requirement thatexpectations should be rational that is economic agentsshould rationally use available information This meansthat past errors will be considered when formulating newexpectations in a continuous learning process More-over in this context perceptions about the behaviour ofthe government become relevant especially about thenature of the measures taken by the authorities In partic-ular if it is perceived that current policy measures willaffect future variables credibly and permanently thenagents will adapt their behaviour immediately

The emphasis of the new classical macroeconomic para-digm on forward-looking behaviour and expectationshelp to rationalise the apparent puzzle of fiscal consoli-dations with expansionary effects Recent theoreticalmodels belonging to this paradigm show that consump-tion may react to fiscal policy measures in an oppositeway than predicted by standard models in the Keynesiantradition thus leading to effective output expansions(contractions) when fiscal policy is meant to be contrac-tionary (expansionary) The same has been shown in thecase of investment under particular circumstances pol-icy measures aimed at adjusting the budget deficit maylead to a boost in investment with a potentially expan-sionary effect on aggregate output The lsquoconsumptionchannelrsquo and the lsquoinvestment channelrsquo through whichfiscal policies may operate in a non-Keynesian fashionare illustrated below

Non-Keynesian effects of fiscal policy the consumption channel

If agents are forward-looking and rational in forming theirexpectations they will anticipate that a tax cut todayfinanced by government debt will translate into highertaxes at some point in the future If in addition govern-ment intervention is non-distortionary capital markets areperfect and consumers sufficiently long-lived the so-called Ricardian equivalence should hold namely perma-nent income will be unaffected by fiscal policy and soconsumption Under these abstract circumstances fiscalmultipliers will be zero since higher government savings

Table IV1

Some puzzling effects of fiscal policy

Country YearDeficitGDP (1)

Debt GDP

GDPgrowth (2)

Denmark (3) 1982 89 625 30

1986 ndash 33 623 36

Ireland 1986 105 1138 03

1989 17 1001 62

Sweden 1989 ndash 54 453 24

1993 122 758 ndash 22

The table presents the changes in the fiscal stance and its impact on debt andGDP growth Values are shown for the year before the consolidation (stimulus)started and its last year(1) Negative values correspond to a surplus(2) Annual change(3) In Denmark the debt was on a downward path after a peak of 734 in

1984 and real GDP growth accelerated to 44 in 1984 before returning tothe previous level in 1986

Source Giavazzi and Pagano (1996)

yen1part However in this respect it should be mentioned that forward-lookingbehaviour was also incorporated in some Keynesian consumption modelsnotably the life-cycle model In the original formulation of these modelshowever there is no requirement of consumersrsquo expectations to be rational

obtained through fiscal consolidations will be compen-sated by an equivalent reduction in private savings (1)

However if distortions introduced by taxation are takeninto account a first reason for expecting non-Keynesianeffects of fiscal policy emerges This can be the case forinstance when a current expenditure cut is expected tobe offset in the future by a reduction in future distortion-ary taxes Such a case for non-Keynesian effects of fiscalpolicy was first illustrated by Blanchard (1990) In thismodel it is shown that the effects of fiscal policy onaggregate consumption are likely to be non-linear Thereason is that the dead-weight loss of taxation increasessignificantly with the extent of taxation So if a consol-idation is made starting from a low level of current debta traditional positive fiscal multiplier will result (2) Ifinstead a fiscal consolidation is made starting from ahigh debt level consumption may react positively as aresult of an expected increase in permanent income Thereason is that by consolidating now the government willnot raise taxes too much in the future to pay back thedebt This reduces the dead-weight loss imposed bytaxes thus raising agentsrsquo permanent income (3)

A different motive to expect fiscal policy to have non-lin-ear effects has been proposed by Bertola and Drazen(1993) The assumption here is that when public expend-iture becomes alarmingly high then agents start antici-pating a future major fiscal adjustment to occur This mayoffset any loosening of fiscal policy At the same time aconsolidation occurring when public spending is highmay then change agentsrsquo expectations concerning afuture major retrenchment and the lower expected levelof taxes raises permanent income and consumption (4)

A further rationale for possible non-Keynesian effectsthrough the consumption channel emerges if fiscalconsolidations are assumed to affect the risk of govern-ment insolvency By reducing their budget deficits gov-ernments will signal to markets their willingness toswitch to lsquosound financesrsquo If this signal is taken as cred-ible interest premiums on government bonds will fall

The consequent reduction in interest rates will in turncontribute to raise agentsrsquo permanent income since theywill discount future income streams at a lower rate Thecrucial ingredient of this explanation for the emergenceof non-Keynesian effects is the credibility of governmentaction to make public finances sustainable As empha-sised for instance by Feldstein (1982) the credibility ofthe regime shift can be enhanced by the size of the con-solidation While small adjustments in the budget may bebelieved to be short-lived or not enough to correct theimbalances major fiscal retrenchments may signal thewillingness of the government to face the political costsassociated with the shift to sound public finances Fur-thermore as illustrated for instance by Cotis et al (1998)the introduction of fiscal rules for the maintenance ofbudgetary discipline (like the SGP) may increase the per-ception of the intertemporal budget constraint andthereby the credibility of the fiscal adjustment and thelikelihood of the emergence of non-Keynesian effects

Non-Keynesian effects of fiscal policy the investment channel

Expansionary consolidations working through theconsumption channel act on aggregate demand leavingsupply conditions unaffected (factor supply TFP hellip)Output expansions above potential obtained throughthe consumption channel are therefore inevitably short-lived However recent empirical research has shownthat fiscal consolidations may produce significantshort-run expansionary effects also through the invest-ment channel thus affecting not only demand but alsosupply factors (Alesina and Ardagna 1998 AlesinaPerotti and Tavares 1998 Alesina et al 2002)

The rationale for fiscal policies producing non-Keyne-sian effects through an investment channel has been for-malised in Alesina et al (2002) The highlighted channelgoes beyond possible reductions in real interest ratesassociated with fiscal contractions as predicted by stand-ard macroeconomic models The link between fiscalpolicy and investment behaviour is rather represented bythe labour market

As in models rationalising non-Keynesian effects throughthe consumption channel agents are assumed to be for-ward-looking and to behave on the basis of the actualvalue of future income streams The relevant agents are inthis case firms that decide about their factor service pur-chases by looking at the present value of profits Invest-ment decisions are driven by the expected present value ofthe net marginal product of capital which in turn is anegative function of real wages Fiscal consolidations

yen1part If consumers have short-term horizons or are affected by liquidityconstraints Ricardian equivalence will no longer hold and fiscal policy willaffect consumption according with the predictions of standard models inthe Keynesian tradition (see for example Blanchard 1985)

yen2part In Blanchard (1990) this is due to the fact that agentsrsquo horizons are shortterm since each of them are faced with a constant positive probability ofdeath Hence Ricardian equivalence does not hold in this model even in theabsence of tax distortions

yen3part Results similar to those to Blanchard (1990) are obtained in Perotti (1999)In this model however Ricardian equivalence does not hold on aggregatebecause a fraction of consumers are assumed to be liquidity-constrained

yen4part A similar non-linear effect of fiscal policy is obtained in Sutherland (1997)

obtained through expenditure cuts may increase short-runinvestments via reduced wage pressures for a number ofreasons A reduction in the government wage bill will ingeneral contribute to wage moderation in the private sec-tor as well A similar effect would be obtained by meansof reductions in government transfers The possibility forfiscal consolidations to exhibit non-Keynesian effectsthrough the investment channel will then crucially dependupon the composition of adjustment (expenditure cuts ver-sus tax increases) and on institutional factors above all theworking of the labour market (1)

In sum in view of the latest developments in the theoret-ical paradigm a number of reasons have been identifiedin the theoretical literature that may explain why fiscalconsolidations may have expansionary effects The pos-sibility of non-Keynesian effects working through theconsumption channel is expected to be mainly affectedby factors affecting the credibility of the adjustment andagentsrsquo expectations such as the size of the consolida-tion and the initial state of public finances The likeli-hood of non-Keynesian effects acting via the investmentchannel is instead crucially affected by the compositionof adjustment As illustrated in the next chapter theempirical research on budgetary consolidations hasfocused on the above factors to identify the characteris-tics of expansionary consolidations and the relevantchannels

yen1part Clearly adjustments in the tax structure which mdash within an overall fiscalconsolidation mdash favour a reduction in the tax wedge on labour would alsoimply an increase in the net present value of profits

3 Characteristics and effects of fiscal consolidations in the EU evidence from cross-country analysis

31 Survey of existing studies

In existing cross-country studies (see Table IV2) thehypothesis that fiscal consolidation may have expan-sionary effects is analysed empirically in several waysCrucial to this end is the definition of what fiscal consol-idation is Usually it is defined in terms of a givenimprovement in the budget balance as a fraction of GDPachieved over a time period of several years In order toexclude changes in the budget balance associated withthe economic cycle measures of the cyclically-adjustedbudget balance have generally been used Moreover tobetter isolate fiscal policies of a discretionary type inter-est expenditures have been deducted from the structuralbudget balance in most studies that is changes in theprimary cyclically-adjusted budget balance have there-fore been adopted to identify consolidation periods

Depending on the particular study considered theconcept of fiscal consolidation has been focused eitheron the idea of a sufficiently strong fiscal adjustmentachieved in a given period (size criterion) or on the ideaof a sufficiently long time period during which thebudget balance constantly improves (persistence crite-rion) Some studies refer to a further refinement of theconcept of consolidation by defining as successful thoseconsolidations that manage to bring about a sustainedreduction in the debt-to-GDP ratio

The methodologies adopted in the existing studies differquite widely In almost all studies there is a descriptiveanalysis of the sample characteristics of relevant fiscaland macroeconomic variables before during and afterconsolidation periods This allows for the checking ofthe general requirement for the identification of expan-

sionary fiscal consolidations the occurrence of positivegrowth development after the fiscal adjustment Bylooking at sample averages of fiscal variables it is possi-ble to describe the characteristics (in terms of size ofadjustment initial conditions of public finances or com-position of adjustment) of fiscal consolidations and toidentify how these characteristics differ depending onwhether consolidations turned out to be expansionary orcontractionary In some studies ProbitLogit regressionshave also been performed in order to identify economet-rically the main factors affecting the probability for fis-cal consolidation to be successful (Von Hagen Hughes-Hallet and Strauch 2001) or expansionary (Alesina andArdagna 1998) Sample evidence on relevant macroeco-nomic variables (for example interest rates or exchangerates) permits to judge whether fiscal consolidationshave in general been accompanied by active monetarypolicies or devaluations Some studies complementdescriptive sample statistics with country case studiesaimed at better understanding the policy environmentduring consolidation periods (for example wage agree-ment policies exchange rate devaluations etc)

In a number of studies empirical verifications of theoret-ically grounded hypotheses are also provided Giavazziand Pagano (1996) estimate consumption functions totest whether fiscal consolidations may have non-Keynesian effects via the consumption channel due toconsumersrsquo revised expectations and increased expectedlife-time income Giavazzi Jappelli and Pagano (2000)perform a similar test by estimating saving functionsAlesina et al (2002) instead verify empirically thehypothesis that non-Keynesian effects of consolidationsmay come from the investment channel by estimatinginvestment equations

Table IV2

Cross-country evidence on fiscal consolidations

Study and sample Definition of consolidation Aim of the analysis Type of analysis Main findings

McDermott and Westcott (1996) IMF (1996)20 OECD countries 1970ndash95

The primary structural balanceimproves by at least 15 ofGDP over two years and does notdecrease in any year

Analyse the characteristics andeffects of successful consolida-tions that is of consolidationsleading to a 3 of GDP reduc-tion in debt

Descriptive Successful consolidations leads onaverage to increased growth un-successful to reduced growth Sizeand composition both important toidentify successful consolidations

Giavazzi and Pagano (1996)19 OECD countries 1970ndash92

The cumulative change in theprimary structural balance isabove a given threshold as a of GDP (5 4 or 3) over a givennumber of years (resp 4 3 or 2)

Analyse the existence of non-Keynesian effects of fiscal con-solidations via the consumptionchannel

Panel data estima-tion of consump-tion functions

Size of adjustment is relevant toidentify episodes exhibiting non-Keynesian features

OECD (1996)18 OECD countries 1975ndash95

The cumulative change in thestructural budget balance isabove 3 of GDP over a periodof at least two years

Analyse characteristics and ef-fects of fiscal consolidations

Descriptive There were fiscal consolidationsduring which growth was abovepotential Accommodating mone-tary policy seems to matter to limitoutput contractions

Cour et al (1996) 17 OECD countries 1970ndash94

Continuous improvement in theprimary structural budget bal-ance with a period of at mostthree years during which the pri-mary structural budget balanceimproves by at least 3 of GDP

Analyse characteristics and ef-fects of fiscal consolidation epi-sodes with a particular focus onthe consumption channel ofnon-Keynesian effects

Descriptive andestimation of con-sumption func-tions

Size of adjustment is relevant toidentify expansionary episodes

Alesina Perotti and Tavares (1998) 19 OECD countries 1960ndash95

The primary structural balanceimproves by at least 15 ofGDP

Analyse characteristics and ef-fects of fiscal consolidation ex-ploring alternative channels fornon-Keynesian effects

Descriptive Successful consolidations morelikely to lead to expansions Com-position more important than sizeto identify expansionary episodesLabour market structure alsomatters

Alesina and Ardagna (1998) 20 OECD countries 1960ndash94

The primary structural balanceimproves by at least 2 of GDPor by at least 15 of GDP peryear over two years

Descriptive Probitregressions collec-tion of case studies

Composition more important thansize to identify expansionary epi-sodes Wage agreements and ex-change rate devaluations are alsorelevant accompanying factors

Perotti (1999) 19 OECD countries 1965ndash94

na Analyse whether initial fiscalconditions are relevant for theeffects of fiscal policy

Estimation of dy-namic consump-tion functions

High debt levels are associated witha higher probability for fiscal policyto have non-Keynesian effects

Giavazzi Jappelli and Pagano (2000) 18 OECD countries 1970ndash96

The structural balance improvesby at least 15 of GDP per yearover two years

Panel data estima-tion of savingfunctions

Size of adjustment is relevant toidentify episodes exhibiting non-Keynesian features Non-Keynesianeffects more likely for tax changesthan expenditure changes and forfiscal consolidations than for fiscalexpansions

Von Hagen Hughes-Hallet and Strauch (2001)20 OECD countries 1960ndash98

The structural balance improvesby at least 125 of GDP peryear over two years or by at least15 of GDP in one year and bya positive amount in a consecu-tive year

Describe characteristics and ef-fects of fiscal consolidations withspecial reference to the EU

Descriptive analy-sis case studiesProbit regressionsestimation of out-put equations andmonetary and fis-cal policy reactionfunctions

Fiscal policies exhibit in generalKeynesian effects but in the EU inthe nineties there is no evidenceneither in favour nor against Key-nesian effects

Alesina et al (2002)18 OECD countries 1960ndash96

Analyse the existence of non-Keynesian effects of fiscal con-solidations via the investmentchannel

Estimation of in-vestment equa-tions descriptiveanalysis

Cuts in public expenditure particu-larly in public employeesrsquo compen-sations boost investmentExpansionary consolidationsassociated with acceleration ininvestment growth

In spite of the above-mentioned differences in methodol-ogy a number of results are common to almost all stud-ies

bull There is evidence of fiscal consolidations likely toexhibit non-Keynesian features in almost all studies

bull Consolidations leading to a permanent reduction indebt (lsquosuccessfulrsquo) are more likely to be expansion-ary

bull During expansionary consolidations both an accel-eration in private consumption and business invest-ment is observed

bull The policy environment in which fiscal consolida-tions are undertaken matters In particular themonetary exchange rate and wage policies accom-panying consolidations may affect significantly theimpact of fiscal adjustments on growth

Where consensus is missing is on the specific factorsdetermining the expansionary effects of fiscal consolida-tions Some papers find that fiscal adjustments withexpansionary effects are more likely when the size ofconsolidation is large (Giavazzi and Pagano 1996Giavazzi Jappelli and Pagano 2000) In other studiesinstead it is found that what is most significant to char-acterise expansionary consolidations is the compositionof the adjustment Fiscal adjustments based on expendi-ture cuts rather than tax increases have expansionaryeffects with a higher probability especially if expendi-ture cuts are concentrated on public employeesrsquo compen-sations and on government transfers (Alesina Perottiand Tavares 1998 Alesina and Ardagna 1998 Alesinaet al 2002) Finally there are studies that emphasise theinitial state of public finances Consolidations are morelikely to have non-Keynesian effects when they occur incountries and periods where debt-to-GDP ratios are high(Alesina and Ardagna 1998 Perotti 1999)

Overall although cross-country empirical analyses permitto shed light on several features of fiscal consolidationsthe results arising from such analyses need to be inter-preted with caution for a number of reasons First thereare problems in measuring and defining fiscalconsolidation episodes In particular relying on deficit-based measures tends to exclude fiscal reforms with a lim-ited impact on current budget balances but potentiallylarge effects on long-term public finances such as pensionreforms Second existing empirical analyses quite often

fail to take properly into account relevant factors such asdevelopments in monetary and exchange-rate policiesthat contribute to shaping the links between fiscal consol-idations and economic activity (1) Third when interpret-ing the links between fiscal policy and economic activitysimultaneity issues are to be taken into account Not onlyfiscal consolidations affect output growth but actual andexpected growth affect budget balances and policy mak-ersrsquo choices (2) Finally there is the possibility that resultsare driven to some extent by a sample selection bias prob-lem Most of the episodes of fiscal consolidations thatonce started have been aborted early due to very adversegrowth consequences are by definition missing from thesamples used in cross-country analyses

32 Were there expansionary fiscal consolidations in the EU A close look at the data

321 How to define periods of budgetary consolidation with expansionary effects

This section carries out a statistical analysis of the fiscalconsolidations that took place in the EU in the past dec-ades It covers the current EU countries with the excep-tion of Luxembourg during the period 1970ndash2002 (3)The source of the data used in the analysis is theAMECO database developed by the Directorate-Generalfor Economic and Financial Affairs

The main purpose of the analysis is that of identifying anddescribing the characteristics of the fiscal consolidationepisodes that appear to be expansionary An analysis ofthe macroeconomic scenario preceding and following thefiscal consolidation episodes is also provided Comparedwith existing event studies of expansionary fiscal consol-idations the focus here is on testing the robustness of thisconcept with respect to alternative definitions of fiscalconsolidation episodes and of their expansionary status

As shown in the previous section in the existingliterature analysing fiscal consolidation episodes using

yen1part In Von Hagen Hughes-Hallet and Strauch (2001) there is an attempt totake into account the links between fiscal and monetary policies by esti-mating together with output equations fiscal and monetary policyreaction functions

yen2part Some studies (Giavazzi and Pagano 1996 Giavazzi Jappelli and Pagano2000) account for possible simultaneity problems by using 2SLS estima-tion techniques

yen3part The exclusion of Luxembourg is due to missing data As will be clear in thefollowing exposition the very last years of the sample are necessarilydropped when identifying expansionary consolidations since it is not possi-ble to evaluate countriesrsquo growth performances after those years

countryyear panel datasets quite different definitions offiscal consolidation have been proposed so that the com-parison of findings is not always easy and immediate Inthe statistical analysis carried out here in order to cap-ture changes in the government budget balance of discre-tionary nature consolidation periods are generally iden-tified by looking at changes in cyclically-adjustedfigures for budget balances budget balance (possibly netof interest payments to isolate discretionary fiscal adjust-ments from developments in the interest rates)

By fiscal consolidation period it is generally meanteither (see Table IV2)

(i) a period in which a given country experiences a suffi-ciently large improvement in its budget balance due todiscretionary policy or

(ii) a period of continuous improvement of the budgetbalance due to discretionary policies

(iii) or a combination of both the above criteria

Criterion (i) emphasises the size aspect of the adjustmentin a given time period while criterion (ii) focuses on thepersistence aspect that is the fact that fiscal consolida-tions are protracted policy actions which are notreversed in their immediate aftermath For instance thedefinitions provided in Alesina and Ardagna (1998) orAlesina et al (2002) mainly refer to the size criterionwhile those in Cour et al (1996) Giavazzi and Pagano(1996) or OECD (1996) refer especially to the persist-ence criterion (see Table IV2)

As mentioned in the previous section in several analysesthere is reference to a further refinement of the conceptof fiscal consolidation that is that of successful fiscalconsolidation (see for example Alesina and Ardagna1998 or Von Hagen Hughes-Hallet and Strauch 2001)By lsquosuccessfulrsquo consolidation it is meant a consolidationepisode that contributes to improve the budget balanceover a relatively long time period (that is debt levels arepermanently lowered) In the following analysis thenotion of successful consolidations is not used (1)

Concerning the definition of expansionary fiscal consoli-dations the criteria used in existing work differ widely Ingeneral for a fiscal consolidation period to be defined asexpansionary the economy must perform sufficientlywell (for example growth sufficiently fast with respect toprevious years or some benchmark growth rate) after thefiscal adjustment takes place It is to note that the refer-ence period considered to evaluate the growth perform-ance of consolidating countries is generally a relativelyshort-term one (one to three years after consolidation)

The benchmark definition of fiscal consolidation used inthis study is taken from Alesina and Ardagna (1998)According to this definition a year of fiscal consolida-tion is a lsquoyear in which the cyclically-adjusted primarybalance improves by at least 2 of GDP or a period oftwo consecutive years in which the cyclically-adjustedprimary balance improves by at least 15 per year inboth yearsrsquo This notion of fiscal consolidation putsemphasis on the size of the improvement in the primarybudget balance

The benchmark notion of expansionary fiscal contrac-tion used in the present study is the same as that pro-posed by Alesina et al (2002) This criterion classifies asexpansionary an episode of fiscal consolidation if lsquotheaverage real GDP growth in each adjustment year and inthe two years after is greater than the average real GDPgrowth in the two years beforersquo (2)

In order to test the sensitivity of the results to the differ-ent definition of both the fiscal consolidation and of theexpansionary effects in Section 322 while keepingconstant the benchmark definition of expansion expan-sionary consolidation periods will be identified anddescribed according with the benchmark size-based def-inition of consolidation and with an alternative criterionof consolidation based on persistence

In Section 323 instead while keeping constant thesize-based benchmark definition of consolidation

yen1part The focus of the present analysis is in fact on the distinction betweenexpansionary and non-expansionary consolidations Moreover the conceptof successful consolidation tends to overlap with that of fiscal consolida-tion based on a persistence criterion

yen2part The above criterion is different for instance with respect to that employed inAlesina and Ardagna (1998) which specifies that the average real GDPgrowth rate (in difference from the G7 average) in the period of consolidationand in the two years after it must be greater than the average value of thesame variable across all episodes of consolidation Therefore the concept ofexpansion used in Alesina and Ardagna (1998) identifies those consolidationepisodes after which growth has been higher relative to the average consoli-dation periods of the sample In this study the criterion based on growthacceleration proposed by Alesina et al (2002) is chosen as the benchmarkbecause it is better suited to identify fiscal consolidation episodes specific tothe country and potentially exhibiting non-Keynesian features

expansionary consolidation periods will be identifiedand described according to the benchmark definition ofexpansion based on growth acceleration and to alterna-tive expansion criteria acceleration in trend growth inthe cyclical component of growth and on the growthdifferential with the EU average

In identifying expansionary consolidations a further dis-tinction will be made in order to isolate those expan-sionary consolidation episodes that are unlikely to beattributable to concomitant monetary policy easing orexchange-rate devaluation policies It has been shown infact that fiscal contractions have been quite frequentlyaccompanied by expansionary monetary policies in EUcountries (see for example OECD 1996 Alesina andArdagna 1998) The notion of lsquopurersquo expansionary fis-cal consolidation is thus proposed as one during whichshort-term real interest rates do not fall (1)

Using the different definitions several characteristics ofconsolidation periods are analysed in the next twosections including their size the initial state of publicfinances and how the fiscal adjustment is achieved(tax increases or expenditure cuts) The macroeconomicenvironment before during and after consolidation peri-ods is analysed by reporting average statistics on growthoutput gaps interest rates and on the change in the com-ponents of aggregate demand

322 When does a fiscal consolidation occur

The first exercise is to identify consolidation episodes bycomparing the characteristics of expansionary fiscal con-solidations that arise using different definitions To thisend the results obtained when using the benchmark defini-tion by Alesina and Ardagna (1998) based on the size ofadjustment are compared with an alternative definitionbased on the persistence of adjustment According to thisalternative criterion fiscal consolidations occur when theprimary cyclically-adjusted budget balance improves by atleast 3 percentage points of GDP over three consecutiveyears (the note to Table IV3 provides a formal definition)

Table IV3 reports the number of fiscal consolidationsidentified and describes which countries and in which peri-ods experience expansionary episodes In the sample of

462 observations used (14 EU countries 33 years) 49 fiscalconsolidation episodes have been identified which areconsistent with the definition based on size (2) Using theconcept of fiscal consolidation based on persistence thenumber of consolidation episodes rises to 59

Among the episodes of fiscal consolidation identifiedroughly half of the total number of consolidation experi-ences amount to being expansionary This result does notseem to depend on the definition of fiscal consolidationemployed (size or persistence) Refining further the con-cept of expansionary consolidation to account for themonetary stance or possible devaluations about half ofthem are found to be lsquopurersquo (11 and 16 episodes usingrespectively the size and the persistence concept of con-solidation period)

Concerning the description of the expansionary consoli-dation episodes the evidence of expansionary effectsregistered in Belgium Denmark and Ireland reported inprevious studies is confirmed Sweden also appears to behave experienced expansionary consolidations duringthe mid-1980s and in the late 1990s The identificationof expansionary consolidations in the remaining EUcountries depends quite strongly on the concept used todefine consolidation periods Overall the correlationindex between lsquosizersquo and lsquopersistencersquo expansionaryconsolidation indicators is positive but quite low(033) (3)

Table IV4 reports statistics concerning the characteris-tics (size of adjustment initial state of public financescomposition of adjustment) of the fiscal consolidationsidentified distinguishing whether the consolidationproved to be expansionary or not

Results appear to be very robust with respect to theconcept of fiscal consolidation employed (size or persist-ence) and supportive of findings reported in previousstudies (Alesina and Ardagna 1998 Alesina et al 2002)In particular it is not the simple fact that an adjustment iscarried out that really matters rather it is the compositionof the adjustment which explains its expansionary effectIndeed the amount of the adjustment (measured by the

yen1part Under likely assumptions non-decreasing real interest rates tend to excludeboth monetary expansions under floating exchange rates and devaluationpolicies under fixed exchange rates regimes This is the case for instancein a Mundell-Fleming open economy setting with uncovered interest rateparity (see for example Krugman and Obstfeld 2001)

yen2part The episodes may not coincide with those reported in Alesina and Ardagna(1998) because the method used to obtain cyclically-adjusted figures differ(HP filter in the present study Blanchard-type trend regressions in Alesinaand Ardagna 1998)

yen3part Expansionary consolidation indicators take the value 1 for countryyearcombinations in which an expansionary consolidation occur and zerootherwise

change in the primary cyclically-adjusted budget bal-ance) does not seem to be significantly different betweenexpansionary and non- expansionary consolidation peri-ods using both definitions of fiscal consolidation Whatappears to be relevant to distinguish expansionary fromnon-expansionary periods of fiscal adjustment mdash usingboth definitions of consolidation mdash is its compositionFiscal adjustments based on expenditure cuts are morelikely to be expansionary than consolidation periodsbased on tax increases Looking at overall values forprimary expenditure and for government revenues

(cyclically-adjusted or not) differences are statisticallysignificant irrespective of the concept of consolidationemployed (size or persistence) The definition of consol-idation appears to matter instead as far as the compositionof expenditure is concerned In particular the reductionin the public wage bill found to be relevant to character-ise expansionary fiscal consolidations in other studies issignificantly higher in expansionary than in non-expan-sionary consolidations only when adopting a persistence-type definition of fiscal consolidation

Concerning the initial state of public finances the averagevalue of debtGDP ratios are found to be higher in expan-sionary fiscal consolidation periods by about 10 GDPpercentage points irrespective of the concept of consoli-dation employed (size or persistence) However t testsshow that this difference is not statistically significant (1)

Table IV5 presents data characterising the macro-economic environment preceding during and follow-ing consolidation periods Several results emerge Firstconsolidations are more likely to be expansionary afterperiods characterised by relatively low growth and bynegative output gaps (2)

Second growth appears to accelerate during the consol-idation year and during the following year for expan-sionary episodes while in non-expansionary episodesgrowth is more likely to decelerate Interestingly trendgrowth accelerates in expansionary consolidation peri-ods when consolidation is defined according to persist-ence while trend growth appears to be constant beforeand after consolidation when using a definition based onsize As for unemployment it worsens during non-expansionary consolidations while this is not the casefor expansionary fiscal adjustments

Third both private consumption and business investmentaccelerate during expansionary consolidation periods withinvestment registering a much higher acceleration By con-trast investment decelerates during non-expansionaryperiods and even drops after the consolidation (negativegrowth rates of investment) (3) Moreover an acceleration

Table IV3

Expansionary consolidations description of episodes with alternative definitions of consolidation

Size Persistence

Number of consolidation episodes 49 59

Number of expansionary episodes 24 31

Number of lsquopurersquo expansionary episodes

Description of expansionary episodes

Size Persistence

BE 1984 1985 1985 1986 1987

DK 1983 1984 1984

DE 1982 1982 1983 1984

EL 19821987 1994 1996 1994 1997 1998

ES 1986

FR 1996 1997

IE 1976 1987 1988 1984 1987 1988 1989

IT 1976 1977 1993 1993

NL 1993 1982 1983

AT 1996 1997

PT 1986

FI 1993 1977

SE 1983 1987 1995 1998 1982 1983 1984 1995 1997 1998

UK 1997 1981 1982 1997

Definitions of fiscal consolidationSize The primary cyclically-adjusted budget balance improves by at least 2 per-

centage points of GDP at time t or by 15 at least points in two consecutiveyears (ie t and t-1 or in t and t+1)

Persistence The primary cyclically-adjusted budget balance improves by at least3 percentage points of GDP over three consecutive years (ie between t-2and t or between t-1 and t+1 or between t and t+2) and in each year thechange in the primary cyclically-adjusted budget balance cannot be belowndash05 percentage points of GDP

Definition of an expansionary fiscal consolidationA fiscal consolidation in which the average real GDP growth between t andt+2 is greater than between t-1 and t-2

Definition of a pure expansionary consolidationAn expansionary fiscal consolidation in which the average change in realshort run interest rates between t-1 and t+1 is non-negative

yen1part When performing comparisons between variables t tests permit to take intoaccount both measures of position (averages) and of variability (standarddeviations) This helps in understanding when apparently large differencesin averages are mainly driven by the fact that variables are highly volatile

yen2part This effect however may be due in part to the autonomous development ofthe business cycle which resumes from a period of below potential growth

yen3part It should be noted that in spite of the greater variation in investment thecontribution of consumption changes to growth is always higher than thatof investment due to the larger weight on total aggregate demand

in TFP growth is recorded Concerning the current accountbalance while during non-expansionary consolidations amarked worsening of the current account is observed thisis not the case for expansionary consolidations

Finally during consolidation periods both expansionaryand non-expansionary there is a reduction in nominalinterest rates irrespective of the definition of consolida-tion employed This finding is consistent with the factthat in these periods the fiscal stance is meant to be con-tractionary Moreover falling short-term nominalinterest rates are a possible indication of concomitantmonetary expansions or exchange rate devaluations (1)

323 When is a fiscal consolidation expansionary

The second exercise undertaken is that of analysing therobustness of the characteristics of expansionary fiscalconsolidations with respect to different criteria to iden-tify expansionary episodes

For this purpose after having seen that alternative defi-nitions of consolidation produce similar results the

benchmark size-based definition of consolidation is keptconstant and different definitions of expansion are usedTwo alternatives to the benchmark expansion definitionby Alesina et al (2002) are proposed

The first definition employs the notion of trend outputgrowth as opposed to the of real GDP growth to identifyexpansionary episodes (see note to Table IV6 for the for-mal definition) Resting on the assumption that fiscal pol-icy may affect potential output the idea is that an episodeof fiscal adjustment is meant to be expansionary providedit is associated with an acceleration of trend output Suchdefinition of expansion permits to distinguish consolida-tion periods associated with positive developments in theeconomic cycle from those which are associated withpositive output developments of a more structural natureThe second criterion defines as expansionary those fiscalconsolidations that are associated with an increase in thedifference between the growth rate in countriesrsquo GDP andthe EU average GDP The aim of this criterion is that ofidentifying those expansionary episodes which are associ-ated with a growth acceleration which is not attributable tothe EU-wide economic cycle (2)

Table IV4

Size and composition of expansionary consolidations alternative definitions of consolidation

Criterion of fiscal consolidation Size Persistence

Non exp Exp t test for (1) ne (2)

Non exp Exp t test for(3) ne (4)Variables (change as a of GDP) Average values Average values

(1) (2) (3) (4)

Primary CAB 29 28 08 17 16 02

Debt (level as a of GDP) 654 751 ndash 09 619 760 ndash 15

Primary expenditure 00 ndash 16 29 (2) 01 ndash 11 28 (2)

Government investment ndash 02 ndash 03 16 ndash 01 ndash 03 20 (2)

Public employees compensation 00 ndash 02 14 00 ndash 02 19 (1)

Total government revenues 23 10 41 (2) 14 05 29 (2)

Total cyclically-adjusted government revenues 24 11 33 (2) 13 04 26 (2)

NB t test values labelled by (1) and (2) refer respectively to cases in which the average value of variables during expansionary and non-expansionary consolidations arestatistically different at a 90 and 95 confidence interval

yen1part Depending upon the evolution of inflation falling nominal interest ratesmay not correspond necessarily to effectively monetary easing Howeverin most of the cases real interest rates also appear to fall between t and t-1both during expansionary and non-expansionary consolidations whilechanges between t and t+1 show a less clear pattern (unreported) Concern-ing nominal exchange rates it is found that during both expansionary andnon-expansionary consolidations the exchange rate of the consolidatingcountry with respect to the US dollar tends to depreciate overall the wholeperiod between t-1 and t+1 (unreported)

yen2part A third definition of expansion complementary to the first one as also beentested According to this definition an episode of fiscal consolidation isexpansionary provided it is associated with an increase in the differencebetween actual and trend output growth The results however are particu-larly close to the baseline scenario (correlation index at 098) given thatmost of the movements in this variable is due to changes in actual growthTherefore the results of such exercise are not shown

Table IV6 reports the number of fiscal consolidationsidentified and describes which countries and in whichperiods experience expansionary episodes An interest-ing result is already that irrespective of the definitionused to identify expansionary episodes the number ofexpansionary consolidations is about 20 that is roughlyhalf the total number of consolidation experienced in EUcountries Most of the country-specific cases are identi-fied under the three definitions

Adopting the narrower definition of lsquopurersquo expansionaryconsolidation that is excluding the expansionary consolida-tion periods likely to be associated with monetary expan-sions or exchange rate devaluations the number of expan-sionary episodes reduces to about 10 Again this result isfairly robust with respect to the definition of expansion used

So irrespective of the definition of expansion usedabout half of the consolidation periods experienced by

Table IV5

Macroeconomic environment in expansionary consolidations alternative definitions of consolidation

Criterion for fiscal consolidation Size Persistence

Variables Non-exp Exp Non-exp Exp

Growth rate of real GDP ()

t-1 26 16 26 12

t 11 21 20 22

t+1 07 34 24 31

Output gap ( of trend output)

t-1 04 ndash 11 03 ndash 18

t 02 ndash 15 02 ndash 16

t+1 ndash 03 ndash 08 07 ndash 10

Trend GDP growth

t-1 26 26 29 25

t 25 26 28 26

t+1 25 26 27 28

Growth rate of real private consumption ()

t-1 24 14 23 13

t 14 18 17 19

t+1 15 30 23 26

Growth rate of real business investment ()

t-1 35 03 54 06

t ndash 06 37 05 35

t+1 ndash 33 67 ndash 15 64

Growth rate in real current account surplus ()

t-1 30 01 31 00

t ndash 01 ndash 02 ndash 41 00

t+1 ndash 02 04 ndash 43 ndash 05

Growth rate in TFP ( change)

t-1 09 10 12 09

t 02 16 08 17

t+1 02 21 13 21

Unemployment rate ( of labour force)

t-1 65 87 7 95

t 69 9 76 94

t+1 89 89 79 91

Short -term nominal interest rates

t-1 113 125 109 97

t 109 115 102 93

t+1 99 102 98 86

EU countries appear to be expansionary and about onequarter appear to be lsquopurersquo expansionary (not likely tobe accompanied by expansionary monetary policies ordevaluations)

Turning to the description of the expansionary consoli-dation episodes all criteria used to identify expansion-ary episodes permit to isolate the experiences of Den-mark (1983ndash84) and Ireland (1987ndash88) which sinceGiavazzi and Pagano (1990) are known to be the clas-sical examples of fiscal adjustment exhibiting possiblenon-Keynesian features Expansionary fiscal consoli-dations are found in Spain and Portugal in 1986 as wellas in West Germany in 1982 Non-expansionary epi-sodes are instead found in France Findings concerningGreece Italy Sweden and the UK depend quite cru-cially on the criterion chosen to define an expansionaryadjustment Concerning Finland not surprisingly anexpansionary period in 1993 is found using all criteriaexcept that based on trend growth since results are very

much driven by the strong output contraction experi-enced in 1991

Correlation indexes (reported in Table IV1) amongexpansionary consolidation indicators based on differentdefinitions of expansion help to understand the extent towhich alternative criteria tend to yield overlappingresults The benchmark criterion based on the accelera-tion of real GDP growth is correlated to a certain extentwith the trend growth criterion (063) The resultsobtained using the definition of expansionary consolida-tions using the criterion of actual minus EU growth ismore correlated with the baseline scenario (076) thanwith trend growth scenario (051)

Table IV8 reports average values and t tests for thecharacteristics of the fiscal consolidations identified dis-tinguishing according to the expansionary status of theconsolidation and repeating the analysis for the differentdefinitions of expansion

Table IV6

Expansionary consolidations description of episodes with alternative definitions of expansion

Growth Trend growth Actual minus EU growth

Number of consolidation episodes 49

Number of expansionary episodes 24 22 21

Number of lsquopurersquo expansionary episodes 11 11 11

BE 1984 1985 1984 1985 1984 1993

DK 1983 1984 1983 1984 1983 1984

DE 1982 1982 1982

EL 19821987 1994 1996 19861987 1991 1994 1996 19821991 1994 1996

ES 1986 1986 1986

IE 1976 1987 1988 1987 1988 1987 1988

IT 1976 1977 1993 1997 1976 1977 1992 1993

NL 1993 1993

AT 1984

PT 1986 1986 1986

FI 1993 1993

SE 1983 1987 1995 1998 1995 1996 1998 1983 1998

UK 1997 1980 1997 1998

NB All fiscal consolidations are of the size-type (see note to table ) A lsquopurersquo expansionary fiscal consolidation is an expansionary fiscal consolidation in which the average change in real short run interest rates between t-1 and t+1 isnon-negative

Definitions of expansionary fiscal consolidationGrowth average real GDP growth between t and t+2 greater than between t-1 and t-2Trend growth average trend growth between t and t+2 greater than between t-1 and t-2Actual minus EU growth average difference (actual real GDP growth ndash EU average real growth) between t and t+2 greater than between t-1 and t-2

The results shown in Table IV8 are fairly robust withrespect to alternative definitions of expansion (based ongrowth trend growth difference between growth andtrend growth difference between growth and EU aver-age growth) In general there is support for the view thatthe composition of adjustment is more significant toidentify expansionary episodes rather than the size of theadjustment carried out In particular an expansionaryadjustment would be a combination of tax increases andcuts in primary expenditure where however the lattermeasure would be more sizeable Consistently with theargument proposed by Alesina et al (2002) it is also

found that during expansionary consolidations there is amore marked reduction in expenditure on public employ-eesrsquo wage bill However this difference is significant(and highly so) only when a criterion of expansion basedon trend growth is chosen This finding is consistent withthe idea that the wage bill of public employees affectsreal output through higher profits and then greaterinvestment To the extent that investment affects bothdemand and supply conditions one should expect trendoutput to be affected while this is not the case if wageswould only affect output via the demand channel

Table IV9 shows data illustrating the macroeconomicenvironment before during and after consolidations Itconfirms the result that in general expansionary consoli-dations follow periods of low growth and negative output

gaps Regarding the behaviour of aggregate demand com-ponents again both private consumption and businessinvestment accelerate during expansionary consolidationperiods with investment registering a greater accelerationThe finding that during non-expansionary periods invest-ment decelerates quite significantly is also confirmed androbust with respect to the notion of expansion adoptedAgain the level of short-term nominal interest rates fallsduring both expansionary and non-expansionary consoli-dations irrespective of the definition of expansion used

What seems to differ quite significantly depending on thedefinition of expansion adopted is the behaviour of thecurrent account balance When the expansion is measuredby trend growth the current account balance worsens dur-ing expansionary consolidations while the opposite is true

Table IV7

Correlation indexes among alternative indicators of expansionary consolidations

Growth Trend growthActual minus

EU growth

Growth 1

Trend growth 063 1

Actual minus EU growth

076 051 1

Table IV8

Size and composition of expansionary consolidations alternative definitions of expansion

Non-exp Exp t test for (1) ne (2)

Non-exp Expt test for (3) ne (4)

Average values Average values Average values

(1) (2) (3) (4) (7) (8)

Primary CAB 29 28 06 29 28 02 29 27 07

Debt (level as a of GDP) 654 751 ndash 09 639 777 ndash 16 616 811 ndash 22 (2)

Primary expenditure 00 ndash 16 32 (2) 00 ndash 18 36 (2) ndash 04 ndash 14 17 (1)

Government investment ndash 02 ndash 03 19 ndash 02 ndash 03 ndash 013 ndash 02 ndash 03 00

Public employees compensation 00 ndash 02 16 01 ndash 04 40 (2) 00 ndash 02 12

Total government revenues 23 10 39 (2) 22 09 41 (2) 20 11 28 (2)

Total cyclically-adjusted government revenues

24 11 33 (2) 26 08 49 (2) 21 12 21 (2)

when the other criteria for consolidation are used Thisinteresting result highlights that the evolution of the exter-nal sector may be a consequence of the type of fiscaladjustment carried out rather than its determinant There-fore a less unfavourable evolution of the current accountbalance may help to identify fiscal consolidation episodesleading to cyclical improvements (that is when theexchange rate tends to depreciate) but not those associ-

ated with growth improvements of a structural nature (thatis when the exchange rate would tend to appreciate) Inthe latter cases in fact the current account gives on averagea negative contribution to the evolution of growth Theview that expansionary fiscal consolidations should beseen as a phenomenon mainly associated with exchangerate depreciations or devaluations and consequent currentaccount improvements is thus not supported

Table IV9

Macroeconomic scenario in expansionary consolidations alternative definitions of expansion

Definition of expansion Growth Trend growth Actual minus EU growth

Variable Non-exp Exp Non-exp Exp Non-exp Exp

t-1 26 16 22 20 28 11

t 11 21 12 21 13 20

t+1 07 34 16 27 13 31

t-1 04 ndash 11 09 ndash 19 00 ndash 07

t 02 ndash 15 01 ndash 16 ndash 03 ndash 11

t+1 ndash 03 ndash 08 ndash 02 ndash 10 ndash 02 ndash 10

Trend GDP growth

t-1 26 26 31 20 26 25

t 25 26 29 22 26 25

t+1 25 26 28 23 26 26

t-1 24 14 21 17 23 14

t 14 18 12 20 18 13

t+1 15 30 15 31 19 26

t-1 35 03 04 34 45 ndash 08

t ndash 06 37 ndash 06 41 18 12

t+1 ndash 33 67 ndash 26 68 ndash 07 49

t-1 30 01 03 26 22 03

t ndash 01 ndash 02 01 ndash 04 00 ndash 04

t+1 ndash 02 04 00 02 00 02

Growth rate in TFP ()

t-1 09 10 07 12 13 04

t 02 16 05 14 02 17

t+1 02 21 08 15 04 20

t-1 65 87 62 79 66 88

t 69 90 70 80 69 94

t+1 89 89 75 80 72 94

Short run nominal interest rates

t-1 113 125 124 114 103 132

t 109 115 120 105 95 127

t+1 99 102 108 93 89 112

324 Summary of findings

The analysis carried out in this chapter relying upon alter-native definitions of fiscal consolidation and on differentcriteria to identify expansionary fiscal adjustments leads toa number of findings that can be summarised as follows

bull Fiscal consolidation episodes exhibiting non-Key-nesian features can be found in Europe growthappears to have accelerated after about half of theconsolidation episodes identified and in roughly onequarter of the cases this happened without a mone-tary stimulus Hence there is an indication thatroughly half of the expansionary fiscal consolida-tions are unlikely to be attributable to concomitantmonetary policy easing or devaluations

bull Expansionary fiscal consolidations are more likelyto be based on expenditure cuts than on tax increasesirrespective of the definition of fiscal consolidationor expansion employed Expansionary fiscal adjust-ment periods also appear to be associated with initialhigh levels of debt while the simple fact that therehas been an adjustment is not enough to guaranteeits positive effect on output Consolidations basedon cuts in wage expenditure seem to be more likelyto spur potential growth (1) Consistent findings arefound in previous studies (Alesina and Ardagna1998 Alesina et al 2001)

bull The macroeconomic environment preceding expan-sionary consolidation periods is characterised byslow growth and negative output gaps comparedwith that characterising non-expansionary consoli-dations This finding appears robust with respect tothe definition of consolidation used and the defini-tion of expansion adopted

bull There is evidence that the acceleration in growthfollowing fiscal consolidations may have either astructural nature (trend growth is affected) or acyclical one or have both a structural and a cyclicalcomponent During expansionary consolidationsboth consumption and investment accelerate Thebehaviour of business investment seems especiallyhelpful in distinguishing between expansionary andnon-expansionary episodes Irrespective of the defi-nition of consolidation and expansion used while innon-expansionary cases investment falls in expan-

sionary periods there is a strong acceleration in thiscomponent of aggregate demand

bull The results presented above highlight the fact thatcredibility and confidence may play a role in deter-mining the effects on output of the fiscal adjustmentBox IV1 provides some examples about the rela-tionship between confidence and fiscal adjustmentsThe indicators of householdsrsquo and businessesrsquo con-fidence are below average before the consolidationstarts and tend to improve in those cases of budgetconsolidations followed by acceleration in growth

Before taking firm policy conclusions however itshould be recalled that the above results are to be inter-preted with caution As mentioned in Section 31 cross-country empirical analysis on fiscal consolidations aresubject to a series of problems and limitations In partic-ular in interpreting results referred to the short-run it isquite difficult to understand to what extent consolida-tions affect growth or if it is actual and expected outputgrowth which affects budget balances and budget poli-cies (2) Moreover it is quite difficult to isolate the effectof external factors (such as monetary and exchange-ratepolicies) that shape the links between fiscal consolida-tions and economic activity

An ideal way to overcome the above difficulties in inter-preting the empirical evidence would be that of creatinga policy experiment in which a fiscal shock occurs in iso-lation from other policies and from other types of shocksto macroeconomic variables Though real-world policyexperiments are not feasible the use of applied macro-economic models helps to understand how such hypo-thetical policy experiments would work in reality Tothis end the next chapter presents simulations on theeffects of alternative types of fiscal consolidations fromthe Directorate-General for Economic and FinancialAffairs QUEST model

yen1part However this finding is quite fragile with respect to the definition of fiscalconsolidation or expansion used

yen2part The possibility of a mistaken interpretation of results is somehow sup-ported by the fact that expansionary consolidations are more likely to occurafter weak growth and when output gaps are negative The growth pick-upobserved after expansionary consolidations may therefore be related tosome extent to independent cyclical developments However even restrict-ing the analysis to relatively homogenous cases from the viewpoint ofcyclical conditions the evidence still seems potentially consistent with thehypothesis of consolidations with non-Keynesian effects In order to avoidextreme cases where this independent cyclical effect is more likely to playa relevant role the sample could be limited to fiscal consolidations epi-sodes (according to the benchmark definition) occurring when output iswithin 2 percentage point from potential (which is the case for about 80 of the cases) In this case average growth is 17 14 and 18 respectively inthe year before during and after consolidation which still shows that theconsolidation would not have recessionary effects

Box IV1 Expansionary fiscal consolidations and confidence indicators

The rationale for the emergence of non-Keynesian fiscal consolidations is based on the forward-looking behaviour of con-sumers and investors The improvement of the government budget position may lead to increased consumption or invest-ment if the expectations of economic operators are affected positively Consumers may raise their consumption spendingif the consolidation of public finances credibly signals reduced future taxation thus leading to a higher perceived perma-nent disposable income Businesses may invest more if the fiscal consolidation leads to the perception of improvedexpected future profit opportunities A common indicator to measure the level of confidence of consumers and businessesis the economic sentiment indicator (ESI) developed by the National Bureau of Economic Research (NBER) which sum-marises the attitudes and judgements on the current economic situation through surveys conducted on a large number ofeconomic actors For EU countries the economic sentiment indicator is calculated on a monthly basis by the EuropeanCommission within the framework of the joint harmonised EU programme of business and consumer surveys (1)Table IV1 reports values of the economic sentiment indicator during periods of fiscal consolidations resulted to be expan-sionary (see Table IV3 and Table IV4) The fiscal consolidation episodes chosen are those in Ireland in 1987 and 1988in Italy in 1993 in Greece in 1994 and 1996 and in Sweden in 1998 On the left-hand axis the value of the ESI is reported(changing on a monthly basis) on the right-hand axis the value of the primary cyclically-adjusted CAB (annual data) isreported

(1) The European Commission economic sentiment indicator is the result of monthly surveys collected on a sample of 67 000 firms and 24 000 consumersacross the EU The questions included in the surveys concern the perception of economic actors on the state of the economy in the coming monthsAnswers are ranked according to their degree of lsquooptimismrsquo with higher scores for more optimistic answers Answers from different economic actorsare aggregated using predetermined weights (40 for industrial firms 20 for households 20 for construction firms 20 for retail trade firms)Figures are seasonally adjusted and normalised such that 1995=100

Graph IV1 Economic sentiment indicators during expansionary consolidations

Economic sentiment indicators during expansionary consolidations Ireland 1987 1988

Primary CAB 1999

Primary CAB 1998

Primary CAB 1987

Primary CAB 198695

Box IV1 (continued)

Economic sentiment indicators during expansionary consolidations Italy 1993

Primary CAB 1994

Primary CAB 1993

Primary CAB 1992

Economic sentiment indicators during expansionary consolidations Greece 1994 1996

Primary CAB 1997Primary CAB 1996

Primary CAB 1995

Primary CAB 1994

Primary CAB 1993

ndash 3

ndash 2

ndash 1

Box IV1 (continued)

It is difficult to compare annual budgetary data with monthly surveys and to attribute to specific months the effect of eachbudget one should determine whether the impact on confidence materialises when the budget is announced when it isapproved or when evidence about its implementation emerges Nevertheless some gross information can be obtained bylooking at the above figures In all cases an improvement in the economic sentiment indicator is observed in the monthsduring which the consolidation was taking place In Ireland confidence improved after the consolidation of 1987 tookplace and the ESI continued to improve also after the consolidation occurred in 1988 In Italy the consolidation of 1993coincided with an inversion of the trend in the ESI during 1992 confidence was falling starting from mid-1993 confidencebegan to rise In Greece it is worthwhile to observe that the improvement in the ESI during the consolidation of 1994 wasonly temporary The worsening of the primary cyclically-adjusted balance in 1995 coincided with a fall in confidenceConfidence improved again during the consolidations of 1996 and 1997 Concerning Sweden between 1997 and 1999 therise and fall pattern in the ESI follows quite closely that in the primary cyclically-adjusted budget balance

This evidence is generally consistent with the view that fiscal consolidations may have expansionary effects via improvedeconomic confidence of economic operators

Economic sentiment indicators during expansionary consolidations Sweden 1998

Primary CAB 1999

Primary CAB 1998

Primary CAB 1997

4 Assessing ex ante the effects of fiscal consolidations simulation results from the QUEST model

41 Introduction (1)

This chapter describes the macroeconomic effects offiscal consolidations based on simulations using theQUEST model QUEST is an applied macroeconomicmodel whose foundations can be characterised as a mod-ern version of the neoclassical-Keynesian synthesisBehavioural equations in the model are based on inter-temporal optimisation of households and firms with for-ward-looking expectations (2) Unemployment is gener-ated by imperfect matching between workers and firmsPrices adjust sluggishly and the nominal wages responseis delayed because of overlapping wage contracts Themodel has Keynesian features in the short run but theeffectiveness of fiscal policy is more limited than in thetraditional econometric models because of the built-inintertemporal budget constraints However since plan-ning horizons are finite there is no complete tax dis-counting and Ricardian equivalence does not holdMoreover total consumption is represented as the aggre-gation of the responses of two groups of households oneforward-looking group that follows the optimal con-sumption rule given by the life cyclepermanent incomehypothesis and a liquidity-constrained group whose con-sumption depends on current disposable income

Taxes are in general distortionary in the model and affectlong-term employment and capital formation as well asconsumption decisions by private agents Consolidationsthrough tax increases have therefore long-term negative

consequences in the model The only exception to this islump-sum taxes which do not create any distortions butthis is of limited practical relevance

A reduction in government expenditure in QUEST affectsconsumption of the liquidity-constrained householdswho see their current disposable income decline if wagesand employment are falling However the non-liquidity-constrained households could increase their consump-tion as interest rates fall and if they anticipate higherdisposable incomes in the future The removal of distor-tions that this entails could boost employment and outputand already affect life-time income in the short runExpansionary effects through the consumption channelmay occur in the medium term but if a sizeable share ofhouseholds is liquidity-constrained it is unlikely that inthe short run the boost to consumersrsquo spending thatmight result from the fiscal consolidation will be strongenough to offset the negative impact of the reduction ingovernment spending Thus the emergence of non-Keynesian effects of fiscal consolidations through consum-ersrsquo spending crucially depends on the severity of creditconstraints and on the degree of distortions associatedwith public intervention (3)

Besides the consumption channel QUEST allows for theworking of non-Keynesian effects through the workingof the investment channel A reduction in public expend-iture in particular public employment will raise unem-ployment and exert downward pressure on wages Thisin turn tends to boost profits and raise investment spend-

yen1part For an extended analysis see Giudice et al (2003)yen2part The model has a richer theoretical structure than most macroeconometric

models Moreover as in standard computable dynamic general equilibriummodels it allows for adjustment costs and nominal rigidities For a presen-tation of QUEST II model see Roeger and inrsquot Veld (1997 2002)

yen3part The fraction of liquidity-constraint households in QUEST is obtained fromavailable estimates

ing This is the investment channel emphasised forinstance in Alesina et al (2002)

The question arises whether the non-Keynesian channelsdescribed above could prevail over the traditional Keyne-sian channels and lead to expansionary fiscal consolida-tions If this is the case it is then relevant to understandwhich type of fiscal consolidations are more likely toinduce a prevalence of non-Keynesian channels

For comparability all scenarios of consolidation in thesimulations are of equal ex ante size and standardised toconsolidations of 1 percentage point of GDP that ispermanent increases in taxation or reductions in expend-iture of 1 of (baseline) GDP (1) It should be noted thatan annual budgetary adjustment equivalent to 1 ofGDP would be large relative to what Member States areenvisaging in their stability and convergence pro-grammes in order to reach the SGP goal of budget posi-tions which are lsquoclose to balance or in surplus Thisimplies that two of the factors that are generally investi-gated in analysing fiscal consolidations that is the sizeof the adjustment and the initial state of public financesare not directly explored here (2) The policy experimentsare also applied to one country in isolation (Germany)and no attention is paid to possible cross-country spill-over effects (3)

All scenarios assume that the fiscal consolidations arepermanent and credible that is private agents fully andcorrectly anticipate the effects of fiscal consolidationand do not expect the fiscal policies stance to be revertedin the future An exercise is carried out in Section 431to assess the implications of fiscal consolidation whichare perceived as non-credible since they are reversed inthe following years

The default monetary policy assumption in the scenariosdescribed below is based on a forward looking Taylor-

type rule The monetary authorities are assumed to setshort-term interest rates at a level that depends both onthe deviation of the forecast of inflation from the targetinflation rate and on the magnitude of the output gap Toevaluate the impact of the monetary policy stance on theeffects of fiscal consolidation an alternative monetarypolicy rule leading to a looser policy stance is alsoconsidered (see Section 432)

The simulation results are presented as changes in levelsof relevant macroeconomic variables These results areequally interpretable as deviations from baseline steady-state growth

42 Tax increases

With distortionary taxes it should come as no surprisethat a fiscal consolidation through tax increases has anegative impact on output The purpose of this section ismerely to provide a comparison for the simulations ofexpenditure reductions and contrast the potential effectson output Three simulations are carried out below per-manent tax increases of 1 of GDP in labour incometax corporate profit tax and VAT respectively

As expected all these scenarios show negative GDPeffects in the short and medium run the tax rises increasethe distortions in the economy and lower output Labourincome tax and VAT affect consumption more thaninvestment and they both reduce employment Incontrast the consolidation through an increase in thecorporate tax rate has the largest impact on capital for-mation which falls sharply on impact while the increasein unemployment is only of temporary nature On thewhole these negative output effects broadly confirm thefindings in the previous section that consolidationsthrough tax rises are seldom expansionary

43 Expenditure cuts

In the episode study in the previous section it was foundthat fiscal adjustments based on expenditure cuts seem tohave a higher probability to be expansionary than thosebased on tax increases The set of scenarios below are fis-cal consolidations through alternative types of expenditurereductions cuts in government purchases in governmentemployment or in government transfers to households

All the policy experiments considered lead to negativeGDP effects on impact in the short run but are reversedin the medium to long run Permanent cuts in govern-

yen1part The simulated fiscal consolidations have an impact on the size and evolu-tion of public debt The solution of the model requires the debt to be sus-tainable In the simulations the debt is stabilised at a 10 lower level as apercentage of GDP through reductions over time in labour income taxes

yen2part The non-linearities in the model are not substantial enough to analyse theimportance of larger versus smaller fiscal consolidations and the modelresults are close to proportional for larger adjustments than the standard-ised consolidations of 1 percentage point considered here Nor are weexploring here the significance of the initial state of public finances Insteadwe focus our attention on the composition of fiscal adjustments and look atthe effects for different tax and expenditure categories

yen3part Note that as the simulations are performed under an existing EMU frame-work there is also no role for an exchange rate channel a potentiallyimportant element in some of the episodes studied in the previous chapter

ment purchases and government employment can alreadyboost consumption spending in the short run as forward-looking households are anticipating higher disposableincome in the future (1) The simulations show that thiseffect becomes relatively stronger over time strongenough to offset after some years the negative effect onGDP on impact associated with reduced aggregate demandfrom the public sector When instead it is transfer pay-ments to households to be reduced the boost to private

spending in anticipation of lower tax liabilities in the futureappears not to be large enough to offset the negative impactof lower transfer receipts Consumption remains belowbase although investment spending gradually recovers

A reduction in government employment can from thethird year on increase investment spending This scenariodisplays the largest potential gains in terms of highergrowth after the initial decline in the first years The short-term rise in unemployment in this case puts downwardpressure on real wages in the private sector and increasesprofits for firms (Alesina et al 2002) Lower real wagecosts also boost private sector employment again in the

Table IV10

Permanent increase in labour income tax of 1 of GDP

change from baseline 1st year 2nd year 3rd year 4th year 5th year 10th year

GDP ndash 036 ndash 047 ndash 06 ndash 071 ndash 080 ndash 109

Private consumption ndash 090 ndash 110 ndash 119 ndash 125 ndash 131 ndash 142

Private investment ndash 029 ndash 057 ndash 086 ndash 109 ndash 129 ndash 191

Real wage costs 070 094 071 056 058 019

Real effective exchange rate 014 008 ndash 001 ndash 010 ndash 016 ndash 042

Absolute change from baseline

Short-term interest rate ndash 008 ndash 006 ndash 005 ndash 005 ndash 005 001

Real short-term interest rate ndash 004 ndash 009 ndash 009 ndash 007 ndash 007 000

Unemployment rate 028 075 098 107 115 138

Debt ( of GDP) ndash 037 ndash 121 ndash 192 ndash 259 ndash 329 ndash 763

Deficit ( of GDP) ndash 100 ndash 083 ndash 074 ndash 073 ndash 082 ndash 086

Table IV11

Permanent increase in corporate tax of 1 of GDP

Private consumption 085 138 137 130 125 147

Real wage costs ndash 013 ndash 025 ndash 025 ndash 029 ndash 040 ndash 132

Real effective exchange rate 010 011 007 003 ndash 001 003

Real short-term interest rate 001 ndash 003 ndash 004 ndash 005 ndash 004 005

Unemployment rate 008 005 002 001 ndash 001 ndash 081

yen1part Higher future disposable income is associated with the lower future taxesthat become possible after the consolidation under the assumption that thedebt ratio is stabilised at a 10 of GDP lower level

medium term and total employment recovers graduallyThe cross-country evidence on expansionary consolida-tions supports this view As found in the previous sectionreductions in the wage bill of the public sector are morelikely to be linked with expansionary consolidations whenthese are defined in terms of trend growth

431 Temporary versus permanent cuts

One of the regularities found in cross-country analysesof fiscal consolidations is that lsquosuccessfulrsquo consolida-tions leading to a permanent reduction in debt are morelikely to produce expansionary effects than adjustmentswhich are reversed in the subsequent years All the

QUEST simulations presented so far concerned fiscalconsolidations resulting from permanent tax increases orexpenditure cuts The hypothesis of a permanent adjust-ment is crucial Since the QUEST model builds upon theassumption of rational expectations agents anticipatethe permanent reduction in government spending and thelower tax liabilities even though these will only materi-alise in the future

To test the importance of the credibility of the adjust-ment (proxied here by its permanence) and how thisfeeds through the channel of agentsrsquo expectations thehypothesis of permanent consolidation is relaxed the

Table IV12

Permanent increase in VAT of 1 of GDP

Real wage costs 049 069 050 037 038 ndash 006

Real effective exchange rate ndash 008 ndash 018 ndash 026 ndash 031 ndash 035 ndash 043

Table IV13

Permanent reduction in government purchases of 1 of GDP

GDP ndash 033 ndash 006 ndash 004 ndash 005 ndash 004 041

Private investment ndash 063 ndash 085 ndash 086 ndash 084 ndash 081 015

Real effective exchange rate 002 001 002 004 005 037

Short-term interest rate 000 002 002 003 004 007

Real short-term interest rate ndash 004 001 002 002 003 010

following simulations concern therefore expenditurecuts of the same type and size as those considered previ-ously (Tables IV13ndashIV15) but are temporary that isare reversed in the subsequent year

Results are reported in Table IV16 and show that whenconsolidations are temporary (and perceived by economicagents as likely to be reversed) they tend to produce largercontractionary effects in the short run This is due to thefact that since consolidations are only temporary it willbe unlikely that future tax liabilities will be reduced Con-sequently since agents will not expect any change in their

future income no wealth effects will materialise in thiscase to offset the contractionary fiscal stance

In all the three cases considered (reduction of govern-ment purchases in government transfers and in gov-ernment employment) without any rise in permanentincome there is now a more pronounced reduction inconsumer spending as current income declines Giventhe real interest rates decline following the markedcontraction in GDP investment is likely to increasesomewhat but not enough to offset the negative effectsof the consolidation on output

Table IV14

Permanent reduction in government transfers to households of 1 of GDP

Private consumption ndash 027 ndash 027 ndash 023 ndash 022 ndash 022 013

Real short-term interest rate 008 004 001 000 000 007

Unemployment rate 004 004 003 003 003 ndash 046

Table IV15

Permanent reduction in spending on government employment of 1 of GDP

GDP ndash 093 ndash 059 ndash 02 002 016 063

Private investment ndash 100 ndash 031 049 093 116 193

Debt ( of GDP) 028 ndash 055 ndash 164 ndash 277 ndash 392 ndash 880

432 Accommodating monetary stance

One of the findings in the episodes analysis was thathalf the expansionary fiscal consolidations appearedto have been accompanied by a possible effectivemonetary relaxation (that is falling real interestrates) All scenarios described above were character-ised by a rise in real interest rates (lsquopurersquo expansion-ary fiscal consolidations in terms of the episode anal-ysis in the previous section) By contrast the scenariospresented in Table IV17 assume a monetary policy rule(monetary targeting) consistent with a small fall in realinterest rates on impact (1)

This reduction in interest rates reduces the negativeimpact of the fiscal consolidations and helps to boostgrowth in all cases considered Private consumptionregisters a bigger increase in the case of cuts in govern-ment purchases and government employment and a

smaller reduction in the case of cuts in governmenttransfers Moreover investment is boosted further bythe fact that real interest rates fall It is to note that inthe case of cuts in government purchases or transfersfiscal consolidations accompanied by a supportivemonetary stance appear to have expansionary effectsalready on impact

As in previous simulations after some negative effectsin the first years of the adjustment the largest benefits onoutput appear in the case of cuts in public employmentgiven the sizeable effects on investment

The scenarios in this chapter have illustrated the realeffects of fiscal consolidations and shown under whatcircumstances these effects can be expansionary on out-put A number of results emerge

bull The impact on output of budgetary consolidationdepends on whether it takes place on the revenue orexpenditure side Tax increases are likely to have anegative impact on output both in the short and

Table IV16

Temporary expenditure cuts (1 of GDP)

1st year 2nd year 3rd year 4th year 5th year 10th year

Reduction in government purchases

GDP ndash 075 014 007 004 003 001

Private consumption ndash 012 009 007 005 006 017

Private investment 058 033 008 ndash 001 ndash 001 023

Real short-term interest rate ndash 017 ndash 004 ndash 002 ndash 000 000 001

Reduction in government transfers

GDP ndash 021 004 002 001 002 012

Private investment 013 006 ndash 000 ndash 002 ndash 001 022

Real short-term interest rate ndash 004 ndash 001 000 000 001 001

Reduction in spending on government employment

GDP ndash 121 021 023 014 010 012

Private investment 045 063 042 022 011 018

NB Figures refer to changes from baseline except in the case of real short-term interest rates where changes are reported in absolute terms

yen1part See Giudice Turrini and inrsquot Veld (2003) for details on the monetary ruleassumed in the simulations reported in Table IV17 Alternatively the fall ininterest rates could be interpreted as linked to a reduction in risk premiumsFor highly indebted countries a credible fiscal consolidation could lead toa reassessment of the marketsrsquo perceptions of the risks involved and lead toan elimination or at least a reduction of a risk premium on that countriesrsquobonds

medium run By contrast the short-run negativeimpact on output of permanent expenditure cuts islikely to turn positive in the medium to long runThis may be the result of non-Keynesian featuresvia the anticipated effects of higher future disposa-ble income or profitability

bull The short-run immediate negative impact on outputwill be smaller in case of permanent as opposed totemporary expenditure reductions

bull The consumption channel is a major offsettingforce to the standard Keynesian effects but theinvestment channel can also be of great relevancefor consolidations occurring through cuts in thegovernment wage bill

bull The expansionary effects of fiscal consolidationsoccurring both through the consumption or theinvestment channel are likely to be reinforcedwhen the fiscal consolidations are associated witha favourable monetary stance or with structural

reforms improving the efficiency of factor andproduct markets (see Box IV2) Under such cir-cumstances positive effects on output of the fis-cal consolidation may emerge already in the shortrun

Overall given the limited impact on output in the shortrun in spite of a budgetary adjustment equivalent to1 of GDP (which is larger than what currentlyplanned by Member States at this juncture) theseresults are in contrast with the assertion that fiscal con-solidation should be avoided during slowdowns andshow that sizeable positive effects could materialise inthe medium to long run

The QUEST simulations performed consider some butnot all the possible channels through which consolida-tions could have expansionary effects Further work mayattempt to also take into account the effects of consolida-tions on the risk premia on countriesrsquo public debt thatneed in this case to be determined endogenously in themodel as a function of debt levels

Table IV17

Permanent expenditure cuts (1 of GDP) with accommodating monetary stance

GDP 026 040 025 016 009 032

Private investment 100 005 ndash 022 ndash 042 ndash 057 ndash 010

GDP 035 030 021 017 011 017

Private investment 084 026 017 -001 ndash 016 ndash 014

Real short-term interest rate ndash 037 001 ndash 002 -003 ndash 002 005

Reduction in government employment

Box IV2 Fiscal consolidation as catalyst for structural reforms in Germany

The evidence suggests that fiscal consolidations based on expenditure cuts are more likely to be expansionary than consol-idations based on tax increases The mechanism described in the existing literature (for example Alesina et al 2002)through which expenditure-based consolidations can produce expansionary effects emphasises the role of increased profitexpectations associated with reduced wage pressure A further reason why expenditure-based fiscal consolidations mayhave non-Keynesian effects is that they accompany and quite often induce the realisation of structural reforms in labourand product markets The positive impact on output of fiscal consolidations may thus also be associated with expectedimproved profit opportunities coming from a better functioning of markets and from productivity gains that are the resultof structural reforms

In order to capture the overall impact of fiscal consolidations that occur together with structural reforms some simulationsare performed in conjunction with shocks to the parameters of the model that reproduce the effect of structural reformsThe simulations are made using the QUEST model concerning Germany and are similar to the simulations shown inTable IV13 to Table IV15 (respectively reduction in government purchases transfers and employment) The shocks rep-resenting structural reforms are based on those presented in European Commission (2002b) they concern reforms in boththe labour and product markets and reforms inducing an increase in overall efficiency Structural reforms in the labour mar-ket are modelled as an lsquoemployment-friendlyrsquo shift of the wage-setting curve encouraging employment participation andreducing the wage mark-ups Reforms in the products markets are modelled instead via a fall in the price mark-ups reflect-ing an improvement in competitive conditions These shocks are further combined with an increase the total factor produc-tivity parameter capturing an improvement in the overall productive efficiency (1)

(1) The size of the shocks to model parameters is one third of that assumed in the simulations presented in the European Commission (2002 b) wherelabour market reforms product market reforms and productivity improvements were analysed separately In the present simulations the assumedreduction of wages along the wage-setting curve is by 13 of a percentage point as it is the supposed increase in TFP As for the reduction in mark-upsit is assumed to be equal to 16 of a percentage point

Graph IV2 Expenditure-based fiscal consolidations and structural reforms effects on GDP ( change from baseline)

ndash 05

1st year 2nd year 5th year 10th yearWithout structural reforms With structural reforms

Box IV2 (continued)

Graph IV2 reports the percentage change in baseline GDP when expenditure cuts occur with and without such structuralreforms Results show that when expenditure cuts are accompanied by structural reforms the effect of consolidations onoutput becomes generally positive already in the short run In all the simulations performed after two years GDP increasesby about percentage points compared with the baseline In the long run (after 10 years) the effect on output of expendi-ture-based fiscal consolidations is positive irrespective of whether they are accompanied by structural reforms When struc-tural reforms take place however the impact on output is about four times higher instead of being about 05 percentagepoints it amounts to around 2 percentage points

In sum it seems that expenditure-based consolidations accompanied by structural reforms in labour and product marketscould have a very positive impact on output and growth not only in the medium (where it may be very large) but also inthe short run

ndash 05

1st year 2nd year 5th year 10th year

ndash 1

ndash 05

Without structural reforms With structural reforms

Part V

Meeting the EUrsquos budgetary requirementsnational expenditure rules and fiscal relations across levels of government

Summary

The EUrsquos fiscal rules impose important and challengingbudgetary obligations on Member States Countries arerequired by the Treaty to avoid excessive deficit posi-tions (defined against a reference value for deficits of3 of GDP) and under the Stability and Growth Pactthey are required to achieve and maintain a budget posi-tion of lsquoclose to balance or in surplusrsquo These EU fiscalrules focus on the budget balance that is the differencebetween total revenues and total expenditures and not onthe level or the composition of the two

During the 1990s and in particular since 1997 most EUcountries introduced expenditure rules There is a greatdeal of variety in their design as regards the types ofspending items covered by a rule how the rule is defined(in real or nominal terms as a ceiling or a rate ofgrowth) the time frame involved and the robustness ofsurveillance and enforcement mechanisms In the major-ity of Member States expenditure rules feed into thebudgetary-setting process (rather than representing abinding obligation which must be respected) and ex postcontrol and implementation mechanisms are ratherweak While expenditure rules for the most part wereintroduced with national policy objectives in mind theycan also enable Member States to meet the budget bal-ance requirements of the Treaty and SGP by helpingthem to better control expenditure items that are subjectto overruns Depending on their design they can alsocontribute to other policy objectives such as avoiding apro-cyclical loosening of fiscal policy in good times (viaa discretionary increase in public spending) and improv-ing the quality of the composition of public spending

Preliminary empirical analysis indicates that the existingrules have not had a significant impact on trends in pub-lic spending Judging compliance with expenditurerules however is difficult as in many cases they coverseveral years and are subject to revisions In some coun-tries expenditure rules are not ambitious enough andadherence with them is easily achieved in other casesthe rule has been adjusted or abandoned if perceived as

being too ambitious Nonetheless even a relatively weakexpenditure rule can provide useful guidance and signalsto actors involved in the budgetary process

The Treaty and SGP requirements are defined in terms ofthe budget balance of the general government (that iscentral and localstate governments and social security)although the specific budget targets in stability and con-vergence programmes are set by the central governmentThe challenge in meeting EU budgetary requirements istherefore affected by the way in which Member Statesallocate fiscal functions (both revenues and expendi-tures) across different levels of government This isespecially the case in federal countries and the MemberStates where local authorities have considerable budget-ary autonomy The contribution of sub-central authori-ties to the overall budget position is changing in anumber of countries in light of efforts to devolve certainpublic functions to regionallocal authorities

The direct contribution of lower levels of government tothe general government deficit is generally limited sinceall Member States apply restrictions to local governmentborrowing the exception is Germany where net borrow-ing by local and state governments accounts for nearlyhalf of the general government budget deficit in 2002However it should be borne in mind that de facto centralgovernments often have to bear the cost of financing dif-ficulties that emerge at sub-central level To help complywith the EUrsquos fiscal rules federal Member States andItaly and Spain have recently introduced arrangementsthat aim at coordinating the budgetary position acrosslevels of government (usually referred to as national sta-bility pacts) More experience with the implementationof these arrangements is needed before conclusions canbe drawn on their effectiveness in contributing to theobjectives of the EU fiscal framework A priori a stronglegal base and enforcement mechanism would beexpected to contribute to the credibility and effective-ness of the arrangements

The process of decentralising responsibility for some pol-icies raises a second issue in the context of EMU namelythe operation of automatic stabilisers Experience showsthat in general systems are designed to shield sub-national governments from cyclical variations However

empirical evidence for the US and Germany suggestssome degree of procyclical behaviour at state level Fur-ther research would be needed however before policyconclusions can be drawn on the interaction of fiscaldecentralisation and automatic stabilisation

1 Introduction

The EUrsquos fiscal rules impose important and challengingbudgetary obligations on Member States Countries arerequired by the Treaty to avoid excessive deficit posi-tions (defined against a reference value for deficits of3 of GDP) and under the Stability and Growth Pactthey are required to achieve and maintain a budget posi-tion of lsquoclose to balance or in surplusrsquo These EU fiscalrules focus on the budget balance ie the differencebetween total revenues and total expenditures and not onthe level or the composition of the two

A further important feature of the EUrsquos fiscal rules isthat notwithstanding the fact that budgetary commit-ments are given at Community level by the central gov-ernment the requirements in terms of the budget balanceconcern the general government this covers central andlocal (state) governments and social security that is itdoes not distinguish between the allocation of fiscalunbalances across different levels of government butonly looks at the overall budgetary position It is theresponsibility of Member States to organise their fiscalrelations across different levels and sectors of govern-ment so as to ensure that they can meet the budgetaryrequirements set down in the Treaty and SGP

This part examines some of the challenges which Mem-ber States face in complying with the EUrsquos fiscal rulesand also analyses a number of policy instruments that arebeing developed to this end

Section 2 considers the role and effectiveness of nationalexpenditure rules which many Member States haveintroduced in recent years with the purpose of establish-ing a better control of public spending It analyses thedesign of expenditure rules across Member States andconsiders how they relate to the EU framework and cancontribute to the objective of sound and sustainable pub-lic finances Particular attention is paid to a preliminaryevaluation of how rules worked in practice during thefirst years of application

Section 3 considers the issue of fiscal decentralisation Itprovides a brief overview of the allocation of responsi-bility for public expenditure and revenues items acrossdifferent levels of government and then examines howthis interacts with the EU framework for fiscal surveil-lance Firstly attention is paid to the contribution of eachlevel of government to the budget balance of the generalgovernment as a whole Consideration is given to vari-ous institutional arrangements (such as national stabilitypacts) that have been put in place by Member States tocoordinate the budgetary positions across levels of gov-ernment in part to comply with the provisions of theTreaty and SGP Secondly the impact of fiscal decen-tralisation on the potential for automatic stabilisation isexamined Finally the link between the EU fiscal sur-veillance framework and recent institutional reforms isexamined in more detail in case studies on Spain andGermany

2 Expenditure rules in EU Member States

21 The need for expenditure rules as a means to control public finances

Since the beginning of 1990s a growing literature hasinvestigated the design of fiscal rules which have beenintroduced in many countries as a response to growingbudgetary imbalances (1) According to Hallerberg et al(2001) lsquoa fiscal rule is a combination of a fiscal targetwith a set of prescriptions of what governments are sup-posed to do to achieve this targetrsquo Any ex ante constraintto budget deliberation could constitute a fiscal rule Eventhe presentation of the budget law or a budget documentwith some political commitments that sets up an ex antetargets for at least the following year could be consideredas a fiscal rule

Kopits and Symanski (1998) define a fiscal rule as lsquoapermanent constraint on fiscal policy expressed in termsof a summary indicator of fiscal performance such as thegovernment budget deficit borrowing debt or a majorcomponent thereofrsquo This definition is narrower becausea fiscal rule should have two specific characteristicsnamely being lsquopermanentrsquo and defined through an lsquoindi-catorrsquo that can be easily monitored

Within the wide spectrum of fiscal rules expenditurerules are of growing relevance in a number of MemberStates (2) Growing recourse to expenditure rules can beexplained by the importance of expenditure control aspart of a successful strategy of budgetary consolida-tion (3) Moreover slippage from agreed budget targetsoften arises on the expenditure side that is more subjectto discretionary actions

The issue is how national budget processes based onexpenditure rules interact with the EU fiscal frameworkNational expenditure rules can act as complementaryinstruments to the EU rules-based framework for severalreasons

bull First their respect does not prevent automatic stabi-lisers to play since the greatest impact of the cycleover the budget is on the revenue side

bull Second appropriate recourse to expenditure rules atnational level could also help contribute to the pol-icy objective of improving the quality of the compo-sition of public spending that is help restructure thecomposition of spending toward so-called produc-tive items such as investment in infrastructures andR amp D Expenditure rules at national level could bedesigned in a way that places a stricter control onspending on items that are considered as being lessconducive to long-term growth and ensuring thatmore productive items receive more favourableconsideration in budgetary consolidation efforts

bull Third expenditure rules could also make an impor-tant contribution to broader economic and budgetarypolicy objectives established at EU level as part ofthe BEPGs and the Lisbon strategy For example inits communication on lsquoStrengthening the coordina-tion of budget policiesrsquo (see Part II2 of this report)the Commission suggested that a temporary deterio-ration in the budget balance could be envisaged ifthis is due to large structural reforms However thisshould not compromise the objective of sound andsustainable public finances A close monitoring ofMember Statesrsquo compliance with their own nationalexpenditure rule could reduce the degree of uncer-tainty on the budget balance intertemporal profile

The contribution of different expenditure items to meet-ing overall budgetary objectives is illustrated inGraph V1 This shows in index form the evolution of

yen1part See for a review of the main features of fiscal rules Kell (2001) Kopits andSymansky (1998) Kopits (2001) Inman (1996)

yen2part See for example Brunila (2002) Hallerberg et al (2001) and Mills andQuinet (2001) for some comparison of expenditure rules across EU Mem-ber States

yen3part The 2001 and 2002 Broad Economic Policy Guidelines recommendedMember States lsquoto introduce or enhance mechanisms that help assess andcontrol spending including budgetary proceduresrsquo

P a r t VM e e t i n g t h e E U rsquo s b u d g e t a r y r e q u i r e m e n t s

n a t i o n a l e x p e n d i t u r e r u l e s a n d f i s c a l r e l a t i o n sa c r o s s l e v e l s o f g o v e r n m e n t

different components of primary expenditure as a shareof GDP over the last 10 years for EU-15 countries as awhole On average the level of primary expendituredecreased by almost 9 between 1992 and 2000 whileit increased by 5 during the subsequent two yearsWhereas spending on compensation of public employ-ees and gross fixed capital formation fell significantlyover the period spending on intermediate consumption(purchases of goods and services by the public adminis-tration) and social transfers other than in kind actuallyincreased (1) These different trends across expenditureitems illustrate that it is more difficult to curtail spend-ing on particular categories of expenditure

Table V1 examines expenditure trends for several Mem-ber States for the 1998ndash2001 period Public expenditure isclassified according to seven main lsquofunctionsrsquo of the Stateseveral functions (such as defence public order andsafety general public services) refer to the core activitiesof the State for example those functions that are at thebase of the functioning of a modern State (2) Other

expenditure programmes aim at addressing market fail-ures These programmes include mainly education andhealthcare but also economic services Finally part ofpublic expenditure has primary a redistribution roleachieved through social protection programmes

The numbers highlighted in bold show spending itemswhich changed by more than total public spending (lastcolumn of the Table V1) (3) Clearly it should be takenin mind that the expenditure-to-GDP ratios differ mark-edly across different functions social protection repre-sents the greatest share of expenditure (around one thirdof total expenditure) while defence public order andsafety rarely reach more than 2 of GDP

With the exception of Austria spending on healthcare inall countries increased substantially more than totalexpenditure during the last years For instance totalexpenditure in Italy contracted by 3 between 1998

Graph V1 Trends in different items of public expenditure at EU level

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Social transfers other than in kind Compensation of employees Intermediate consumptionGross fixed capital formation Primary expenditure

ExpenditureGDP (1992=100)

yen1part Subsidies and lsquoother current and capital expendituresrsquo are not presenteddue to their low share of GDP

yen2part The so-called COFOG classification See European Commission (2002a)for a detailed explanation of the functional classification

yen3part The residual component (lsquoothersrsquo) in Table V1 includes limited expendituresas environmental protection community amenities and religious expenses

and 2001 whereas healthcare expenditure increased by105 In Portugal spending on healthcare grew at twicethe pace of total expenditure while in Belgium despitethe strong decrease of total expenditure (ndash 95 ) health-care increased by 82 However healthcare expendi-

ture is not the only item that presents such a dynamicSpending on education and social protection also tendedto increase faster than total expenditure albeit by a lesseramount and in a smaller group of countries

22 The design and implementation of expenditure rules

221 The design of expenditure rules

According to the standard theory of economic policy(Tinbergen 1956) expenditure targets should be strictlyunder the control of the government since their develop-ment represents an intermediate objective to reach thefinal aim of budgetary control Therefore when design-ing an expenditure rule several choices have to be madeas follows

bull whether the rule should target an outcome of a par-ticular expenditure item (or an aggregate of expend-iture items) or whether it should target the effects ofa particular policy measure

bull whether certain expenditure items should beexcluded from an aggregate expenditure target

bull whether an expenditure target should be defined innominal or real terms

bull whether the target should be defined in terms of alevel of expenditure or as a rate of change

bull the time span of the target

Targeting an expenditure outcome or the impact of apolicy measure A rule that targets the expenditure out-come can be defined as follows

where is the targeted outcome of expenditure item Eat time t is the projected level of expenditure intime t forecasted at time t ndash 1 and is the policyaction planned in t ndash 1 to correct the trend and thereforeto achieve the target

The outcome Et is defined as

Table V1

Trends in public expenditure items in selected EU countries (variation in percentage points between 1998 and 2001)

General public

services

Economic affairs

Health EducationSocial

protection

Defence public order and safety

Others Total

BE ndash 238 ndash 170 82 ndash 46 ndash 74 ndash 97 167 ndash 95

DK 00 ndash 125 39 105 ndash 16 00 91 03

DE ndash 60 49 00 ndash 45 ndash 05 ndash 67 43 ndash 10

EL ndash 90 1000 83 27 12 48 00 08

IT ndash 167 ndash 24 105 20 ndash 11 ndash 63 ndash 37 ndash 30

NL ndash 110 188 25 21 ndash 60 33 31 ndash 17

AT ndash 34 78 ndash 275 ndash 33 23 ndash 80 00 ndash 35

PT 15 34 115 30 55 ndash 27 120 50

FI ndash 72 ndash 148 17 ndash 31 ndash 84 ndash 94 ndash 160 ndash 72

NB Figures in the table show the cumulated change of expenditure-to-GDP ratios for each spending category and for total expenditure (last column) For instance the100 increase registered in Greece for economic affairs spending-to-GDP ratio implies that expenditure doubled between 1998 and 2001

Et1ndash( )

Pt1ndash( )+=

Et1ndash( )

Pt1ndash( )

Et Et1ndash( )

Pt δ+ +=

where Pt is the policy action as it results ex-post and δ isthe forecast error on Et which is positive when expendi-ture turns out higher than forecasted

Assuming that the outcome Et equals the expectedoutcome it can be shown that

If the trend expenditure turns out to be lower thanexpected (ie the forecast error is negative such thatδ lt 0) the ex-post policy correction neededto reach the target can be smaller than what wasplanned ex ante On the contrary if expenditure growsfaster than expected (and δ gt 0) then the expendituretarget ( ) will be overshot even if the planned policyaction ( ) is implemented in full

The formulae show that the following steps are neededto define an expenditure rule first the definition of theexpenditure item (or aggregate of expenditures) to tar-get second a forecast of the trend in targeted expendi-ture item third an ex-ante quantification of the policyaction necessary to achieve the target fourth the possi-bility to accurately verify ex-post compliance In partic-ular they highlight the central importance of definingthe appropriate target For instance attention should bepaid as to whether to include high volatile items in anaggregate expenditure rule as a high forecast error δ willaffect the outcome rendering the expenditure rule lesseffective for the purpose of budgetary control (1)

An alternative approach to setting a target in terms of thelevel of expenditure(s) would be to directly target theimpact a particular policy action (P) as follows

Under this approach the expenditure rule is respected ifthe policy maker implements the announced correctivemeasures irrespective of the actual outcome interms of expenditure The advantage of directly targetingthe specific policy action is that it is not necessary to takeaccount the economic cycle or other exogenous factorsthat affect the outcome However in practice it may bedifficult to quantify ex ante the precise budgetary impact

of the planned policy measures rendering it difficult toassess compliance

Whether to exclude certain items from the aggregateexpenditure target While the main purpose of an aggre-gate expenditure rule is to contribute to sound publicfinance positions certain categories of expendituresmight be excluded from the target so as to ensure consist-ency with other public policy goals At least three cate-gories of expenditure items warrant consideration in thisregard

bull Firstly it may be appropriate to exclude interestpayments from the target and focus on primaryexpenditure which is more under the discretionarycontrol of government The inclusion of interestpayments within the expenditure target increases therole of forecasts errors Other things being equal arule that targets an aggregate that includes interestpayments can be fulfilled with a lower policy effortif interest payments are overestimated (2)

bull Secondly unemployment-related transfers could beexcluded from the target to prevent pro-cyclicalbehaviour For example the rigid adherence to anominal expenditure target that includes unemploy-ment transfers in periods of low growth would cete-ris paribus result in a tightening of the fiscal stanceas de facto it would prevent part of the automatic sta-bilisers from operating

bull Thirdly one may wish to exclude specific categoriesof productive public spending (such as publicinvestment) from an expenditure target this wouldprevent corrective measures needed to achieve theexpenditure target from affecting these desirablepublic expenditure items

yen1part On the importance of forecast errors in the functioning of fiscal rules seealso Auerbach (1994)

Pt Pt1ndash( ) δ+=

Pt Pt1ndash( )ndash( )

Pt1ndash( )

Pt Pt1ndash( )

Pforall=

Pt1ndash( ) yen2part Equation [1] when interest payments are targeted can be rewritten as

[1a]where expenditure E is now the sum between interest payments I andanother primary expenditure item A The target is the sum of thetargeted outcome on item A and the outcome on interest payments Theoutcome at time t and can be rewritten as

[2a]Therefore the outcome depends on the forecasted levels for A and I theex-post policy action and the forecast error This has twocomponents one is primary expenditure and one is interest paymentsIf the outcome equals the targeted expenditure level after some passages itresults that

It1ndash( )+( ) At

1ndash( )It

1ndash( )+( ) Pt1ndash( )+=

It+( )

At It+( ) At1ndash( )

It1ndash( )+( ) Pt ε It It

1ndash( )ndash( )+ + +=

ε It It1ndash( )ndash( )+

Pt1ndash( )

Ptndash ε It It1ndash( )ndash( )+=

The definition of the target in nominal or real termsThe difference between a real or a nominal target is rel-evant in the case of forecast errors in inflation projec-tions (1) In fact price deflators differ across governmentexpenditures items and they also differ from GDP defla-tors A target defined in nominal terms has the advantageof transparency making monitoring easier It can alsohelp to keep expenditure under control through a higher-than-expected adjustment if the inflation outcome ishigher than expected However if the rule has defined anlsquoescapersquo clause so that higher-than-expected inflationshould not force a higher real adjustment in order to fulfilthe nominal target then a nominal rule risks to producea bias such that a lower-than-expected inflation allows alower adjustment effort while a higher-than-expectedinflation does not entail a stronger adjustment On thecontrary if the target is defined in real terms complianceis not affected by inflationary developments but it canresult in it being more difficult to measure the compli-ance

The definition of the target in terms of levels (absolutevalues or as a share of GDP) or as a rate of growthWhen the target is defined as a share of GDP the resultcan depend on GDP developments and in particular onGDP forecast errors Thus the rule might turn out to bepro-cyclical since the expenditure ceiling fluctuates inline with GDP around its trend This problem can beovercome by formulating the target as a fixed rate ofgrowth in the expenditure item(s) or as an absolutelevel

The time span covered (2) A multiannual rule is gener-ally superior to a rule where the target is fixed for onlyone year This is because an annual rule can be more eas-ily circumvented simply by postponing expenditures tothe first day of the following budget year and is suscep-tible to accounting practices When the target is fixed exante for several years the possibility to postpone expen-

ditures or structural adjustment to the future becomesmore difficult

222 The implementation of expenditure rules

The implementation and ex-post assessment mecha-nisms are constituent elements of an expenditure ruleSeveral elements warrant consideration (Kopits andSymanski 1998) the availability of instruments tomonitor and if necessary correct the dynamic of budg-etary position during budget execution provisions todeal with non-compliance including sanctions escapeclauses when failures in respecting the rule are beyondpolicy control

Implementation mechanisms can have different formsand degrees of enforcement from automatic contin-gency measures once the deviation from the targetappears to more flexible (and weak) measures such asnon-binding suggestions for discretionary corrections

The availability of data is essential in order to monitorand control the budget execution Data on budgetaryaggregates (such as budget balances or total expendi-tures) are often easier to collect and subject to less revi-sions than information on specific expenditure itemswhere different spending units of the government areinvolved

To avoid a pro-cyclical or perverse outcome an expend-iture rule should usefully define provisions for cateringfor worse-than-expected economic conditions andorother unexpected events (such as a flood) that requireadditional spending However while flexibility of sucha nature is essential in the case of budget balance rulesthe need for such provisions is less evident in the case ofexpenditure rules as the sensitivity of most expenditureitems is very limited (apart from exceptions such asunemployment transfers)

Sanctions in the case of non-compliance with the targetshould always be defined ex ante to make the rule cred-ible and enforceable (Inman 1996) These could takedifferent forms such as an obligation to amend thebudget law (3) automatic sequesters if there is clearinformation that the target is not going to be fulfilledduring the budget year or pecuniary sanctions imposedby a higher level of government While the existence ofwell-defined sanctions is only a necessary condition to

yen1part See Brunila and Kinnunen (2002)yen2part A clear example of the importance of the time span of spending rules is the

experience of the Budget Enforcement Act (BEA) endorsed in 1990 in theUS In brief a series of annual caps on public spending were set for theperiod 1990ndash95 and the rule specifies that lsquoenacted policies cannot raise thedeficit relative to initial projected levelsrsquo (Poterba 199624) A key differ-ence with the Gramm-Rudman-Hollings (GRH) rule that has been in forceduring the second half of 1980s in the US is that the latter fixed targetsyear-by-year on the basis of the outcome of the previous year and thereforeit was easier to postpone expenditure to future fiscal years Auerbach(1994) presents evidence that during the last years of the GRH there was atendency to reduce deficits of the current year at the expense of the follow-ing year yen3part This is the mechanism implied by the GRH rule see Gramlich (1990)

make the rule credible it is not a sufficient one To befully credible the sanctions should have a legal or con-stitutional basis and should not be based on politicalcommitment alone

In addition an expenditure rule is more credible if thereis an independent authority that monitors the develop-ment of the budgetary position and that is in charge ofthe enforcement measures including the application ofthe sanctions Without a clear legal basis andor wherethere are no clear defined sanctions the penalty for non-compliance with the rule is only reputational

223 A taxonomy of expenditure rules

It is possible to classify expenditure rules according totheir degree of strictness (1) Following the terminologyof Poterba (1996) expenditure rules are classified asbeing either lsquonarrowrsquo or lsquoweakrsquo see Table V2

An expenditure rule is classified as lsquoweakrsquo if

bull the target includes volatile expenditure items so thatthe actual level of spending is subject to a forecasterror and is only partly influenced by the applicationof spending control mechanisms

bull the target includes interest payments In this casethe target could be respected without the govern-ment taking policy actions simply if interest pay-ments develop favourably (2)

bull there is no ex-post control mechanism to verifywhether ex ante targets have been respected and ifenforcement mechanisms are based on a politicalcommitment rather than legal provisions (3)

In contrast a rule is classified as being lsquonarrowrsquo if

bull it targets a less volatile expenditure item(s) and ittargets the budgetary impact of the policy actionrather than the final outcome

bull there are well-defined mechanisms for carrying outan ex-post verification of compliance with targets

bull enforcement mechanisms and sanctions are definedex ante

bull surveillance is carried out by an independent author-ity that can enforce authorities to respect the rule

23 National expenditure rules

231 Main features of expenditure rules within EU Member States

Almost all EU countries have put in place rules to controlwide aggregates of expenditures Table V3 shows themain features of expenditure rules currently in place in

yen1part As reported by Inman (1996) a fiscal index called an lsquoACIR stringentindexrsquo has been developed to measure the tightness of the statersquos budgetbalance rules constraint in US states with higher values indicating a morestringent constraint The index is a composite measure where several fea-tures of the fiscal rule are considered and in particular it awards points forwhether the rule lsquorequires the governor to submit a balanced budget(1 point) requires the legislature to pass a balanced budget (2 points)allows the state to carry a deficit into the next fiscal year (4 points) doesnot allow the state to carry a deficit into the next fiscal year (6 points if abiennium budget 8 points if an annual budget)rsquo (Inman 19967) In addi-tion additional extra points are awarded if the fiscal rule is based on a leg-islative or constitutional instrument

yen2part However Mills and Quinet (2001) underline that since the main goal of anexpenditure rule is to make the objectives of a decreasing debt and a lowertax burden mutually compatible interest payments should be kept withinthe targeted aggregate

yen3part See Bohn and Inman (1996) and Kopits and Symansky (1998)

Table V2

A taxonomy of expenditure rules

Weak Narrow

Design Aggregate expenditures including interest payments Specific target on non-volatile item(s)

Specific target on volatile items Target on variation in levels

Implementation Only ex ante target Ex ante target ex post control

Internal surveillance Surveillance by an independent authority

Statutory instrument Political commitment Constitutional or legal basis

Enforcement mechanism Reputational or economically insignificant sanctions Economically significant (but not excessive) sanctions

Member States (1) The table describes for each countrythe item targeted the definition of the target (either inreal or nominal terms as a ceiling or as a rate of change)the level of application (general central or local govern-ment) the date of introduction of the rule and the timespan It also underlines whether there are measures spec-ified ex ante in case of non-compliance with the rule andpossible lsquoescape clausesrsquo in case of economic shocksFinally it summarises how the rule worked in practiceduring the first years of application

Although the expenditure rules differ substantiallyacross Member States some common features can beidentified (2) First the expenditure rules of many Mem-ber States either as regards their timing or structurewere influenced by the Stability and Growth Pact Apartfrom Spain (which established a ceiling on nominalexpenditure starting from 2003) and Portugal (where thetarget has been introduced in 2002) all other countriesintroduced expenditure rules in past years in particularsince 1997 Such rules have been generally withinmedium-term frameworks in line with the medium-termfocus of the SGP However there are cases where spend-ing rules anticipated the SGP Germany already hadthese kind of rules since the mid-1980s while the Neth-erlands introduced a rule in 1994

Second the target tends to cover a wide aggregate ofexpenditure items that includes all public expendituresIn all cases except Denmark Ireland Greece and Italythe aggregate includes interest payments Public invest-ment is netted out in the case of Denmark and BelgiumItaly recently introduced an expenditure rule (the so-called lsquoexpenditure freezersquo law) whereby all legislationresulting in new or higher public expenditures shouldexplicitly specify the authorised amount (3)

Third almost all Member States apply their expenditurerules to the central government (coupled with borrowing

and budgeting restrictions for lower levels of govern-ment see Section 32) An exception is Germany whereexpenditure rules also apply to the regional and localgovernments In Italy within the context of a domesticstability pact ceilings are established for primary currentexpenditure of regions

Fourth most of the expenditure rules are based on politi-cal commitments rather than legislation This explainswhy in many cases discretionary adjustments to expend-iture rules have taken place when the original targets havestarted to act as a constraint In some cases this has lim-ited the effectiveness of the rule as an instrument to con-trol public finance developments

Besides these common characteristics rules differ acrosscountries in terms of specific design Targets are formu-lated in levels or rates of growth and both in nominal orreal terms These four possibilities can all be found inpractice which illustrates the diversity of arrangementsthat have been put in place Real growth targets can befound in Belgium Denmark and France Nominalgrowth targets are set up in Germany Ireland Italy andLuxembourg Specific ceilings on absolute values (lev-els) have been put in place in Spain Italy the Nether-lands Finland Sweden and the UK Specific arrange-ments exist in Greece and Portugal for publicemployment Here the target is the number of employ-ees rather than financial expenses

Overall expenditure rules in EU countries belong to thecategory of lsquoweakrsquo rules as described in Section 22since in most cases they are based on political commit-ment solely The outcome depends on policy actions indue course as well as on the development of volatileitems included in the targets or on interest paymentsThe implementation and enforcement mechanisms aregenerally less developed since the rules lack a firm legalbasis Sanctions are generally absent or economicallyinsignificant In sum many expenditure rules put inplace in EU countries lack some necessary features to befully credible since they allow for the option to ignoremiss or abandon the rule when a divergence arisesbetween targeted variables and outcomes

232 How have national expenditure rules worked in practice

This section contains a preliminary empirical assessmenton the implementation of national expenditure rules In

yen1part According to information available to the Directorate-General for Eco-nomic and Financial Affairs of the European Commission Either as a spec-ification of the general expenditure rule or as an additional requirementmost Member States also have defined ceilings for individual ministries orspecific spending categories (Hallerberg et al 2001)

yen2part Case studies for several countries (the Netherlands Italy Finland and Swe-den) are carried out in the correspondent country sections of Part VI of thisreport

yen3part However the list of expenditures that can be frozen if the spending ceiling isbreached excludes important items such as pensions public sector wages andunemployment benefits See the country section on Italy in Chapter VI8 ofthis report

lsquopoi

cersquo

ndash200

P u b l i c f i n a n c e s i n E M U mdash 2 0 0 3

is lim

ses fi

ndash20

entrsquos

98ndash2

lsquosafe

lesrsquo

ndash04

ndash03

001ndash

ndashreg

tly th

000ndash

lic se

simila

t of fl

2ndash05

) (1 )

t stil

99ndash2

s mdash th

r with

entrsquos

s of t

entrsquos

rsquos b

limits

particular it examines spending on various expenditureitems before and after the introduction of an expenditurerule It also examines whether there is a link between theSGP commitments and the non-compliance with Mem-ber Statesrsquo expenditure targets

The results should be interpreted with caution Expendi-tures are affected by many other factors outside directcontrol of policy makers since most national expendi-ture rules target expenditure outcomes and not theimpact of specific policy actions it is difficult to identifythe net effect of the rule on the budgetary position

Table V4 shows the average rate of growth of the itemsfalling under an expenditure rule when data on specificexpenditure categories covered by a rule are not availa-ble a close proxy is used Averages are calculated for thethree years before the introduction of the rule and for theyears following the introduction of the rule up to2002 (1) In four countries (Denmark France Luxem-bourg and Belgium) the rule is defined in terms of realrate of growth of expenditure while in Ireland the targetis in terms of nominal rate of growth Five countries(Sweden Greece the Netherlands Austria and Finland)have a more composite definition that can be proxied toa nominal ceiling However since the final aim is to con-trol expenditure to assess whether the rule worked thereal rate of growth is used as a proxy of the target

In five out of 10 countries the rate of growth after theintroduction of the rule has been lower compared withthe years immediately prior to its introduction In partic-ular the rate of growth of the expenditure targeted fell inall those countries where the target has been defined as aceiling rather than as a rate of change however asshown by t-statistics differences in means are rarely sta-tistically significant

Whenever there is a correction of expenditure trends theeffectiveness of an expenditure rule depends on its levelof ambition In general over-ambitious targets risk notto be fulfilled in some cases Member States havechanged the medium-term targets when it became clearthat these objectives would be difficult to respect A tar-get that is not ambitious enough on the other hand cre-ates the risk of pushing expenditure up to the ceiling Astrict adherence to a credible and realistic framework

would have probably enhanced the credibility of theframework and contributed to the overall compliancewith the EU fiscal rules

In many cases spending rules do not seem to be suffi-ciently ambitious (2) In France the 2000 updated stabil-ity programme fixed a target of 49 in real growth (ona cumulative basis) for the three-year period 2001ndash03During the same period real GDP growth is expected tobe at 41 (3) Therefore expenditure as a share of GDPcan increase without breaching the rule (4) In Belgiumthe rule fixes a real growth of primary expenditure of15 each year (5) Real GDP grew by 08 in 200107 in 2002 and it is expected to grow by 13 in2003 Thus compliance with the rule does not necessar-ily imply a reduction of the expenditure-to-GDP ratioalthough admittedly the increase is at least in part due tothe low growth rates

Table V5 investigates whether there is a link between afailure on the part of a Member State to respect its ownexpenditure rule and respect of the lsquoclose to balance orin surplusrsquo requirement of the SGP It compares the dif-ference between the targeted (in the relevant stability orconvergence programme) and the actual outcome of totalexpenditures as a share of GDP for cases identifiedwhere countries missed their expenditure rule (6) Thefinal column shows the deterioration in the cyclically-adjusted budget balance for the year in question com-pared with the previous year In all cases except Italy in2002 and Finland in 2001 and 2002 non-compliancewith a national expenditure rule coincided with a wors-ening cyclically-adjusted budget position ConcerningFinland the behaviour can be explained by the fact thatthe Finnish expenditure rule stands out as a very ambi-tious one as it aims at freezing real expenditure at thelevel of 1999 (7) In Italy cyclically-adjusted improve-ments rely mainly on one-off measures that loweredexpenditure

yen1part 2000 for Ireland when the rule was abandoned Countries not included inthe Table implemented expenditure rules too recently to be assessed

yen2part An exception is Ireland it decided not to enforce its spending limits for2001ndash02 which were quite tight compared with nominal GDP growth Fin-land also has an ambitious target that is a frozen real central governmentspending at the 1999 level In Sweden the norm is that the real rate ofchange should be zero

yen3part According to the European Commission spring 2003 forecastsyen4part Nevertheless the target has been revised in the following updates of the

stability programme it became 52 in the updated programme 2001 and65 in the updated programme 2002

yen5part The rule regards primary expenditure in entity I (Federal government andsocial security)

yen6part Cases have been identified according to information available by the Euro-pean Commission Directorate-General for Economic and FinancialAffairs

yen7part See also the chapter on Finland in Chapter VI13 of this report

To sum up the overall picture signals that there are noevident changes in the behaviour of expenditure oncespending rules are introduced Nevertheless the com-pliance with the rule is difficult to judge Targets arein many cases set up over several years and there areoften revisions in due course In some countries tar-gets are not ambitious enough and adherence with

them is easily reached In other cases the rule hasbeen adjusted or abandoned since it was perceived tobe too ambitious Moreover the assessment of howrules worked is limited by a lack of quantitative infor-mation so that expenditure trends are difficult tomonitor This is particularly true in those cases wherethe target concerns detailed expenditure categories

Table V4

The impact of expenditure rules on spending trends

Item controlledDefinition of the rule

Year of introduction

Real rate of growth of the measured item (1)

3 years before the introduction of the rule (A)

After the introduction of the rule (B)

T-testfor A ne B

DK Public consumption Real rate of growth 1999 24 16 10

FR Total expenditure Real rate of growth 1997 17 21 08

LU Total expenditure Real rate of growth 1999 35 62 10

BE Primary expenditure Real rate of growth 1999 20 26 10

SE Primary expenditure Real rate of growth 1997 09 33 19

IE Total expenditure Nominal rate of growth 1997 56 94 16

EL Compensation of employees Nominal ceiling 1997 123 71 11

NL Total expenditure Nominal ceiling 1994 22 10 11

AT Compensation of employees Nominal ceiling 2000 00 ndash 27 07

FI Total expenditure Nominal ceiling 1999 11 10 00

(1) Nominal rate of growth for Ireland as defined in the expenditure rule

Table V5

Total expenditure targets and spending rules

ExpenditureGDP Changes in cyclically-adjustedbudget balance ( GDP)Target Outcome Difference

BE (1999) 480 501 21 ndash 04

DK (1999) (1) 519 524 05 ndash 13

DE (2002) 480 486 06 ndash 03

FR (2002) 523 537 14 ndash 11

IT (2001) (2) 475 485 10 ndash 07

IT (2002) (2) 467 475 08 10

FI (2001) (3) 240 249 09 01

FI (2002) (3) 243 251 08 06

(1) Outcome before statistical revision(2) Targets recalculated by Commission services according to EU standards to ensure consistency with outcomes Planned sales of real assets have been subtracted

from the expenditure targets (06 percentage points of GDP only in 2002) and additional expenditure items have been included as required under Commis-sion Regulation (EC) No 15002000 (03 percentage points of GDP both in 2001 and 2002) Sales of real assets lowered outcomes by 02 percentage points ofGDP in 2001 and by 09 percentage points of GDP in 2002

(3) Central government total expenditure

Source Commission services on the basis of data provided by Member States in their stability or convergence programmes

andor when the rule covers only part of the generalgovernment

24 Conclusions

Expenditures rules are becoming a common featureamong EU Member States as an additional tool to con-trol budgetary development In the majority of cases theyare lsquoex antersquo rules they fix a target that helps to keepexpenditures under control during the process of budget-ary formation However implementation mechanismsand lsquoex postrsquo control are rather weak As a consequencethe medium-term expenditure target tends to be revisedif it becomes clear it cannot be reached

Thus what counts for an effective expenditure rule is agood design and the existence of control mechanismsthat allow to correct trends in the course of budget imple-mentation Control mechanisms should be accompanied

by enforcement mechanisms to render the rule fullyimplemented

In the EU context national expenditure rules can com-plement the fiscal framework currently in place but can-not be seen as a substitute First because they are notsubject to budgetary surveillance at EU level Secondtheir current designs and implementation mechanismsdo not ensure the achievement and maintenance of soundpublic finances over the long term

However even a lsquoweakrsquo rule can be helpful as a guid-ance of fiscal policy and to signal to the actors involvedin the budgetary process which are the components ofthe budget that create more concern Also the redirec-tion of public expenditure towards those items that aremore conducive to economic growth becomes easierTherefore in all cases in which specific items less undercontrol crowd out other perhaps more productiveexpenditures a rule can increase the efficiency of publicexpenditure

3 Fiscal relations across levels of government

31 Fiscal relations across different levels of government in EU Member States

In recent years the management of public finances in EUMember States has not only been affected by the processof European integration it has also been influenced by aprocess of decentralisation whereby the budgetary auton-omy of lower levels of government has been increasedThis reshaping of the division of budgetary competenciesbetween layers of government within Member States hasconsequences for the budgetary requirements at the EUlevel as the Treaty and SGP obligations concern the gen-eral government as a whole that is central state andlocal government plus social security

The process of transferring more budgetary authority tolower levels of government is motivated in part by polit-ical factors namely as a way of reconciling divergenceor tension between communities with national politicalcohesion or has been an expression of the citizensrsquo rightto participate in the conduct of public affairs (Committeeof the Regions 2001) (1) Decentralisation may also bejustified on economic grounds in particular lower lev-els of government may be able to better tailor the provi-sion of public services to local needs and preferencesand to establish a link with the taxes that are needed tofinance them thereby increasing accountability at thelocal level Box V1 provides an overview of the keyarguments of the theory of fiscal federalism

There are large differences between EU Member Statesin the way budgetary responsibilities are divided between

different levels of government This is in part linked tothe system of government and particular whether thecountry is a federal (Austria Belgium and Germany) orunitary State However the distinction is not clear cutSpain and Italy could be classified in both groups sincethey are unitary States with some characteristics of a fed-eral State (2) The Nordic countries (Denmark Finlandand Sweden) also have some special characteristics asthey are unitary States where the principle of lsquoself-gov-ernmentrsquo is grounded in the constitution

A common indicator for assessing the degree of fiscaldecentralisation is to look at sub-national expendituresand revenues both as a percentage of GDP and of totalpublic expenditures Table V6 reports this indicatorbased on the data available in the European system ofaccounts (3) The figures are based on a calculation ofrevenues and expenditures at different levels of govern-ment as the sum of their components since there are noharmonised data ESA95 available for total revenues andexpenditures at lower levels of government (4) Thesefigures must be interpreted with care as they give anapproximate indication of the size of lower levels of gov-ernment but do not measure budgetary autonomy

yen1part See page 48 of Committee of the Regions (2001) for examples of devolu-tion in Europe It should be noted that decentralisation is not a uniformtrend in all Member States It is a long-term process that has taken placeduring the last few decades See the decentralisation web site of the WorldBank (wwwworldbankorgpublicsectordecentralization) for an overviewof the different arguments surrounding the debate on decentralisation

yen2part In Spain the constitution does not directly specify the regions (lsquoautono-mous communitiesrsquo) which account for a large part of public expenditure(Table V6) Italy also has federalist characteristics since regional authori-ties exercise legislative powers comparable with those of regions or statesin federal Member States (Committee of the Regions 2001)

yen3part The most common databases for cross-country comparison in this field arethe Government Finance Statistics of the IMF and the OECD Revenue Statis-tics

yen4part Total expenditure is calculated as the sum of (ESA categories are indi-cated) D3 subsidies D4 Property income D5 Current taxes on incomeand wealth D62 Social benefits other than transfers in kind D7 Other cur-rent transfers P3 Final consumption expenditure D9 Capital transfers P5Gross capital formation K2 Acquisitions of non-produced non-financialassets Total Resources are calculated as the sum of K1 Consumption offixed capital B2 Operating surplus D2 Taxes on production and importsD4 property income D5 Current taxes on income and wealth D61 Socialcontributions D7 Other current transfers D9 Capital transfers

Table V6 shows that in general the federal and the Nor-dic countries are the most decentralised according to theindicator When measured in terms of sub-governmentexpenditure (that is State and local) as a percentage oftotal government spending then Denmark (57 ) Ger-many (43 ) Belgium (41 ) Sweden (40 ) and Spain(38 ) stand out as having a highly decentralised fiscalstructure (1) A second group consists of the Netherlands(35 ) Finland (34 ) Austria (33 ) Italy (30 ) theUK (26 ) and France (19 ) The most centralisedMember States are Luxembourg Portugal (both 14 )and Greece (4 ) With respect to the development oflower levels of government over time the figures gener-

ally show slow changes in the level of decentralisationsince 1995 the first year for which figures are availablefor all Member States Nevertheless a relative increasesince 1995 is recorded in the size of the states in Austriaand Spain and the local level of government in DenmarkSweden and Italy A relative decrease is recorded in thesize of the local government in the Netherlands

Table V7 examines the composition of public spendingby sub-central levels of government in Member Stateswhere data was available According to the theory of fis-cal federalism public spending of sub-central authoritiescould be expected in policy domains where there arelarge differences in preferencesneeds across regionsbut less so in areas whereas economies of scale and spill-over effects prevail

Box V1 Key arguments of the theory on fiscal federalism

The theory of fiscal federalism has developed criteria for the assignment of government activities to different layers of gov-ernment The main benefits of centralisation are the internalisation of externalities and spillovers (that is when market fail-ures have cross-border effects on other jurisdictions) and the exploitation of economies of scale However these need tobe weighed against the benefits of decentralisation which include a capacity to adjust the provision of public goods andservices to local preferences and needs the avoidance of diseconomies of scale more competition and innovation in theprovision of public goods and services and improved accountability and transparency of policy makers by establishing amore direct link between the benefits of public expenditures and the taxes levied to finance them

Fiscal federalism yields no clear-cut policy conclusions on the assignment of public functions whose main objective is toensure an efficient allocation of resources A costbenefit assessment is needed on a case by case basis Some public goodsservices may need to be centralised where there are large spillover effects covering the entire country (national transportinfrastructure) whereas others may be more efficiently provided at local level (local transport infrastructures)

In contrast stronger policy conclusions are drawn as regards the benefits of centralising the public function that aim atredistribution (either across regions or individuals) for several reasons Firstly the demand for redistribution policies maycover an entire country in that citizens may be concerned about the living standards of the entire population and not justin their own locality or State Secondly it may be very difficult to operate redistribution policies efficiently at sub-centrallevel labour mobility may result in the migration of low-income persons to regions providing the most generous benefitswhereas high-skilled persons may move to regions with the lowest taxes

Fiscal federalism in general reaches strong policy conclusions on centralising the stabilisation function This is becauselower levels of government might not have the right incentives to provide an optimal level of stabilisation since a consid-erable part of their stabilisation efforts would leak away to other jurisdictions Furthermore the possibilities of local gov-ernments to run counter-cyclical policies (for example by means of letting the automatic stabilisers work) are often limitedgiven the existence of borrowing restrictions

In general the theory of fiscal federalism provides stronger arguments in favour of centralised revenue collection comparedwith expenditures Centralised revenue collection could lower the costs of collection and compliance due to economics ofscale it could prevent tax evasion induced by mobile tax basis and prevent excessive tax competition This can give riseto a rsquovertical fiscal imbalancersquo whereby central sub-national governments have to rely on the central government to providethem with revenues to finance decentralised public expenditures

yen1part One should keep in mind that this figure does not measure local autonomyin deciding on expenditure

As expected defence is never decentralised reflecting thepresence of spillover effects economies of scale and polit-ical considerations A considerable percentage of theresources of sub-central authorities are devoted to itemssuch as education housing recreation and culture decen-tralised provision of these items may be justified on theground of tailoring public goods and services to localneeds and preferences The largest differences betweenMember States can be found in the categories of healthand social security and welfare where sub-central author-ities in several countries have an important role to play

It should be noted however that the scale and composi-tion of public spending by sub-central authorities doesnot coincide with the actual degree of budgetary auton-omy of sub-national authorities This is because the cen-tral government can influence to a large degree theexpenditure choices of sub-central authorities for exam-ple by mandating standards of public goods and servicesthat sub-central authorities must provide Local or state

government expenditures for example include expendi-tures that are part of national programmes In the NordicMember States central control is generally confined tosetting a broad policy framework leaving them a highdegree of independence in areas like primary educationsocial and health services Their counterparts in theNetherlands Germany Austria and Italy have a role tooin providing the major welfare services though withmore detailed steering by higher tiers of government(Committee of the Regions 2001)

Sub-central authorities can be financed through taxesgrants service charges and fees (1) Table V8 shows themain categories as according to the ESA95 classifica-tions Taxes that are collected by the central governmentand automatically transferred to the local and state gov-

Table V6

Expenditure and revenues at State and local government level

MS Structure

Total expenditures Total revenues

of GDP of total of GDP of total

1995 2000 2001 1995 2000 2001 1995 2000 2001 1995 2000 2001

BE Federal State 14 13 14 26 27 27 13 14 14 27 27 28

Local 7 7 7 12 14 13 7 7 7 14 13 13

DK Unitary local self-government Local 32 31 31 53 56 57 33 31 31 56 53 54

DE Federal State 13 14 14 27 29 28 12 13 12 26 28 27

Local 8 7 7 15 15 14 8 7 7 16 15 16

EL Unitary Local 2 2 2 3 4 4 2 2 2 5 4 4

ES Unitary federal features State 7 9 9 15 22 23 6 8 8 16 21 21

Local 6 6 6 13 15 15 6 6 6 15 16 16

FR Unitary Local 10 10 10 18 19 19 10 10 10 20 19 19

IT Unitary federal features Local 13 14 14 24 30 30 13 14 15 28 30 32

LU Unitary Local 7 6 15 14 7 6 15 13

NL Unitary Local 23 16 16 45 35 35 23 16 16 49 34 35

AT Federal State 8 10 10 14 18 18 9 10 10 16 20 19

Local 9 8 8 16 15 15 8 8 8 16 16 15

PT (1) Unitary Local 5 7 12 14 5 5 14 12

FI Unitary local self-government Local 19 16 17 31 33 34 20 16 16 36 29 30

SE Unitary local self-government Local 23 22 23 34 39 40 23 23 23 37 38 38

UK Unitary four constituent nations Local 12 10 11 26 28 26 11 10 11 29 25 26

EUR-12 16 16 31 33 16 15 33 32

EU-15 16 15 31 33 16 15 33 32

(1) Figures for PT concern 1999

yen1part That is in the absence of borrowing See Graph V3 on the contribution oflower levels of government to general government borrowing

ernments (for example as part of a tax-sharing agree-ment) are registered as if they were collected directly bythe local or state government According to ESA95 thecategory of transfers within the general governmentmainly shows block transfers to the local and state gov-ernments that do not correspond to any specific categoryof taxes

There are large differences in the way Member Statesfinance their expenditure at lower levels of governmentIn Belgium the states rely mostly on transfers from thecentral government For the states in Austria and Spaintransfers also account for a large part of their revenuesalthough to a lesser extent than in Belgium In Austriatax sharing represents another important part of incomewhile the states in Spain have increased their tax auton-omy in the second half of the 1990s For the Germanstates the transfers from the central government aremuch smaller and tax income is the most importantsource of revenue This reflects the importance of taxsharing of national taxes with the central government

Transfers to local governments are relatively high inthe UK and the Netherlands which indicates their rela-tively centralised system of financing local govern-ments This contrasts with Italy and France where theautonomy of lower levels of government in raisingtaxes is higher In Italy in particular reforms in the1990s have strongly decreased local governmentsrsquodependence on transfers from the centre and extendedtheir autonomy in raising taxes Finally the data for thecategory of taxes on income and wealth show verylarge differences between Denmark Finland and Swe-den where figures range from 10 to 15 of GDP andother Member States where this figure is usually below2 of GDP in line with the fact that income taxes arethe most important source of income at local level forthe Nordic countries

32 Fiscal decentralisation and its interaction with the EUrsquos fiscal rules

321 Fiscal decentralisation and the goal of sound and sustainable public finances

The data in Section 31 clearly illustrate the importanceof public finances at sub-central level when consideringthe overall budgetary situation of a Member State Aquestion arises whether there is a link between thedegree of fiscal decentralisation and the budgetary per-formance in particular the capacity of Member States to

meet the budget balance and debt requirements for thegeneral government set down in the Treaty and SGP

Graph V2 compares an indicator for fiscal decentrali-sation with indicators for budget balance and debt Itshows that at first glance there is no apparent linkbetween the degree of fiscal decentralisation and budg-etary performance

However a possible link between fiscal decentralisationand budgetary performance may exist depending uponwhether or not a sub-central authority faces a hardbudget constraint (for example Rodden 2000) Theargument is that lower levels of government may nottake adequate account of the spillover effects of theirbudget policies and may face incentives to shift the costsof their expenditure decisions to the central level of gov-ernment The extent to which they might be able to actaccording to these incentives depends on the institutionalset-up of the system of financing of lower levels of gov-ernment (Eichengreen and von Hagen 1996 Rodden2002 Ter-Minassian and Craig 1997)

There may be a tendency for higher levels of publicspending and deficits if there is a vertical fiscal imbal-ance that is when sub-central authorities have importantresponsibilities for public expenditures but limited ownresources and are thus reliant on transfers and grantsfrom central authorities These transfers may create theperception that local public spending is funded by non-residents As a consequence expenditure discipline andcost-awareness might deteriorate the costs of grantsmay not be fully internalised at the local level causing todemand above-optimal levels of public expenditures onitems that are financed by grants for central authorities(for example Rodden and Wibbels 2002) This pressurefor increased transfers to sub-central authorities couldtranslate into higher deficits and debt of the general gov-ernment On a related point sub-central authorities mayengage in excessive levels of borrowing if they considerthat in the event of default they will be bailed out by ahigher level Pressures to bail out sub-central authoritiesmay rise with the degree of vertical imbalance since thesmaller the tax base and the control over it at sub-national level the smaller are the possibilities at thatlevel to raise taxes in the event of financial problems

In response to these pressures governments in recentyears have paid close attention to the incentives embed-ded in the design of grants and revenue sharing arrange-ments with sub-central authorities Many countries have

ndash 1

(1 )Fi

also introduced borrowing restrictions for lower levels ofgovernment (for an overview see Ter-Minasian andCraig 1997) and empirical studies indicate that higherdegrees of vertical imbalance and sub-national borrow-ing restrictions are indeed associated (Eichengreen andVon Hagen 1996)

Borrowing restrictions are usually found to be effectivein restraining fiscal policies at lower levels of govern-ment (for example Bayoumi and Eichengreen 1995)All EU countries apply restrictions to local governmentspending and borrowing but in various forms anddegrees (Dafflon 2002) Their impact within the EU isexamined on Graph V3 which contrasts the general gov-

Graph V2 Fiscal decentralisation and budgetary situation

ndash 500

ndash 400

ndash 300

ndash 200

ndash 100

000 010 020 030 040 050 060

Fiscal decentralisation

DKSEFI

EL DEIT

000 010 020 030 040 050 060

PTFR ES

ernment budget balance (dark column) and the budgetbalance of local and (where relevant) state governmentsLocal and state governments usually balance their budg-ets or run small deficits or surpluses The only notableexception is Germany where net lending by local andstate government accounts for almost half of the generalgovernment deficit in 2002

Clearly this does not provide for an adequate picture ofthe overall contribution of lower levels of government tothe general government budget balance For example asub-national government that is facing a borrowingrestriction might obtain a higher amount of grants or per-centage of shared taxes from the central governmentincreasing the deficit at that level

322 Recent measures in several Member States to coordinate budgetary positions across levels of government in light of EU requirements

In recent years a number of Member States have re-considered the fiscal relations across different levels ofgovernment which take into account the need to complywith EU budgetary requirements These initiatives alsosought to correct a form of vertical institutional imbal-ance whereby the Treaty and SGP obligations concernthe general government as a whole (ie central state andlocal government plus social security) but commitmentsgiven at European level (notably in the annual updates tostability and convergence programmes) are made by thecentral government Compliance with budgetary com-mitments given at EU levels is dependent upon the budg-etary performance of all levels of government whereas

the costs of non-compliance (either the reputational costor ultimately in the form of a pecuniary sanction) areborne by central government

Apart from borrowing and budgeting restrictions forsub-national authorities (as discussed in the previoussection) the federal Member States and Italy and Spainhave also introduced institutional arrangements atnational level usually referred to as national stabilitypacts These arrangements can be summarised accordingto the formulation and scope of their targets the meas-urement of the targets their legal status the process ofsurveillance and the enforcement including possiblesanctions The usual hypothesis is that a complete designacross all these dimensions will contribute to the effec-tiveness of the arrangements

Graph V3 The contribution of lower levels of government to general government net lending (+) or borrowing (ndash) in 2002

ndash 4

ndash 3

ndash 2

ndash 1

BE DK DE EL ES FR IE IT LU AT NL PT FI SE UK

Lower levels of government

General government

In January 1999 a domestic stability pact was enacted inAustria In October 2000 it was amended by an agree-ment between the federal government provinces and thelocal authorities that covers the period until 2004 Theagreement covered the joint achievement of a balancedbudget by 2002 as well as financial burden sharingarrangements The provinces undertook to contribute toan average budget surplus over the whole period of notless than 075 of GDP up to 2004 Temporary under-runs of ndash 015 of GDP are allowed if over the wholefinancial burden-sharing period the averaged value of075 GDP is maintained The local authorities under-took to balance their budget up to 2004 Temporaryoverruns of 01 of GDP are allowed if over the wholeperiod the average position of a balanced budget isattained The system of monitoring and enforcementincludes possible fines subject to unanimous decisionfrom all interested parties The flood disaster in 2002 ledto a temporary suspension of the rule that is not takingaccount of flood-related expenditure in the years 2002and 2003

In Belgium the coordination of the budget balance posi-tion of various levels of government is ensured by theagreement concluded initially in 2000 and renewed in2002 between the federal government the communitiesand regions to adhere to the budgetary targets as recom-mended each year by the High Council of Finance (1)The communities and regions draw up internal medium-term stability programmes each year at least equal induration to the Belgian stability programme which areevaluated by the High Council of Finance The agree-ment covers the period of 2001ndash05 The cooperationagreement does not include formal sanctioning proce-dures in case of deviation from the permissible deficitsHowever the federal government can restrict the bor-rowing capacity of communities and regions for a periodof up to two years upon recommendation of the HighCouncil of Finance and after the regions involved havebeen consulted (IMF 2001)

On 21 March 2002 the federal government and theLaumlnder in Germany agreed on a kind of National Sta-bility Pact for the implementation of the SGP (for amore detailed description see the case study on Ger-many in Section 342) The federal government and theLaumlnder (including the local governments falling within

their competence) commit to comply with the budget-ary rules of EMU and lsquoshall strive towards a reductionin net borrowing with the aim of achieving balancedbudgetsrsquo The Financial Planning Council to which theFederal Minister for Finance the Federal Minister forCommerce and Labour the Finance Ministers of theLaumlnder as well as representatives of local authoritiesand local authority associations belong discusses thecompatibility of the budgetary developments of territo-rial authorities with the provisions of the SGP TheFinancial Planning Council will issue recommenda-tions on budgetary policies mdash and in particular on acommon expenditure line mdash taking into account theeconomic and fiscal factors Regarding enforcementthe Financial Planning Council will discuss the reasonsof non-respect of the rules and give recommendationsin order to restore budgetary discipline

In Italy a domestic stability pact came into force throughlegislation adopted in connection with the budget law for1999 It aims at improving the budget balances of localgovernments by fixing targets for the reduction of theirdeficits Healthcare expenditure which accounts for overtwo thirds of regional expenditure is subject to a separateagreement The Treasury is to monitor cash flows duringthe year and report on a quarterly basis to the conferencefor relations between regions and State and the confer-ence for state-municipalities which are expected to indi-cate measures to achieve the targets in case of divergencePossible fines under the budgetary rules of the Treaty andthe SGP are to be levied on the local authorities that havefailed to meet their targets in proportion to the overshootfor which they are responsible

In Spain the General Law of Budgetary Stability enactedin 2001 has taken effect from 2003 (for a more detaileddescription see the case study on Spain in Section 341)The central feature is that all general government sub-sectors should show a surplus or a balanced budgetTemporary deficits are allowed only in exceptional situ-ations where two-to-three year plans will be discussedin Parliament to return to a surplus or a balanced budgetThe central government monitors budgetary executionand assesses the degree of fulfilment of the objectivesAs a part of enforcement the central government will beable to condition any recourse to debt by sub-nationalgovernments Possible fines under the budgetary rules ofthe Treaty and the SGP will be shared by those publicentities responsible for the deficits

yen1part Advisory board on fiscal policy of the government and communities andregions

This short overview shows differences and similarities inthe way Member States address the challenge of coordi-nating the overall budgetary position across levels ofgovernment The differences reflect historical circum-stances variation in political structure and diversity inbudgetary processes Some Member States have chosento replicate the medium-term objective of the SGP oflsquoclose to balance or in surplusrsquo at the local or regionallevel while others have chosen to define specific budget-ary targets on a yearly basis In some cases the arrange-ments are laid down in national law while in others theyare formulated as an agreement between levels of govern-ment There are also institutional differences with respectto the way the arrangements are implemented and moni-tored Finally some arrangements specify the specificactions to be taken in case of non-compliance such asimposing sanctions while others do not

More experience with the implementation of thearrangements is needed before firm conclusions can bedrawn on their effectiveness in contributing to the over-all fiscal objectives of the SGP A crucial issue is howthe mechanisms are implemented when a divergencearises between targets and expected outcomes that can-not be attributed to exceptional circumstances In thisrespect a strong legal base and enforcement mechanismwould be expected to contribute to the credibility andeffectiveness of the arrangements

33 Fiscal decentralisation and automatic stabilisation

Apart from the issue of how fiscal decentralisationaffects the capacity of Member State to achieve soundand sustainable public finances it may also be relevantas regards the effects of fiscal policy on the stabilisationof economic activity and in particular the operation ofautomatic stabilisers Stabilisation could be beneficialboth to smooth taxes and consumption over time and toavoid excessive output and employment variability andboom-bust fluctuations

EMU raises particular concerns as regards the role ofnational fiscal policies for stabilisation purposes (seeEuropean Commission 2001a) it is widely argued thatgiven the loss of national monetary policy in EMUbudgetary policy may need to play a more significantrole in smoothening the impact of country-specificshocks on real output The philosophy underlying theTreaty and the SGP reflects widespread scepticism onthe use of discretionary fiscal policies for stabilisation

purposes (European Commission 2002a) and the normfor budgetary behaviour in EMU should be to let auto-matic stabilisers operate freely over the economiccycle Adhering to budgetary positions of lsquoclose to bal-ance or in surplusrsquo will provide for an adequate safetymargin to prevent nominal budget deficits from breach-ing the 3 of GDP reference value while letting auto-matic stabilisers play fully

The traditional literature on fiscal federalism providesarguments in favour of centralising the stabilisationfunction Lower levels of government might not have theright incentives to provide an optimal level of stabilisa-tion since a large part of their stabilisation effort wouldleak away to other jurisdictions Likewise local govern-ments could try to free ride on the effort of others Fur-thermore the possibilities of local governments to runcounter-cyclical policies (for example by means of let-ting automatic stabilisers work) are in many cases lim-ited given the existence of borrowing and budgetingrestrictions As a result it is widely believed that theremay be good reason to shield the income of lower levelsof government to some extent from cyclical fluctuationsTer-Minassian (1997) summarises the broad consensusin the literature that the central government should beassigned taxes that among other things have a higherincome elasticity lsquothat is to provide the central govern-ment with stabilisation instruments and also to shelter tothe extent possible the budgets of sub-national govern-ments from cyclical fluctuationsrsquo (1) This kind of sheltercan be achieved either by only assigning tax bases tolower levels of government that are sufficiently stableover the cycle or by devising a system of shared taxes orgrants that correct for cyclical variability in own taxes atlower levels of government

The empirical literature on fiscal federalism and auto-matic stabilisation focuses mainly on the US andsometimes on other large federalist States as well (suchas Canada and Germany) where state budgets are largeenough to potentially influence overall automatic stabi-lisation The results indicate agreement that more strin-gent borrowing controls are associated with less cycli-cal response of the budget balance at the level of thestates within federations (Soslashrensen et al (2001)Alesina and Bayoumi (1996) Bayoumi and Eichen-green (1995)) Moreover Alesina and Bayoumi (1996)

yen1part Ter-Minassian (1997) also provides an overview of which taxes would bemore suitable for assignment to the central government or to lower levels ofgovernment

find that the lower flexibility of the budget balancedoes not affect output variability at state level withinthe US indicating that balanced budget rules for the USstates are effective in enforcing fiscal discipline buthave no costs in terms of increased output variabilityLastly Soslashrensen et al (2001) specifically investigatethe cyclical variability of different components of thebudget for the US states indicating that state revenuesand expenditure are both pro-cyclical but the pro-cyclicality of revenue dominates so that the overallbudget balances improve during upturns and worsenduring downturns These results indicate mdash at least forthe US mdash a gap between practice and the recommenda-tion of shielding sub-national revenues and expenditurefrom cyclical variations No firm conclusions arereached however on the desirability of automatic sta-bilisation at lower levels of government

From the point of view of the EU a relevant question iswhether the trend of fiscal decentralisation might impacton the extent to which budgets of sub-national govern-ments are shielded from cyclical variations Greater taxautonomy at lower levels of government might increasethe cyclical variability of revenue at local level and leadto a degree of procyclical behaviour if borrowingrequirements are in place For example if tax revenuesat lower levels of government decrease in a recessionthen expenditure would have to be cut as a result

To investigate the issue it is necessary to examine thevariability of budget balances at the stateregional levelsof government and the cyclical variability of revenuesand expenditure at state levels of government Table V9presents figures for aggregate net lending (ndash) and bor-rowing (+) at the state-level government for the federal-ist Member States (including Spain) and the local levelfor the Nordic countries It also shows the developmentof the output gaps over time The aggregate budget bal-ances at state or local level generally show little cyclicalvariation over time For Belgium and especially Ger-many the aggregate budget balances of the states couldindicate a small degree of cyclical sensitivity Neverthe-less the limited period for which data are available doesnot allow for a firm conclusion in this respect

The crucial question is whether a low degree of cyclicalresponse of the budget balance at state or local level isdue a low cyclical variability of revenues and expendi-ture According to the proposition that lower levels ofgovernment should be shielded from cyclical variationsin their revenues and expenditures one would expect asteady growth in real revenues and expenditures of lowerlevels of government at the rate of trend GDP (in absenceof any change in the size of lower levels of government)If on the contrary revenue and expenditure at lower lev-els of government would be responsive to the cycle thena lack of cyclical movement of state budget balancescould indicate a degree of pro-cyclical behaviour possi-

Table V9

Aggregate budget balances at state level (AT BE ES DE) local level (DK FI SE) and output gaps

1995 1996 1997 1998 1999 2000 2001

AT B balance 01 03 06 04 03 02

Output gap ndash 08 ndash 09 ndash 15 02 07 19 05

BE B balance ndash 08 ndash 04 ndash 01 03 04 02 08

ES B balance ndash 06 ndash 06 ndash 03 ndash 03 ndash 02 ndash 05 ndash 05

Output gap ndash 30 ndash 31 ndash 18 ndash 03 07 16 09

DE B balance ndash 12 ndash 11 ndash 12 ndash 07 ndash 05 ndash 04 ndash 13

Output gap 02 ndash 08 ndash 10 ndash 07 ndash 02 11 04

DK B balance 05 ndash 03 ndash 04 ndash 04 01 00 ndash 01

Output gap 04 04 08 07 10 14 06

FI B balance 14 09 ndash 04 ndash 01 ndash 01 02 ndash 03

Output gap ndash 25 ndash 11 17 28 23 43 14

SE B balance 00 ndash 02 ndash 49 ndash 02 ndash 54 03 ndash 02

bly influenced by borrowing restrictions (1) In this casethe typical pattern would be that revenues show a degreeof cyclical variability and that expenditures are adjustedin a pro-cyclical manner as a result

The following figures therefore plot the yearly changesin the level of real revenues and expenditures at the stateregional level of government as well as the output gapsGraph V4 shows the results for Germany from 1991onwards Changes in the level of revenues and spendingshow a strong correlation and seem to move to somedegree at least in line with the economic cycle The lastyear shows a stronger drop in revenues than expenditurewhich is in line with the recent increase of the budget

deficit for the states In sum the figures suggest a degreeof cyclical variation in revenues followed by a smallerdegree of pro-cyclicality on the spending side (and hencesome degree of cyclical variation of the deficit ratio atthe level of the states)

Graph V5 shows the available results for the Spanishregions The growth rates of expenditure and revenuewell above at the trend rate of GDP are in line with theincrease in fiscal responsibilities of the Spanish regionsas reported elsewhere (for example Committee of theRegions 2001) The figures seem to provide little or noindication of pro-cyclicality in spending A relevantquestion however is whether the recent budgetaryreform in Spain which combines a higher degree of taxautonomy for lower levels of government and balancedbudget requirements could lead to a greater degree ofpro-cyclicality in the future (see case study on Spain inSection 341)

Graph V6 shows the results for Denmark a unitary Statewith a high degree of decentralisation and local auton-omy A relevant feature of the Danish system is thatblock grants to lower levels of government are adjusted

for changes in the burden of tasks that the central govern-ment assigns to local governments and the effects ofbusiness-cycle fluctuations (OECD 2003b) Thesecyclical variations are covered by the lsquobudget guaran-

yen1part Rodden (2002) presents an index of borrowing autonomy for lower levelsof government where a score of 1 implies no borrowing autonomy and ascore of 5 a high degree of borrowing autonomy The scores for the Mem-ber States as shown here are States Austria 185 States Spain 28 StatesGermany 27

Graph V4 Germany output gap and changes in the level of real revenues and expenditure at State level

ndash 6

ndash 4

ndash 2

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

TE State TR State Output gap

Graph V5 Spain output gap and changes in the level of real revenues and expenditure at State level

Graph V6 Denmark output gap and changes in the level of real revenues and expenditure at local level

ndash 4

ndash 2

1996 1997 1998 1999 2000 2001

ndash 4

ndash 3

ndash 2

ndash 1

1996 1997 1998 1999 2000 2001

TE TR Output gap

teersquo which implies that the State adjusts its grants forchanges in expenditure (such as unemployment benefits)that are caused by cyclical variations As expected sincelocal governments are not allowed to run deficits (exceptin short periods) changes in revenues and expendituresshow a large correlation over time In principle thecounter-cyclical adjustments of the block grant need notimply that total expenditures at local level are counter-cyclical Nevertheless a marked difference with thecases described above is that revenues and expendituresat local level show a rise in 2001 against a background oflower growth which may indicate a degree of counter-cyclicality in line with the philosophy of the SGP

In interpreting the results of the examples above oneshould be careful to recognise the preliminary nature ofthe analysis The analysis is a partial one as it onlyinvestigates the cyclical pattern of government financesat the state and local level and is based on aggregate datafor a limited period of time A follow-up study couldinvestigate the total degree of cyclical variability ofbudgets of Member States and investigate the contribu-tion of all levels of government (that is central statelocal and social security) as well as its actual effects onoutput

34 Case studies

341 Spain

Introduction

Spainrsquos budget deficit was gradually reduced during thesecond half of the 1990s in line with EMU fiscal rulesMore recently attention has focused on how to ensurebudgetary stability in a context of increasing fiscal decen-tralisation At present territorial governments representmore than 30 of total general government expenditureand nearly 70 of general government investment

The General Law of Budgetary Stability (GLBS) cameinto force in 2003 Its adoption follows the new financingsystem for regional governments implemented in 2002which implies considerably greater taxation powers forregional authorities and widens joint fiscal responsibilityThe GLBS aims at ensuring that increased decentralisa-tion of public finances should not put at risk overall budg-etary stability It does so by requiring that all the generalgovernment sub-sectors should show a surplus or bal-anced budget and by introducing new budgetary proce-

dures and norms These institutional changes are seen asmore important in ensuring budgetary stability than themere setting of quantitative targets

The principle of budgetary stability implying a surplusor a balanced budget will be applied to all public entitiesThus apart from the central government (State socialsecurity and autonomous entities) and regional and localgovernments public bodies (even if they are notincluded in the general government definition on anational accounts basis) are covered by this new legalframework Therefore the scope of the GLBS is widerthan the general government definition on ESA95 basis

Main principles of the GLBS

The GLBS is based on four basic principles

bull each entity of the public sector must fulfil the crite-rion of budgetary stability which is defined in thelaw as lsquoa situation of balance or in surplus in termsof financing capacity according to ESA95 method-ologyrsquo As far as public entities and enterprises areconcerned the definition of budgetary stability ismore vague For these entities budgetary stabilitymeans lsquoa balanced financial situation which mightimply if necessary the adoption of restructuringstrategies to avoid or lower economic losses andprovide adequate profits for the fulfilment of theirinstitutional purposesrsquo

bull multiannual framework for budgetary setting whichimplies that each public entity must prepare thebudget on the basis of medium-term projections(three years) This framework is in line with the timehorizon of the stability programme

bull transparency meaning that each public entity mustprovide enough information to allow the assessmentof its budgetary situation and the fulfilment of thebudgetary stability criterion

bull efficiency in the use of public funds in order toaccomplish the budgetary stability criterion for eachpublic agent To give practical implementation tothese principles the GLBS introduces new budget-ary procedures both for the public sector as a wholeand for each sub-sector

Budgetary procedure innovations concerning the whole of the public sector

All public sector entities are required to modify theirspecific budgetary procedures to ensure compliance withthe budgetary stability criterion The central governmentis responsible for the assessment of budgetary stability inthe public sector as a whole (1) In particular all publicentities will have to consider the following

bull budgetary deficits have to be justified by the publicsector entity concerned and will require the formula-tion of a medium-term (three years) plan to restore abalanced budget situation

bull in the first quarter of each year the central govern-ment will release the budgetary objectives for thenext three years for the whole general governmentsector and for each sub-sector These objectives areto be discussed in the Parliament together with themacroeconomic scenario for the same period set outin the stability programme

bull before 1 September of each year the General Inter-vention of the State (IGAE henceforth) will submita report on the degree of fulfilment of the stabilityobjectives in the previous year The report will besent to the Fiscal and Financial Policy Council (theofficial body responsible for coordinating fiscal pol-icy between central and regional governments)Imbalances will have to be justified and will requirethe formulation of a plan to correct them

bull the financial penalties due to the non-fulfilment ofthe commitments assumed by Spain within SGP willbe shared by those public entities responsible for thedeficits

Budgetary procedures innovations for central government and social security

The following rules apply to the central government andsocial security system taking into account that the budg-etary stability objectives for these two sub-sectors willbe considered jointly until the process of separation ofsocial security financing is completed in 2012

bull Before releasing the Budget Law the Ministry ofthe Economy prepares a multiannual programme ofexpenditure and revenues for each year specifyingthe spending commitments for lsquoevery budgetarypolicyrsquo

bull Along with the budgetary stability objectivesannounced in the first quarter of each year for thenext three years the government sets a maximumexpenditure limit for the State on an annual basis forthe same period

bull Based on the maximum limit set for the non-financialexpenditure for the State a contingency fund is cre-ated up to a maximum of 2 of the such limit Thisfund is to be used for changes in spending commit-ments to meet unforeseen circumstances The Minis-try of Public Finances has to inform parliament aboutthe use of such funds on a quarterly basis Thus newspending commitments have to be financed throughthis fund or by reducing other expenditures It is notpossible to carry over unspent amounts in the fundfrom one year to the following one

bull Surpluses recorded by the State are allocated to debtreduction while those registered by the social securityare allocated with priority to the pension reserve fund

bull Public entities and enterprises not included in the gen-eral government sector on a national accounts basisbut dependent on the central government have to con-tribute to budgetary stability Thus in case of lossesaffecting negatively the central government budget-ary objective a medium-term plan containing appro-priate measures to remedy this situation has to beadopted The legal procedures contents and deadlinesfor these plans will be set out in a specific regulation

Budgetary procedure innovations concerning regional governments

In addition to the rules that apply to the whole of the pub-lic sector regional governments are required to respectthe following criteria

bull The budgetary stability objective for the wholeregional government sub-sector released by the cen-tral government in the first quarter of each year willhave to take into account a previous report by theFiscal and Financial Policy Council Once the budg-etary stability objective for the whole regional gov-

yen1part This responsibility will be to some extent shared when assessing thebudgetary stability for regional and local governments The so-called lsquoFis-cal and Financial Policy Councilrsquo made up of central and regional author-ity representatives will carry out the assessment for regional governmentsIn turn the lsquoNational Committee for Local Entitiesrsquo co-assesses the finan-cial situation of local governments

ernment sub-sector is released by the centralgovernment the Fiscal and Financial Policy Councilhas one month to translate it into budgetary objec-tives for each regional government If in this periodthe Council does not reach an agreement eachregional government has to prepare its budgetrespecting at least a balanced budget objective

bull If a regional government approves its budget fore-seeing a deficit or fails to achieve the budgetarystability objective set in the previous budget amedium-term plan aiming at rectifying this situationis required This plan must include all the necessaryrevenue and expenditure measures to restore budg-etary stability within three years and requires theapproval by the Fiscal and Financial Policy CouncilThe Ministry of Public Finances is responsible forthe monitoring of this plan

bull The State can condition the issuance of new debt andthe recourse to bank credit by the regional govern-ments to the fulfilment of their budgetary stabilityobjectives In addition the Ministry of PublicFinances is allowed to request information fromregional governments and to set up a public informa-tion agency for loan operations debt issuance andassumption of risks by regional authorities

bull Regional governments are able to take measures soas to reach budgetary stability in relation to publicentities and enterprises not included in the generalgovernment sector on a national accounts basis butdependent on regional authorities

Budgetary procedure innovations concerning local governments

The procedures that apply to local governments arebroadly the same as to those addressed to regionalauthorities In this case the National Committee forLocal Entities plays a role analogous to that of the FiscalFinancial Policy Council

A tentative assessment

The GLBS can be seen as a means to keep publicfinances on a sound basis so as to respect the fiscal com-mitments undertaken at European level while allowingto share fiscal responsibility among all general govern-ment tiers It redresses the potential asymmetry regard-ing budgetary stability between the central government

which is the only responsible for fiscal commitmentsvis-agrave-vis EU authorities and territorial governmentswith an increasing role in public expenditure

The law aims at entrenching the dynamics of fiscal con-solidation based on the expenditure side through theannual limit on expenditure at the State level and the so-called contingency fund An additional positive featureof the GLBS is the multiannual stability objectivesannounced by the government for budgetary setting Inorder to keep credibility the budgetary target set in thefirst quarter of each year should be only subject to lim-ited changes in the Budget Law and the USP

However despite the validity of the central goal ofensuring that fiscal decentralisation remains compatiblewith the budgetary stability as defined by EMU fiscalrules some questions arise as to the means foreseen toachieve it A principal criticism is that the objective ofbudgetary stability defined in nominal terms mighthamper the stabilisation function of fiscal policy sincethe effect of the cycle on the budget is not taken intoaccount Nevertheless the difficulty of estimating cycli-cally-adjusted balances at sub-national level can explainthe choice of applying objectives in nominal terms

The adoption of the GLBS complements that of the newsystem for financing of regional governments By mak-ing regions finances increasingly dependent on own taxrevenues the new system of financing increases the sen-sitivity of regional budgets to the economic cycle aggra-vating the risk of pro-cyclical policies Should deficitsoccur the responsible public entities have three years torestore the balanced budget In case of a severe reces-sion this period might prove to be insufficient Somemargin of flexibility however can be expected in theimplementation of the three-year plans to restore a bal-anced budget situation The issue raised by GLBS con-cerning its compatibility with a proper functioning ofautomatic stabilisers will need some time to be assessed

It is also claimed that the GLBS could reduce publicinvestment causing serious problems for a catching-upcountry such as Spain The objective of a balancedbudget or a surplus would mean that public investmentcould only be financed through current revenues How-ever recent research suggests that public investment isnot constrained by a ban on deficits as no significantdirection of causality has been detected between publicinvestment and deficits

The law could have been more ambitious in someaspects The joint objective of budgetary stability for theState and social security system (up to 2010) will allowthe State to record deficits without having to presentconsolidation plans at all A stricter formulation couldhave required that the social security surpluses beentirely allocated to the reserve fund together withrequirements for the State balances

The transparency at each level of government is essentialfor the effectiveness of the GLBS The law includesadvances in this direction particularly concerning sub-national governments for which budgetary informationhas traditionally been poor The GLBS may pave theway for additional information requirements recognis-ing that stability and transparency are complementary

Finally this law will only produce the awaited results interms of long-term sustainability only if the GeneralBudgetary Law which contains the main budgetary pro-cedures and the social security system are properlyreformed The latter is especial relevant for Spain giventhe expected budgetary impact due to ageing which can-not be tackled by the simple implementation of the GLBS

342 Germany

The constitutional framework

In constitutional terms the Federal Republic of Germanywas actually founded by the Laumlnder (see Praumlambel) As aconsequence Article 70 (1) of the German constitutionclearly states that lsquothe Laumlnder have the right to legislationas long as this constitution does not defer this right to thefederal levelrsquo The following articles then define whichare the responsibilities of the federation and in which areasboth government levels may intervene In line with theseregulations Article 104a states that lsquothe federation and theLaumlnder are mdash in clear separation mdash in charge of theexpenditures which result from the responsibilities whichthis Constitution confers upon themrsquo

Article 106 then specifies which taxes are collected bywhich level of government Article 105 (3) states thatfederal laws on taxation which regard taxes at least par-tially collected by lower level of government are subjectto approval by the Bundesrat (Upper chamber of Parlia-ment composed of Laumlnder representatives) (1) Further-more Article 106 (3) states that the uniformity of livingconditions on the federal territory has to be guaranteed

Expenditure and revenue by levels of government

On the basis of these constitutional provisions theregional and local governments play a substantial rolefor the development of public finances in Germany asindicated already in Table V7

On average expenditure by regional governments is of asimilar magnitude as federal spending If one incorpo-rates spending by local entities federal expenditureaccounts for only 40 of total expenditure by all levelsof government (that is excluding social security sys-tems) As shown in Graph V3 the share of lower levelsof government account for almost half of the generalgovernment budget deficit

Given the importance of lower levels of government forpublic spending and revenue collection the coordinationof budgetary policies is obviously very relevant for therespect of the SGP Furthermore given that only the fed-eral government is at the European level responsible forthe respect of the deficit and debt criteria the FederalMinister has a strong interest in having his policies sup-ported by the other levels of government In the run-upto EMU however attempts to agree upon a national sta-bility pact failed due to constitutional problems andpolitical considerations Recently however the respon-sibilities of the Finanzplanungsrat (Financial PlanningCouncil) have been clearly reinforced

The role of the Financial Planning Council

The Finanzplanungsrat itself consists of the FederalMinister for Finance the Laumlnder Ministers of Financethe Federal Minister for Economics and representa-tive(s) of local authorities It meets twice a year (nor-mally in June and November) following the presenta-tion of the economic forecast and the respective meetingof the working group Steuerschaumltzung (lsquotax revenuesestimatersquo) (2) Given that the April economic forecasthas a medium-term time horizon (that is normally thefollowing three years) the June meeting of the Finanzpla-

yen1part Following regional elections in the Laumlnder of Lower Saxony and HesseChristian Democratic-led Laumlnder governments currently lsquocontrolrsquo 41 votesout of a total of 69 votes conferring on the opposition parties an importantrole in economic policy-making

yen2part At the end of January the Federal Government normally presents itsJahreswirtschaftsbericht (annual economic review) which also contains itseconomic projections for the spring meeting of the Finanzplanungsratthese projections can be revised The projection of the Federal Governmentserves as a basis for discussion in the Finanzplanungsrat however currentprojections of economic research institutes and of international organisa-tions including the EU are also presented The medium-term projections ofthe federal government are only published once a year in April

nungsrat also discusses medium-term budgetary projec-tions while the November meeting mdash based on theshort-term forecast published in October mdash will onlydiscuss prospects for the current and the following year

Automatic stabilisation

When the Finanzplanungsrat met for the first time inMarch 1968 it was to contribute to the fine-tuning of thebusiness cycle in line with Article 109 (2) of the Germanconstitution whereby the federal government and theLaumlnder in their budgetary management have to respectthe requirements of the overall macroeconomic equilib-rium (1) Since the early 1980s the focus has shifted tofiscal consolidation in the mid-1990s it was decidedthat the rise in (nominal) expenditure of all levels of gov-ernment should not exceed 2 per year Regarding theissue of automatic stabilisation past experience showsthat lower levels of government tend to follow a pro-cyclical pattern if in one year tax revenues turn out to behigher than originally budgeted nominal deficits firsttend to decline In the following year the growth rate ofexpenditure would clearly accelerate (see Graph V4)

The Law on Budgetary Principles

Following the adoption of the SGP and the introductionof the euro the Ecofin Council in its opinion on theupdated German stability programme had repeatedlyrecommended to the German authorities to agree upon akind of lsquonational stability pactrsquo in order to make theattainment of the budgetary targets of the updated pro-grammes more credible and in order to avoid pro-cyclicalpolicies In line with this recommendation a modifica-tion to Article 51a Haushaltsgrundsaumltzegesetz (lsquoLaw onBudgetary Principlesrsquo) was decided upon on 20 Decem-ber 2001

Article 51a (1) of the new law now contains a clear ref-erence to the responsibilities of all levels of governmentto respect Article 104 of the EU Treaty and proclaimsthe overall aim of bringing the deficit down in orderto reach a balanced budget Article 51a (2) states thatlsquothe Finanzplanungsrat will issue recommendations on

budgetary policies in particular on a common expendi-ture line taking into account the economic and fiscalfactors The Finanzplanungsrathellip shall discuss the con-sistency of budgetary developments in particular of thedevelopment of expenditures and deficits by the federa-tion and by the Laumlnder (including the local authorities)with the regulations of Article 104 of the EU Treaty andwith the European Stability and Growth Pactrsquo FinallyArticle 51a (3) now stipulates that in case of non-respectof the principles described in Article 51a (1) and (2) theFinanzplanungsrat will discuss the reasons thereof andlsquogive recommendation in order to restore budgetary dis-ciplinersquo

Following the Commission recommendation to the Coun-cil of 30 January 2002 to give an early warning to Ger-many the date of implementation of the new Article 51aHaushaltsgrundsaumltzegesetz was carried forward from1 January 2005 to 1 July 2002

Furthermore in its special meeting of March 2002 theFinanzplanungsrat agreed upon ambitious expendituretargets for 2003 and 2004 Federal expenditure was pro-jected to decrease by 05 per year and Laumlnder expend-iture was to rise by 1 per year in nominal terms onlyIn the November 2002 meeting it was decided that theexpenditure line for 2005 and 2006 should be discussedin the first meeting in 2003 Furthermore not least due tothe costs implied by reconstruction from the floods ofsummer 2002 the expenditure pattern was changed butthe targeted overall rise in expenditure remained almostunchanged

In its opinion on the updated stability programmeadopted in January 2003 the Council urged the Germanauthorities to respect the agreed expenditure targets for2003 and 2004 and to reach an agreement on ambitiousexpenditure targets for 2005 and 2006

While recent legal developments clearly constitute animprovement compared with the preceding rules itremains to be seen how effective the new law turns outto be in practice The lack of threat of sanctions goingabove recommendations could imply less compliancewith mutually agreed targets

yen1part lsquoBund und Laumlnder haben bei ihrer Haushaltsfuumlhrung des Erfordernissen desgesamtwirtschaftlichen Gleichgewichts Rechnung zu tragenrsquo

Part VI

Member State developments

1 Belgium

Recent developments

Despite an unfavourable macroeconomic context a 01 of GDP general government surplus was achieved in2002 Initially a government surplus of 03 of GDPwas planned in the 2002 budget under a 13 real GDPgrowth assumption however in the course of the yearactivity proved to be more subdued than expected andreal GDP growth reached 07 only

In March and July 2002 budgetary control exerciseswere organised associating all levels of governmentExpenditures were contained particularly at federallevel of government applying the lsquoanchor principlersquowhich consists in holding the utilisation rate of credits

under or at the rate of 2001 in part of the year was instru-mental in controlling spending In the social securitysector health spending was better controlled Thus thegovernment primary surplus in 2002 was maintained at ahigh level 61 of GDP

The government debt ratio which reached 1085 ofGDP in 2001 was lowered to 1053 of GDP in 2002During the period 2000ndash02 the pace of debt reductionslowed primarily due to low GDP growth in real andnominal terms Moreover in 2001 and to a lesser extentin 2002 financial operations included in the stock-flowadjustment decelerated the reduction process theseoperations consisted of the assumption by the State ofdebt in a number of public entities

Table VI1

Composition and balances of general government Belgium (1) (as of GDP)

2000 2001 2002 2003 2004

Government balance (2) 01 04 01 ndash 02 ndash 01

mdash Total revenue 495 498 502 495 492

Of which mdash current taxes 304 302 304 302 298

mdash social contributions 161 164 165 164 164

mdash Total expenditure (2) 494 494 501 497 493

Of which mdash collective consumption 78 79 81 81 81

mdash social transfers (3) 287 293 300 305 305

mdash interest expenditure 68 65 60 55 49

mdash gross fixed capital formation 18 15 16 14 15

Primary balance (2) 69 70 61 53 48

Pm Tax burden 459 460 463 459 455

Government debt 1096 1085 1053 1027 989

Pm Cyclically-adjusted balance ndash 12 ndash 04 01 02 00

Pm Cyclically-adjusted primary balance 56 62 61 57 49

(1) Commission spring 2003 economic forecasts(2) Data for 2001 (except cyclically-adjusted) include UMTS receipts of 02 of GDP(3) In kind and other than in kind

The 2003 budget expected the general governmentaccounts to be in balance on the basis of a 21 realGDP growth assumption Attaining a government sur-plus of this order of magnitude was also recommendedin the 2002 BEPGs The balanced budget objective isexpected to be reached while implementing further taxcuts that are to be compensated by equal decline in inter-est payments

The federal government real primary expenditure is pro-jected to increase by 13 in 2003 The general govern-ment primary surplus was expected to decline somewhatin 2003 as a result of a reduction in the primary surplusof Entity I (Federal government and social security) Thegovernment debt ratio was projected to be lowered to anestimated 1023 of GDP and no ad hoc financial oper-ations are planned for 2003

However due to further deterioration in the externalenvironment the real GDP growth assumption underly-ing the budget estimates was revised downwards to14 in February 2003 while the government balanceobjective was maintained Such an adjustment is possi-ble by further containment of federal expenditure apply-ing the lsquoanchor principlersquo higher-than-expected taxrevenues registered at the end of 2002 and a morefavourable projection for interest payments (made possi-ble by interest rate developments)

In the 2003 Commission spring forecasts real GDPgrowth is further adjusted downward to 12 in 2003consequently under the assumption of no further adjust-ment measures a government deficit of 02 of GDP isforecasted At the same time the government debt isexpected to decline to 1027 of GDP in 2003

Reducing the debt ratio within a global budgetary strategy

In recent years Belgium has succeeded in reducing itsgovernment debt ratio by means of achieving highgovernment primary surpluses The 2002 update of thestability programme projects a reduction in the govern-ment debt ratio to 94 of GDP in 2005 this is to beachieved by sustaining primary surpluses in the order of55 of GDP The programme also states that no finan-cial operations are foreseen in the time period covered bythe stability programme (2002ndash05) although a decisionto assume a part of the debt of the national railway com-pany (SNCB) may have an impact in coming years

The need to run down debt levels is motivated in part byconcerns about the projected budgetary impact of ageingpopulations (see Part I3) of this report The strategy ofthe Belgian authorities to meet the budgetary costs ofageing populations is based on achieving a steadydecline in the government debt ratio by sustaining highprimary surpluses even beyond the time horizon of thestability programme However sustaining a high pri-mary surplus over the very long run poses a substantialbudgetary challenge especially if at the same timeother budgetary objectives such as a reduction in the taxratio are being pursued in parallel

The Belgian authorities are currently making a muchneeded effort to alleviate the tax burden weighing partic-ularly on labour Since 1999 social securitycontributions paid by employers have been lowered anda programme of tax cuts is currently being implementedcovering the period 2002ndash05 In order to foster labourmarket participation which is low in Belgium by inter-national standards particularly among older workersboth demand and supply of labour are to be encouragedFiscal measures have been decided aiming at a phasedreduction in personal income taxes over the period2002ndash05 also reducing the lsquomarriage penaltyrsquo betterproviding for children charges and sustaining lsquogreenrsquoinitiatives The global impact of the reform is estimatedin the 2002 update of the stability programme at 13 ofGDP in 2006

In 2003 personal income taxes have been cut by 04 of GDP including in particular lowering the top rateimplementing the final stage of phasing out of the crisiscontribution and introducing an income tax credit forlow-wage earners At the same time as from April 2002further reductions in social security contributions havebeen introduced concerning both contributions paid byemployees in order to improve low-paid categoriesrsquo dis-posable income and contributions paid by employersparticularly for older workers Moreover in 2003 ratesfor enterprises income taxes have been lowered from4017 to 3399 while the more favourable fiscal regimefor SME has been maintained the tax rates applied tothem being reduced from 2884 to 2498 These meas-ures in favour of the enterprises are meant to be budget-ary neutral being compensated by offsetting measures

As far as pensions reform is concerned draft legislationhas been tabled to Parliament providing a regulatoryframework for the lsquosecond pillarrsquo of supplementary pen-sions This covers about one third of the employees in

P a r t V IM e m b e r S t a t e d e v e l o p m e n t s

the private sector Reform of the healthcare sector is alsoan objective of the government

A measure specific to Belgium is the creation of aSilver Fund (September 2001) financed by budgetarysurplus social security surpluses and non-tax rev-enues In 2003 EUR 625 million should be allocated

to the Fund from non-tax revenues At the end of theyear the capital of the Fund is expected to reach about07 of GDP (excluding interests on investments)Use of the reserves of the Fund will be allowed from2010 only under the condition that the level reachedby the government debt ratio would be below 60 of GDP

Table VI2

Key figures of the Belgian stability programme (1) (2003ndash05)

2001 2002 2003 2004 2005

Real GDP growth (annual change) 08 07 21 25 25

General government budget balance ( of GDP) 03 00 00 03 05

Primary surplus ( of GDP) 69 61 55 56 56

Government debt ( of GDP) 1086 1061 1023 979 936

(1) UMTS receipts excluded (02 of GDP in 2001)

Source 2002 update of the stability programme of Belgium

2 Denmark

Recent developments and medium-term prospects

In 2002 a surplus of 20 of GDP was recorded thesixth consecutive year with a surplus Swaps amountedto 013 of GDP leaving the surplus in nationalaccounts definition at 19 of GDP (1) This compareswith a target surplus of 16 of GDP in the most recentupdate of the convergence programme and the differ-ence is mainly due to higher-than-expected tax revenues

Compared to 2001 the surplus fell by 08 percentagepoints of GDP In addition to the effects of slowergrowth this resulted from the disappearance of theone-off effect of the UMTS-sale in 2001 amounting to02 percentage points of GDP (2) and secondly theimpact of lsquothe special pension contributionrsquo beingchanged from a public pension scheme to a private one(as a result of the redistributive element being removedfrom the scheme) which has led to a permanent reduc-tion of the budget balance of percentage point

Revenues are still affected by the volatile pension fundyield tax The taxation on pension fund yields waschanged in 2000 (3) The change has resulted in revenuesbeing far more volatile It is estimated that revenues canfluctuate by slightly more than 1 of GDP on averageleading to increased volatility of the surplus on publicfinances of the same amount and changes are very diffi-cult to predict Furthermore the prolonged downturn inthe stock market has resulted in this tax generating

hardly any revenues in 2001 or 2002 and only smallrevenues are expected in 2003 as well In a year withlsquonormalrsquo stock market developments the tax is expectedto generate revenues of around 1 of GDP

The tax burden fell markedly in 2002 due to the afore-mentioned changes to lsquothe special pension contributionrsquoIn the forecast period the tax burden is set to declineonly marginally despite the inclusion of an announcedtax reform in 2004 amounting to 04 of GDP This isa result of the revenue lost by the tax reform being morethan outweighed by the positive effects of increasedGDP growth on public finances and by the fact that thepension fund yield tax as mentioned should begin to gen-erate revenues again

The ratio of primary expenditure to GDP was largelyunchanged in 2002 Over the forecast horizon a fall ofaround 1 of GDP in total government expenditure is pro-jected mostly as a result of declining interest payments

Government consumption rose in real terms by 1 in2002 This is in line with the multiannual target of 1 increase in consumption growth but slightly lower thanthe target actually set for the year The target for the yearwas set at 13 with a subsequent reduction of the targetin 2003 to 07 averaging 1 over the two years

Over the forecast horizon continued surpluses on gen-eral government finances are expected at around 2 ofGDP every year This should result in the debt-to-GDPratio being reduced from the current level of 45 to 40 by the end of 2004 In cyclically-adjusted terms the pri-mary balance remains largely unchanged over the fore-cast horizon thereby indicating that the fiscal policiesare neutral with respect to the cycle

The governmentrsquos medium-term public finance strategycontinues to be focused on reducing the debt by keepingsurpluses of 1 ndash2 of GDP on average every yeartowards 2010 and adherence to the tax freeze The debt-

yen1part Compared to the figures used in the autumn forecast Statistics Denmarkhas implemented methodological changes to the public finance statisticsamounting to a downward revision of the surplus of 013 of GDP

yen2part It should still be noted that Statistics Denmark has decided to treat theUMTS proceeds as an annuity over the next 20 years which is not in linewith Eurostatrsquos recommendation

yen3part The tax rate on yields on equities was increased and the tax rate on yieldson bonds was reduced to ensure the same tax rate on yields from the twotypes of assets As the development in prices on equities is far more volatilethan on bonds the volatility of the revenues from this tax has increasedmarkedly Given the poor performance of the stock market in 2001 thisresulted in lower revenues

reduction strategy has mainly been implemented in orderto prepare public finances for the budgetary impact of anageing population Sustainability calculations show thatthe public finances are in a good position to handle theimpact of rising expenditure due to the ageing popula-tion However in order to make room for the targeted

average annual growth in real public consump-tion (1) increases in labour force participation rates areneeded to ensure the continued high surpluses

Tax freeze and tax reform

When the current government took office late in Novem-ber 2001 a novelty was introduced into Danish publicfinances as a tax freeze was implemented This sectiondeals with the implications of the tax freeze for expend-iture control and tax reforms

The tax freeze means that no direct or indirect tax mdashwhether legislated in kroner or as a percentage mdash can beincreased Furthermore a nominal ceiling has been puton the property value tax However if there are compel-ling reasons for introducing or raising a tax rate another

tax rate has to be reduced by an amount which leavestotal tax revenues unchanged (2)

The introduction of the tax freeze has several implica-tions First the wording of the tax freeze is actuallyslightly misleading as the implication of the tax freeze isa trend-wise reduction of the tax burden The reductionof the tax burden stems from the fact that excise dutiesexpressed in kroner and the tax base for property valuetax are no longer adjusted in parallel with priceincreases thereby eroding the effective value of rev-enues from these sources The erosion is estimated to bearound of GDP between 2002 and 2010

Second given the overall target for public finances ofa surplus of 1 ndash2 of GDP every year the taxfreeze also has implications for the need for expenditurecontrol If the tax freeze is strictly implemented itimplies that the marginal budget improvement in orderto secure the surplus will have to be taken on the expend-iture side as the tax side has to be taken as given Thiswould mark a break compared to the historic tradition

Table VI3

Composition and balances of general government Denmark (as of GDP)

2000 2001 2002 2003 2004

Government balance (1) 26 28 20 18 21

mdash Total Revenue 573 581 570 562 561

Pm Tax burden 496 499 493 490 490

Government debt 474 454 452 427 399

Pm Cyclically-adjusted balance 15 23 19 20 22

(1) Data exclude UMTS receipts amounting to 02 of GDP in 2001(2) In kind and other than in kind

yen1part The multiannual target for public consumption growth has been 1 for theyears up to 2004 in 2004 and 2005 the target is and from 2006 the tar-get is reduced to

yen2part The definition of the tax freeze also covers user charges and fees therebycovering all sources of income for the public sector

where marginal budget improvements often have beenfound by increasing taxes

A very tentative assessment might suggest that the taxfreeze actually has acted as a mechanism of discipline ofexpenditure control for 2003 and thereby supported theachievement of a growth rate of real public consumptionlower than 1

The strict implementation of the tax freeze is howevernot given as it implies adherence by all levels of govern-ment In Denmark counties and municipalities havecompletely autonomous taxing powers and they governaround two thirds of public consumption Each year anagreement is made between central government and theassociations of counties and municipalities concerningexpenditures in counties and municipalities and theblock grant from the State to these These agreementsare however not legally binding for individual countiesand municipalities

In order to ensure the implementation of the tax freezethe government therefore announced that any breach ofthe tax freeze would be penalised by the central govern-ment This penalising mechanism consists of centralgovernment recuperating the extra revenues earned fromtax increases and using it for reducing State taxes leav-ing the counties and municipalities with a higher tax bur-den but no extra revenues

Despite the announcement of a sanction mechanismbreaches of the tax freeze did occur in late 2002 whencounties and municipalities made their budgets for 2003This could perhaps be viewed as a test by counties andmunicipalities of whether the government would be will-ing and able to implement sanctions However countiesand municipalities have so far only agreed to respect thetax freeze for 2003 No agreements have been made forsubsequent years and a risk therefore exists that the gov-

ernment might find it more and more difficult to enforcethe tax freeze

As mentioned previously the tax freeze in itself implies areduced tax burden over time The reduction is achieved viareducing the tax burden on property and goods submitted toexcise duties It is not as a result of an explicit political pri-oritisation that the reduction in taxes falls on these itemsbut only a result of the fact that these tax rates happened tobe expressed in terms of kroner and not in percentage termswhen the tax freeze was implemented

Increasing the labour supply is considered to be one ofthe main challenges for the Danish economy but the cur-rent prioritisation of where tax reductions are takingplace as a result of the tax freeze does not seem toaddress this problem to any large degree

Judging by comments made by leading ministers a verystrict interpretation has been chosen for the interpreta-tion of when lsquocompelling reasons arriversquo for changing atax rate (1) thereby effectively blocking for revenue-neutral tax reforms which might reduce further the taxeson earned income while increasing other tax rates

The government has announced a tax reform from 2004to 2007 especially intended to help increase the laboursupply The proposal includes an increase in the thresh-old for the intermediate bracket of the State tax and theintroduction of an earned income tax credit When fullyimplemented the tax reductions are estimated to be of GDP by 2007

The main objective of the reform is stated to be anincrease in the labour supply by reducing marginal taxes

Table VI4

Key figures of the Danish convergence programme (2001ndash06)

2001 2002 2003 2004 2005 2006

Real GDP growth (annual change) 10 15 22 18 17 na

General government budget balance ( of GDP)

28 21 22 25 24 na

Primary surplus ( of GDP) 43 34 33 35 33 na

Government debt ( of GDP) 447 439 421 392 367 na

Source 2002 update of the convergence programme of Denmark

yen1part An example given of a reason for changing a tax rate is tax changesimposed by a decision within the EU

However the way the reform is constructed is probablyone of the more expensive ways to increase the laboursupply so if this was the only target more could havebeen achieved for the same costs by reducing the topState tax or further reductions to the intermediate Statetax It therefore appears that also there has been a strongeye to distributional effects in the proposal for the taxreform This focus does not seem to be an obvious policychoice at the expense of increasing labour supply furthergiven the very equal income distribution in Denmark

The overall reduction of of GDP is larger than whathad been announced as tax cuts within the governments

medium-term projection However if the induced laboursupply effect is too small to achieve the targets set in thepublic finance strategy and further additional fiscal lee-way cannot be found consideration could be given toimplementing a less rigid interpretation of when lsquocom-pelling reasons arriversquo for changing a tax rate in order toincrease the scope for reducing taxes on earned incomeby a reprioritisation within the current tax frameworkThis would also be in line with the Council opinion onthe Danish convergence programme 2001 in which thetax freeze was first presented where it was noted that thetax freeze should not be an impediment to reductions ofmarginal taxes on labour

3 Germany

Recent developments

Following a revised 2001 outcome of 28 of GDP thegeneral government deficit is currently estimated to havereached 36 of GDP in 2002 This rise in the deficit ismostly due to a marked shortfall in tax revenues com-pared with the official May 2002 tax estimate andanother widening of the deficit in social security sectorsNot surprisingly the debt ratio has breached the respec-tive Treaty criterion by rising to close to 61 of GDP byend-2002 With the 2002 general government deficitclearly above the respective reference value of theTreaty the Council on 21 January 2003 decided that anexcessive deficit existed in Germany The Council interalia recommended to the German government to imple-ment up to 21 May 2003 the measures announced in thebudget for 2003 amounting to 1 of GDP and to bringthe deficit below the 3 of GDP reference value of theTreaty by 2004 at the latest

The lsquoannual economic reportrsquo by the federal governmentimplies mdash in line with the updated German stability pro-gramme of December 2002 mdash a decline in the nominaldeficit to 28 of GDP in the current year However theCommissionrsquos spring forecast for the 2003 deficit isclearly more pessimistic (34 of GDP) this is mostlydue to the Commission forecast for nominal GDP growthin 2003 being more than 1 percentage point of GDP lowerthan projected by the federal government in its annualeconomic report of January 2003 Furthermore the gov-ernmentrsquos deficit projection still incorporates a consider-able rise in tax revenues from the tax amnesty and theSteuerverguumlnstigungsabbaugesetz which was howeverrejected by the Bundesrat on 14 March (1) Finally theCommission forecast does not incorporate all of theexpenditure savings projected at the level of the Federal

Labour Office by the federal government According toinformation available in early May 2003 the cyclically-adjusted balance would improve in 2003 by around08 percentage points of GDP

In 2004 accelerating growth conducive to employmentcreation should result in a more important fall in thenominal deficit in spite of the implementation of thenext step of income tax reform with a volume of 03 per-centage points of GDP The debt ratio however is pro-jected to rise further to 63 of GDP Based on thestandard no-policy-change assumption (2) and due notleast to the planned tax cuts the improvement in thecyclically-adjusted deficit in 2004 would be minor

A low nominal rise in expenditures and strict expendi-ture control are indispensable to create the margin for thetax cuts planned for 2004 (03 of GDP) and for 2005(around 1 of GDP) To make the achievement of theambitious expenditure targets of the December 2002update of the German stability programme more proba-ble a profound reform of social security systems is anabsolute necessity

Budgetary impact of current reforms

Following the general elections in September 2002 thereconfirmed federal government has embarked on amore ambitious course in economic policy mattersMore courageous structural reforms are to be imple-mented with the overall objective of increasing thegrowth potential of the German economy and reducingunemployment At the same time the federal govern-ment claims that budgetary consolidation will

yen1part In early April this law was still under discussion in the lsquoMediation Com-mitteersquo (Vermittlungsaus-schuss) between the Bundestag and Bundesrat

yen2part The spring 2003 deficit forecast for 2004 is based on the assumption ofunchanged social security contribution rates Furthermore none of themeasures announced by the Chancellor on 14 March could be taken intoaccount as some of them are not yet outlined in detail or have not yet beenintroduced into the legislative procedure

continue in spite of some expenditure-raising measuresannounced in the meantime (for example the investmentprogramme for local public investment and the pro-gramme for the promotion of private construction mdash bothannounced by Chancellor Schroumlder on 14 March 2003)

Regarding the labour market the first proposals pre-sented in August 2002 by the Hartz Commission havealready been implemented in January and in April 2003(incentive schemes for older workers creation of per-sonal service agencies gradual benefit phase-out for lowincome earners) Furthermore the government hasannounced that further proposals in line with thoseadvanced by the Hartz Commission would enter intoforce in 2004 In addition to the more structural meas-ures the rules for entitlement to Arbeitslosenhilf (assist-ance for the long-term unemployed) have been tight-ened as the income of the unemployed personrsquos partneris now being taken into account

For public finances the overall impact of these measuresis clearly positive but in general difficult to quantifyThe projections of the federal government in this regardappear very optimistic Based on a real GDP growthforecast for 2003 of 1 the average number of unem-ployed is projected to reach 421 million a rise by

150 000 on the preceding year At the same time the fed-eral budget assumes that the Bundesanstalt fuumlr Arbeit(Federal Labour Office) mdash in stark contrast to 2002 mdashwill need no federal transfers in the current year In spiteof a projected rise by 150 000 in the overall number ofunemployed in 2003 the number of unemployed peopleentitled to Arbeitslosengeld is to decrease by 203 000 toa large part due to the implementation of the above-men-tioned measures

On 14 March Chancellor Schroumlder in an official lsquodecla-ration of the governmentrsquo to the Bundestag announcedadditional reform measures regarding Arbeitslosenhilfethe maximum period of entitlement shall be reduced to12 to 18 months from presently up to 32 months Thecurrent benefit withdrawal for long-term unemployedtaking up work will be reduced and the sanctions forthose who refuse a job offer will be tightened FinallyArbeitslosenhilfe and Sozialhilf (social assistance) are tobe merged with the benefit level of Arbeitslosenhilfegoing down to the level of Sozialhilfe

Without any doubt these measures will increase incen-tives to take up a job instead of relying on social benefitpayments which in the past often discouraged unem-ployed from accepting a job offer Furthermore they are

Table VI5

Composition and balances of general government Germany (1) (as of GDP)

2000 2001 2002 2003 2004

Government balance (2) 11 ndash 28 ndash 36 ndash 34 ndash 29

mdash Total expenditure 459 483 486 489 484

Primary balance 45 05 ndash 04 ndash 02 03

Pm Tax burden 432 415 407 413 414

Pm Cyclically-adjusted balance ndash 21 ndash 30 ndash 33 ndash 26 ndash 24

Pm Cyclically-adjusted primary balance 13 03 ndash 01 06 08

fully in line with the projections of the updated stabilityprogramme submitted by Germany in December 2002which projected a clear decrease of the share of lsquosocialtransfers other than in kindrsquo from a (rounded) 19 ofGDP in 2002 to 18 in 2004 mdash the year when most ofthese measures are to be implemented

Regarding healthcare the government declaration of14 March announced a whole catalogue of differentmeasures insurers are to gain stronger bargaining power

and shall be allowed to negotiate costs directly with doc-tors and the cost sharing by patients shall be increased toraise their cost awareness The Chancellor also proposedthat in the future employees should seek a private insur-ance for the continued salary payment in case of sick-ness which is currently paid by the public health system

According to the Chancellor the overall aim of thereform of the public healthcare system is to bring thecontribution rate down below 13 of gross income

(from a currently estimated 144 ) While this target ishighly welcome given the negative effect of currentcontribution rates on employment the tax financing ofthe so-called versicherungsfremden Leistungen (1) alsoannounced by the Chancellor may constitute a risk to thevery ambitious consolidation programme laid out in themost recent update of the German stability programmeof December 2002 Furthermore Mr Schroumlder remainedelusive on some aspects indicating only that parts of thenecessary measures were being prepared by the respec-tive ministries while important questions regarding thefinancing part should be presented by the Ruumlrup Com-mission in May

Regarding the pension system the government declara-tion conceded that the projections underlying the recentreform (Riester-Rente) have already proved too optimis-tic and underlined that he expected detailed proposalsfrom the Ruumlrup Commission on how to further adopt thepension system

In his speech of 14 March the Chancellor also announcedmeasures aimed at liberalising regulations for crafts andat reducing bureaucracy especially for small and

medium-sized companies As had been frequentlypointed out by the Commission in the past the implemen-tation of such measures appears very important to raisethe currently very low growth potential of the Germaneconomy However their impact on public finances willin the short term probably be negligible In the mediumterm however stronger average growth appears as thebest way to put public finances on a sustainable basis

All in all the reform measures already implemented orcurrently discussed go into the right direction Howeverat the current juncture many proposals are not yetelaborated in such a way as to allow a final judgementon whether their implementation would allow theachievement of the very ambitious budgetary targets ofthe updated German stability programme of December2002 In particular it remains to be seen how courageousthe proposals for the health and pension system turn outand whether the currently discussed reforms will actu-ally be implemented

In this regard a reform of the social security systemsaimed at cutting expenditures and at bringing contribu-tion rates down to acceptable levels appears as the bestmeans to raise the growth potential of the German econ-omy and to put public finances again on a sustainablebasis

Table VI6

Key figures of the German stability programme (2002ndash06)

2002 2003 2004 2005 2006

General government budget balance ( of GDP) ndash 38 ndash 28 ndash 15 ndash 10 00

Primary surplus ( of GDP) ndash 05 05 20 20 30

Source 2002 update of the stability programme of Germany

yen1part Benefits currently paid by health insurance systems deemed not to be cov-ered by contributions

4 Greece

Recent developments

Despite strong economic growth in 2002 the generalgovernment deficit was only slightly reduced to 12 ofGDP from 14 in 2001 The government gross debtfell after two consecutive years of increase but remainedat a high level equal to 1049 of GDP in 2002

The favourable domestic economic conditions in com-bination with measures of further containment of taxevasion and enhancement of the tax base contributed toan increase in total revenues at the targeted rate How-ever the general government surplus of 08 of GDPanticipated in the 2002 State budget and in the 2001 sta-bility programme did not materialise mainly due to thedisappearance of the one-off effects of the UMTS-salein 2001 and the reclassification of a number of opera-tions which primarily affected the expenditure side andto a lesser extent government revenues In additionoverruns in almost all categories of primary expendi-tures increased the deficit of the State budget to 35 of GDP compared to the estimated 29 The primarysurplus in 2002 declined to 43 of GDP from 49 achieved in 2001

The 2003 State budget projects a central government def-icit of 43 of GDP corresponding to a general govern-ment deficit of 09 of GDP Notwithstanding the signif-icant increase in the deficit of ordinary budget as well asin the deficit of public investment programme the Statebudget deficit in percent of GDP is estimated to be thesame as in 2002 as a result of the projected high GDPgrowth On the other hand the surplus of social securityfunds and local authorities which is estimated to slightlyincrease in 2003 appears to be the main factor shaping theforeseen reduction in the general government deficit (1)

According to the Commission forecasts the general gov-ernment deficit for 2003 is projected to stand at 11 ofGDP compared to an estimated 12 of GDP in 2002The deceleration in government consumption expendi-tures projected in the State budget could be consideredrather optimistic (2) In fact the uncertainty characteris-ing some categories of expenditures mainly wages mayresult in an overshooting of the projected primary expen-ditures The general government consolidated grossdebt-to-GDP ratio is projected to stand at 101 at theend of 2003 compared to 1002 estimated in the Statebudget and in the 2002 stability programme

In the 2002 stability programme a further improvementin the budgetary position is projected throughout theperiod covered by the programme The central govern-ment deficit is expected to stand at 37 in 2004 and todecline to 23 in 2006 The general government deficitis projected to turn into a surplus from 2005 onwards andthe government debt ratio is expected to decline by123 percentage points in the period 2004ndash06 reaching879 of GDP at the end of 2006

The projected progressive deceleration in primary spend-ing is subject to the risks mentioned above Consideringthe foreseen slowdown in budget revenues an overshoot-ing of the projected spending would lead to a ratherslower than the expected reduction in the general govern-ment debt-to-GDP ratio

Revisions of budgetary data and their impact on the general government deficit and debt

In 2002 the bilateral discussions between Eurostat andthe Greek statistical authorities led to a significant revi-

yen1part According to the last notification (March 2003) the surplus of social secu-rity funds and local government amounted to 27 of GDP in 2001 and isestimated to have been equal to 35 of GDP in 2002

yen2part In the 2002 update of the stability programme government final consump-tion expenditure is estimated to increase by 25 in 2003 compared to67 in 2002 However according to revised data in 2002 the generalgovernment consumption expenditure appears to have been increased by115 in nominal terms

sion of the Greek budgetary data for 2000 and 2001 Infact the agreed changes resulted in an upward revisionof the government debt ratio while the anticipated gov-ernment surpluses for 2001 and 2002 turned into deficitsThe slow decline in the debt ratio from 1997 onwardshas been reversed and in fact the debt ratio increasedboth in 2000 and 2001

The reclassifications required by Eurostat were relatedto large debt management financial operations that havebeen reflected in the unusually high stock-flow adjust-ments as well as to government expenditures previouslyexcluded from the budget (1) Specifically the increasein general government deficit for the years 2000 and2001 resulted from treating debt assumptions as well ascapital injections to public enterprises as capital trans-fers Moreover before the adjustments the debt man-agement related financial operations were either notincluded or incorrectly treated in government books cre-ating a picture of government balances not correspond-ing to the actual evolution of the debt-to-GDP ratioThus the treatment of debt creating financial operations

according to generally accepted practices is expected toimprove the transparency and credibility of the Greekbudgetary accounts

The reclassified operations can be grouped into the fol-lowing categories

bull Capital injections The treatment of capital injections(that is of increases in the share capital of publicenterprises) in the ESA government accounts is notstraightforward These transactions are recorded asfinancial transactions without any direct impact onthe government deficit when the national account-ants consider that the government is acting as a share-holder which provides funds and expects to receiveproperty income in future However when the capitalinjections are no more than a grant that is paid tocover losses or to compensate the company for publicservices the transaction should be recorded as gov-ernment expenditure and included in the governmentdeficit In the case of Greece Eurostat considered thatthe distinction between these two cases was not strictenough and asked the Greek statistical service torecord capital injections to a group of enterprises inthe deficit

Table VI7

Composition and balances of general government Greece (1) (as of GDP)

2000 2001 2002 2003 2004

Government balance (2) ndash 19 ndash 14 ndash 12 ndash 11 ndash 10

Pm Tax burden 388 366 364 362 357

Government debt 1062 1070 1049 1010 970

(1) Commission spring 2003 economic forecasts(2) Data include UMTS receipts amounting to 05 of GDP in 2001(3) In kind and other than in kind

yen1part The large financial operations which affected the evolution of the debt ratiowere mirrored in the stock-flow adjustments which reached 71 of GDPin 2001 and stood at 37 of GDP in 2002

bull Debt assumptions According to the ESA95 rulesthe assumption of State guaranteed debt of public orprivate companies is recorded as capital transferthat is a government expenditure However Greeceused to register debt assumptions as financial trans-actions and not as government expenditure

bull Coinage In Greece as in most EU Member Statescoins are issued by the Treasury and are a compo-nent of government debt This implies that the pro-ceeds collected by government at the issuance ofcoins have a financial nature and therefore do nothave any direct favorable effect into the deficit (1)However in Greece the coinage proceeds used to berecorded as government revenue and improved thedeficit The correction of this accounting inconsist-ency had a negligible impact on the years before2002 since the regular issuance of coins is verysmall However for 2002 the impact was quiteconsiderable since it was the year that the wholestock of coins in circulation was replaced because ofthe euro cash changeover

bull Securitisation The Greek government has been rel-atively active in securitising expected future reve-nue The Greek statistical authorities used to recordthe securitisation proceeds outside the governmentdeficit and therefore the Eurostat decision of July2002 did not have any impact on the Greek govern-ment deficit However Eurostat also decided thatthe proceeds collected through securitisation shouldbe treated as loans and therefore included in the gov-ernment debt

bull Finally Eurostat considered that according to theESA95 rules share exchangeable and share convert-

ible bonds should be treated as the normal govern-ment bonds and should be included in the stock ofgovernment debt

The agreed total revisions of budgetary accountsamounted to 13 of GDP in 2001 and 19 of GDPin 2002 Correspondingly the debt ratio was revised by73 percentage points in 2001 and 80 percentage pointsin 2002

Specifically in 2001 more than half of the revision of thegeneral government deficit was accounted for by thecapital injections to public enterprises The rest of theadjustments resulted almost entirely from debt assump-tions whereas the impact on interest payments was lessthan 01 of GDP

Overall the estimated surplus of 01 of GDP reportedin the September 2002 notification was turned into a def-icit equal to 12 of GDP in the revised notificationsubmitted in November 2002 whereas in the March 2003notification the general government deficit for 2001 wasfurther raised to 14 of GDP due mainly to an increasein public investment and interest payments

Concerning government debt an amount equal to 54 of GDP related to proceeds from securitisation of futurerevenues and share convertible bonds was alreadyincluded in the debt in the September 2002 notificationHowever the proceeds from share exchangeable bondsadded an amount equal to 19 of GDP raising the gov-ernment debt to 107 of GDP from 1051 of GDPreported in the September 2002 notification

In 2002 the reclassification of capital injections to pub-lic enterprises raised government deficit by 07 ofGDP while debt assumptions added another 02 ofGDP to the deficit In the same year an amount equal to04 of GDP representing proceeds from coinage was

Table VI8

Key figures of the Greek stability programme (2001ndash06)

2001 2002 2003 2004 2005 2006

Real GDP growth (annual change) 41 38 38 40 37 36

General government budget balance ( of GDP) ndash 12 ndash 11 ndash 09 ndash 04 02 06

Primary surplus ( of GDP) 51 44 44 46 50 52

Government debt ( of GDP) 1070 1053 1002 961 921 879

Source 2002 update of the stability programme of Greece

yen1part In fact there is even a small detrimental impact into the government deficitas the cost of minting the coins is recorded as government expenditure

excluded from government revenues Moreover thegeneral government deficit for 2002 was furtherincreased by 06 of GDP due mostly to the budgetaryoutcome of the year reaching 19 of GDP Thus theestimated surplus of 08 of GDP reported in the 2001update of the stability programme turned into a deficit of11 of GDP The same deficit is reported in the 2002update while the March 2003 notification reports ahigher deficit equal to 12 of GDP due to higher publicinvestment spending

Government debt was similarly revised upwards by 8 of GDP in 2002 the main contributors to this increasebeing the same as in 2001 Thus the estimated govern-ment debt of 973 of GDP reported in the 2001 updateof the stability programme was revised up to 1053 of

GDP in the 2002 update However the March 2003 noti-fication reports a slightly lower debt ratio equal to1049 of GDP due to a higher than the previously esti-mated increase in GDP

The correction of budgetary data while improving thecredibility of the Greek public accounts points at thesame time to the imperative need for further and moredecisive consolidation of the Greek public finances Allthe adjustments in the budgetary data were linked to cur-rent expenditures indicating the persisting pressures forincreases in public spending even under the favourableconditions of strong growth Additional measures aretherefore required to limit current spending and bringdown the debt ratio at a faster pace in view of theexpected budgetary costs from an ageing population

5 Spain

Recent developments

Since the mid-1990s Spainrsquos fiscal strategy based onexpenditure restraint has been successful in reducing thegeneral government deficit from 66 of GDP in 1995to 01 in 2002 In the same period the debt-to-GDPratio declined from 639 in 1995 to 540 in 2002While fiscal consolidation was supported by the strongexpansion of the economy until mid-2001 the reductionof the deficit continued in 2001ndash02 The balanced budgetin 2002 was obtained thanks to revenue buoyancysupported by relatively strong domestic demand andemployment creation coupled with savings on publicconsumption and interest payments In particular thecorporate income tax posted a record increase (24 ona cash basis) due to a surge in declared capital gainsfollowing the introduction of a favourable regime fortheir reinvestment Additionally civil service pay wasincreased below the CPI inflation rate helping to moder-ate public consumption Finally the interest paymentsfall reflected both the decreasing debt burden and lowerinterest rates In cyclically-adjusted terms the fiscalstance in 2002 can be regarded as slightly restrictive

As a result the GDP share of current resources rose to395 in 2002 (390 in 2001) while total currentexpenditure remained broadly stable at 353 of GDP(351 in 2001) The slight increase in public saving asa percentage of GDP was accompanied by the marginalincrease in the share of gross capital formation reaching33 of GDP in 2002

In the baseline scenario of the 2002ndash06 updated stabilityprogramme a target of a general government balancedbudget is envisaged for 2003 and 2004 (maintaining thetarget for 2003 and revising only marginally the targetfor 2004 with respect to the previous update) Targets for2005 and 2006 are small surpluses of 01 and 02 ofGDP respectively The primary surplus is set to remainbroadly unchanged at close to 27 of GDP throughoutthe programme period

The debt-to-GDP ratio is expected to continue to declineby around 2 percentage points every year throughout theprogramme period falling below 47 of GDP by 2006These objectives assume the economy grows at a rateclose to potential (3 ) between 2003 and 2006 withhigher inflation compared with the previous update(average annual growth of the GDP deflator of 28 and25 respectively) The fiscal strategy continues to relyon restraint of primary current expenditure supported bylower interest payments while allowing for a strength-ening of public investment The programme incorporatesthe effects of the recently implemented reform of per-sonal income tax with an estimated direct cost of 04 of GDP in 2003 and 2004 (see next section for details)

Finally the programme incorporates the full effect ofthe new financial system for regional governmentswhich has involved further decentralisation of tax andspending powers The parallel implementation of theGeneral Law of Budgetary Stability which prescribesthat all public entities have to present their accounts inbalance or in surplus (1) is meant to provide furthersupport to the consolidation strategy in a context ofhigher fiscal decentralisation

For 2003 the target of a general government balancedbudget is being tested given the worsening in the macr-oeconomic scenario and the implementation of the per-sonal income tax reform By comparison the Commis-sion forecasts a deficit of 04 of GDP based on GDPgrowth of 20 reflecting also a less optimistic assess-ment of the effects of the tax reform on domesticdemand However for the rest of the projection periodfiscal objectives appear to be based on cautious growthassumptions and seem attainable (for comparison theCommission services forecast a GDP growth of 3 anda slight deficit of 01 in 2004 on an unchanged policy

yen1part Deficit budgets can be presented in certain circumstances if justified andreturning to balance or surplus within the three-year planning period (see thecase study on Spainrsquos General Law of Budgetary Stability in Chapter V5)

basis) All in all the underlying budgetary positionimproves by over a percentage point over the pro-gramme period to a surplus of 03 of GDP in 2006

The new income tax reform in Spain main features and implications

Main features of the new tax reform

The new personal income tax was approved at the end of2002 The 2003 income tax declaration on incomesearned in 2002 will still be based on the previous systemand the first tax declaration according to the new taxrules will be submitted in June 2004 However theeffects of this reform are already evident in 2003 as the

new tax rates are currently being applied to income sub-ject to withdrawal at the source

The reform introduces fewer and smaller changes thanthe previous reform adopted in 1998 of which the newreform is considered to be a continuation Accordinglythe measures aim at simplifying further the tax systemby lowering the number of tax brackets and increasingthe income threshold below which an individual is nolonger required to file a tax return The major changescan be summed up as follows

Minimum and maximum marginal rates are loweredfrom 18 and 48 to 15 and 45 respectively (20 and56 in the income tax prevailing up to 1998) In turn

Table VI9

Composition and balances of general government Spain(as of GDP)

2000 2001 2002 2003 2004

Pm Tax burden 357 356 361 359 358

Pm Cyclically-adjusted balance (1) ndash 16 ndash 08 ndash 04 ndash 04 ndash 01

Pm Cyclically-adjusted primary balance (1) 17 23 25 23 24

Table VI10

Key figures of the Spanish stability programme (2001ndash06)

2001 2002 2003 2004 2005 2006

General government budget balance ( of GDP) ndash 01 ndash 02 00 00 01 02

Source 2002 update of the stability programme of Spain

the number of tax brackets is reduced from six to five(see Table 1)

The minimum level of earned income which impliesthe obligation of filling a tax return is increased toEUR 22 000 when this income stems from a singlewage earner compared to EUR 21 035 in the previoussystem (1) The new tax keeps the concept of taxableincome introduced in the 1998 reform taxable incomeis obtained after deducting a tax-free allowance theso-called lsquoexempted minimum living standardrsquo whichreplaced a vast set of tax reliefs As in the previousscheme this tax-exempt minimum living standardvaries depending on personal and family circum-stances However these thresholds have now beenraised For instance the basic individual exemptedincome increases by 28 to EUR 3 400

The reform introduces a more favourable fiscal treat-ment for some disadvantaged groups to promote theirinsertion in the labour market and raise employmentSpecifically tax reliefs for working women with chil-dren (EUR 1 200 for every child aged below three)higher tax reliefs for unemployed workers accepting ajob implying geographical mobility tax advantages fordisabled workers and workers aged above 65

With a view to remedying low geographic mobility ofworkers partially attributable to the poor functioning ofthe housing market the new income tax establishesfiscal advantages for letting of accommodation Thisincludes a relief of 25 of net rental income an addi-tional relief of 25 for five years for housing at presentunoccupied and let before the end of 2004

A more favourable fiscal treatment of income from cap-ital in the reform is targeted at promoting saving In par-ticular realised capital gains (net worth gains) on assetsheld for more than one year are now taxed at 15 (18 previously) while tax relief for capital incomes fromassets held for more than two years is raised to 40 from30 In addition capital gains obtained from invest-ment funds will not be taxable as long as they are rein-vested in other funds

Private pension plans are promoted by raising the thresh-olds to be deducted in the tax base In addition pension

insurance contracts are to have a similar fiscal treatmentas pension funds when the main purpose of the insurancepolicy is long-term saving for retirement

Finally the withholding tax rate applied to interest fromdeposits capital gains stemming from share sales andother non-labour incomes is lowered from 18 to 15 inline with the minimum marginal income tax

A tentative assessment of the new income tax

The new income tax regime does not change dramati-cally the existing structure put in place by the 1998 taxreform However the reform is likely to reinforce thereduction in the share of taxation directly paid by house-holds observed since the mid-1990s According to offi-cial estimates the current reform will involve a reduc-tion of the effective average income tax rate of 11 while by level of income the impact is officially esti-mated as being progressive However estimates carriedout by independent researchers highlight an unevenimpact of the reform with a significant reduction in theeffective average tax rate occurs only for the lowest andthe highest income brackets (2) marginal tax rates formiddle-range incomes are broadly unchanged

The reform can be expected to boost the labour supplygiven the reduction in the marginal tax rate at the bottomof the income scale The tax relief introduced for work-ing women with children aims at increasing the femaleemployment rate which at present is very low It mightalso have some positive impact on the fertility rate whichis one of the lowest among developed countries The fis-cal rebates on labour incomes for workers aged above65 could also have positive effects on the labour partici-pation of older workers

The more favourable taxation of unemployed workersaccepting a job offer implying a move to another placeof residence is a positive measure given the low labourmobility in Spain and the wide disparities in unemploy-ment between regions Nevertheless mobility is unlikelyto increase significantly in the absence of a reform of thecurrent benefit system and a better functioning of thehousing market In this respect the new fiscal treatmentof letting of accommodation might imply an increase inthe current rather limited supply of this kind in SpainHowever some doubts arise on the final effect of thismeasure given the absence of reduction in the current

yen1part According to the Spanish Statistical Institute the average gross wage(including non-labour costs) in annual terms is estimated at approximatelyEUR 23 450 yen2part See for example Pampillon and Raymond (2002)

fiscal relief for housing purchase which is more favour-able than that envisaged for letting

In general the new income tax contains positive meas-ures to encourage labour participation and improve thefunctioning of labour market However a fuller assess-ment will only be possible after a certain period of time

As for the fiscal treatment of saving a positive aspect ofthe new income tax refers to long-term savings related toretirement The rise in the annual thresholds to qualifyfor tax relief for private pension contributions is a posi-tive measure in the light of the future financial pressureson the public pension system stemming from ageingLikewise the tax exemption for capital gains realised onan investment fund and reinvested in another fundshould promote saving Additionally this measure isexpected to increase competition not only among differ-ent types of funds but also among financial institutions

Regarding the macroeconomic and budgetary impactaccording to government estimates the income taxreform will add 05 percentage points to GDP growth(although whether this impact takes place over one ortwo years is not specified) The estimated loss of reve-nues is set at 03 of GDP in 2003 including the sec-ond-round effects caused by the reform This estimatemight prove optimistic given the average tax reductionof 11 the cost of the reform excluding second-roundeffects could be roughly estimated at around 06 ofGDP As to the effects on growth both in terms ofimmediate impact and second-round effects an econo-metric simulation performed with the CommissionQUEST model suggests that the impact of the reformon GDP growth is an increase by 01 in 2003 In themedium term this impact is estimated as adding around02 percentage points per year to GDP between 2004and 2006

Table VI11

Main features of recent tax reforms

1998 income tax 2002 income tax

Net tax base up to EUR

Taxable income

Rest up to EUR

Marginal tax rate

Taxable income

Rest up to EUR

Marginal tax rate

000 000 3 67819 180 000 0 4 000 150

3 67819 66207 9 19548 240 4 00000 600 9 800 240

12 87370 2 86899 12 26064 283 13 80000 2 952 12 000 280

25 13432 6 33875 15 32580 372 25 80000 6 312 19 200 370

40 46030 12 03995 26 97342 450 45 00000 13 416 mdash 450

67 43355 24 17799 mdash 480 mdash mdash mdash mdash

6 France

Recent developments

In 2002 the situation of French public finances deterio-rated markedly The general government deficit reached31 of GDP thus breaching the 3 of GDP referencevalue of the Treaty This outcome is to be compared witha general government deficit of 14 of GDP plannedby the French authorities in the Finance Law for 2002For the first time since 1998 the general governmentdebt ratio increased in 2002 reaching 591 of GDP upfrom 568 of GDP in 2001 The larger part of the slip-page in the 2002 general government deficit is due to adeterioration in the cyclically-adjusted budget positionaccording to Commission calculations the cyclically-adjusted balance worsened by 11 percentage points ofGDP in 2002 to reach 33 of GDP This results from(1) an overrun in expenditures (2) the implementation oftax cuts worth percentage point of GDP and (3) a rel-atively low tax-to-GDP elasticity The remaining reflectsa base effect due to the incorporation in the deficit of acapital injection in the firm RFF (Reacuteseau Ferreacute deFrance) worth 01 percentage point of GDP and theimpact of adverse cyclical developments Indeed realGDP grew by 12 last year as against 25 projectedin the budget for 2002 According to Commission calcu-lations the cyclical component of the deficit worsenedby 05 percentage points of GDP in 2002

The developments in public finances in 2002 provideevidence of the existence of an excessive deficit positionin France The Commission has therefore decided inMarch 2003 to initiate an excessive deficit procedure(EDP) in the case of France This procedure follows theearly warning issued by the Council in January 2003and recommending that France lsquoensures that the 3 ofGDP reference value for the general government deficitwill not be breached in 2003rsquo A recommendation to theCouncil to recommend to France measures to correct theexcessive deficit has been adopted by the Commissionon 7 May 2003 and is expected to be endorsed by theEcofin Council on 3 June

However under current policies French public financesare expected to deteriorate further in 2003 the budget for2003 does not contain measures reducing sizeably theunderlying deficit and unfavourable cyclical develop-ments will continue weighing on fiscal revenues The gen-eral government deficit is projected by the French author-ities to reach 34 of GDP and by the Commission toreach 37 of GDP In the same year the gross govern-ment debt is projected by the Commission and the Frenchauthorities to breach the 60 Treaty reference value

These projections are subject to downside risks In par-ticular after a year of freeze in real wages wage claimsby unions in the central government sector could triggerstronger than projected current expenditures This effectcould overlap with the financing of the priorities of thenew government in the field of national security On theother side the French authorities decided to cancelexpenditures worth 01 of GDP and to freeze creditsfor an amount of 015 of GDP However as long asthey are not cancelled the credits frozen can still bespent in the current budgetary exercise

In 2004 despite the acceleration in economic activity toa close to potential rate the general government deficitis projected by the Commission under a no policychange assumption to decrease only marginally to 35 of GDP The decline in the deficit in 2004 will be bur-dened by the lagged impact of the low 2003 GDP growthon fiscal revenues The French authorities expect astronger decline in the government deficit in 2004 to29 This forecast is based on the assumption thatmeasures ensuring an improvement in the cyclically-adjusted balance by 05 percentage point of GDP in 2004will be implemented in the budget for that year

The urgency of reforming the French pension system

As in many other European countries public finances inFrance will face problems arising from ageing popula-

tion over the next decades Existing projections showthat the old-age dependency ratio will increase rapidlyto almost double between 2000 and 2050 In the absenceof further reforms the share of pension expenditures toGDP will increase by around 4 percentage points of GDPover the next 40 years The pension system todaybroadly balanced could then post a deficit as high as38 of GDP in 2040

While the magnitude of ageing comparable in France tothat expected in the other EU countries the timing willbe somewhat different as the larger part of the demo-graphic change will occur earlier in France than in most

other EU countries Pension expenditures will startincreasing faster than GDP as from 2005 and the growthdifferential will widen markedly as from 2010 Pensionexpenditures are projected to increase by 3 percentagepoints of GDP in France between 2000 and 2020 and byonly 1 percentage point of GDP on average in the EU

Therefore reforming the pension system in view toensure its financial sustainability is urgent The Frenchauthorities committed themselves to implement a com-prehensive reform of the pension system before thesummer 2003 This commitment follows a long period ofbroad consultations with the social partners Since the

Table VI12

Composition and balances of general government France (1) (as of GDP)

2000 2001 2002 2003 2004

Of which mdash current taxes (3) 277 275 255 255 255

Primary balance (4) 17 16 00 ndash 05 ndash 02

Pm Tax burden 450 447 440 438 439

Pm Cyclically-adjusted primary balance 09 09 ndash 03 ndash 03 01

(1) Commission spring 2003 economic forecasts(2) Data include UMTS receipts amounting to 01 of GDP in 2001(3) Taxes on production and imports and current taxes on income and wealth(4) In kind and other than in kind

Table VI13

Key figures of the French stability programme (2002ndash06)

2001 2002 2003 2004 2005 2006

General government budget balance ( of GDP) ndash 14 ndash 28 ndash 26 ndash 21 ndash 16 ndash 10

Primary balance ( of GDP) 17 04 06 10 15 20

Source 2002 update of the stability programme of France The figures presented from 2004 are those of the lsquocautiousrsquo scenario of the stability programme which projects real GDP growth at 25 as from 2004 and was considered by the Commission as the most plausible one

implementation of the reforms of 1993 and 1995 whichincreased the number of contribution years giving rightto a full pension the main new measure has been thecreation of a Pension Reserve Fund in 1999 This Fundis projected to have accumulated assets for a totalamount of 10 of GDP in 2020 and is only intended tosmooth the financial shock during the retirement of theearly baby boom cohorts Indeed the assets of the fundwill be largely insufficient to cover increased spendingon pensions

Limited information has been released up to now on themain lines along which the reform will be based (seeBox VII) However it appears likely that a driving prin-ciple is to safeguard the compulsory schemes financedon a pay-as-you-go basis which the national strategyreport regards as an essential condition for inter- andintra-generational solidarity The reinforcement of thethird pillar based on encouraging private saving seemsalso to be among the intentions of the current govern-ment as well as the willingness of putting on a moreequal footing conditions for retirement in the public andin the private sectors

In this context any possible reform of the pension systemwill necessarily be organised around the modification ofthe three essential parameters of the system (1) thereplacement ratio (2) the rate of social contributionsand (3) the retirement age The reform will probably relyon a change of all these parameters Indeed according to

the estimates presented by the French authorities in thenational strategy report on pensions achieving the sus-tainability of the pension system changing only one ofthese parameters would require too large an effort Cur-rent estimates show that solving the problem via a reduc-tion in the replacement ratio alone requires a reduction ofthis parameter by more than 30 percentage points In thesame vein changing only the average retirement agewould necessitate an increase by at least six years of thecontribution period and relying only on increasingsocial contributions would imply an increase in thelabour cost by more than 6

If this latter option was to be followed the resultingincrease in the labour cost would be huge and couldhave strong negative effects on labour demand It isindeed generally accepted that a rise in the labour costby 1 percentage point reduces the demand for labour by03ndash05 percentage points This option would not befully compatible with the Lisbon strategy neither sat-isfy the objective of fairness across generations

Finally in France still exists a large scope for increasingthe effective retirement age by encouraging labour sup-ply of older people as the employment rate of olderworkers is among the lowest in the EU This could beachieved notably by strengthening the link betweencontribution and benefits in order to increase the incen-tives to remain at work when entering in more maturecohorts

Box VI1 Main features of the French pension system

The French pension system is based on compulsory pay-as-you-go schemes which cover 98 of total pension expenditureand are financed by social security contributions and taxes The larger scheme is the general scheme which covers themajority of workers of the private sector Civil servants and State enterprise employees are covered by a variety of specialschemes which are generally more generous than those for private sector employees The basic schemes contain solidarityelements and give pension on the basis of the number of contribution years Alongside the basic schemes compulsorycomplementary schemes exist which cover workers by category (AGIRC for managers and for ARRCO other employers)The benefit formula of these supplementary schemes is based on a point system and ensures a close link between contri-butions and benefits

On its current form the system is relatively generous compared to other countries Indeed the legal retirement age set at60 and the effective average retirement age currently at 587 years according to Eurostat are among the lowest in the EUThe replacement ratio is relatively high in France compared to other EU countries and retired households are at no higherrisk of poverty than other households as a minimum level is guaranteed The current system provides weak incentives tocontribute beyond the age at which a full pension entitlement is acquired

7 Ireland

Recent developments

After five years of surpluses with a peak of 43 ofGDP in 2000 the out-turn for the general governmentbalance in 2002 is estimated to have been a negligibledeficit of 01 of GDP (or 02 of GDP excludingUMTS receipts) around percentage point below tar-get (1) As in 2001 the deviation from target is due to alarge tax undershoot and some expenditure overruns (ona general government basis) While cyclical develop-ments are undoubtedly in part to blame for the large rev-enue shortfalls of the past two years difficulties seem tohave arisen in accurately costing tax packages and fore-casting revenues Regarding expenditure in 2002 sav-ings on interest payments and public investment partlycompensated for overruns on current primary spendingGiven high nominal growth the debt-to-GDP ratiowhich has been the second-lowest in the EU since 2000fell by three percentage points to one third of GDP at theend of 2002

The cyclically-adjusted balance is estimated to havedeteriorated by almost 1 percentage point of GDP in2002 Although calculations of the output gap are subjectto a particularly large margin of error in Ireland thispoints to a discretionary easing of budgetary policy in2002 rather than broadly neutral as planned in the previ-ous update of the stability programme 2002ndash04 and asrecommended by the broad economic policy guidelinesfor 2002 By the same measure fiscal policy was loos-ened by more than 3 percentage points of GDP over theperiod 2000ndash02

By contrast the budget plans for 2003 unveiled on4 December 2002 together with the new stability pro-gramme 2003ndash05 implement a tightening of fiscal

policy by some of GDP The budget for 2003 (2)increases the tax take by 09 of GDP compared to ano-policy change scenario two thirds of which comesfrom increases in indirect taxes and stamp duties On theexpenditure side a 1 cut in nominal capital spending(which translates into a very significant real cut in view ofhigh construction inflation) makes room for increased cur-rent spending Even so the budget plans a marked reduc-tion in the growth rate of current discretionary expendi-ture (3) to 8 for 2003 from 15 in 2002 and 22 in2001 The main measures regarding current spending area relatively modest social welfare package and a rise in thepublic sector pay and pensions bill by 11 (4)

The original budget-day target for the general govern-ment balance in 2003 a deficit of 07 of GDP wasrevised to 08 in March (5) The Commission spring2003 economic forecasts project a slightly better out-come with a deficit of 06 of GDP for 2003 corre-sponding to a restrictive fiscal stance In 2004 the deficitis expected to widen further to 09 of GDP (on a no-policy change basis)

According to the updated stability programme the gen-eral government deficit is projected to reach 12 ofGDP in 2004 and to remain at that level in 2005 Thesetargets incorporate technical provisions for unspecifiedfuture budget measures with a full-year cost of 07 ofGDP in each year which is subject to review lsquoin light ofemerging economic conditionsrsquo They also include

yen1part For this assessment the original budget-day target (+ 07 of GDP)has been adjusted to (i) include UMTS receipts of 02 of GDP and(ii) exclude a transfer from the Central Bank of 05 of GDP which had tobe reclassified below the line

yen2part The rest of this parafigure is based on the budget plans in terms of theExchequer cash accounts

yen3part This refers to the concept of lsquovotedrsquo current spending for which annualapproval by Parliament is needed and which excludes inter alia the serv-ice of the national debt and the contribution to the EU budget

yen4part This includes a provision of 04 of GDP for payment of the first quarterof the lsquobenchmarkingrsquo awards (backdated to December 2001) The bench-marking process was initiated in mid-2000 to adjust pay rates in the publicsector by reference to rates in the private sector for comparable jobs Thebenchmarking bodyrsquos report of mid-2002 recommended pay increases dif-ferentiated by grade leading to an 89 rise in public sector pay costswith an estimated full-year cost of 08 of GDP

yen5part From the March 2003 reporting of government deficits and debt levels inaccordance with Council Regulation (EC) No 360593 as amended byCouncil Regulation (EC) No 4752000

contingency provisions (against unforeseen develop-ments) of 04 of GDP in 2004 and 08 in 2005 Incyclically-adjusted terms the targets for 2004ndash05 implya broadly neutral stance but excluding the contingencyprovisions would have a tightening bias The debt ratiois projected to rise by less than 1 percentage point overthe programme period to just below 35 by 2005 With-out the build-up of non-general government assets in theNational Pensions Reserve Fund (NPRF) (1) howeverthe (gross) debt ratio would continue to fall to 2005

Recent initiatives on expenditure management

Driven by the need to improve infrastructure and publicservices discretionary spending almost doubled between1997 and 2002 (2) The occurrence of overruns andconcerns about securing lsquovalue for moneyrsquo raise theissue of whether control and management systems areadequate This section reviews progress on implement-ing the recommendations on expenditure management in

Table VI14

Composition and balances of general government Ireland (as of GDP)

2000 2001 2002 2003 2004

Government balance (1) 43 11 ndash 02 ndash 06 ndash 09

Pm Tax burden 321 307 293 292 287

Pm Cyclically-adjusted balance (1) 26 00 ndash 09 ndash 03 01

Table VI15

Key figures of the Irish stability programme (2003ndash05)

2001 2002 2003 2004 2005

General government budget balance ( of GDP) (1) 16 ndash 05 ndash 07 ndash 12 ndash 12

Primary surplus ( of GDP) (1) 31 10 09 03 04

(1) Data exclude UMTS receipts amounting to 02 of GDP in 2002 and include contingency provisions (against unforeseen developments) of 04 of GDP in 2004and 08 of GDP in 2005

Source 2002 update of the stability programme of Ireland

yen1part The NPRF receives 1 of GNP annually from general governmentresources At the end of 2002 it was worth over 7 of GNP yen2part Total lsquovotedrsquo spending (see above) rose by 924

the 1996 report lsquoDelivering better governmentrsquo (DBG)thereby putting the range of measures taken or announcedsince 2002 in context (1)

In 1994 the strategic management initiative (SMI) waslaunched to enhance the quality of public services As afollow-up the DBG report proposed to change manage-ment structures human resource management and finan-cial management systems (2) Concerning the latter itmade the following recommendations

Firstly DBG favoured moving to multiannual budgetingThe budget for 1997 marked a first step in this directionproducing aggregate budgetary projections on a no-pol-icy change basis for 1998 and 1999 Subsequent budgetshave provided more detailed projections over a three-yearhorizon thus covering the same period as the stabilityprogrammes that have accompanied each budget In 2000it was decided to defer the original plan to introducethree-year financial envelopes for each departmentbecause existing multi-year programmes (such as thethree-year social partnership agreements (3) and theseven-year investment programme) were considered toprovide sufficient medium-term guidance In November2002 however the Minister for Finance announced thathe was considering extending working with five-yearfinancial envelopes (as is currently done for public trans-port) to other large capital spending areas (4)

Secondly DBG sought to delegate financial authority tothe maximum extent possible This would be accompa-nied by the requirements that each department report atyear-end on outcome versus plan mdash not only financiallybut also in output terms mdash and that regular expenditurereviews be carried out (see next point) (5)

Thirdly the government launched the expenditurereview initiative (ERI) in May 1997 which was origi-nally intended to review all expenditure from a results

perspective over a three-year period This turned out tobe over-ambitious and by end-2000 only 62 reviewshad been completed with 21 more underway togetherrepresenting at most 37 of government spendingDrawing on an assessment of the ERI by the Comptrollerand Auditor General (6) the government decided in mid-2001 to adopt somewhat revised arrangements (i) theselection of topics for review should ensure that the ERIfocuses on significant areas of expenditure and criticalareas of government policy (ii) the Department ofFinance is to enhance its provision of central supportand (iii) departments are encouraged to publish thereviews they carry out The topics for review in thesecond round (2002ndash04) were approved in May 2002and include two pilot cross-departmental reviews

Related to this the government set up an IndependentEstimates Review Committee (IERC) in the course of2002 to help prepare the spending plans for 2003 (7) Theobjective of this group of three former civil servants wasto find EUR 900 million (07 of GDP) worth of sav-ings on the estimated cost of maintaining the lsquoexistinglevel of servicersquo in 2003 (8) This was to be achieved byidentifying programmes (i) which were no longer justi-fied because of changed circumstances or (ii) whichcould be deferred or spread over a longer period and bysuggesting new delivery or user-charging mechanismsThe ensuing budget was based on a reduction of theexisting level of service cost in 2003 by 06 of GDPA similar review is to be carried out in 2003 regardingthe spending targets for 2004ndash05

Fourthly DBG recommended to strengthen the admin-istrative budget system introduced in 1991 Adminis-trative budgets cover the administrative (or running)costs of departments of which pay constitutes by farthe largest part Each department has to agree with theDepartment of Finance on a level of administrativespending for three years and can manage these fundsrather flexibly (rights to switch to carry-over and toappoint staff all subject to certain limits) The systemhas been enhanced and extended to other departmentsand offices The IERCrsquos report recommended to intro-duce an efficiency dividend of 2

yen1part See also National Economic and Social Council (2002)yen2part See Coordinating Group of Secretaries (1996) A working group set up to

oversee implementation of DBGrsquos financial management recommenda-tions produced detailed proposals in July 1999

yen3part These agreements not only contain a wage clause but also cover tax andspending measures

yen4part In addition revised arrangements for capital spending are being put inplace providing detailed information of the size and time-scale of spendingcommitments

yen5part In this context DBG recommended that departments be rewarded for sug-gesting savings In November 2002 the Minister for Finance announcedthat savings would be earmarked to the same department for use in high-priority areas

yen6part See Comptroller and Auditor General (2001)yen7part The IERCrsquos report to the Minister for Finance is available at www

budgetgovieyen8part This concept has recently replaced the no-policy change basis and allows a

clearer distinction between technical and policy adjustments

Fifthly as recommended by DBG a new managementinformation system is to be implemented by the end of2005 In addition to cash data it will provide data on anaccruals basis In addition to financial data it will providenon-financial information By focusing on outputs it willenable measurement of performance thus providing valu-able information for value for money studies and expend-iture reviews The development of performance measure-ment systems has received much attention under the socialpartnership process because recent national agreementshave included a conditionality clause for public sector payrises The final pay rise under the Programme for prosper-ity and fairness (expiring mid-2003) was conditional ondeveloping and agreeing performance indicators and mak-ing sufficient progress towards modernisation targets Allpay rises in the proposed new agreement Sustainingprogress are similarly dependent on verifiable progresson modernisation and flexibility (1)

Apart from reforms prompted by DBG several measureshave recently been taken to address the need to remainwithin spending allocations which has become morepressing in view of the tighter budgetary situation InNovember 2002 the Minister for Finance announcedthat the assessment of expenditure overrun risks wouldbe improved and that contingencies to cater for unfore-seen pressures would be introduced Special attentionwould be given to demand-led schemes In January2003 a report on accountability was endorsed contain-ing recommendations to strengthen internal financialcontrol and audit systems and to adopt formal risk man-agement strategies

An area of particular concern regarding budgetarycontrol and value for money is the health sector (2) In2002 an Independent Commission on Financial Man-

agement and Control Systems was set up to make recom-mendations on how to enhance the timeliness and qualityof the available financial information in the health serv-ice While not yet published its report is expected tohighlight serious deficiencies in existing financial man-agement procedures and to recommend the establish-ment of a new national health services executive as wellas the urgent implementation of new budgetary andaccountability systems and performance managementprogrammes (3)

Finally two recent measures are worth mentioning eventhough they are not directly concerned with improvingthe management of expenditure In November 2002 thegovernment decided to publish intra-year spending pro-files by department which can be compared with theevolution of expenditure as published in the monthlycash Exchequer accounts The profiles for 2003 (also fortax revenues) were published at the end of January In afurther move to enhance the transparency of spendingdevelopments the Department of Transport decided toissue monthly progress reports on major transport andinfrastructure projects The first such fiche was pub-lished in early March for the Luas (Dublin light-rail)project it provides the original and updated estimates of(i) total cost and (ii) completion dates

In conclusion the 1996 DBG report constituted an ambi-tious programme to improve public expenditure man-agement While progress has been made on severalfronts implementation of the recommendations remainsincomplete The measures announced during 2002 willfurther improve expenditure management but someissues require ongoing attention such as the roll-out ofthe management information system mdash and its contribu-tion to securing value for money mdash as well as themedium-term planning of spending

yen1part The new agreement not only awards general pay rises (a cumulative 7 )but also allows for a gradual and full implementation of the benchmarkingawards (89 on average mdash see footnote above) The first tranche ofbenchmarking (25 ) is unconditional and is to be paid in 2003 backdatedto December 2001

yen2part The involvement of the private sector in the provision of healthcare as in thedelivery of public investment falls outside the scope of this contribution yen3part Irish Times 30 and 31 January 2003

8 Italy

Recent developments

The general government accounts recorded a deficit of23 of GDP in 2002 against an initial target of 05 of GDP The considerable shortfall with respect to plansis in part explained by economic growth assumptionswhich from the outset did not sufficiently reflect theobserved deterioration in the global economic out-look (1) It is also due to the emergence of stronger thaninitially assessed expenditure trends also as a result ofthe marked revision of the 2001 budgetary out-turn (2)Almost half of this revision (around 05 percentagepoints of GDP) was due to an underestimation ofexpenditure of the central and the decentralised adminis-trations In the course of 2002 the government tooksteps to address the serious deficiencies that hadappeared in the budgetary process by passing a lawtightening expenditure controls (reviewed in the nextsection) and adopting provisions aimed at improving theinformation base on disbursements of the central govern-ment and the decentralised administrations

The 2002 budgetary out-turn benefited from a lower debtservicing costs than projected for that year in theNovember 2001 stability programme update (3) Legisla-tion enforced in the second half of the year blockingadditional tax credits for employment creation and

investment increasing tax receipts curbing healthcareexpenditure and as recalled above improving expendi-ture controls played a role in keeping the government def-icit in check In addition measures of a temporary naturecontributed over 1 percentage point of GDP to the 2002result sales of public real assets largely through securiti-sation amounted to 09 of GDP and receipts from a taxamnesty on assets held abroad were 01 of GDP

According to Commission calculations after the deteri-oration recorded in 2001 the cyclically-adjusted budgetbalance improved markedly in 2002 although the cycli-cally-adjusted primary balance posted a much smallerrecovery If the impact of sales of real estate is netted outin both years however the cyclically-adjusted overallbudget balance shows only very slender improvementbetween 2001 and 2002 while the cyclically-adjustedprimary balance deteriorates by 04 percentage points

The general government debt ratio decreased by almost3 percentage points of GDP to 1067 in 2002 well belowthe governmentrsquos own revised estimate of 1094 mainly thanks to operations carried out in the final monthsof the year most notably a debt conversion whichreduced the face value of government debt by 19 ofGDP (4)

The update of the stability programme covering theperiod 2002ndash06 targets a reduction in the actual deficitratio to 15 of GDP in 2003 with the budget approach-ing a balance in 2005 the year in which the debt ratio isto fall below 100 of GDP The budgetary target for2003 relies heavily as in 2002 on one-off measuresincluding the sale of publicly-owned real estate assetsthrough securitisation operations an accelerated tax liti-

yen1part Moreover since 2001 official projections of tax receipts have tended to beconsistently higher than would be warranted by already overoptimisticgrowth forecasts

yen2part In March 2002 the Italian statistical office reported a deficit of 14 ofGDP for 2001 The 2001 deficit estimate was then revised upwards threetimes to 16 in June 2002 mainly because of a higher estimate forhealthcare expenditure to 22 in July 2002 as a result of Eurostatrsquos deci-sion on the treatment of securitisation in national accounts and to 26 inFebruary 2003 following a further correction of healthcare expenditureand State sector expenditure (chiefly purchases of goods and services) andrevenue (tax receipts) After the latest revision the discrepancy betweendeficit reported in the government accounts in cash terms and theMaastricht deficit (in accrual terms) is significantly reduced in 2001

yen3part The sensitivity of Italian government debt to changes in interest rates is stillrelatively high given that over a third of it consists of short-term or variablerate instruments In 2002 interest expenditure was also reduced byEUR 19 billion through swap operations

yen4part Other factors influencing the result were financial operations whichreduced the cash deficit including the disposal of loans and other financialassets by the Cassa Depositi e Prestiti (the public savings and loans bank)in December 2002 the effect of the re-evaluation of the euro on debtdenominated in foreign currencies and a reduction compared to end-2001in the assets held by the Treasury with the Bank of Italy at end-2002

gation settlement scheme and new tax amnesties The2004 budgetary objective depends on replacing the mainone-off measures implemented in 2003 and on an addi-tional significant budgetary correction

The Commissionrsquos spring forecasts show a deficit innominal terms of 23 of GDP in 2003 on the back ofone-off measures amounting to 12 of GDP In 2004the lsquono policy changersquo projection of 31 principally aresult of the expiry of one-off measures implies that avery substantial fiscal correction would have to be car-ried out that year The debt ratio also remains distantfrom the targeted values although it decreases over theforecast period The difference between the Commis-sionrsquos forecasts and the targets in the stability pro-

gramme are in part due to a markedly lower assumptionfor real GDP growth in 2003 in part to a more cautiousevaluation of the fiscal policy measures (although theevaluation of the temporary measures mdash programmedsales of public real assets and tax amnesties mdash is alignedwith the official estimates) Interest rates at historicallylow levels are expected to continue to exert a dampeningeffect on the interest burden The cyclically-adjusteddeficit would improve in 2003 by 03 percentage pointsof GDP over the previous year while the cyclically-adjusted primary balance would remain largely stable

On 18 April 2003 the Ministry for the Economy andFinance released a new projection for the general gov-ernment deficit in 2003 which now stands at 23 of

Table VI16

Composition and balances of general government Italy (as of GDP)

2000 2001 2002 2003 2004

Pm Tax burden 427 425 418 417 411

Government debt 1106 1095 1067 1060 1047

Table VI17

Key figures of the Italian stability programme (2002ndash06)

2001 2002 2003 2004 2005 2006

General government budget balance ( of GDP) ndash 22 ndash 21 ndash 15 ndash 06 ndash 02 01

Source 2002 update of the stability programme of Italy

GDP based on an economic growth forecast of 11 (asagainst 23 in the November 2002 stability pro-gramme update) This is likely to have negative reper-cussions on the planned medium-term adjustment pathmaking the policy dilemma concerning the necessaryadjustment in 2004 more acute

Monitoring and controlling public expenditure the lsquoexpenditure freezersquo law

Amongst the provisions adopted in 2002 to correct fiscalimbalances Law No 2462002 (the so-called leggeblocca spese lsquoexpenditure freezersquo law) represents in theintentions of the Italian authorities an important instru-ment to improve the control of expenditure and to allowtimely correction of any deviation from the publicfinance objectives established in governmentrsquos medium-term economic and financial plan (DPEF) The law is anexample of how the need to fulfil obligations under theStability and Growth Pact provides an incentive tochange national rules and procedures emphasisingbudgetary discipline and fiscal sustainability

The overriding principle of ensuring the consistency offiscal trends with budgetary objectives is contained in arti-cle 81 of the Italian Constitution which states that lsquoWiththe adoption of the budget no new taxes and no newexpenditures can be establishedrsquo (indent 3) and lsquoAny otherlaw [beyond the budget] that establishes new expendituresmust indicate the means through which they will befinancedrsquo (indent 4) The implementation of the constitu-tional principle has proved problematic In 1978 a seriesof instruments (including the Financial Law) were intro-duced in order to rationalise the budgetary process andcontrol public finances (1) Since the late 1980s legisla-tion introducing newhigher current or capital expendi-tures or lower revenues above and beyond the financingmeans provided by the Financial Law in the special capitaland current account funds can be financed only within thelimits of newhigher receipts andor reductions of othercurrent expenditure with an additional constraint that cap-ital revenues cannot be used to finance current expendi-ture (2) All legislation introducing higher expenditure orlowering revenues and any amendment to existing legisla-tion must be complemented by a technical reportquantifying the budgetary impact of each provision andsupplying indications on means of financing

Inevitably there is a risk of underestimating the budget-ary impact of proposed policy measures or overestimat-ing the impact of provisions ensuring their financingThis would not represent an insurmountable problem inthe presence of effective expenditure control mecha-nisms However the experience is that budgetary moni-toring and control have suffered from the complexityand opaqueness of budgetary procedures delays inavailability of information loose practices and institu-tional weaknesses

The lsquoexpenditure freezersquo law aims at making existingcontrol mechanisms more effective To do so it intro-duces new stringent procedures on the one hand facili-tating the monitoring and control of the implementationof legislation and on the other hand allowing emergencyaction to deal with significant slippages from the overallpublic finance objectives of the governmentrsquos medium-term economic and financial plan (DPEF) (3)

In practice all legislation introducing new or higherexpenditure must indicate for every year and for everyprovision the lsquoauthorised expenditurersquo that is dependingon the type of law either the maximum ceiling of dis-bursements or the expenditure forecast attached to the pro-vision In the first case the General Accounting Office(Ragioneria Generale dello Stato RGS) which is the armof the Ministry for the Economy and Finance entrustedwith surveillance and control powers determines whetherthe ceilings are reached and in this event blocks furtherexpenditure appropriations (4) The Minister for Economyand Finance reports to Parliament and the application oflegislation is suspended unless additional financing can beprovided through a new legislative provision In the sec-ond case legislation must define a lsquospecific safeguardclausersquo to compensate for expenditure in excess of fore-cast Surveillance is entrusted to the RGS

The provisions for lsquoemergency actionrsquo empower theMinister for the Economy and Finance to intervene in thegeneral case in which the RGS detects a lsquosignificantdivergencersquo from the overall budgetary objectives of theDPEF (5) In this case the Minister for the Economy and

yen1part Law No 4681978yen2part Law No 3621988

yen3part This may be considered the more structural aspect of the law as suggestedby Grilli (2003)

yen4part An appropriation is a legal obligation to carry out a payment and as such itis distinct from a disbursement which is the moment in which the paymentis effectively carried out

yen5part The size of the budgetary slippage which gives rise to a lsquosignificant diver-gencersquo is not defined in the law An estimated divergence of 03ndash05 per-centage points from the revised budgetary objective of 21 of GDP wasconsidered grounds in late 2002 for applying the law (Grilli 2003)

Finance proposes the necessary corrective measures tothe Council of Ministers The government decides on themeasures and the Prime Minister adopts a decree (atto diindirizzo) containing the general guidelines for thegovernment action to secure more effective expendituremonitoring and control The relevant ParliamentaryCommittees have 15 days to express an opinion afterwhich the Minister for the Economy and Finance can inany case adopt the necessary measures by decree Cru-cially the Minister for the Economy and Finance canlimit State budget appropriations by fixing proportionalacross-the-board cuts on State expenditure excludingwages of public sector employees pensions and otherfixed or obligatory expenditure (1)

Finally the new law also bars the widespread practice ofadministrations charging new expenditure appropriationsto a financial year after it has ended (that is 31 Decem-ber) In addition it reduces the number of years duringwhich capital expenditure arrears can be carried over inthe budget Both these measures are likely to exert adampening effect on expenditures

Given the short period elapsed since the adoption oflsquoexpenditure freezersquo law a full evaluation of its impactmust necessarily be left for future discussion (2) At thisstage it is only possible to examine some of its featureswhich may shed light on its potential to ensure an effec-tive control of expenditures

In some respects the law is less innovative than it mightappear budget appropriations for some non-obligatoryexpenditures (for example purchases of goods and serv-ices) already constituted absolute expenditure ceilingsYet in view of the prevailing practices the reinstating ofprocedures should not be underrated Moreover the mon-itoring of expenditures is now carried out more stringentlyon each single provision instead of in terms of balance-sheet items as in the past

A shortcoming of the law is the limited field of applica-tion in case of detection of a significant budgetary slip-page de facto the expenditure cuts concern essentiallyexpenditures for goods and services and some capitalexpenditures Moreover while the lsquosignificant diver-gencersquo is identified for the general government thedomain of application of the law is restricted to expend-iture of the central government and of non-territorialpublic institutions and organisations such as universitiesor social security funds (3) leaving out expenditure ofthe local administrations (4) This represents a clear lim-itation in the light of past experience (the significantoverruns due to regional expenditure for healthcare in2000 and 2001) and of the budgetary control challengesgenerated by the decentralisation process Anotherweakness of the law could be the fact that since expend-iture cuts in case of significant divergence are uniformlyapplied in principle this does not allow selective actionFinally the lsquoemergencyrsquo instrument of the law hasintrinsically temporary effects in the absence of morefundamental action in the following fiscal year pastexpenditure levels can again be reinstated

The innovative features of the lsquoexpenditure freezersquo laware undoubtedly the wide-ranging powers granted to theMinistry for Economy and Finance in particular theobligation for the RGS to suspend expenditure appropri-ations when the ceilings are reached and the possibility(not the obligation) for the minister to act in the event ofsignificant divergences (even if necessary by supersed-ing the role of parliament) The effective implementationof the emergency procedures depends to a great extenton the relative powers of the Ministry for Economy vis-agrave-vis the rest of the government In any case the powerto impose across the board expenditure limitations is jus-tified by the seriousness of the event a significant diver-gence This confers to the instrument an exceptionalnature whose effectiveness may well depend on itsimplicit threat content The threat of ex post action mayenhance ex ante the role of the Ministry for Economy inthe phase in which the budget is drawn giving addedsubstance to the pivotal role it has long been assigned inthe budgetary process Moreover the credibility of amore stringent application of surveillance procedurestogether with the risk of across the board expenditure

yen1part Interest on public debt accrued liabilities for loan reimbursements obliga-tions ensuing from Community law and international agreements obliga-tions ensuing from contracts etc The law does not contain an exhaustivelist of expenditures In practical terms the RGS has chosen to identify aslsquoobligatory expenditurersquo also lsquojuridically complete obligations vis-agrave-visthird partiesrsquo (Grilli 2003)

yen2part The ministerial decree of end-November 2002 established a cut in budget-ary appropriations of 15 The RGS estimates this resulted in a reductionof EUR 18 billion (02 of GDP) in the State sector borrowing require-ment and EUR 21 billion (02 of GDP) in the general government deficit(Maastricht definition)

yen3part The Minister for Economy can reduce working expenses of non-territorialpublic institutions Surveillance is carried out by the internal audit bodies

yen4part In 2002 the law was applied also to the local health institutions (aziendesanitarie locali ASL) However the action spurred strong reaction from theregions and the ASL As a result the Minister for the Economy has ruledthat in future the law will not be applied to regional funding for healthcare

limitations will likely discourage unrealistic ex anteexpenditure projections

The law should increase reliability of budgetary forecastand transparency enhance surveillance strengthen con-trols on expenditures and avoid overruns and its applica-

tion should allow quick action to address budgetaryimbalances However it remains to be seen whether itsprovisions in particular the freezing of laws reachingtheir authorised expenditure limits and the across theboard limitations on all State non-obligatory expendi-ture leads to an effective control of expenditures

9 Luxembourg

Recent developments

Luxembourg has enjoyed many consecutive years of highgrowth and substantial fiscal surpluses In 2000 and2001 the general government surplus even increased tothe unprecedented levels of 61 and 64 of GDP respec-tively In 2001 the general government balance increasedby an estimated 2 percentage points of GDP due to atransaction concerning the satellite company ASTRAThis was recorded as the sale of a non-produced non-financial asset that is as a negative capital expenditureIn 2002 the fiscal accounts remained in surplus net lend-ing of general government amounted to 26 of GDPThe outcome for 2002 was more favourable than previ-ously expected in the light of the economic slowdownlargely owing to strong corporate tax revenues and lower-than-expected expenditure from special funds

In 2002 tax revenues remained strong in spite of thesharp economic slowdown This is to a large extent dueto high corporate tax revenues partly reflecting thelagged impact of strong earnings in previous years withhigh economic growth Some acceleration in the collec-tion of corporate tax arrears played a decisive role aswell while income tax receipts also remained relativelyfavourable In 2002 taxes on income and wealthincreased by 75 while the receipts of indirect taxesrose by a modest 22 By contrast the rate of growthof social security premium revenue slowed down to66 compared to an increase of around 13 in 2001Total current resources of general government increasedby around 5 However total current expenditure rosemuch faster at around 10 which is higher than theincrease by around 9 in 2001 Strong increases in thepublic wage bill (by approximately 10 ) and in socialtransfers other than in kind (by some 14 ) were mainlyresponsible for the acceleration in expenditure The lat-ter largely reflect the substantial increases in pension andsocial security payments agreed among social partners atthe so-called Rentendeumlsch In addition total publicinvestment also increased rapidly in 2002 by 116

compared to close to 10 in 2001 As a consequencethe ratio of total harmonised government expenditure toGDP (disregarding the satellite transaction mentionedabove) rose by some 1 percentage points to more than45 the highest level since the mid-1990s

Relatively strong revenue from corporate taxes can beexpected to continue into 2003 and possibly 2004despite adverse developments in corporate profits overthe last few years This is the case because the receiptscan be levied up to five years back Hence payment of aconsiderable part of claims accrued in the favourableyears before 2001 is still due while the advances to bepaid are still relatively high as they are being computedon the basis of the still-favourable company accounts ofa few years back As regards the development of taxablepersonal income the effect of decelerating employmentand compensation on revenue will be mainly felt from2003 onwards only

According to the Commission spring 2003 forecasts thegeneral government balance is expected to deteriorate in2003 and 2004 to a deficit of 02 and 12 of GDPrespectively This reflects the lagged impact of theeconomic slowdown on tax revenue and social securitycontributions in combination with continued high ratesof growth of public current and investment expenditureAs regards tax revenues inevitably the impact of thecollection of tax arrears will fade after some years Thiswill also influence revenues of local government that aredirectly linked to corporate taxes Adverse developmentsin the central government accounts would account formost of the deterioration of the general government bal-ance in 2003 and 2004 while local government revenueswould be affected negatively by the effects of the earliertax reforms from 2004 onwards By contrast the balanceof social security funds would still be positive albeit toa lesser extent than in recent years The already lowgross government debt ratio is forecast to decline some-what further to 34 of GDP in 2004

Fiscal prospects in a period of weaker growth

Luxembourg is a very open economy sensitive to cycli-cal swings which have a sizeable impact on publicfinances The sensitivity of government finances to thebusiness cycle is accentuated by the large cross-borderflows of workers (which affect the payment of socialsecurity contributions) and the large exposure to thehighly volatile financial sector However reliable esti-mates of the impact of the current economic slowdownon government finances in Luxembourg are very diffi-cult to make for a number of reasons

First the higher volatility of key macroeconomic aggre-gates and the importance of cross-border labour flowsleads to a higher margin of uncertainty for fiscal projec-tions compared to larger EU economies (the net pay-ments of excise taxes from the customs union with Bel-gium is a notably difficult item) Second the structure ofthe tax system is such that a sizeable part of taxes are col-lected with substantial and variable lags This also makesit harder to assess the impact of the tax reforms of 2000and 2001 on revenue Finally the impact of operations ofspecial funds that accumulated from the fiscal surplusesachieved in past years may cloud forecasts of changes inthe government balance based on past trends

Table VI18

Composition and balances of general government Luxembourg (1) (as of GDP)

2000 2001 2002 2003 2004

Primary balance (2) 64 67 30 00 ndash 11

Pm Tax burden 415 418 432 426 413

Pm Cyclically-adjusted balance na na na na na

Pm Cyclically-adjusted primary balance na na na na na

(1) Commission spring 2003 economic forecasts(2) UMTS receipts excluded(3) In kind and other than in kind

Table VI19

Key figures of the Luxembourg stability programme (1) (2001ndash05)

2001 2002 2003 2004 2005

General government budget balance ( of GDP) 61 ndash 03 ndash 03 ndash 07 ndash 01

Primary balance ( of GDP) 64 02 00 ndash 05 01

(1) UMTS receipts excluded

Source 2002 update of the stability programme of Luxembourg

Clearly the starting position of government finances ofLuxembourg is very favourable given the healthy surplusreached before the current economic slowdown started thevery low level of government debt (which stood at 53 of GDP in 2002) and the sizeable net asset position stem-ming from cumulated surpluses However some potentialrisk factors should not be underestimated Most impor-tantly the rise in government expenditure in Luxembourghas been very strong in the recent years Total governmentexpenditure increased by a cumulative 40 between 1998and 2002 the average yearly increase during that periodwas around 8 Public investment also increased veryrapidly in the past few years by close to 10 on averagein nominal terms between 1998 and 2002

Luxembourg has accumulated some reserves that areavailable to cushion the negative budgetary impact of atransitory economic slowdown However such reservescould not cater for the long-term impact on the budgetposition of a prolonged slowdown in economic growth

Existing reserves should be used to fund the budgetarycosts of ageing that will increase markedly in the longerterm Thus the existence of substantial reserves in thesocial security system (estimated at around 22 of GDPin 2001) is fully justified by the budgetary costs of age-

ing and is necessary to guarantee the payment of pensionclaims also for non-resident workers in the event ofreduced employment growth In addition the existenceof substantial surpluses in social security funds is not afeature that can be for certain in the medium term asthey depend on continuing rapid growth of employmentof both residents and cross-border workers

While it is clearly important to address the budgetaryconsequences stemming from a cyclical slowdown aperhaps even more daunting challenge for fiscal policyin the period ahead stems from the possibility that eco-nomic growth may slow down for a prolonged period torates well below the ones enjoyed for many years in thepast decades At the present juncture estimates of therate of potential real GDP growth of the Luxembourgeconomy are surrounded by large margins of uncer-tainty However it seems likely that in the years aheadLuxembourg will experience growth rates that on aver-age will be lower than in the decade up to and including2000 Hence policy measures might be needed to adjustthe growth of public expenditure to a rate consistent withthe revenue base This would help ensure that a budget-ary position close to balance or in surplus would beachieved and maintained in the medium term

10 The Netherlands

Recent developments

The fiscal accounts in the Netherlands deteriorated mark-edly in 2002 against the background of a sharp economicslowdown After having reached a surplus of 01 ofGDP in 2001 the general government balance turned intoa deficit of 11 of GDP in 2002 (a worse outcome thanthe 05 of GDP deficit expected in the 2003 budget)This deterioration mainly reflects the impact of the eco-nomic slowdown as well as the lagged impact of taxreforms Revenue shortfalls related mainly to corporatetaxes and increases in tax-exempt pension premiums paidinto private schemes According to Commission calcula-tions the cyclically-adjusted general government deficitremained broadly constant in 2002 at around 1 of GDP

The fiscal outlook is highly uncertain at the time of writ-ing due to the political situation Following elections inMay 2002 a new cabinet was formed in July The coali-tion parties formulated their policy proposals in a coalitionagreement known as the lsquostrategic accordrsquo which set outthe fiscal policy objectives for the whole 2003ndash06 cabinetterm of office However the cabinet fell on 16 Octo-ber 2002 which led to general elections on 22 January2003 At the time of writing of this report negotiations toform a new coalition government following the electionsare still ongoing The 2003 budget was approved by Par-liament with some relatively minor changes despite thefall of the government and contains a package consistingof reallocations expenditure increases in some areas andtax revenue raising measures The net combined impact ofthese measures on the government balance is an estimatedimprovement of around EUR 5 billion or approximately1 percentage point of GDP in 2003 According to the 2003budget this would result in a stabilisation of the deficit at05 of GDP in 2003 with real GDP growth of 1

However in the absence of additional measures the deficitin 2003 will increase further than forecast in the budget dueto the less favourable starting position of public finances in2002 according to the latest data available and the worsened

economic outlook Under the technical assumption of nopolicy changes and assuming real GDP growth of 05 the Commission spring 2003 forecasts expect the generalgovernment balance to deteriorate in 2003 to a deficit of16 of GDP as unfavourable cyclical developments willcontinue weighing on fiscal revenues The deficit wouldincrease further to 24 of GDP in 2004 under the no pol-icy change assumption reflecting the weakness of theexpected upturn as well as the lagged impact of slowgrowth in 2003 According to the estimates in the springforecast the cyclically-adjusted general government bal-ance would improve slightly in 2003 and deteriorate againto a deficit of around 1 of GDP in 2004 (1) As a result ofprojected deficits and low economic growth the gross gov-ernment debt ratio would fall only slightly in 2003 andincrease again somewhat in 2004 to 528 of GDP

An incoming government will most likely announce con-solidation measures even though a full assessment canonly be given on the basis of a coalition agreement Hencefor 2004 the current projected deficit may be interpreted asan upper bound to expected deficits An important chal-lenge for the incoming government is to leave some scopefor automatic stabilisers to work while achieving the nec-essary improvement of the underlying balance

The sensitivity of public finances to the business cycle and the importance of expenditure rules

As in other open EU economies Dutch governmentfinances are sensitive to cyclical swings in activity Thevery marked deterioration of government finances to alarge extent due to the impact of the economic slowdown

yen1part Note that the forecast horizon here covers the period up to 2004 Owingto the characteristics of the estimation method the outcome for the cycli-cally-adjusted balance in any year will change when the forecast horizonis altered Thus forecasts covering a longer time horizon such as forinstance used in stability programmes will typically yield a somewhatdifferent result even if the same input data would be used for the periodup to and including 2004

that started in 2001 testifies to this According to Com-mission calculations based on the spring 2003 forecaststhe cyclically-adjusted general government balanceremained stable in 2002 (showing an estimated deficit of10 of GDP) Thus the deterioration of the nominalgeneral government balance by 12 percentage points in2002 seems to be wholly accounted for by cyclical factorswith a shortfall in revenues being the main determinant

The precise impact of cyclical conditions on publicfinances of course also depends on the composition ofGDP growth Typically a change in the growth rate ofdomestic demand will have a more profound impact onthe fiscal accounts than a shock to external demand Inaddition the structure of revenue and expenditure alsodetermines the sensitivity of public finances to the busi-ness cycle For instance the share of corporate taxeswhich are highly sensitive to cyclical conditions in totaltax receipts has increased markedly in the Netherlands inthe past decade or two In 1987 this share was approxi-mately 13 of total tax revenue It increased to more than17 in 1997 and 1998 and stood at around 16 in 2001

This mainly reflects three factors First an increase incorporate tax receipts as a percentage of GDP from36 in 1987 to 41 in 2001 Second the fact that thesubstantial reduction in the overall tax burden since the

late 1980s was largely achieved through a reduction inincome taxes thus raising the relative share of corporatetaxes as a source of revenue Third the economic boomof the second half of the 1990s which strongly boostedcorporate tax receipts The latter effect is likely to be atleast partially reversed as the impact on tax revenue oflower corporate profits in the wake of the cyclical down-turn feeds through Thus seen from a longer-term per-spective the increasing share of corporate taxes as asource of revenue has arguably increased the sensitivityof Dutch government finances to cyclical fluctuations

Expenditure restraint is important in the current situationto avoid a further deterioration of the general govern-ment balance in response to prolonged weak economicactivity A continuation of the basic tenets of the currentbudgetary framework which uses expenditure rules as acornerstone for fiscal policy may be a useful instrumentto help maintain stable government finances in themedium term and contain the growth of public expendi-ture In this respect the Dutch experience may be instruc-tive (see part V of this report for an analysis of the roleof expenditure rules in the EU context)

It suggests that it helped reduce the incidence of ad-hocmeasures in response to unexpected changes in the vola-tile nominal government balance Note however that

Table VI20

Composition and balances of general government the Netherlands (1) (as of GDP)

2000 2001 2002 2003 2004

Pm Tax burden 416 400 394 396 389

(1) Commission spring 2003 economic forecasts(2) Data for 2000 and 2001 (except cyclically-adjusted) include UMTS receipts of 07 and 02 of GDP respectively(3) In kind and other than in kind

while the use of real expenditure ceilings should in prin-ciple facilitate the working of automatic stabilisers iteffectively mitigates somewhat their working on theexpenditure side That said this need not be a majordrawback since in the Netherlands automatic stabilisersmainly work via the income side

Rules to limit the increase of a large part of total publicexpenditure under pre-determined ceilings defined in realterms were introduced in the Netherlands by the first pur-ple cabinet in 1994 to be applied from 1995 onwardsSince then relevant government expenditure was success-fully kept below these ceilings (see Table VI21 for theoutcome during the second purple cabinet) although thiswas facilitated by strong economic growth and conse-quent lower expenditure (mainly on interest paymentsand unemployment benefits) for most of the period 1996ndash2002 covered This enabled a redistribution of windfallsto sub-sectors of general government with higher-than-projected expenditure growth as well as additionalexpenditure increases in areas such as healthcare educa-tion infrastructure investment and public safety

The overall experience with the expenditure rule sincethe mid-1990s has been positive as it is widely believedthat it helped contain expenditure growth Furthermoreclearly defining fixed expenditure margins for the wholecabinet period helped anchor expectations of economicactors However the fact that the budgetary frameworkwas respected was not enough to prevent public financesfrom deteriorating in the wake of the economic slow-

down This was partly because higher revenue and lowerexpenditure during the years of higher-than-expectedeconomic growth had been used to intensify spendingrather than to use it as an additional buffer But moreimportantly one has to bear in mind that the parametersof any budgetary rule need to be adjusted to changingeconomic prospects in order to ensure that fiscal policyremains consistent with a budgetary position close tobalance or in surplus in the medium term

In the strategic accord the outgoing government retainedmany of the basic characteristics of the previous budget-ary expenditure rule with some modifications (seeBox VI2) It should be noted that the future of the budg-etary framework is uncertain at the present juncture withnegotiations to form a new government still ongoing Inany case the budgetary rules put in place by an incominggovernment will be put to a genuine test given the sever-ity of the economic slowdown

Table VI21

Expenditure in the Netherlands mdash relevant ceilings and outcome

1999 2000 2001 2002

Targeted (bn EUR ) 1507 1573 1666 1740

Outcome 1492 1563 1666 1738

Overrun (+) underachievement (ndash) ndash 15 ndash 10 00 ndash 02

Source Ministry of Finance

Box VI2 The Dutch framework for expenditure ceilings

The budgetary framework adopted by the outgoing government resembles the one embedded in the coalition agreement ofthe two previous governments The use of expenditure ceilings in real terms for a large part of total expenditure is the pivotalmechanism of the framework (1) In particular each of the three main sectors of the general government (central govern-ment social security and healthcare) will have to respect separate expenditure ceilings for the relevant expenditure itemsidentified (irrespective of revenues) In case overruns occur they should be compensated within each sector

bull Fiscal projections are based on cautious macro-economic assumptions

bull The automatic stabilisers will be allowed to work freely on the revenue side as long as the government balance will bebetween 0 of GDP and a surplus of 25 of GDP There are also provisions in case a (nominal) surplus of more than1 of GDP would emerge mdash a scenario that at present appears to be not very relevant

yen1part A technical change to the framework adopted by the previous government is that in the deflator for gross domestic expenditure will be used to calculateexpenditure ceilings in nominal terms The previous budgets used the GDP deflator which is more sensitive to shocks to the terms of trade

11 Austria

In 2002 general government finances in Austria weak-ened markedly From a surplus of 03 of GDP in 2001the budgetary position deteriorated by almost 1 percent-age point to a deficit of 06 of GDP despite the factthat output growth accelerated slightly to 10 from07 in 2001 This outcome compares with an initialobjective of a balanced budgetary position set in theNovember 2001 stability programme based on a realgrowth assumption of 13 and also exceeds the deficittarget of ndash 02 of GDP retained in the low-growth sce-nario assuming a real GDP expansion of 09

While in 2001 a strong rise in tax revenues helped toimprove the cyclically-adjusted position despite low out-put growth the decline in domestic demand in 2002depressed tax revenues The gross tax intake accountingfor 97 of the revenues in the budget 2002 fell short ofthe budgeted amounts by 32 or 08 of GDP How-ever the marginal item lsquoother revenuesrsquo increased to theextent that total revenues came in only slightly below thebudget (by ndash 01 or 003 of GDP)

Although expenditure exceeded the budgeted figure by23 or 06 of GDP this increase was lower thananticipated against the background of rising unemploy-ment and almost stagnating employment entailinglower pension contributions and thus higher federal out-lays for public pensions In addition the flood disasterin summer 2002 and the emergency package adopted inits aftermath was expected to increase spending but hadcontrary to expectation virtually no budgetary impactin 2002

These factors had led the Austrian fiscal authorities to apreliminary deficit estimate of 10 of GDP in 2002Due to statistical reasons and data revisions the actualdeficit of 06 of GDP turned out clearly lower despitea decline in the surplus at the Laumlnder level

The March 2003 update of the stability programmeprojects that in the near term the general governmentfinancial position will deteriorate markedly both innominal and in cyclically-adjusted terms before improv-ing again as late as in 2007 The deficit will remain onaverage at 1 of GDP until 2007 which is in sharpcontrast to the objective of the previous programme aim-ing at a balanced budget position in 2003 and a smallsurplus in 2004 and 2005

Specifically according to the stability programmes thedeficit is forecast to deteriorate from 06 in 2002 to13 of GDP in 2003 despite higher output growth Whilea temporary improvement is expected in 2004 the plannedincome tax reform will take its toll as of 2005 when thedeficit is estimated to increase to 15 of GDP and toremain above 1 of GDP in 2006 A sizeable improve-ment to a deficit of 04 of GDP is forecast only for 2007

The budgetary strategy has changed significantly com-pared with the previous programme The highlights ofthe new strategy are twofold a fundamental reform ofthe public pension system tackling many of its key prob-lems and a sizeable income tax reform

On the revenue side the tax reform is intended to reducethe tax burden to 43 of GDP by the year 2006 It is esti-mated to cost EUR 3 billion or 13 of GDP and to takeeffect in two steps a smaller one in 2004 (EUR billion)and a more substantial one of EUR 1 billion or almost1 of GDP in 2005 The reform aims at lowering taxesfor low and middle incomes as well as on retained profitsstrengthening work incentives for lower incomes reduc-ing non-wage labour costs and rendering the tax systemmore environment-friendly Conversely an increase inenergy taxes effective as of 2004 should entail additionalrevenues of EUR 450 million or some 03 of GDP

On the expenditure side a comprehensive pensionreform which is announced to start in 2004 and will bephased in until 2009 is without doubt the most remark-able feature of the updated stability programme

This reform if fully implemented would rein in thestructural upward pressure on spending and could provecentral to ensuring the long-term sustainability of gov-ernment finances Further cuts in government personnelmeasures to raise efficiency in the healthcare sector andrestructuring the federal railways complement expendi-ture side measures

As regards the regional authorities the national stabilitypact between the federal and lower levels of governmentis temporarily suspended owing to the flood disaster insummer 2002 Although the regional authorities hadcommitted themselves to achieve on average annual sur-pluses of 07 of GDP over the medium term this obli-

gation is not binding in 2002 and 2003 as far as flood-related spending is concerned

Mainly due to a substantial upward revision of publicdebt by 66 percentage points of GDP (details seebelow) the debt-to-GDP ratio stood at 687 at the endof 2002 which was 91 percentage points above the596 objective set in the November 2001 stability pro-gramme As a consequence the projected decline in thedebt-to-GDP ratio is delayed compared with the previ-ous version of the programme The debt ratio is plannedto drop below the 60 benchmark with a delay of fiveyears by 2007 decreasing by more than 8 percentagepoints from its peak in 2002 helped by further privatisa-

Table VI22

Composition and balances of general government Austria (1) (as of GDP)

2000 2001 2002 2003 2004

Government balance (2) ndash 15 03 ndash 06 ndash 11 ndash 04

Pm Tax burden 435 456 451 458 464

Table VI23

Key figures of the Austrian stability programme (2002ndash06)

2002 2003 2004 2005 2006

Source 2002 update of the stability programme of Austria

tion of public assets and the expiration of a specialfinancing scheme for State-owned enterprises (detailssee section below)

Sharp increase in debt for statistical reasons

The debt-to-GDP-ratio was significantly revised upwardsfollowing a Eurostat decision (1) on securitisation opera-tions and also due to the inclusion of debt issued for pub-lic enterprises which had been erroneously omittedFirst Eurostatrsquos decision on securitisation operationsentailed a reclassification of debt within the governmentsector and resulted in an increase of public debt byEUR 2 593 million or 12 of GDP in 2001 The sec-ond reclassification concerned bonds issued by the Aus-trian government in order to finance certain public enter-prises (Rechtstraumlgerfinanzierung) which had not beenincluded in gross debt At the end of 2002 these opera-tions amounted to EUR 117 billion or 54 of GDPThus the total effect of these two revisions is an increasein the debt-to-GDP ratio by 66 percentage points in2002

Securitisation operations mdash The case of the Blue Danube Loan Funding GmbH

In the case of Austria Eurostatrsquos decision on securitisa-tion operations concerns debt issued by a lsquospecial pur-pose vehiclersquo set up by the Land Niederoumlsterreich (prov-ince of Lower Austria) In an effort to comply with thenational stability pact which obliges lower levels ofgovernment to attain an annual surplus of 075 ofGDP some provinces sold their mortgage loan portfo-lios that is accounts receivable relating to State-subsi-dised housing Economically this makes sense as pro-ceeds are re-invested to bear interest on the financialmarket and thus increase revenues

To this end the Land Niederoumlsterreich set up a companythe lsquoBlue Danube Loan Funding GmbHrsquo (BDLF) towhich it sold its mortgage loan portfolio consisting ofaccounts receivable relating to some 150 000 State-sub-sidised housing loans The buyer purchased the right tocollect principal and interest from this portfolio

The BDLF financed this purchase by issuing bonds foran amount of EUR 2 593 million in 2001 The finalmaturity date of these bonds is May 2049 From May

2012 onwards the issuer will have the right to redeemthe bonds (first every five years that is in May 2017May 2022 and May 2027 and at any date thereafter)

Yet despite the sale Niederoumlsterreich keeps guarantee-ing payment of the principal and interest as well as anyother amount due should the issuer for any reason failto meet its obligation

Eurostat considers that guarantees by the State governmentimply an insufficient transfer of risk Therefore the debt ofthis lsquospecial purpose vehiclersquo was reclassified within thegovernment sector entailing an increase of public debt byEUR 2 593 million or 12 of GDP in 2001

Financing public undertakings mdash Rechtstraumlgerfinanzierung

In Austria a favourable financing scheme for State-owned enterprises was put in place in 1998 with the aimof minimising their financing costs Under this scheme(Rechtstraumlgerfinanzierung) the federal government issuesbonds in its own name and forwards the amounts raisedas loans to the respective enterprise mainly AsfinagOumlBB SCHIG OumlIAG (2) all owned to 100 by thegovernment

For the bondholder the government remains debtor ofprincipal and interest that is bondholders have a directclaim on the government which is committed to makethe corresponding payments An internal agreementbetween the government and the State-owned enter-prises however specifies that the respective enterpriseredeems all payments principal and interest ie the gov-ernment is also creditor

According to the Treaty and successive regulations (3)public debt mdash for the purpose of the EDP notification mdashis a gross concept and therefore all debt issued by gen-eral government without exception has to be included (4)Due to a misinterpretation of the reporting rules theAustrian authorities had netted out accounts receivableand payable resulting from the governmentrsquos double role

yen1part Decision of Eurostat on deficit and debt No 802002 of 3 July 2002 lsquoSecu-ritisation operations undertaken by general governmentrsquo

yen2part Asfinag mdash road infrastructure OumlBB mdash federal railways SCHIG mdash rail-way infrastructure OumlIAG holding of public enterprises

yen3part Regulation (EC) No 360593 yen4part This is further specified in the Council minutes of 22 November 1993

when Regulation (EC) No 360593 was adopted where a statement readslsquoThe Council and the Commission agree that the amounts outstanding inthe government debt from the financing of public undertakings will be thesubject of a separate presentation which will reveal the institutional charac-teristics in force on the subject in the Member Statesrsquo

as creditor and debtor in these operations As a conse-quence bonds issued in order to finance public undertak-ings had not been included in the compilation of publicdebt until 2002 As of the spring 2003 notification thereporting practice was corrected and the gross conceptapplied entailing an upward revision of governmentdebt by EUR 117 billion or 54 of GDP in 2002

Economically the Rechtstraumlgerfinanzierung enablesState-owned enterprises to borrow money at very favour-able interest rates benefiting from both bigger emissionvolumes and Austriarsquos AAA credit rating As a conse-quence issuance of these debt instruments has progres-sively increased since 1998 Government bonds passedon as loans to State-owned companies represented only116 of these enterprisesrsquo long-term liabilities in 1998increased to 472 in the year 2001 and are estimated tohave represented almost 54 in 2002 The interest ratespread between government bonds and bonds issued inthe companiesrsquo own name although being 100 gov-

ernment owned ranged from 42 to 63 basis points As aresult cumulated interest savings since 1998 are esti-mated to total EUR 733 million or 03 of GDP

As liabilities relating to financing State-owned companiesneed to be reported as government debt this instrument isnow being abandoned entailing two consequences Firstfinancing costs for State-owned companies will increasesince their emission volumes are fairly small even if bun-dled for several enterprises Moreover in order to raisefunds on the capital market each of these firms needs acredit rating hinging among other factors on the enter-prisersquos relative independence of the government In mostcases these firms are not autonomous in their decisionmaking such as setting prices which impacts negativelyon the credit rating (road tolls for example are set by thetransport ministry and not by Asfinag) Second thedecline in the debt-to-GDP ratio after peaking in 2002should be fairly pronounced since by 2012 all claimsrelating to the Rechtstraumlgerfinanzierung will be settled

12 Portugal

Recent developments

According to the March 2003 notification as revised byEurostat (1) the general government deficit in 2002 isestimated at 27 of GDP and the debt ratio at 581 Implementation in 2002 of the 2001 stability programmeupdate was severely hampered by the significant budget-ary slippage registered in 2001 which led the Council on5 November 2002 to decide that an excessive deficitexists in Portugal The extent of the budgetary slippageregistered in 2001 has had considerable knock-on effectsin 2002 not least because it was recognised only with aconsiderable delay

However even in a situation of incomplete informationthe Portuguese authorities realised in April 2002 that thebudgetary situation was developing less favourably thanforeseen in the stability programme update of December2001 requiring corrective measures Therefore a recti-fying budget was approved in June 2002 includingsaving measures worth about 06 of GDP notably arise in the normal VAT rate from 17 to 19 and areduction in investment expenditure (2) Following theapproval of the rectifying budget the new deficit targetfor 2002 was raised by 1 percentage point to 28 ofGDP Therefore the preliminary deficit estimate com-plies with the target as set in the rectifying budget

During 2002 budgetary execution at the central govern-ment level developed less favourably than projected in

the rectifying budget basically because of weaker activ-ity than expected (GDP growth is estimated at asagainst an initial forecast of 1 ) faltering domesticdemand which depressed tax revenue particularly in thesecond half of the year and disappointing revenues fromsales of government property Therefore in order tocomply with the deficit target set in the rectifying budgetand given uncertainties regarding the outcome for thehealthcare sector and local authorities the Portugueseauthorities adopted a number of one-off measures at theend of the year notably a tax amnesty which in total areestimated to have yielded additional revenue of about1 of GDP (3)

The reduction in the general government deficit from42 of GDP in 2001 to 27 in 2002 resulted basicallyfrom a strong increase in total revenue of about 13 per-centage points of GDP while total expenditure remainedrelatively stable at about 463 virtually unchangedfrom 2001 On the one hand the increase in total reve-nue despite the current unfavourable cyclical condi-tions is due to the rise in indirect taxes by about 102 caused by the discretionary rise in the standard VAT ratein June together with the favourable impact of the taxamnesty decided at the end of the year on direct taxesand social security contributions (more 41 and 79 respectively)

On the other hand the virtual stabilisation in the totalexpenditure-to-GDP ratio conceals a sharp rise in currentprimary expenditure which was offset by an equivalentdecline in capital expenditure It is important to recall thatin the period that led to the budgetary slippage of 2001current primary expenditure grew consistently abovenominal GDP As regards current primary expenditure

yen1part Eurostat news release 302002 of 17 March 2003 The Portuguese govern-ment deficit was revised upwards by Eurostat to exclude revenue receivedby the Portuguese government at the occasion of the liquidation of theEFTA industrial development fund for Portugal which had been set up in1976 The revision is worth EUR 1395 million (or 01 of GDP) Accord-ing to Eurostat the ESA95 rules imply that this kind of liquidation pro-ceeds have no impact on the deficit As a consequence the governmentdeficit for 2002 has been revised from 26 of GDP (the figure notified bythe Portuguese authorities) to 27

yen2part The rectifying budget included other measure notably the freezing of hir-ing by the government the closure and merger of public institutes and theend of new interest rate subsidies to mortgage loans The rectifying budgetalso provided for the sale of government property

yen3part In mid-November 2002 the government declared an amnesty for interestsurcharges on the payment of arrears on tax and social security contribu-tions if paid before the end of 2002 The tax amnesty was a huge successthe extent of which was largely unanticipated having brought in an addi-tional EUR 1 367 million in revenue (or about 1 of GDP)

no progress has yet been achieved in curbing the rise to379 of GDP which increased by 11 percentage pointsin 2002

The growth rate of current primary expenditure hasstabilised at around 8 per year in the 2001ndash02period that is more than 2 percentage points above theaverage growth rate of nominal GDP The growth rateof collective consumption which decelerated onlyfrom 79 in 2001 to 74 together with an increasein the GDP ratio of total social transfers by 08 percent-age points to 256 resulting in part from the dynam-ics of pension expenditure at unchanged policies andin part from the first step in the intended convergence

of minimum pensions towards the minimum net wagewhich is due to be completed by 2006 The rise in cur-rent primary expenditure in 2002 was offset by thereduction in government investment which fell byabout 74 in comparison with 2001 This raises ques-tions about the quality of overall expenditure

In the meantime the government adopted a number ofmeasures that are likely to yield over time significantbenefits the freezing of hiring in the central governmenta policy of wage moderation in the general governmentand a comprehensive set of measures to curb healthcarespending

Table VI24

Composition and balances of general government Portugal (1) (as of GDP)

2000 2001 2002 2003 2004

Primary balance (2) 04 ndash 11 03 ndash 04 ndash 02

Pm Tax burden 367 362 371 370 370

Pm Cyclically-adjusted primary balance ndash 08 ndash 15 05 05 09

Table VI25

Key figures of the Portuguese stability programme (2003ndash06)

2002 2003 2004 2005 2006

General government budget balance ( of GDP) ndash 28 ndash 24 ndash 19 ndash 11 ndash 05

Primary balance ( of GDP) 02 08 12 19 25

Source 2002 update of the stability programme of Portugal

Compliance with the budgetary target for 2003 is a major challenge on the road to sound public finances

The achievement of the Portuguese authorities in 2002deserves due credit in particular given the difficult condi-tions under which it was obtained but the budgetaryadjustment must be confirmed in 2003 In this respect theCouncil opinion of 7 March on the 2002 stability pro-gramme update emphasised the need to ensure that thegovernment deficit in 2003 be further reduced well below3 of GDP and that the debt ratio be kept below the 60 of GDP reference value Failure to comply with the deficittarget for 2003 would constitute a severe set-back for eco-nomic policy for three reasons first it would underminepolicy credibility second it would not support the correc-tion of a number of imbalances affecting the economynotably the external balance and thirdly in order tosecure government accounts close to balance by 2006 asenvisaged in the current stability programme updatesteady progress has to be achieved on fiscal consolidationTherefore it is paramount to secure both a timely anddetermined implementation of structural reforms

In the last update of the stability programme the Portu-guese authorities have outlined an ambitious programmeof structural reforms which is in line with the broader

strategy defined in the 2002 broad economic policyguidelines The twin aims of these reforms are first thepursuit of the process of budgetary consolidation on asustainable basis and second to enhance the growthpotential of the economy Reforms in key areas notablyin public administration education healthcare andsocial security are likely to have a direct impact onbudgetary consolidation Other reforms (for instance inthe labour market) are likely to have an indirect impacton fiscal consolidation either by fostering a more effi-cient use of resources or by broadening the tax bases asa result of successful supply-side policies

However the medium-term budgetary consolidationstrategy foresees only limited progress on expenditurereduction in 2003 because structural reforms take time toyield benefits In fact only from 2004 onwards budget-ary consolidation is to be achieved through a sustainedand significant reduction in the primary expenditure-to-GDP ratio In the meantime given the weakness of eco-nomic activity the likely shortfall in tax revenue com-bined with the wearing-off of the significant amount ofone-off measures adopted in 2002 it is difficult to imag-ine how the Portuguese authorities will be able to meetthe government deficit target of 24 of GDP for 2003without recourse to additional one-off measures whichhave yet to be announced

13 Finland

Owing to an equally strong boost from domestic and for-eign demand real GDP growth recovered somewhat to16 in 2002 and was held back by a strong inventory run-down in the manufacturing and shipping industries On theback of substantial deceleration in economic activity since2000 when GDP rose by 55 the general governmentfinancial surplus fell slightly to 47 (1) of GDP in 2002although exceeding the estimate of the stability programmeupdate of November 2002 by 09 percentage points

The change in public finances since 2000 results from anormalisation of exceptionally high capital and corpo-rate tax revenue from 2000ndash01 The better-than-expected outcome in 2002 owes mainly to certain one-off timing factors in corporate capital gains and optiontax income Overall these factors are estimated to haveamounted to about of GDP In addition a declinein taxation on used cars together with a rise in corporateand energy tax intake increased tax revenue more thanwas expected In spite of these exceptional revenues thesurplus of central government finances fell by 03 per-centage points to 17 of GDP Local governmentfinances continued to post a small deficit of 03 ofGDP although the finalisation of taxation of the tax year2001 increased municipal revenue by some 03 ofGDP at the end of 2002 Social security institutionslargely maintained their position thanks also to theongoing preparation for age-related future expenditurepressures with a surplus of 33 of GDP

In spite of good indirect tax accrual the general governmentrevenue ratio slid marginally by 02 percentage points to

just below 54 in 2002 This was mainly the result of rev-enue shortfalls due to discretionary income tax cuts of theorder of 05 of GDP as well as the normalisation of cor-porate and capital tax revenue On the other hand govern-ment income from sales of property rose markedly

On the expenditure side a repeated slippage in centralgovernment spending and higher social benefits follow-ing a marked rise of pensioners contributed to a rise ofgeneral government expenditure by 02 percentagepoints to 492 of GDP in spite of a significant fall ininterest payments Central government real expenditurewas about 1 higher in real terms in 1999ndash2001 com-pared with the target of freezing the spending at 1999levels In 2002 the cumulative overrun was morepronounced about 3 This owes to discretionaryincreases in permanent expenditure in many areas of thebudget According to the budget for 2003 the deviationfrom the spending guidelines is expected to continuewith the anticipated cumulative overrun of the centralgovernment expenditure target reaching 3 in realterms (2) Consequently the central governmentrsquos aim ofachieving a structural surplus of 1 to 2 of GDP in themedium term seems all the more challenging in thefuture

Due to a still strong primary surplus of 7 of GDP andsubstantial privatisation proceeds of about 19 ofGDP the general government debt ratio fell to 427 in2002 from 438 in the previous year ie close to theestimate of the updated stability programme The stock-flow adjustment decelerated the fall of government debtas the pension funds continued to restructure their assetsby shifting large parts of their Finnish government bondsto bonds issued in other countries of the euro areaAlthough the governmentrsquos aim of pushing the centralgovernment debt ratio to below 50 of GDP (3) by 2003

yen1part It should be noted that Statistics Finland revised the national accounts dataat the beginning of 2003 by changing the base year of price data to 2000from 1995 Along with other small changes in classification this revisedupwards net lending of general government for earlier years by about 01ndash02 percentage points

yen2part In fact in budgets for 2002 and 2003 direct VAT-income distribution to thesocial insurance institution was increased implying a cumulative overrunof about 4

(424 of GDP in 2002) has been reached the need tocreate a safety margin against age-related expenditurepressures warrants a further reduction in the debt ratio

The November 2002 update of the stability programmeforesees a general government surplus of 27 of GDPin 2003 Recently this estimate was revised to 26 which deviates markedly from the Commission servicesestimate of 3 The difference is due mainly to a more

pessimistic national estimate of the costs in 2003 of low-ered car taxation and on a less optimistic view of domes-tic demand Also the normalisation effect of 2000ndash01corporate and capital tax revenues in 2003 are estimatedto be larger in the national forecast

In view of expected cuts of excise duties on tobacco andalcohol owing to the end of EU exemption the stabilityprogramme of November 2002 foresees the general gov-ernment surplus to continue moderating to just over 2 of GDP in 2004 which further deviates from the Com-mission estimate of 3 This follows largely from the

Table VI26

Composition and balances of general government Finland (1) (as of GDP)

2000 2001 2002 2003 2004

Primary balance 98 79 70 54 50

Pm Tax burden Inclusive social contribution 480 460 459 450 444

(1) Commission spring 2003 economic forecasts(2) No UMTS receipts included(3) In kind and other than in kind

Table VI27

Key figures of the Finnish stability programme (1) (2002ndash06)

2001 2002 2003 2004 2005 2006

49 38 27 21 26 28

(1) No UMTS receipts included

Source 2002 update of the stability programme of Finland

yen3part Excluding income from sales of government property

no-policy-change assumption of the Commission fore-cast In the light of mounting tax competition on corpo-rate income and the experience of expenditure slippagein the recent past renewed efforts to control centralgovernment spending seem to be warranted if thegovernment is to secure a sustainable path of publicfinances

Experiences with the expenditure rule

At the beginning of the 1990s following one of the mostsevere economic depression in Finland the governmentadded a new tool into the budget process to achieve con-solidation in public finances (see Part V of this report foran analysis on expenditure rules in the EU context)Annual expenditure limits (so-called lsquoframesrsquo) wereintroduced for central government spending to helpbudgetary planning in the medium term In particularthe government sought to terminate the chronic accumu-lation of central government deficits caused by hikingsocial security spending and reducing overall revenuesDuring the first half of the 1990s the frames alsoincluded targets for the central government personnelbut this feature was eradicated by 1995 whereas plans oninterest payments for the State debt have always beenincluded in the frames

Expenditure rule

Expenditure frames turned into spending ceilings whenthe currentstepping aside government took office in1999 and defined as one of its fiscal policy targets tofreeze central government real expenditure at the level ofthe 1999 original budget (EUR 32 billion) for its term ofoffice until 2003 According to the government pro-gramme of 1999 all spending needs would be financedwithin the spending ceilings implying savings measuresshould any new expenditure items arise The 2000 updateof the stability programme further stipulated lsquothe parlia-mentary factions of the ruling parties have agreed torefrain from using any automatic savings generated by adecrease in unemployment and reduced debt servicing tocover new spending items or levels should the economiccycle so requirersquo In view of the governmentrsquos other fiscalpolicy targets of reducing central government debt tobelow 50 of GDP and cutting labour taxes by EUR17ndash19 billion over the election period adhering to strictspending control was therefore essential

Annually in FebruaryMarch the government agrees onexpenditure frames by the ministries for the next four-

year period taking into account existing legislation allrelevant coming spending items (inter alia wage rises)and large specific development plans Thus on theone hand indexation-induced lsquoautomaticrsquo spendingincreases are included in the frames and on the otherhand any major developing process can be agreed andincluded upon the spending plans already in advance Onthe other hand as the government drafts new framesevery year there is a customary tendency of overrunningthe previous frames instead of using the previouslyagreed frame as a basis for next yearrsquos budget therebyeffectively undermining the genuine purpose of theexpenditure frames Expenditure frames lack the statusof being legally binding nor is there any requirement ofcovering the possible overruns Individual ministries areobligated to draft their budget proposal for the next yearaccording to the frames agreed by the government inspring although the ministries can include developingprojects into the budget proposals thus deviating fromthe initial expenditure frame

Assessment of accomplishment

Budgetary consolidation during the past decade has beensuccessful and the on-budget (1) expenditure fell by wellover 10 percentage points (2) of GDP between 1995 and2001 (see Table 133 from 364 of GDP in 1995 to249 in 2001) Particularly for the early years much ofthis owed to expenditure frames while part of the fall inexpenditure ratio in later years is also due to robustgrowth of nominal GDP (3) and sturdy privatisation pro-ceeds (4) Owing to the revenue from sales of govern-ment property interest payments on government debthave decreased faster than was targeted in the govern-ment programme of achieving the level of central gov-ernment debt of below 50 of GDP (5) by the end of theterm of the government

yen1part Central government finances also include extra-budgetary funds such asthe National Housing Fund of Finland the State Pension Fund the Devel-opment Fund of Agriculture and Forestry and the Intervention Fund ofAgriculture

yen2part Budgetary outcomes of different years are not strictly comparable over theperiod owing to some of the functions having been transferred to net budg-eting and some others to State-owned companies

yen3part Of about 6 per year on averageyen4part Totalling to EUR 67 billion or 5 of GDP during 1999ndash2002yen5part Estimated at 422 of GDP in 2002 The target was later complemented to

exclude privatisation proceeds The debt-to-GDP ratio is estimated at about47 in 2002 if all the income from property sales had been excluded fromthe use of reducing the central government debt

Table VI28

Difference of budgetary outcomes and expenditure ceilings (excluding interest payment) million EUR

In spite of clearly successful budgetary consolidationduring the second half of the 1990s the current expend-iture rule has not been fully adhered to Central govern-ment real expenditure including falling interestpayments on government debt is estimated to exceed thetarget of the 1999 budget level by somewhat over

EUR 1 billion in 2003 Central government nominalspending by ministries increased by EUR 55 billionwhereas interest payments decreased by EUR 13 billionabout 1 percentage point of GDP between 1999 and2003 The over-shooting was mild in 2000 but acceler-ated sharply in 2001 making for a overrun in 1999ndash2001

ndash 500

ndash 300

ndash 100

1999 2000 2001 2002 2003

Table VI29

Central government expenditure frames 1994ndash2003 million EUR in nominal terms

YearExpenditure ceiling(as defined in t-1)

Budgetary outcomeDifference btw target

and outcome Outcome

of GDP

1994 28 056 31 780 133 362

1995 31 352 34 626 104 364

1996 33 583 34 042 14 345

1997 33 411 31 817 ndash 48 297

1998 31 928 32 424 16 279

1999 32 060 32 120 02 268

2000 32 460 32 953 15 253

2001 32 595 33 765 36 249

2002 (1) 34 195 35 249 31 251

2003 (1) 35 625 35 755 04 245

(1) Latest budget proposal for the year in question

of about 1 in real terms In 2002ndash03 the overrunwas more pronounced about 3 Part of the overrunresults from a deceleration in the growth of social secu-rity contributions which has increased transfers from thecentral government budget to social security funds To alarge extent however the increased central governmentspending is due to increasing transfer payments to localgovernment whilst consumption expenditure also grewmarkedly in particular in 2002

Source of overrun

The expenditure ceilings are expressed by administrativebranches that is ministries not by functions Conse-quently the ceilings bring a certain lack of flexibilityand coordination as every ministry strives for the opti-mal budgetary funding for itself Furthermore the min-istries have a tendency to overrun the expenditure ceilingof spring when they present their budget proposal to theMinistry of Finance in July after only five to six monthsof agreement of the ceilings The general shortcoming isthat the expenditure ceilings are changed annuallyinstead of adhering to them for their whole four-yearperiod Furthermore as the government complementsthe annual budget with two to three supplementary budg-ets in the course of the budget year only modest effort isgiven to adhere to spending ceilings or the originalbudget for the year in question The current expenditurerule applies only over the governmentrsquos term of office Inaddition the last word in compiling the budget rests withparliament which has often taken a softer approach onadhering to the spending ceilings agreed by the govern-ment

Latest expenditure ceilings

On 27 February 2003 the government reached an agree-ment on the expenditure frames for the next four-yearperiod up to 2007 (1) (see Table 134) According to thelatest ceilings central government total expenditure in2004ndash07 is estimated to exceed the level of the 2003budget expenditure by about 1 in real terms The fallof interest expenditure on government debt is expectedto discontinue (2) owing to a rise of nominal debtConsequently nominal expenditure seems to grow byabout EUR 2 billion between 2003 and 2007 The deci-

sion on ceilings include all currently decided futurespending items and expected social transfers on interalia unemployment Furthermore guidelines take intoaccount the expenditure pressure arising from risinghealthcare costs and they further assume a 75 costindexation on local government state grants instead ofthe current 50

Overall spending ceilings for 2004ndash07 assume a virtualfreeze on real expenditure which in view of fixed inter-est expenses imply that central government is expectedto spend more money merely on price rises and wageincreases over the coming four-year period Further-more falling interest outlays no longer seem to offer lee-way for extra spending

Improving the expenditure rule

Implied by the expenditure overruns and the currentobscure structure of the expenditure rule it appears thatexpenditure ceilings should be made operationally moresimple To this end the authorities should considerreformulating the real expenditure target so as to avoidtransparency problems That could be achieved forexample by explicitly agreeing how nominal govern-ment expenditure will be adjusted for inflation On theother hand nominal targets are more transparent andtherefore easier to monitor Additionally nominal tar-gets require correctional measures in case of faster-than-expected inflation

Additional improvement could be gained from applyingthe four-year ceilings in full that is using them as the truemedium-term targets instead of changing the ceilingsevery year An overall priority plan for the total centralgovernment spending would be helpful in that regard Inaddition the current supplementary budget procedureshould be reformulated to take better account of the exist-ing spending limit and budget for each year It seems thatstricter enforcement of the limits should be implementedTo this end spending decisions which overrun the ceil-ings should be offset by spending cuts

It would pay off to consider whether interest paymentson public debt should be excluded from the ceilingsthereby avoiding a loosening of the spending targets incase of falling interest expenses (see also Part V of thisreport) Additionally this implies also considering thepossibility to exclude other cyclical expenses such asunemployment benefits too Taking this analysis fur-ther one-off-type income measures could also beexcluded from the budgetary planning

yen1part These guidelines are only indicative as the new government to be electedon 16 March 2003 will renegotiate the final spending ceilings for 2004ndash07to be used when preparing the budget proposal for 2004 in autumn 2003

yen2part The government expects interest payments to fall by another EUR 300 mil-lion in 2004 from 2003 but to resume a rising trend between 2005 and2007

Table VI30

Central government expenditure frames for 2004ndash07 by ministries million EUR at 2004 prices and costs

Administrative branch 2004 2005 2006 2007

Council of State 45 45 51 42

Foreign Affairs (1) 747 783 823 864

Justice 663 651 671 665

Interior 1 435 1 447 1 431 1 418

Defence 2 049 2 116 2 121 2 124

Finance 5 441 5 560 5 680 5 765

Education 6 017 6 003 6 005 6 000

Agriculture and Forestry 2 636 2 659 2 682 2 626

Transport and Communications 1 768 1 629 1 485 1 426

Trade and Industry 948 943 948 959

Social Affairs and Health 8 727 8 775 8 826 8 837

Labour 2 101 2 044 2 009 1 970

Environment 657 647 640 635

Primary expenditure 33 337 33 405 33 473 33 433

Interest payments on State debt (1) 3 127 3 068 3 076 3 088

Total 36 464 36 473 36 549 36 521

(1) Interest and Development Cooperation expenses at current prices

14 Sweden

The Swedish government finances have been in surpluseach year since 1998 The overriding goal of fiscal pol-icy is to maintain sound public finances To achieve thisSwedenrsquos medium-term budgetary strategy is three-foldand consists of (i) nominal ceilings on central govern-ment expenditure set annually for three years ahead (ii)a medium-term balanced budget constraint for local gov-ernments and (iii) a 2 of GDP surplus target for gen-eral government finances on average over the business-cycle The latter forms an integral part of Swedenrsquos strat-egy to cope with the budgetary consequences of ageingpopulations

In 2002 the surplus was 13 of GDP (17 expected in the latest convergence programme) downmarkedly from 45 of GDP in 2001 Higher expend-iture and in particular lower revenue contributed to thelower surplus recorded in 2002 Higher public con-sumption and transfer payments to households contrib-uted to the rise in the expenditure-to-GDP ratio Lowertax receipts from both households and companies con-tributed to the fall in the revenue-to-GDP ratio Thisreflects in part the tax cuts on labour income imple-mented in 2002

Central government expenditure covered by the ceiling(cash basis) in 2002 came out just below the ceilingpreviously set The use of expenditure ceilings on cen-tral government as a means for medium-term budgetaryplanning is covered in more detail in the followingsection

The cyclically-adjusted balance fell to 09 of GDP in2002 from 36 of GDP in 2001 and the cyclically-adjusted primary balance fell to 38 of GDP from

68 of GDP This indicates a considerable easing ofthe fiscal stance in 2002 (1)

The general government debt ratio was 524 of GDPin 2002 down by 2 percentage points compared with2001 The debt reduction was lower than the surplus ingeneral government finances mainly due to the netacquisition of financial assets in 2002

In 2003 the surplus in government finances is expectedby the Commission services to fall somewhat to 08 ofGDP as economic activity is forecast to be weaker GDPgrowth of 14 is expected compared with 19 in2002 The expenditure-to-GDP ratio is expected to risein 2003 as a result of the weaker economic activity fore-seen Higher transfer payments to households are pro-jected in part as unemployment is forecast to rise and inpart as sickness insurance payments should be higherthan in the previous year This suggests that the ceilingson central government expenditure will be breached onthe basis of the budget for 2003 presented in October2002 Indeed the Swedish authorities announced in theSpring Fiscal Policy Bill released on 15 April measuresto cut expenditure in line with the Budget Law

The revenue-to-GDP ratio is expected to rise in spite ofthe weaker economic activity foreseen This is in partdue to higher tax rates levied by several local govern-ments in 2003 resulting in higher tax revenues for thegeneral government sector as a whole The cyclically-adjusted surplus is expected to rise by 02 percentagepoints of GDP and the cyclically-adjusted primary sur-

yen1part In the 2002 updated convergence programme an adjustment for the timingof recording of taxes is made which reduces the balance in particular in2001 but also in 2002 The Swedish approach of adjusting the periodisationof taxes gives considerable effects for some years This means that thebudget balance for 2000 is strengthened by 1 percentage point and weak-ened by 25 and 05 percentage points in 2001 and 2002 respectivelySmaller effects are projected for 2003 and 2004 On the basis of such anadditional adjustment the fiscal stance is still expansionary in 2002 but toa lesser degree

plus is expected to rise by 01 percentage points reflect-ing a slightly restrictive stance in 2003

In the latest update of the Swedish convergence pro-gramme the general government finances were projectedto show surpluses of 15 of GDP in 2003 and 16 ofGDP in 2004 These budgetary projections were based onreal GDP growth of 25 in 2003 and in 2004 Thesocial security sector was projected to continue to showconsiderable surpluses in the years to 2004 For the localgovernment sector slight surpluses in 2003 and 2004were projected whereas for the central government defi-cits of around 1 of GDP were projected Overall boththe revenue and expenditure-to-GDP ratios were pro-jected to decline in 2003 and 2004 The government grossdebt-to-GDP ratio fell below 60 in 2000 and isexpected to fall further to 493 by 2004 The targets setfor public finances were considered to be in accordancewith the requirements of the Stability and Growth Pact bythe Council as evident from their latest opinion on theupdated Swedish convergence programme (1)

The overall thrust of the Spring Fiscal Policy Bill isrestrictive and the outlook for the economy and the pub-lic finances were revised downwards compared with the2002 convergence programme (and the budget for2003) The surplus in the public finances were reviseddownwards to 04 of GDP in 2003 (from 15 ) andto 10 of GDP in 2004 (from 16 ) In 2005 and2006 surpluses of 14 and 21 of GDP respectivelywere projected These budgetary projections were basedon real GDP growth of 14 in 2003 (down from25 ) 24 in 2004 (down from 25 ) 26 in 2005and 25 in 2006

The Commissionrsquos spring forecasts suggest that the sur-plus in the public finances will reach a low in 2003 anda surplus of 08 of GDP is projected at the back oflower GDP growth compared with 2002 In 2004 ahigher surplus of 12 of GDP is projected in line withhigher GDP growth The difference between the Com-missionrsquos spring forecasts and the projections in theSpring Fiscal Policy Bill regarding the budget balance inparticular in 2003 can mainly be attributed to the revenueside In particular the Swedish authorities project asmaller rise in current tax receipts compared with theCommission This smaller rise can be explained by anassumption rather than a forecast of wage increases

(hourly earnings) of 35 which may well be on thelow side The budget also projects a larger fall in corpo-rate direct taxes compared with the Commission Inaddition the main new measure in the Bill mdash of reduc-ing sickness insurance mdash results in lower taxableincome and therefore lower tax receipts as benefits aretaxed Moreover a decline in the debt ratio is expectedand the debt ratio is projected by the Commission to fallbelow 50 of GDP in 2004

Sustaining sound public finances mdash the first real test for the procedure of ceilings on central government expenditure

The Swedish Government introduced with the 1996Budget Law a procedure of expenditure ceilings on cen-tral government to be set three years ahead This proce-dure has proven useful in that it limits the risk for slip-page in the budget as it imposes institutional restrictionson increased spending It has also been successful in thesense that these ceilings have been adhered to each yearsince 1997 and expenditure also came out below theceilings in 2002 (see Table VI33 below) At the sametime general government expenditure in relation to GDPhas been on a declining trend It can therefore be said thatthe fiscal policy framework has been instrumental instrengthening the Swedish public finances It hasallowed Sweden to introduce substantial tax cuts in2000ndash02 while keeping the public finances in surplus

Sweden experienced remarkable economic growthbetween 1998 and 2000 averaging 42 accompaniedby strong employment growth and a reduction of theunemployment rate from 82 in 1998 to 56 in 2000(and further to 49 in 2001) This has acted in thedirection of limiting the demand and need for expendi-ture increases beyond projections

However Swedish economic growth as in most othereconomies was more subdued in 2001 and 2002 aver-aging 15 and is set to be slightly below that in 2003Moreover employment growth was virtually flat in 2002and is expected to be slightly negative in 2003 This isexpected to result in a rise in the unemployment ratewidely regarded as being near the NAIRU In the budgetfor 2003 the contingency reserves (the buffers withinthe ceilings) were narrowed for 2003 and 2004 More-over it is likely that there will be overruns in someexpenditure areas if economic growth comes out belowthe governmentrsquos expectations Indeed in the 2003Spring Fiscal Policy Bill GDP growth was revisedyen1part OJ C 26 422003

downwards from 25 to 14 in 2003 Moreover thecontingency reserves (the buffers within the ceilings)were narrowed further for 2003 and 2004

The Budget Law states that the government should twicea year report to Parliament (this has been done when pre-senting the Fiscal Policy Bill in the spring and theBudget Bill in the autumn in the past) If signs of over-runs should emerge the government should proposemeasures to correct these if the overall ceiling is threat-ened However Parliament may decide on changing theceilings which illustrates that the procedure has some

flexibility The government has declared on severaloccasions that it stands ready to take restraining meas-ures on expenditure in order to ensure adherence to theceilings set overall in line with the Budget Law In theSpring Fiscal Policy Bill proposals to contain expendi-ture in 2003 and 2004 were included

The fact that expenditure cuts were proposed in theSpring Bill suggests that the Swedish authorities do takethe procedure of expenditure ceilings seriously Thislends support to the continuation of the hitherto success-ful strategy of maintaining expenditure control

Table VI31

Composition and balances of general government Sweden (1) (as of GDP)

2000 2001 2002 2003 2004

Government balance 34 45 13 08 12

(1) Commission spring 2003 economic forecasts(2) In kind and other than in kind

Table VI32

Key figures of the Swedish convergence programme (2001ndash04)

2001 2002 2003 2004 2005 2006

Real GDP growth (annual change) 12(deg) 21 25 25 23

Primary surplus ( of GDP) 60 23 20 21

NB In the 2003 Spring Fiscal Policy Bill released on 15 April the following projections were made GDP growth 14 in 2003 24 in 2004 26 in 2005 and25 in 2006 General government budget balance ( of GDP) 04 in 2003 10 in 2004 14 in 2005 and 21 in 2006 Government debt ( of GDP)51 in 2003 50 in 2004 484 in 2005 and 464 in 2006

Source 2002 update of the convergence programme of Sweden

Several commentators have argued that the introductionof a rule-based framework for public finances and a pro-cedure for ensuring expenditure control has been instru-mental in strengthening Swedish public finances and hasadded to the achievement of macroeconomic stabilityIndeed Mr Lars Heikensten Governor of the SwedishRiksbank recently said (1) that lsquoif there is a short-termroom for manoeuvre and if it is possible to achievehigher growth and employment without the inflation tar-get being threatened this opportunity should be taken bylowering the repo-rate To let the rule-based fiscal policyframework go when it for the first time is being testedthoroughly would send a very negative signal to all whoassesses the Swedish economic situationrsquo

To this end the proposed increase in the levels of sick-ness and family insurance (2) was postponed in theSpring Bill Moreover cuts in the sickness insurancebenefit levels and a prolongation of the period theemployer pays lsquosickness wagersquo from 14 to 21 days wereproposed This together with other expenditure cuts andpostponements amounted to SEK 53 billion (02 ofGDP) in 2003 and SEK 108 billion (04 of GDP) in2004 Even so the budgetary margins for 2003 and 2004are very narrow at SEK 04 billion and 11 billion respec-tively With the proposed expenditure cuts the fiscalstance is restrictive in particular in 2003 and to a lesserextent in 2004ndash06 Tax increases in the local governmentsector this year contribute to this The Spring Bill notesthat the restrictive fiscal stance lsquolessens the need for atightening of monetary policy in the recovery phasersquo

In order to strengthen the chances of respecting theexpenditure ceiling for 2003 some expenditure compo-nents were advanced from 2003 to 2002 suggesting aslightly better starting position in 2003 However this typeof operation may adversely affect the credibility of theexpenditure ceiling procedure as a mean to avoid slippageIn addition it does jeopardise the very idea of containingexpenditure This is evident from the national accountsdefinition where tax expenditures are booked properly asexpenditures Indeed in the report published on 12 March2002 by the government-appointed Committee on Stabili-sation Policy for Full Employment if Sweden joins theMonetary Union the use of the expenditure ceilings inSweden is being addressed in the context of ensuring main-tained expenditure control in lsquogood timesrsquo The reportnotes that lsquo[hellip] the so-called budget margin mdash the differ-ence between the government expenditure ceiling and esti-mated expenditure mdash has come to be viewed more as aldquoroom for new expenditure increasesrdquo than as a safety mar-gin for dealing with uncertainty in expenditure forecastsrsquo

Hence in order to ensure a successful use of expenditureceilings on central government as a means to containexpenditure in the medium term Sweden would gainfrom a stricter implementation of the so-called budgetmargin to reflect an adequate margin for forecast errorsIn the short-term (in 2003ndash04) the discretionary cuts inspending introduced with the Spring Fiscal Policy Billstrengthens the chances of adhering to the ceilings setwhen they are being tested thoroughly for the first timesince the procedure was introduced It lends support tothe continuation of the hitherto successful strategy ofmaintaining expenditure control This should put Swe-den in a better position to continue the strategy of sus-taining surpluses in public finances over the cycle andwould also make room for the continuation of the strat-egy of lowering taxes

yen1part On 18 March at a hearing in the Parliamentrsquos sub-committee on finance Onthe same day the Riksbank announced that the Executive Board haddecided to cut the repo-rate by 25 basis points to 35

yen2part Proposal in the budget for 2003 to raise the level from 75 to 10 times thebasic amount

Table VI33

Central government expenditure in of GDP

1997 1998 1999 2000 2001 2002 2003 2004

Expenditure central government 365 364 362 346 347 347

Expenditure ceiling central government in t-1 383 365 362 348 348 347 338 335

NB the figures for central government are on a cash basis (national definition) For 2003 and 2004 the Commission services spring 2003 forecastfor nominal GDP is used The expenditure ceiling for 2004 as given in t-2 A technical adjustment to the ceilings in 2003 and 2004 in theSpring Fiscal Policy Bill results in a ceiling (in of GDP) of 339 in 2003 and 337 in 2004 In addition new expenditure ceilings for 2005and 2006 were not proposed in the Spring Fiscal Policy Bill contrary to the information in the 2002 updated convergence programme TheBill states that ceilings for these years will be presented with the budget for 2004 However the Spring Bill includes indicative expenditureceilings These were (in of the Billrsquos GDP) 336 in 2005 and 334 in 2006

Sources Swedish Budget Bills for 1997ndash2003 The 2003 Spring Fiscal Policy Bill Commission services

15 United Kingdom

The government finances in 2002 moved into deficitfollowing four years of surpluses The estimated out-turnfor the general government balance was a deficit of13 of GDP following a surplus of 08 in 2001 Inthe financial year 2002ndash03 the out-turn is now estimatedto be a deficit of 23 compared to 18 in the conver-gence programme Part of the rise from the convergenceprogramme is due to an allocation for the war with IraqA reason for the move into deficit in 2002 was the resultof planned rises in government expenditure in excess ofGDP growth but also receipts were lower than expecteddue to the effects of the global economic slowdown onfinancial markets and companies The tax burden is esti-mated to have decreased from 38 of GDP in 2001 to alittle under 37 in 2002 In particular taxes on incomeactually fell in part to the aforementioned effect on thefinancial sector A rise in current consumption and capi-tal expenditure as a percentage of GDP was partly offsetby a fall in interest payments as UK gross debt relativeto GDP continued to fall The cyclically-adjusted pri-mary surplus as a percentage of GDP fell in 2002 asplanned expenditure rose as a percentage of GDP Thegeneral government debt fell to 384 of GDP at theend of 2002 from 389 at the end of 2001

The public finances are expected to weaken again in2003 and the general government finances are expectedto show a deficit of 25 of GDP in that year Theauthorities in the budget announced in April expect asimilar deficit of 24 of GDP in 2003ndash04 compared to22 in the convergence programme This weakeningin the government finances is due to planned expenditurerises over the period to financial year 2003ndash04 which areonly partially offset by rises in national insurance contri-butions Further government expenditure is expected tobe temporarily inflated in 2003 as a result of the costsof the war with Iraq In addition the public finances willcontinue to be affected albeit temporarily by a continu-

ation of lower than expected tax receipts resulting fromthe weakness in financial markets In sum the rise inthe cyclically-adjusted balance is around 1 of GDPbetween 2002 and 2003 on the Commission servicesprojections as the cyclically-adjusted deficit rises to 2 of GDP in 2003 and 2004 from 1 in 2002 This expan-sionary stance is not expected to present problems in theUK where inflation is amongst the lowest in the EU andindeed rises in general government expenditure espe-cially capital expenditure should help maintain respect-able GDP growth of 2 in 2003

The Commission services are projecting a deficit of25 of GDP in 2004 the same as in 2003 The latestbudget projections show the public finances moving intodeficit of 24 of GDP in 2003ndash04 as stated above anda deficit of 21 of GDP in 2004ndash05 falling to 19 in2005ndash06 The slightly lower deficits of the authorities ascompared to the Commission services can be largelyexplained by a more optimistic growth forecast for 2004However in the short term these projected deficits ofthe authorities are a little higher than those in the conver-gence programme due to a more negative output gap butin 2006ndash07 and subsequently the deficit is projected at17 of GDP a little above that of the convergence pro-gramme and it is also 17 in cyclically-adjusted termsThis deficit persists as the result of addressing the lowlevel of government investment

Gross debt as a percentage of GDP is expected to bearound 40 in 2007ndash08 in the budget projections Thisis relatively low On current policies and assumptionsthe UK is well placed to meet the budgetary costs asso-ciated with an ageing population

The UK approach to public investment

The government has introduced a number of reforms tofiscal policy making and public expenditure planningand control to ensure that public investment is main-

tained at levels appropriate to securing the governmentrsquosgoals (1)

These reforms reflect the view that in recent years pub-lic investment had fallen to very low levels as a propor-tion of GDP (only 05 in net terms in 1999ndash2000)Among the EU economies the ratio of public sector netinvestment to GDP in the UK was around the lowest overthe period 1970ndash2004 The reforms also reflect theimportance the government attaches to public invest-

ment in its own right as an important ingredient inadvancing two of its five long-term goals namely

bull raising the sustainable rate of UK productivity todeliver rising national prosperity (by improving thenationrsquos infrastructure)

bull establishing world-class public services with signif-icant extra investment tied to reform and results

The following describes the UK approach to publicinvestment in four important areas namely the role ofpublic investment in the macroeconomic frameworkthe broad planning approach to public investment in the

Table VI34

Composition and balances of general government United Kingdom (1) (as of GDP)

2000 2001 2002 2003 2004

Pm Tax burden 382 380 367 369 371

Pm Cyclically-adjusted balance 12 07 ndash 10 ndash 20 ndash 20

Table VI35

Key figures of the United Kingdomrsquos convergence programme (2001ndash02 to 2006ndash07)

2001ndash02 2002ndash03 2003ndash04 2004ndash05 2005ndash06 2006ndash07

Primary balance ( of GDP) 10 ndash 08 ndash 12 ndash 06 ndash 06 na

Source 2002 update of the convergence programme of United Kingdom

yen1part Most recently these were described in the Treasury publication lsquo2002 Spend-ing review departmental investment strategies a summaryrsquo (December 2002)

spending lsquoroundsrsquo the departmental allocation andassessment of investment by results and the role of pri-vatepublic partnerships in delivering investment

The macroeconomic framework

The UKrsquos own fiscal rules introduced in 1997 are nowwell known

bull the golden rule over the economic cycle the gov-ernment will borrow only to invest and not to fundcurrent spending and

bull the sustainable investment rule public sector netdebt as a proportion of GDP will be held over theeconomic cycle at a stable and prudent level

Thus the intent can be seen to promote (public sector)capital investment while ensuring sustainable publicfinances over the long term as borrowing for investmentis conducted in a responsible way

The chart reveals the low level to which investment hadfallen in recent years and also shows the pick-up sincethe rules were established though investment stillremains at low levels Of course part of the historical fallis explained by the decisions of governments to moveout of activities previously delivered by the public sec-tor but the fall is not fully explained by these changes

The broad planning approach

Public investment allocations play an important role inthe four key themes of the 2002 spending reviewnamely raising productivity extending opportunitystrong and secure communities and Britain in the worldWithin the increased level of resources devoted toinvestment the government has focused on four priorityareas mdash education transport health and housing

Public sector investment falls within the budgetingregime which is intended to secure compliance with thefiscal rules The main ingredients of this as far as invest-ment is concerned are

bull firm and fixed three-year departmental expenditurelimits (DEL) to help departments plan and manageresources with greater certainty over the mediumterm (so extending planning horizons from the his-toric levels of one year to fixed three-year spendingplans and with longer-term plans for key pro-grammes such as transport and health)

bull separate resource (current) and capital budgets con-sistent with the distinction in the fiscal rules Depart-ments can only spend capital allocations on capitalprogrammes This helps to ensure that investment isnot sacrificed to meet short-term current pressures

bull full end-year flexibility which allows departments tocarry forward under-spends from one year to thenext

bull coherent investment strategy to deliver assets neces-sary to support public services

The recent spending review established departmentspending plans for the three years mdash 2003ndash04 to 2005ndash06 Net investment is planned to rise from 12 of GDPin 2002ndash03 to 21 in 2005ndash06 and is projected to risefurther to 22 of GDP by 2007ndash08 which if achievedas planned would bring investment up to rates last seenat the end of the 1970s (see Graph VI1)

While spending has risen significantly especiallyrecently it would be fair to say that there has been someslippage from previously announced plans In the firstspending review of 1998 (covering the years from 1998ndash99 to 2000ndash01) net investment was planned to rise to12 of GDP in 2000ndash01 In the event the out-turn inthat year was 05 of GDP A reason for the undershootis that departments have taken time to respond to the stepchange in capacity to manage investment programmes

Departmental allocations and assessment of results

Overall totals for public investment are establishedconsistent with meeting the fiscal rules and achieving thegovernmentrsquos broad objectives Departments each havewhat are called public service agreements (PSAs) Theseset out the outcomes that departments are aiming toachieve and the targets that underpin them Overallcapital budgets for departments are then agreed in thespending review appropriate to the established PSAsDepartments then prioritise within these allocationsDepartmental investment strategies (DISs) explain howinvestment will contribute to the achievement of theseobjectives The strategies are also backward lookingsuch that progress on previous strategies can be evalu-ated However since the PSAs are in some cases to beachieved over a longer time frame than three years thecontribution so far is critical to achieving the overall tar-get Departments strive to achieve best practice forproject appraisal based on guiding principles in theTreasuryrsquos lsquoGreen Bookrsquo

The role of the private sector in public investment

Investment secured through publicndashprivate partnerships(PPPs) and the private finance initiative is not includedin the totals for public sector investment The way thesework is that the public sector buys services from a pri-vate sector partner The private sector partner undertakesthe capital investment and its ability to manage risksallocated to it can result in the provision of a service at aprice that represents value for money Approval of a PFIscheme depends on an assessment of the lifetime costs ofproviding and maintaining the underlying asset (a schoolsay) and the running costs of delivering the requiredservice

The government stresses that PPPs must be seen in con-text and that PFI contracts make up 10ndash15 of total

investment in any one year but do not replace the lsquosignif-icantrsquo investment committed by the government itselfThey are pursued only when they represent better valuethan the public service alternative

Assessment

The UK approach establishes a comprehensive frame-work for the determination of public investment from itsrole in the macroeconomic fiscal rules to its role in meet-ing specific objectives of government policy Whileinvestment is rising rapidly now it has often come inunder projections since the new framework was set up in1997 The challenge for the authorities will be to ensurethat investment rises as planned and to ensure and dem-onstrate that public investment has played its intendedrole in securing the policy outcomes desired

Graph VI1 Public sector net investment of GDP

ndash03

Part VII

Resources

1 Code of best practice on the compilation and reporting of data in the context of the excessive deficit procedure

This code of best practice (1) aims at clarifying andstreamlining procedures both at the Member State andthe Commission levels when compiling and reportinggovernment accounts in particular data for governmentdeficit and debt covering the previous four years (actualdata) and the current year (planned data) in the contextof the excessive deficit procedure (EDP) The coderespects the definitions deadlines or obligations estab-lished by the legal acts in force The reporting procedureis governed by Regulation (EC) No 360593 (2) TheProtocol on the EDP annexed to the Treaty stipulates inArticle 4 that lsquoThe statistical data to be used for theapplication of this Protocol shall be provided by theCommissionrsquo Therefore the Commission fulfils the roleof statistical authority However it does not directlycompile government data in the Member States butdepends on data compiled and reported by the nationalauthorities For that reason the accurate and speedycompilation of budgetary data and their prompt reportingto the Commission is of utmost importance

The Commissionrsquos role as statistical authority in the con-text of the EDP is exercised by Eurostat on behalf of theCommission

11 Compilation of budgetary data by Member States

Actual data The actual data of the ESA95 governmentaccounts shall be compiled by the national statistical

institutes (NSIs) and where applicable by the nationalcentral banks (NCBs) In certain Member States in viewof current national institutional arrangements actualdata can be compiled by the ministries of finance (MOF)The NSIs act in full scientific independence in strictrespect of the accounting rules as defined in Regulation(EC) No 360593 Regulation (EC) No 222396 (3) (theESA95 regulation) and in the ESA95 manual on govern-ment deficit and debt Central regional and local gov-ernment and the social security funds shall ensure thatthe accurate basic data and other information needed forcompiling reliable ESA95 accounts is made available tothe compiling authorities in time and with sufficientdetail

Planned data The planned data are in general providedby the ministries of finance on the basis of the ESA95government accounts They shall be the most recent offi-cial forecasts taking into account the most recent budget-ary decisions and economic developments and prospectsand should be produced shortly before the reportingdeadline where possible The planned data together withthe actual data must form a consistent time series

12 Reporting of budgetary data by Member States to the Commission

Reporting deadlines Member States shall strictlycomply with the reporting deadlines before 1 Marchand before 1 September as laid down by Regulation

yen1part Endorsed by the Ecofin Council of 18 February 2003yen2part OJ L 332 31121993 p 7 as amended by Council Regulation (EC)

No 4752000 (OJ L 58 332000 p 1) and Commission Regulation (EC)No 3512002 (OJ L 55 2622002 p 23)

yen3part OJ L 310 30111996 p 1 as amended The amendments most relevant forgeneral government data are Regulation (EC) No 15002000 OJ L 1721272000 p 3 Regulation (EC) No 25162000 OJ L 290 17112000p 1 Regulation (EC) No 9952001 OJ L 139 2352001 p 3 and Regula-tion (EC) No 25582001 OJ L 344 28122001 p 1

(EC) No 360593 (1) The reporting institutions mdash foractual data in general the NSI (in cooperation with theNCB where applicable) or in certain cases the MOF andfor planned data in general the ministry of finance mdashtake responsibility for the content timeliness and trans-mission of their respective part of the report

Reporting tables The Commission shall in cooperationwith the Committee on Monetary Financial and Balanceof Payments Statistics (CMFB) as soon as possible putforward a more detailed set of reporting tables andrequired supplementary information on the basis of thelegal acts in force (2) This shall be implemented by theMarch 2004 notification

Revisions Member States shall inform the Commissionas soon as they become available of revisions of theactual accounts and of major revisions of the planneddata Major revisions should be properly documentedincluding a breakdown of the revisions In any case revi-sions have to be reported and properly documented if thereference values as specified in the relevant Treaty Pro-tocol are being surpassed

13 Securing the quality of the actual budgetary data

Statistical inventory For the purpose of data qualityassessment by the Commission the NSIs (in cooperationwith the NCBs and the MOFs where applicable) shallfollowing a proposal by Eurostat and after consultationof the CMFB during 2004 provide a detailed inventoryof the methods procedures and sources used for thecompilation of actual government deficit and debtdata (3) This inventory shall be updated regularly

Resolving methodological issues When there are doubtson the correct accounting treatment of a specific govern-ment measure without prejudice to the authority exer-cised by Eurostat on behalf of the Commission MemberStates are strongly advised to at the earliest stage organ-ise consultations at national level between the financeministry the NSI and where applicable the NCB Incases where the doubts prevail the NSI shall formallyask Eurostat to rule on the matter Eurostat shall liaisewith other Commission departments and if necessarywith the ECB and give prompt advice about the record-ing of the government transaction in question in theESA95 accounts (4) In cases which are not covered ade-quately by ESA95 or are particularly complex or of gen-eral interest Eurostat shall consult the CMFB before tak-ing a decision (5) The Member States shall provideEurostat and the CMFB with the information necessaryto decide on any accounting issue Eurostat as a generalrule shall publish its decision together with the CMFBopinion within the timetable laid down in the CMFBrules of procedure for consultations on EDP statisticsThe decisions of Eurostat shall be systematically pre-sented in the ESA95 Manual on Government Deficit andDebt which is regularly updated and which may lead toamendments of ESA95 in case of substantial clarifica-tions In case amendments are required the Commissionshall initiate secondary legislation in conformity with therules on competence and procedure laid down in theTreaty and Regulation (EC) No 222396 (the ESA95regulation) Eurostat can also take decisions on theaccounting of government transactions on its own initia-tive The CMFB may also provide opinions on its owninitiative

Monitoring of data Eurostat assesses the compliance ofthe reported data with the accounting rules including thecompleteness plausibility and consistency of the dataThe Member States shall promptly provide the Commis-sion access to the information required for the purpose ofthis assessment Eurostat may when necessary examinein depth the ESA95 government accounts of each Mem-ber State Eurostat may request the assistance of otherparties represented in the CMFB and may publish theresults taking due account of the confidentiality of sta-tistical data

yen1part Should a Member State because of unexpected and unforeseen reasons beunable to comply with the deadlines it will promptly inform the Commis-sion of the reasons for the delay and inform them of the expected reportingdate In case such unexpected and unforeseen reasons concern planneddata the Member State could report planned and actual data separatelyThe Member States shall inform the Commission which national institu-tions are responsible for the EDP reporting

yen2part More detailed information at the level of government sub-sectors (centralregional and local government and social security funds) is needed onactual data

yen3part Such an inventory already exists for the compilation of GNPGNI and GDPin the context of the Communitiesrsquo fourth resource (Council Directive89130EC of 13 February 1989 on the harmonisation of the compilation ofGNP at market prices OJ L 49 2121989 p 26)

yen4part The formal request including the necessary information for a Eurostat rul-ing should be made in due time to ensure that no accounting issue is leftpending at the time of the notifications

yen5part The CMFB is a consultative body and its opinion is therefore not bindingfor Eurostat However Eurostat takes the utmost account of the opinionsexpressed by the CMFB

P a r t V I IR e s o u r c e s

14 Publication of the budgetary data by the Commission

Actual data Eurostat shall assess and publish for eachMember State the actual government deficit and debtfigures within two weeks after the reporting deadlineDelays in the reporting by any Member State do not con-stitute a motive for Eurostat to delay its publication Anyreservation expressed when publishing the actual dataincluding if necessary and possible amendments byEurostat and a reference to the objected figures shall becommunicated no later than two working days beforethis publication to the Member State concerned and tothe EFC President When the issue is subsequentlyresolved the withdrawal of the reservation is also pub-lished Following revisions the Commission (Eurostat)recording the results of the debate with the MemberState shall within two weeks publish on their web site

the updated government accounts and the effects on gov-ernment deficit and debt

Planned data The Commission does not publish thereported planned data However the planned data arecommunicated by the Commission to the EFC Thesedata do not preclude the Commission (Directorate-General for Economic and Financial Affairs) to publishtheir own forecasts

Reporting to the EFC In a report on the main reportingresults to the EFC within one month after the reportingdeadline the Commission shall summarise major issuesor problems in the reporting tables submitted by theMember States with a view to find solutions and to con-stantly improve the quality and timeliness of data TheEFC may request further information or a follow-up tothe report

2 Glossary

Accession countries Countries that will become mem-bers of the EU in May 2004 and include Cyprus theCzech Republic Estonia Hungary Latvia LithuaniaMalta Poland Slovakia and Slovenia

Automatic stabilisers Various features of the tax andspending regime which react automatically to the eco-nomic cycle and reduce its fluctuations As a result thebudget balance tends to improve in years of high growthand deteriorate during economic slowdowns

Broad economic policy guidelines (BEPGs) Annualguidelines for the economic and budgetary policies ofthe Member States They are prepared by the Commis-sion and adopted by the Council of Ministers responsiblefor Economic and Financial Affairs (Ecofin)

Budget balance The balance between total publicexpenditure and revenue in a specific year with a posi-tive balance indicating a surplus and a negative balanceindicating a deficit For the monitoring of Member Statebudgetary positions the EU uses general governmentaggregates See also structural budget balance primarybudget balance and primary structural balance

Budgetary rules Rules and procedures through whichpolicy-makers decide on the size and the allocation ofpublic expenditure as well as on its financing throughtaxation and borrowing

Budgetary sensitivity The variation in the budget bal-ance in percentage of GDP brought about by a change inthe output gap In the EU it is estimated to be 05 onaverage

Candidate countries Countries that wish to accede tothe EU Besides the accession countries they includeBulgaria Romania and Turkey

Close-to-balance requirement A requirement con-tained in the Stability and Growth Pact according to

which Member States should over the medium termachieve an overall budget balance close to balance or insurplus

Code of conduct on the format and content of the sta-bility and convergence programmes Policy documentendorsed by the Ecofin Council in July 2001 settingdown the information requirements and key definitionsto be followed by Member States in preparing their sta-bility or convergence programmes

Convergence programmes Medium-term budgetaryand monetary strategies presented by each of thoseMember States that have not yet adopted the euro Theyare updated annually according to the provisions of theStability and Growth Pact Prior to the third phase ofEMU convergence programmes were issued on a volun-tary basis and used by the Commission in its assessmentof the progress made in preparing for the euro See alsostability programmes

Crowding-out effects Offsetting effects on output dueto changes in interest rates and exchange rates triggeredby a loosening or tightening of fiscal policy

Cyclical component of budget balance That part of thechange in the budget balance that follows automaticallyfrom the cyclical conditions of the economy due to thereaction of public revenue and expenditure to changes inthe output gap See automatic stabilisers tax smoothingand structural budget balance

Cyclically-adjusted budget balance See structuralbudget balance

Demand and supply shocks Disturbances that affect theeconomy on the demand side (for example changes inprivate consumption or exports) or on the supply side(for example changes in commodity prices or techno-logical innovations) They can impact on the economyeither on a temporary or permanent basis

Dependency ratio A measure of the ratio of people whoreceive government transfers especially pensions rela-tive to those who are available to provide the revenue topay for those transfers

Direct taxes Taxes that are levied directly on personal orcorporate incomes and property

Discretionary fiscal policy Change in the budget bal-ance and in its components under the control of govern-ment aiming at stabilising the economy It is usuallymeasured as the residual of the change in the balanceafter the exclusion of the budgetary impact of automaticstabilisers See also fiscal stance

Early-warning mechanism is part of the preventive ele-ments of the SGP and is activated when there is signifi-cant divergence from the budgetary targets set down in astability or convergence programme

Economic and Financial Committee (EFC) Formerlythe Monetary Committee renamed the Economic andFinancial Committee as of January 1999 Its main task isto prepare and discuss (Ecofin) Council decisions withregard to economic and financial matters

Economic Policy Committee (EPC) Group of seniorofficials whose main task is to prepare discussions of the(Ecofin) Council on structural policies It plays a largerole in the preparation of the BEPGs and it is active onpolicies related to labour markets methods to calculatecyclically-adjusted budget balances and ageing popula-tions

Effective tax rate The ratio of broad categories of taxrevenue (labour income capital income consumption)to their respective tax bases

ESA95ESA79 European accounting standards for thereporting of economic data by the Member States to theEU As of 2000 ESA95 has replaced the earlier ESA79standard with regard to the comparison and analysis ofnational public finance data

Excessive deficit procedure (EDP) A procedure accord-ing to which the Commission and the Council monitor thedevelopment of national budget balances and public debtin order to assess the risk of an excessive deficit in eachMember State Its application has been further clarified inthe Stability and Growth Pact See also stability pro-grammes and Stability and Growth Pact

Expenditure rules A subset of fiscal rules that target (asubset of) public expenditure

Fiscal consolidation A continuous improvement in thebudget balance either specified by the amount of theimprovement or the period over which the improvementcontinues

Fiscal decentralisation The transfer of authority andresponsibility for public functions from the central gov-ernment to intermediate and local governments or to themarket

Fiscal federalism A subfield of public finance thatinvestigates the fiscal relations across levels of govern-ment

Fiscal impulse The estimated effect of fiscal policy onGDP It is not a model-free measure and it is usually cal-culated by simulating an econometric model The esti-mates presented in the present report are obtained byusing the Commission servicesrsquo model QUEST

Fiscal rule A permanent constraint on fiscal policyexpressed in terms of a summary indicator of fiscal per-formance such as the government budget deficit bor-rowing debt or a major component thereof See alsobudgetary rule expenditure rules

Fiscal stance A measure of the discretionary fiscal pol-icy component In this report it is defined as the changein the primary structural budget balance relative to thepreceding period When the change is positive (negative)the fiscal stance is said to be expansionary (restrictive)

General government As used by the EU in its processof budgetary surveillance under the Stability and GrowthPact and the excessive deficit procedure the generalgovernment sector covers national government regionaland local government as well as social security fundsPublic enterprises are excluded as are transfers to andfrom the EU budget

Government budget constraint A basic condition apply-ing to the public finances according to which total publicexpenditure in any one year must be financed by taxationgovernment borrowing or changes in the monetary baseIn the context of EMU the ability of governments tofinance spending through money issuance is prohibitedSee also stock-flow adjustment sustainability

Hodrick-Prescott (HP) filter A statistical techniqueused to calculate trend GDP and output gaps by filteringactual GDP

Indirect taxation Taxes that are levied during the pro-duction stage and not on the income and property aris-ing from economic production processes Prominentexamples of indirect taxation are value added tax (VAT)excise duties import levies energy and other environ-mental taxes

Interest burden General government interest paymentson public debt as a share of GDP

Maastricht reference values for public debt and defi-cits Respectively a 60 general government debtGDPratio and a 3 general government deficitGDP ratioThese thresholds are defined in a protocol to the Maas-tricht Treaty on European Union See also Excessive def-icit procedure

Maturity structure of public debt The profile of totaldebt in terms of when it is due to be paid back Interestrate changes affect the budget balance directly to theextent that the general government sector has debt witha relatively short maturity structure Long maturitiesreduce the sensitivity of the budget balance to changesin the prevailing interest rate See also public debt

Minimal benchmarks Values indicating a budgetaryposition that would provide a cyclical safety margin forthe automatic stabilisers to operate freely during eco-nomic slowdowns without leading to excessive deficitsThe minimal benchmarks are estimated by the EuropeanCommission They do not cater for other risks such asunexpected budgetary developments and interest rateshocks and should not be confused with the close to bal-ance or in surplus medium-term requirement of the Pact

Monetary conditions index (MCI) An indicator com-bining the change in real short-term interest rate and inthe real effective exchange rate to gauge the degree ofeasing or tightening of monetary policy

Mundell-Fleming model Macroeconomic model of anopen economy which embodies the main Keynesianhypotheses (price rigidity liquidity preference) In spiteof its shortcomings it remains useful in short-term eco-nomic policy analysis

NAIRU Non-Accelerating Inflation Rate of Unemploy-ment

Non-Keynesian effects Supply-side and expectationseffects which reverse the sign of traditional Keynesianmultipliers Hence if non-Keynesian effects dominatefiscal consolidation would be expansionary

Old age dependency ratio Population aged over 65 as apercentage of working age population (usually definedas persons aged between 15 and 64)

Output gap The difference between actual output andestimated potential output at any particular point in timeSee also cyclical component of budget balance

Pay-as-you-go pension system (PAYG) Pension sys-tem in which current pension expenditures are financedby the contributions of current employees

Pre-accession economic programmes (PEPs) Annualprogrammes submitted by candidate countries which setthe framework for economic policies The PEPs consistof a review of recent economic developments a detailedmacroeconomic framework a discussion of publicfinance issues and an outline of the structural reformagenda

Pre-accession fiscal surveillance framework (PFSF)provides the framework for budgetary surveillance ofcandidate countries in the run up to accession It closelyapproximates the policy coordination and surveillancemechanisms at EU level

Policy-mix The overall stance of fiscal and monetarypolicy The policy-mix may consist of various combina-tions of expansionary and restrictive policies with agiven fiscal stance being either supported or offset bymonetary policy

Primary budget balance The budget balance net ofinterest payments on general government debt

Primary structural budget balance The structural (orcyclically-adjusted) budget balance net of interest pay-ments

Pro-cyclical fiscal policy A fiscal stance which ampli-fies the economic cycle by increasing the structuralprimary deficit during an economic upturn or bydecreasing it in a downturn It can be contrasted with

(discretionary) counter-cyclical policy that has theopposite effects A neutral fiscal policy keeps the cycli-cally-adjusted budget balance unchanged over the eco-nomic cycle but lets the automatic stabilisers work Seealso tax-smoothing

Production function approach A means to estimate thepotential level of output of an economy on taking inputson labour and capital as well as trend factor productivityinto account This is used to estimate the output gap thatis a key input in the estimation of cyclical budget compo-nent

Public debt Consolidated gross debt for the generalgovernment sector It includes the total nominal value ofall debt owed by public institutions in the Member Stateexcept that part of the debt which is owed to other publicinstitutions in the same Member State

Public goods Those goods and services that are con-sumed jointly by several economic agents and for whichthere is no effective pricing mechanism that would allowprivate provision through the market

Public investment The component of total publicexpenditure through which governments increase andimprove the stock of capital employed in the productionof the goods and services they provide

Publicndashprivate partnerships (PPP) Agreements thattransfer to the private sector investment projects that tra-ditionally have been executed or financed by the publicsector To qualify as a PPP the project should concern apublic function involve the general government as theprincipal purchaser be financed from non-publicsources and engage a corporation outside the generalgovernment as the principal operator that provides sig-nificant inputs in the design and conception of theproject and bears a relevant amount of the risk

Quasi-fiscal activities Activities promoting public pol-icy goals carried out by non-government units

QUEST The Directorate-Generalrsquos macroeconomicmodel of the EU Member States plus the US and Japan

Ricardian equivalence Under fairly restrictive theoret-ical assumptions on the consumerrsquos behaviour (inter aliainfinite horizon for decision making) the impact of fis-cal policy does not depend on whether it is financed bytax increases or by a widening deficit The basic reason-

ing behind this statement dates back to Ricardo and wasrevisited by Robert Barro in the 1970s

Securitisation Borrowing (issuing of bonds) with theintention of paying interest and capital out of the pro-ceeds derived from assets (use or sale of) or from futurerevenue flows

Sensitivity analysis An econometric or statistical simu-lation designed to test the robustness of an estimatedeconomic relationship or projection given variouschanges in the underlying assumptions

Significant divergence A sizeable excess of budget balanceover the targets in the stability or convergence programmesthat triggers the early warning procedure of the SGP

lsquoSnowballrsquo effect The self-reinforcing effect of publicdebt accumulation or decumulation arising from a posi-tive or negative differential between the interest rate paidon public debt and the growth rate of the national econ-omy See also government budget constraint

Social security contributions (SSC) Mandatory contri-butions paid by employers and employees to a socialinsurance scheme to cover for pension healthcare andother welfare provisions

Stability and Growth Pact (SGP) Approved in 1997 theSGP clarifies the provisions of the Maastricht Treatyregarding the surveillance of Member State budgetarypolicies and the monitoring of budget deficits during thethird phase of EMU The SGP consists of two Councilregulations setting out legally binding provisions to be fol-lowed by the European institutions and the Member Statesand two resolutions of the European Council in Amster-dam (June 1997) See also excessive deficit procedure

Stability programmes Medium-term budgetary strate-gies presented by those Member States that have alreadyadopted the euro They are updated annually accordingto the provisions of the Stability and Growth Pact Seealso convergence programmes

Stock-flow adjustment The stock-flow adjustment(also known as the debt-deficit adjustment) ensures con-sistency between the net borrowing (flow) and the vari-ation in the stock of gross debt It includes the accumu-lation of financial assets changes in the value of debtdenominated in foreign currency and remaining statisti-cal adjustments

Structural budget balance The actual budget balanceadjusted for its cyclical component The structural bal-ance gives a measure of the underlying trend in thebudget balance when taking into account the automaticeffect on the budget of the economic cycle It is referredto also as the cyclically-adjusted budget balance Seealso primary structural budget balance

Sustainability A combination of budget deficits anddebt that ensure that the latter does not grow withoutbound While conceptually intuitive an agreed opera-tional definition of sustainability has proven difficult toachieve

Tax gaps Measure used in the assessment of the sustain-ability of public finances They measure the differencebetween the current tax ratio and the constant tax ratioover a given projection period to achieve a predeter-mined level of debt at the end of that projection period

Tax smoothing The idea that tax rates should be keptstable in order to minimise the distortionary effects oftaxation while leaving it for the automatic stabilisers tosmooth the economic cycle It is also referred to as neu-tral discretionary fiscal policy See also cyclical compo-nent of fiscal policy

UMTS Third generation of technical support for mobilephone communications Sale of UMTS licences gaverise to sizeable one-off receipts in 2001

Wagnerrsquos law Theory according to which public spend-ing mdash since it comprises lsquoluxury goodsrsquo with high elas-ticity to income mdash would tend to rise as a share of GDPas per-capita income increases

Welfare state Range of policies designed to provideinsurance against unemployment sickness and risksassociated with old age

3 References

Alesina A and S Ardagna (1998) lsquoTales of fiscaladjustmentrsquo Economic Policy 27 pp 489ndash45

Alesina A and T Bayoumi (1996) lsquoThe costs and ben-efits of fiscal rules evidence from US statesrsquo NBERWorking Paper 5614

Alesina A R Perotti and J Tavares (1998) lsquoThe polit-ical economy of fiscal adjustmentsrsquo Brookings Paperson Economic Activity 1 pp 197ndash266

Alesina A S Ardagna R Perotti and F Schiantarelli(2002) lsquoFiscal policy profits and investmentrsquo AmericanEconomic Review 92 pp 571ndash89

Arthur Andersen and Enterprise LSE (2000) lsquoValue formoney drivers in the private finance initiativersquo TreasuryTask Force HM Treasury London

Aschauer D A (1989a) lsquoIs public expenditure produc-tiversquo Journal of Monetary Economics 23 pp 177ndash200

Aschauer D A (1989b) lsquoDoes public capital crowd outprivate capitalrsquo Journal of Monetary Economics 24pp 171ndash188

Aschauer D A (1989c) lsquoPublic investment and pro-ductivity growth in the Group of Sevenrsquo Economic Per-spective 13 pp 17ndash25

Atkinson A and J Stiglitz (1980) Lectures in publiceconomics McGraw-Hill New York

Aubin C J P Berdot D Goyeau and J D Lafay(1988) lsquoThe growth of public expenditure in Francersquo inJ A Lybeck and M Herenkson (eds) Explaining thegrowth of government Amsterdam North Holland

Auerbach A J L J Kotlikoff R Hagemann andG Nicoletti (1989) lsquoThe dynamics of an aging popula-

tion the case of four OECD countiesrsquo NBER WorkingPaper 2797

Auerbach A J (1994) lsquoThe US fiscal problem wherewe are how we got here and where wersquore goingrsquo NBERWorking Paper 4709

Bajo-Rubio O and S Sosvilla-Rivero (1993) lsquoDoespublic capital affect private sector performance Ananalysis of the Spanish case 1964ndash88rsquo Economic Mod-elling 10 pp 179ndash84

Balassone F and D Franco (2000a) lsquoAssessing fiscalsustainability a review of methods with a view toEMUrsquo in Banca drsquoItalia Fiscal Sustainability PublicFinance Workshop Rome

Balassone F and D Franco (2000b) lsquoPublic invest-ment the Stability Pact and the golden rulersquo in BancadrsquoItalia Fiscal Studies pp 21 pp 207ndash29

Balassone F and D Franco (2001) lsquoThe SGP and theldquoGolden Rulerdquorsquo in A Brunila M Buti and D Franco(eds) The Stability and Growth Pact the architectureof fiscal policy in EMU Basinstoke Palgrave

Balassone F D Franco and S Zotteri (2002) lsquoFiscalrules for sub-national governments what lessons fromEMU countriesrsquo Paper prepared for the Conference onRules-Based Macroeconomic Policies in Emerging Mar-ket Economies

Baltagi B H and N Pinnoi (1995) lsquoPublic capital stockand state productivity growth further evidence from anerror components modelrsquo Empirical Economics 20pp 351ndash59

Banca drsquoItalia (2000) Fiscal sustainability PublicFinance Workshop Rome

Barro R (1979) lsquoOn the determination of public debtrsquoJournal of Political Economy 87 pp 940ndash71

Barro R (1981) lsquoOutput effects of government purchasesrsquoJournal of Political Economy 989 pp 1086ndash1121

Barro R (1991) lsquoEconomic growth in a cross-sectionof countriesrsquo Quarterly Journal of Economics 106pp 407ndash443

Barro R and X Sala-i-Martin (1998) EconomicGrowth MIT Press Cambridge Mass

Bayoumi T M and B Eichengreen (1995) lsquoRestrain-ing yourself the implications of fiscal rules for eco-nomic stabilisationrsquo IMF Staff Papers 42 1

Berndt E R and B Hansson (1991) lsquoMeasuring thecontribution of public infrastructure capital in SwedenrsquoNBER Working Paper 3842

Bertola G and A Drazen (1993) lsquoTrigger points andbudget cuts explaining the effects of fiscal austerityrsquoAmerican Economic Review 83 pp 1170ndash88

Blanchard O (1985) lsquoDebt deficits and finite hori-zonsrsquo Journal of Political Economy 93 (2) pp 223ndash47

Blanchard O (1990) lsquoComment on Giavazzi and Paganorsquoin O Blanchard and S Fischer (eds) NBER Macroeco-nomics Annual Cambridge Mass The MIT Press

Blanchard O and F Giavazzi (2002) lsquoReforms thatcan be done improving the SGP through a properaccounting of public investmentrsquo mimeo MIT and Boc-coni University

Bohn H and R P Inman (1996) lsquoBalanced budgetrules and public deficits evidence from the US statesrsquoNBER Working Paper 5533

Brunila A (2002) lsquoFiscal policy coordination disci-pline and stabilisationrsquo Paper presented at the meetingof the Group of Economic Analysis of the EuropeanCommission

Brunila A and H Kinnunen (2002) lsquoSpending limitsand fiscal discipline in euro-area countriesrsquo Bank of Fin-land Bulletin 1

Brunila A M Buti and D Franco (eds) (2001) TheStability and Growth Pact the architecture of fiscal pol-icy in EMU Basinstoke Palgrave

Buiter W and C Grafe (2002) lsquoPatching up the Pactsome suggestions for enhancing fiscal sustainability andmacroeconomic stability in an enlarged EuropeanUnionrsquo CEPR Discussion Paper 3496

Buti M S Eijffinger and D Franco (2002) lsquoRevisitingthe Stability and Growth Pact grand design or internaladjustmentrsquo CEPR Discussion Paper 3692

Buti M and G Giudice (2002) lsquoMaastrichtrsquos fiscalrules at ten an assessment Journal of Common MarketStudies Vol 40 No 5 December pp 823ndash48

Cabral A (2001) lsquoMain aspects of the working of theSGPrsquo in Brunila A Buti M and D Franco (eds)(2001) The Stability and Growth Pact the architectureof fiscal policy in EMU Basinstoke Palgrave

Cambridge Econometrics (1997) Long-term perspec-tives in public revenues Report submitted to the Euro-pean Commission Directorate-General for Economicand Financial Affairs mimeo

Cangiano M and E Mottu (1998) lsquoWill fiscal policy beeffective under EMUrsquo IMF Working Paper 176

Cark T M Elsby and S Love (2001) lsquoTwenty years offalling investment Trends in capital spending on publicservicesrsquo IFS Briefing Note 20

Clarida R H (1993) lsquoInternational capital mobilitypublic investment and economic growthrsquo NBER Work-ing Paper 4506

Committee of the Regions (2001) lsquoRegional and localgovernment in the European Unionrsquo Responsibilitiesand Resources European Communities

Comptroller and Auditor General (2001) lsquoThe expendi-ture review initiativersquo Value for money report No 39October (wwwirlgovieaudgen)

Conrad K and H Seitz (1994) lsquoThe economic benefits ofpublic infrastructurersquo Applied Economics 26 pp 303ndash11

Coordinating Group of Secretaries (1996) lsquoDeliveringbetter government Second report to the government mdash

A programme of change for the Irish civil servicersquo May(wwwbettergovie)

Costello D (2001) lsquoThe SGP how did we get therersquoin Brunila A Buti M and D Franco (eds) (2001) TheStability and Growth Pact the architecture of fiscal pol-icy in EMU Basinstoke Palgrave

Cotis J P Y lrsquoHorty and R Meary (1998) lsquoLes stabi-lisateurs automatiques sont-ils encore efficaces Le casde la France dans les annees quatre-vingt-dixrsquo RevuedrsquoEconomie Financiere 45 pp 95ndash118

Council of the European Union (2001) lsquoThe contribu-tion of public finances to growth and employmentimproving quality and sustainabilityrsquo Report of theCommission and the (Ecofin) Council to the EuropeanCouncil (Stockholm 2324 March 2001) 699701

Cour P E Dubois S Mafhouz and J Pisani-Ferry(1996) lsquoThe cost of fiscal retrenchment revisited howstrong is the evidencersquo Institut National de la Statis-tique et des Etudes Economiques Seacuterie des Documentsde Travail G9612

Crinfield J B and M P H Panggabean (1995) lsquoIs pub-lic infrastructure productive A metropolitan perspectiveusing new capital stock estimatesrsquo Regional Science andUrban Economics 25 pp 607ndash30

Dafflon B (ed) (2002) Local public finance in Europebalancing the budget and controlling debt EdwardElgar Cheltenham UK pp 191ndash208

Dalamagas B (1995) lsquoA reconsideration of public sec-torrsquos contribution to growthrsquo Empirical Economics 20pp 385ndash414

Darby J A Muscatellin and G Roy (2002) lsquoFiscal fed-eralism and fiscal autonomy lessons for the UK fromother industrialised countriesrsquo University of Glasgow

Dexia (2002) Local finance in the 15 countries of theEuropean Union Second edition

Domberger S and P Jensen (1997) lsquoContracting out bythe public sector theory evidence prospectsrsquo OxfordReview of Economic Policy 13 pp 67ndash78

Drazen A (2000) Political economy in macroeconom-ics Princeton University Press Princeton New Jersey

Dur R A J B D Peletier and O H Swank (1999)lsquoVoting on the budget deficit commentrsquo American Eco-nomic Review 89 pp 1377ndash81

Easterly W (1999) lsquoWhen is fiscal adjustment an illu-sionrsquo Economic Policy 28 pp 57ndash86

Easterly W and S Rebelo (1993) lsquoFiscal policy andeconomic growthrsquo Journal of Monetary Economics 32pp 417ndash58

Ebel R D and S Yilmaz (2002) lsquoOn the measurementand impact of fiscal decentralisationrsquo Washington DCWorld Bank Policy Research Working Paper 2809

Economic Policy Committee (2001) lsquoBudgetary chal-lenges posed by ageing populations the impact of publicspending on pensions health and long-term care for theelderly and possible indicators of the long-term sustaina-bility of public financesrsquo EPCECFIN65501-EN final

Eichengreen B and J von Hagen (1996) lsquoFiscal policyand monetary union is there a tradeoff between federal-ism and budgetary restrictionsrsquo NBER Working Paper5517 NEBR March 1996

Eichengreen B and Wyplosz C (1998) lsquoThe StabilityPact more than a minor nuisancersquo Economic Policy 26

Erenburg S J (1993) lsquoThe real effects of public invest-ment on private investmentrsquo Applied Economics 25pp 831ndash37

Erenburg S J and M Wohar (1995) lsquoPublic and pri-vate investment are there causal linkagesrsquo Journal ofMacroeconomics 17 pp 1ndash30

European Commission (2000) lsquoPublic finances in EMUmdash 2000rsquo European Economy Reports and Studies 3

European Commission (2002a) lsquoPublic finances inEMU mdash 2002rsquo European Economy 3

European Commission (2002b) lsquoThe EU economy 2002reviewrsquo European Economy 6

European Commission (2002c) Commission communi-cation to the Council and European Parliament on

lsquoStrengthening the coordination of budgetary policiesrsquoCOM(2002) 668 final

European Commission (2002d) Commission communi-cation to the Council and European Parliament onlsquoInvesting efficiently in education and training animperative for Europersquo COM(2002) 779

European Commission (2003) Commission communi-cation to the Council and European Parliament onlsquoDeveloping the trans-European transport networkInnovative funding solutions Interoperability of elec-tronic toll-collection systemsrsquo COM(2003) 132 final

European System of Accounts ESA 1995 Eurostat1996

Evans P and G Karras (1994) lsquoAre government activ-ities productive Evidence from a panel of US statesrsquoReview of Economics and Statistics 76 pp 1ndash11

Feldstein M (1982) lsquoGovernment deficits and aggregatedemandrsquo Journal of Monetary Economics 9 pp 1ndash20

Fischer J (2001) lsquoNational and EU budgetary rules andprocedures an evolving interactionrsquo Banca drsquoItalia Fis-cal Rules Public Finance Workshop Rome

Fischer J and G Giudice (2001) lsquoThe stability and con-vergence programmesrsquo in Brunila A Buti M and DFranco (eds) (2001) The Stability and Growth Pact thearchitecture of fiscal policy in EMU Basinstoke Pal-grave

Flores de Frutos R M Gracia-Diez and T Perez-Ama-ral (1998) lsquoPublic capital stock and economic growthan analysis of the Spanish economyrsquo Applied Econom-ics 30 pp 985ndash94

Ford R and P Poret (1991) lsquoInfrastructure and private sec-tor productivityrsquo OECD Economic Studies 17 pp 63ndash89

Fottinger W (2001) lsquoBalanced budget versus goldenrule on the remediability of fiscal restrictionsrsquo BancadrsquoItalia Fiscal Rules Public Finance Workshop Rome

Friedman M (1957) lsquoA theory of the consumption func-tionrsquo Princeton University Press General Series 63

Garcia Milagrave T T J McGuire and R H Porter (1996)lsquoThe effects of public capital in state-level production

functions reconsideredrsquo Review of Economics and Sta-tistics 78 pp 177ndash80

Giavazzi F and M Pagano (1990) lsquoCan severe fiscalcontractions be expansionary Tales of two small Euro-pean countriesrsquo NBER Macroeconomics Annual 5pp 75ndash111

Giavazzi F and M Pagano (1996) lsquoNon-Keynesianeffects of fiscal policy changes international evidenceand the Swedish experiencersquo Swedish Economic PolicyReview 3 (3) pp 67ndash103

Giavazzi F T Jappelli and M Pagano (2000) lsquoSearch-ing for non-linear effects of fiscal policy evidence forindustrial and developing countriesrsquo NBER WorkingPaper 7460

Giudice G and A Montanino (2002) lsquoUn pacte pour lastabiliteacute et la croissance economiques en Europersquo Revuedu Marcheacute commun et de lrsquoUnion europeacuteenne ndeg 463December pp 657ndash660

Giudice G A Turrini and J inrsquot Veld (2003) lsquoThe realeffects of budgetary adjustmentsrsquo paper presented at theNIESR conference on lsquoMacroeconomics and the policyprocessrsquo London May 2003

Grilli V (2003) lsquoReport by the Head of the GeneralAccounting Office to the Budget Committee of Parlia-mentrsquo 13 March

Goudswaard K and H Van de Kar (1994) The impactof demographic changes on public revenuesrsquo AtlanticEconomic Journal 22 (3) pp 52ndash60

Gramlich E M (1990) lsquoUS federal budget deficits andGramm-Rudman-Hollingsrsquo AEA Papers and Proceed-ings 80 (2) pp 75ndash80

Grout P (1997) lsquoThe economics of the private financeinitiativersquo Oxford Review of Economic Policy 13pp 53ndash66

Haan J de J E Sturm and B J Sikken (1996) lsquoGov-ernment capital formation explaining the declinersquo Wel-wirtschaftliches Archiv 132 pp 55ndash74

Hagemann R P and G Nicoletti (1989) lsquoPopulationageing economic effects and some policy implications

for financing public pensionsrsquo OECD Economic Stud-ies 55 (4) 12 pp 51ndash96

Hallerberg M Strauch R and Von Hagen J (2001)lsquoThe use and effectiveness of budgetary rules and normsin EU Member Statesrsquo Dutch Ministry of FinanceAmsterdam

Hart O A Shleifer and RW Vishny (1997) lsquoThe properscope of government theory and application to prisonsrsquoQuarterly Journal of Economics 112 pp 1127ndash1161

Hemming R M Kell and S Mahfouz (2002) lsquoThe effec-tiveness of fiscal policy in stimulating economic activity areview of the literaturersquo IMF Working Paper 208

Herenkson M (1988) lsquoSwedish government growth adisequilibrium analysisrsquo in J A Lybeck and M Herenk-son (eds) Explaining the growth of governmentAmsterdam North Holland

Holtz-Eakin D and A E Schwartz (1995) lsquoInfrastruc-ture in a structural model of economic growthrsquo RegionalScience and Urban Economics 25 pp 131ndash51

Inman R P (1996) lsquoDo balanced budget rules workUS experience and possible lessons for the EMUrsquo NBERWorking Paper 5838

International Monetary Fund (1996) World EconomicOutlook Washington DC

International Monetary Fund (2001) lsquoRules-based fiscalpolicy and job-rich growth in France Germany Italy andSpain mdash Report with supplementary informationrsquoSelected euro-area countries IMF Country Report 203

Kavanagh C (1997) lsquoPublic capital and private sectorproductivity in Ireland 1958ndash90rsquo Journal of EconomicStudies 24 pp 72ndash94

Kell M (2001) lsquoAn assessment of fiscal rules in theUnited Kingdomrsquo IMF Working Paper 91

Kirchgassner G and W Pommerehne (1988) lsquoGovern-ment spending in federal systems a comparison betweenSwitzerland and Germanyrsquo in J A Lybeck and M Her-enkson (eds) Explaining the growth of governmentAmsterdam North Holland

Kopits G (2001) lsquoFiscal rules useful policy frameworkor unnecessary ornamentrsquo Washington DC Interna-tional Monetary Fund IMF Working Paper 145

Kopits G and Craig J (1998) lsquoTransparency in gov-ernment operationsrsquo Washington DC InternationalMonetary Fund IMF Occasional Paper 158

Kopits G and Symansky S (1998) lsquoFiscal policyrulesrsquo Washington DC International Monetary FundIMF Occasional Paper 162

Krugman P and M Obstfeld (2001) International Eco-nomics Boston Addison Wesley Longman

La Ferrara E and M Marcellino (2000) lsquoTFP costs andpublic infrastructure an equivocal relationshiprsquo IGIERBocconi mimeo

Lane P (2002) lsquoThe cyclical behaviour of fiscal policyevidence from the OECDrsquo Journal of Public Econom-ics forthcoming

Ligthart J E (2000) lsquoPublic capital and output growthin Portugal an empirical analysisrsquo IMF Working Paper11

Lynde C and J Richmond (1993a) lsquoPublic capital andlong-run costs in UK manufacturingrsquo Economic Jour-nal 103 pp 880ndash93

Lynde C and J Richmond (1993b) lsquoPublic capital andtotal factor productivityrsquo International EconomicReview 34 pp 401ndash414

Martinez-Mongay C (2000) lsquoThe long-run determi-nants of government receiptsrsquo in Banca drsquoItalia FiscalSustainability Rome

Martinez-Mongay C (2000) lsquoThe long-run determi-nants of government receiptsrsquo in Banca drsquoItalia FiscalSustainability Public Finance Workshop Rome

Mas M J Maudos F Perez and E Uriel (1996) lsquoInfra-structures and productivity in the Spanish regionsrsquoRegional Studies 30 pp 641ndash50

Matha T Vanhoudt P and B Smid (2000) lsquoHow pro-ductive are capital investments in Europersquo EIB Papers5 2

Matzamakis E C (2001) lsquoPublic spending and privateinvestment evidence from Greecersquo International Eco-nomic Journal 15 pp 33ndash46

McDermott C J and R F Westcott (1996) lsquoAn empir-ical analysis of fiscal adjustmentrsquo IMF Staff Papers 43pp 725ndash53

Merriman D (1990) lsquoPublic capital and regional outputanother look at some Japanese and American datarsquoRegional Science and Urban Economics 20 pp 437ndash58

Milesi-Ferretti G M (2001) lsquoGood bad or ugly Onthe effects of fiscal rules with creative accountingrsquoCEPR Discussion Paper Series 2663

Mills P and Quinet A (2001) lsquoThe case for spendingrulesrsquo Banca drsquoItalia Public Finance Workshop FiscalRules 9 pp 319ndash330

Monadjemi M S and H Hu (1998) lsquoPrivate and gov-ernment investment a study of three OECD countriesrsquoInternational Economic Journal 12 pp 93ndash105

Morrison C J and A E Schwartz (1996a) lsquoState infra-structure and productive performancersquo American Eco-nomic Review 86 pp 1095ndash111

Morrison C J and A E Schwartz (1996b) lsquoPublicinfrastructure private input demand and economic per-formance in New England manufacturingrsquo Journal ofBusiness and Economic Statistics 14 pp 91ndash101

Musgrave R A (1939) lsquoThe nature of budgetary bal-ance and the case for a capital budgetrsquo American Eco-nomic Review 29 pp 260ndash71

Musgrave R A (1959) The theory of public financestudy in public economy McGraw-Hill New York

National Economic and Social Council (2002) Achiev-ing quality outcomes the management of public expend-iture December (wwwnescie)

Oates W E (1972) Fiscal federalism Harcourt BraceJovanovich New York

Oates W E (1991) Studies in fiscal federalism EdwardElgar Cheltenham UK

OECD (1996) OECD Economic Outlook Paris

OECD (1998) lsquoPublic investment activity an over-viewrsquo ECOCPEWP1(98)11

OECD (1999) lsquoTaxing powers of state and local govern-mentrsquo OECD Tax Policy Studies 1

OECD (2002) lsquoFiscal decentralisation in EU applicantstates and selected EU Member Statesrsquo Report preparedfor the workshop on ldquoDecentralisation trends perspec-tive and issues at the threshold of EU enlargementrdquorsquo

OECD (2002) lsquoFiscal design surveys across levels ofgovernmentrsquo OECD Tax Policy Studies 7

OECD (2002) lsquoFiscal sustainability the contribution offiscal rulesrsquo OECD Economic Outlook 72 4

OECD (2003a) Transparency in government procure-ment the benefits of efficient governance and orienta-tion for achieving it

OECD (2003b) lsquoFiscal relationships across levels ofgovernment in Denmarkrsquo Paper prepared by Denmarkfor the OECD informal meeting on fiscal relations acrosslevels of government

Otto G and G M Voss (1996) lsquoPublic capital and pri-vate production in Australiarsquo Southern Economic Jour-nal 62 pp 723ndash738

Oxley H and J P Martin (1991) lsquoControlling govern-ment spending and deficits trends in the 1980s and pros-pects for the 1990srsquo OECD Economic Studies 17pp 154ndash189

Pampillon F and J L Raymond (2002) lsquoLa reforma delIRPF y la cuota tributaria un ejercicio de simulacioacutenrsquoCuadernos de Informacioacuten Econoacutemica MayoJunio

Peletier B R Dur and O H Swank (1999) lsquoVoting onthe budget deficit commentrsquo American EconomicReview 89 pp 1377ndash81

Pereira A M (2001) lsquoPublic investment and privatesector performance mdash International evidencersquo PublicFinance and Management 1 pp 261ndash77

Perotti R (1999) lsquoFiscal policy in good times and badrsquoQuarterly Journal of Economics 114 pp 1399ndash1436

Pollitt M G (2000) lsquoThe declining role of State infra-structure investments in the United Kingdomrsquo Univer-sity of Cambridge mimeo

Poterba J M (1995) lsquoCapital budgets borrowing rulesand state capital spendingrsquo Journal of Public Econom-ics 56 pp 165ndash87

Poterba J M (1996) lsquoDo budget rules workrsquo NBERWorking Paper 5550

Rodden J (2000) lsquoDecentralisation and the challenge ofhard budget constraintsrsquo World Bank PREM Notes 41

Rodden J (2002) lsquoThe dilemma of fiscal federalismgrants and fiscal performance around the worldrsquo Ameri-can Journal of Political Science 46 (3) pp 670ndash687

Rodden J and E Wibbels (2002) lsquoBeyond the fiction offederalism macroeconomic management in multi-tieredsystemsrsquo World Politics 54

Roeger W and J inrsquot Veld (1997) lsquoQUEST II a multi-country business cycle and growth modelrsquo EuropeanCommission Economic Papers 123

Roeger W and J inrsquot Veld (2002) lsquoSome selected sim-ulation experiments with the European CommissionrsquosQUEST modelrsquo European Commission EconomicPapers 178

Roseveare D W Leibfritz D Fore and W Eckhard(1996) lsquoAgeing populations pension systems and gov-ernment budgets simulations for 20 OECD countriesrsquoOECD Working Papers 168

Roubini N and J Sachs (1989) lsquoGovernment spendingand budget deficits in the industrial countriesrsquo Eco-nomic Policy 8 pp 99ndash132

Seitz H and G Licht (1995) lsquoThe impact of publicinfrastructure capital on regional manufacturing produc-tion costsrsquo Regional Studies 29 pp 231ndash40

Sorensen B E L Wu and O Yosha (2001) lsquoOutputfluctuations and fiscal policy US state and local govern-ments 1978ndash94rsquo European Economic Review 45pp 1271ndash131

Sorensen R J (1988) lsquoThe growth of public spendingin Norway 1865ndash85rsquo in J A Lybeck and M Herenkson

(eds) Explaining the growth of government Amster-dam North Holland

Spackman M (2002) lsquoPublicndashprivate partnerships les-sons from the British approachrsquo Economic Systems 26pp 283ndash301

Sturm J E J Jacobs and P Grote (1999) lsquoOutput effectsof infrastructure investment in the Netherlands 1853ndash1913rsquo Journal of Macroeconomics 21 pp 355ndash80

Sturm J-E and J De Haan (1995) lsquoIs public expendi-ture really productive New evidence from the USA andthe Netherlandsrsquo Economic Modelling 12 pp 60ndash72

Sutherland A (1997) lsquoFiscal crises and aggregatedemand can high public debt reverse the effects of fiscalpolicyrsquo Journal of Public Economics 65 pp 147ndash62

Tabellini G and A Alesina (1990) lsquoVoting on the budgetdeficitrsquo American Economic Review 80 pp 37ndash49

Ter-Minassian T (1997) lsquoIntergovernmental fiscalrelations in a macroeconomic perspective an overviewrsquoin T Ter-Minassian (ed) Fiscal federalism in theory andpractice IMF Washington DC

Ter-Minassian T and J Craig (1997) lsquoControl of sub-national government borrowingrsquo in Ter-Minassian (ed)Fiscal federalism in theory and practice IMF Washing-ton DC

Tinbergen J (1956) Economic policy principles anddesign Amsterdam

Von Hagen J A Hughes-Hallet and R Strauch (2001)lsquoBudgetary consolidation in EMUrsquo European Commis-sion Economic Papers 148

Voss G (2001) lsquoPublic and private investment in theUnited States and Canadarsquo University of Victoria mimeo

Wibbels E (2000) lsquoFederalism and the politics of mac-roeconomic policy and performancersquo American Journalof Political Science 44 pp 687ndash702

World Bank (2002) Expenditure policies towards EUaccession Washington DC

World Bank Group Decentralisation web site wwwworldbankorgpublicsectordecentralisation

4 Useful Internet links

European Union

European Commission europaeuintcomm

Directorate-General for Economic and Financial Affairs europaeuintcommdgseconomy_financeindex_enhtm

European Council ueeuint

European Parliament wwweuroparleuint

Economics and finance ministries

Belgium treasuryfgovbeinterthes Ministegravere des Finances mdash Ministerie van Financen

Denmark wwwfmdk Ministry of Finance

Germany wwwbundesfinanzministeriumde Bundesministerium der Finanzen

Spain wwwminecoes Ministerio de Economiacutea y Hacienda

France wwwfinancesgouvfr Ministegravere Eacuteconomie Finances et lrsquoIndustrie

Ireland wwwirlgoviefinance Department of Finance

Italy wwwtesoroit Ministero dellrsquoEconomia e delle Finanze

Luxembourg wwwetatluFI Ministegravere des Finances

Netherlands wwwminfinnl Ministerie van Financien

Austria wwwbmfgvat Bundesministerium fuumlr Finanzen

Portugal wwwmin-financaspt Ministeacuterio das Financcedilas

Finland wwwvnfivm Ministry of Finance

Sweden finansregeringense Finansdepartementet

United Kingdom wwwhm-treasurygovuk Her Majestyrsquos Treasury

Bulgaria wwwminfinbg Ministry of Finance

Cyprus wwwmofgovcy Ministry of Finance

Czech Republic wwwmfcrcz Ministry of Finance

Estonia wwwfinee Ministry of Finance

Hungary wwwp-mhu Ministry of Finance

Latvia wwwfmgovlv Ministry of Finance

Lithuania wwwfinminlt Ministry of Finance

Malta mfeagovmt Ministry of Finance and Economic Affairs

Poland wwwmofnetgovpl Ministry of Finance

Romania wwwmfinantero Ministry of Finance

Slovak Republic wwwfinancegovsk Ministry of Finance

Slovenia sigov1sigovsimf Ministry of Finance

Turkey wwwmaliyegovtr Ministry of Finance

Japan wwwmofgojp Ministry of Finance

United States of America wwwustreasgov Department of the Treasury

Central banks

European Union wwwecbint European Central Bank

Belgium wwwnbbbe Banque Nationale de BelgiqueNationale Bank van Belgieuml

Denmark wwwnationalbankendk Danmarks Nationalbank

Germany wwwbundesbankde Deutsche Bundesbank

Greece wwwbankofgreecegr Bank of Greece

Spain wwwbdees Banco de Espantildea

France wwwbanque-francefr Banque de France

Ireland wwwcentralbankie Central Bank of Ireland

Italy wwwbancaditaliait Banca drsquoItalia

Luxembourg wwwbcllu Banque centrale du Luxembourg

Netherlands wwwdnbnl De Nederlandsche Bank

Austria wwwoenbcoat Oestereichische Nationalbank

Portugal wwwbportugalpt Banco de Portugal

Finland wwwboffi Suomen Pankki

Sweden wwwriksbankcom Sveriges Riksbank

United Kingdom wwwbankofenglandcouk Bank of England

Bulgaria wwwbnbbg Bulgarian National Bank

Cyprus wwwcentralbankgovcy Central bank of Cyprus

Czech Republic www cnbcz Czech National Bank

Estonia wwweestipankinfo Eesti Pank

Hungary wwwmnbhu National Bank of Hungary

Latvia wwwbanklv Bank of Latvia

Lithuania wwwlblt Lietuvos Bankas

Malta wwwcentralbankmaltacom Central Bank of Malta

Poland wwwnbppl Narodowy Bank Polski

Romania wwwbnroro National Bank of Romania

Slovak Republic wwwnbssk National Bank of Slovakia

Slovenia wwwbsisi Bank of Slovenia

Turkey wwwtcmbgovtr Central Bank of the Republic of Turkey

Japan wwwbojorjp Bank of Japan

United States of America wwwfederalreservegov Board of Governors of the Federal Reserve System

Statistical offices

European Union europaeuintcommeurostat Eurostat

Belgium wwwbnbbe National Bank of Belgium

Denmark wwwdstdk Danmarks Statistik

Germany wwwstatistik-bundde Statistisches Bundesamt Deutschland

Greece wwwstatisticsgr National Statistical Service of Greece

Spain wwwinees Instituto Nacional de Estadiacutestica

France wwwinseefr Institut National de la Statistique et des Etudes Economiques

Ireland wwwcsoie Central Statistics Office

Italy petraistatit Istituto nazionale di statistica

Luxembourg statecgouvernementlu Service Central de la Statistique et des Etudes Economiques

Netherlands wwwcbsnl Centraal Bureau voor de Statistiek

Austria wwwoestatgvat Oumlsterreichisches Statistisches Zentralamt

Portugal wwwinept Instituto Nacional de Estatiacutestica

Finland wwwstatfi Tilastokeskus Statistics Finland

Sweden wwwscbse Statistiska Centralbyraringn Statistics Sweden

United Kingdom wwwstatisticsgovuk Office for National Statistics

Bulgaria wwwnsibg National Statistical Institute

Cyprus wwwpiogovcydsr Statistical Service

Czech Republic wwwczsocz Czech Statistical Office

Estonia wwwstatee Statistical Office

Hungary wwwkshhu Central Statistical Office

Latvia wwwcsblv Central Statistical Bureau

Lithuania wwwstdlt Statistics Lithuania

Malta wwwnsogovmt National Statistics Office

Poland wwwstatgovpl Polish Official Statistics

Romania wwwinssero National Institute of Statistics

Slovak Republic wwwstatisticssk Statistical Office

Slovenia wwwsigovsizrs Statistical Office

Turkey wwwdiegovtr State Institute of Statistics

Japan wwwstatgojpenglishindexhtm Statistics BureauStatistics Centre

United States of America wwwfedstatsgov Federal Statistical Agencies

International organisations

Bank for International Settlements wwwbisorg

EBRD wwwebrdcom

IMF wwwimforg

OECD wwwoecdorg

United Nations wwwunorg

World Bank wwwworldbankorg

World Trade Organisation wwwwtoorg

Statistical annex

Contents

Tables A1 Resources and expenditure of general government by country 288

Tables A2 Contributions to the change in the general government gross debt ratio by country 322

Tables A3 Cyclical adjustment of general government receipts expenditures and budget balances by country 340

Tables A4 Government finance in the Member States 1980ndash2003 by country 358

1 Current tax burden 358

2 Social contributions received 360

3 Current taxes on income and wealth (direct taxes) 362

4 Taxes linked to imports and production (indirect taxes) 364

5 Other current resources 366

6 Total current resources 368

7 Interest payments 370

8 Final consumption expenditure 372

9 Compensation of employees 374

10 Total current uses 376

11 Gross saving 378

12 Gross fixed capital formation 380

13 Total uses 382

14 Net lending (+) or net borrowing (ndash) 384

15 Net lending (+) or net borrowing (ndash) excluding interest 386

16 General government consolidated gross debt 388

17 Cyclically-adjusted total resources 390

18 Cyclically-adjusted total uses 392

19 Cyclically-adjusted net lending (+) or net borrowing (ndash) 394

Tables A5 Gross domestic product trend GDP and output gap 396

1 Gross domestic product at current market prices in billion EUR 396

2 Gross domestic product at constant market prices (annual percentage change) 396

3 Potential GDP at constant market prices (annual percentage change) 398

4 Gap between actual and potential GDP at constant market prices ( of potential GDP) 398

Table A11

Resources and expenditure of general government ( of GDP)

BelgiumFormer definitions

1980 1985 1990 1991 1992 1993

1 Taxes on production and imports 122 120 122 121 121 123

2 Current taxes on income and wealth 180 191 167 163 162 162

3 Social contributions 149 171 169 175 178 181

4 Of which actual social contributions

5 Other current resources 26 23 18 19 18 18

6 Total current resources 476 504 475 477 478 483

7 Government consumption expenditure 173 167 139 143 142 146

8 Of which compensation of employees 134 130 112 115 116 120

9 Collective consumption

10 Social benefits in kind

11 Social transfers other than in kind 236 248 231 240 244 246

12 Interest payments 59 103 104 100 106 106

13 Subsidies 36 37 28 29 27 26

14 Other current expenditure

15 Total current expenditure 513 562 511 522 529 534

16 Gross savings ndash 37 ndash 58 ndash 36 ndash 45 ndash 50 ndash 51

17 Capital transfers received

18 Total resources 476 504 475 477 478 483

19 Gross fixed capital formation 44 25 13 14 14 16

20 Other capital expenditure

21 Total expenditure 561 593 529 539 548 555

22 Tax burden 457 492 466 468 469 475

23 Net lending (+) or net borrowing (ndash) ndash 86 ndash 89 ndash 54 ndash 62 ndash 69 ndash 72

(1) The table is based on ESA 95 definitions which do not necessarily correspond with the former definitions The totals are obtained in ESA 95 as followsLine 6 = line 1 + line 2 + line 3 + line 5Line 7 = line 9 + line 10Line 15 = total of lines 9 to 14Line 16 = line 6 ndash line 15Line 18 = line 6 + line 17Line 21 = line 15 + line 19 + line 20Line 23 = line 18 ndash line 21

Table A11

Former definitions ESA 95 definitions (1)

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

126 122 122 127 129 129 132 131 126 130 130 130

174 178 167 166 171 176 171 173 176 176 173 169

175 174 168 167 165 166 164 161 164 166 165 164

148 146 145 145 144 142 144 146 144 143

15 15 31 32 30 30 28 29 30 30 28 28

489 489 488 493 494 500 495 494 495 501 495 491

145 145 214 217 212 211 212 212 217 221 225 225

120 121 119 119 117 116 116 114 116 120 120 120

79 78 78 77 78 78 79 81 82 82

135 139 134 134 134 134 138 140 144 144

240 242 166 166 163 161 156 153 155 160 162 163

99 88 93 89 80 76 70 68 66 61 56 50

24 24 15 16 14 15 15 15 16 15 15 15

20 21 21 21 21 20 20 21 19 19

519 509 507 508 489 483 474 468 473 479 478 472

ndash 30 ndash 20 ndash 20 ndash 15 05 17 21 27 22 22 18 19

04 04 06 05 06 05 06 05 05 05

489 489 485 491 495 500 496 496 498 504 497 494

16 14 18 16 16 16 18 18 15 17 15 15

10 11 15 13 14 13 09 10 11 11

537 527 528 529 514 507 501 495 494 504 500 496

484 485 468 470 475 480 476 475 476 481 477 473

ndash 48 ndash 39 ndash 43 ndash 38 ndash 20 ndash 08 ndash 05 01 04 00 ndash 03 ndash 02

Table A12

DenmarkFormer definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 30 28 33 32 38 39

16 Gross savings 07 09 02 ndash 10 ndash 04 ndash 10

18 Total resources 508 553 551 547 560 579

22 Tax burden 447 480 476 475 480 495

Table A12

resources and expenditure of general government ( of GDP)

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

173 172 169 173 175 182 181 172 173 175 175 174

306 303 304 306 303 299 308 296 299 297 295 296

28 26 26 26 26 26 32 33 32 27 26 26

16 16 16 16 22 24 23 17 17 17

75 68 68 71 67 66 60 58 61 57 54 53

581 570 568 577 571 574 581 558 565 556 550 549

259 257 258 259 255 260 258 253 259 261 261 260

175 173 173 173 171 175 174 170 172 175 175 176

84 85 82 82 80 77 77 80 80 80

174 174 173 178 179 176 181 182 181 181

217 208 204 198 188 183 178 173 173 176 176 175

67 64 64 61 57 53 48 43 40 37 35 33

37 36 25 26 24 23 23 22 21 21 21 20

22 24 24 26 26 26 27 27 26 26

588 574 573 568 549 546 532 516 520 522 518 514

ndash 07 ndash 05 ndash 05 09 22 28 49 42 45 33 32 35

06 04 05 05 06 05 05 07 05 05

581 570 580 588 583 587 595 572 580 573 563 562

18 18 18 20 19 17 17 17 19 17 17 17

05 03 04 05 06 06 01 04 04 04

607 592 603 598 580 576 563 547 550 554 547 542

507 501 502 507 507 510 523 502 506 501 498 498

Commission services

Table A13

Resources and expenditure of general government( of GDP)

Germany (1)Former definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 23 22 21 24 21 21

16 Gross savings 24 25 13 12 14 05

18 Total resources 443 449 421 435 449 453

22 Tax burden 417 414 392 408 415 420

(1) From 1991 including former East Germany(2) The table is based on ESA 95 definitions which do not necessarily correspond with the former definitions The totals are obtained in ESA 95 as follows

Line 6 = line 1 + line 2 + line 3 + line 5Line 7 = line 9 + line 10Line 15 = total of lines 9 to 14Line 16 = line 6 ndash line 15Line 18 = line 6 + line 17Line 21 = line 15 + line 19 + line 20Line 23 = line 18 ndash line 21

Table A13

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

131 127 114 114 114 116 122 120 119 118 120 120

108 111 111 115 112 115 120 125 111 108 110 112

189 191 188 194 197 193 190 187 185 184 186 185

177 183 186 182 179 176 175 174 176 175

30 27 35 34 32 31 30 28 31 30 29 28

459 456 448 457 455 455 462 460 446 441 445 445

194 195 198 200 195 192 191 191 190 191 191 189

103 102 90 89 87 85 84 82 80 79 79 78

84 84 81 80 80 80 79 79 79 78

114 116 113 112 111 111 111 113 112 111

186 190 181 193 193 190 189 188 189 194 198 196

33 37 37 37 36 36 35 34 33 32 32 33

21 21 21 20 18 19 18 17 16 15 14 13

12 13 14 14 16 17 16 17 17 17

449 456 449 462 456 450 450 446 444 449 452 447

10 00 ndash 01 ndash 05 ndash 01 05 12 14 02 ndash 08 ndash 07 ndash 02

06 05 04 05 05 04 04 04 04 04

459 456 461 469 466 466 473 470 455 450 454 455

26 23 23 21 19 19 19 18 17 16 16 16

16 12 12 13 13 ndash 11 17 16 16 16

484 490 496 503 494 488 488 459 483 486 489 484

425 425 423 431 431 431 438 439 421 415 420 421

ndash 26 ndash 34 ndash 35 ndash 34 ndash 27 ndash 22 ndash 15 11 ndash 28 ndash 36 ndash 34 ndash 29

Commission services

Table A14

GreeceFormer definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 22 52 40 35 36 39

18 Total resources 263 303 325 333 341 354

22 Tax burden 246 289 310 314 319 326

Table A14

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

143 142 136 140 143 144 151 152 148 144 143 141

68 72 74 71 78 95 99 108 96 94 93 90

121 124 126 129 133 136 136 140 139 140 140 139

105 108 111 115 114 118 117 118 119 118

38 42 29 29 34 29 29 32 36 36 36 34

369 381 365 369 388 403 415 432 419 414 411 404

138 153 153 145 151 153 154 157 153 158 155 152

106 113 113 107 116 116 117 117 116 122 121 119

95 85 88 93 94 97 93 97 95 94

59 60 63 60 60 60 60 61 60 59

152 155 151 154 156 158 158 166 163 164 164 163

139 128 112 105 82 78 72 70 63 55 52 49

36 33 04 05 02 01 02 02 02 02 02 01

13 13 11 13 12 11 11 08 08 07

440 451 433 422 402 402 398 405 392 387 380 373

ndash 71 ndash 71 ndash 68 ndash 53 ndash 15 01 17 26 27 27 30 30

16 22 24 26 20

369 381 393 403 424 441 447 470 456 451 460 452

31 33 32 32 34 36 35 41 39 38 40 39

17 12 16 16 20 31 27 26 25 24

468 485 494 477 464 466 465 489 470 463 471 462

334 340 344 348 360 381 393 406 389 383 380 375

ndash 99 ndash 105 ndash 102 ndash 74 ndash 40 ndash 25 ndash 18 ndash 19 ndash 15 ndash 12 ndash 11 ndash 11

Commission services

Table A15

SpainFormer definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 19 24 24 26 25 31

16 Gross savings 06 03 17 12 07 ndash 17

18 Total resources 296 342 384 392 409 409

22 Tax burden 261 306 354 357 375 365

Table A15

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

106 103 102 102 105 111 117 117 114 117 118 119

110 110 101 103 105 102 102 105 105 109 106 106

140 131 130 132 131 130 131 133 136 135 135 135

120 122 122 121 122 125 127 127 127 127

42 36 41 42 40 37 37 34 36 34 34 35

398 380 374 378 380 380 386 389 390 395 393 394

162 160 181 180 175 175 174 176 175 176 178 177

113 112 113 113 109 107 106 105 104 102 103 103

80 78 77 75 74 75 74 75 76 76

101 101 99 99 101 101 101 101 102 101

158 151 139 138 133 128 124 123 122 125 126 126

47 53 52 54 48 43 36 33 31 29 27 25

29 30 11 10 09 11 12 12 11 11 11 11

09 10 11 12 12 12 12 13 12 12

413 403 392 391 376 368 358 356 351 353 353 351

14 14 10 06 07 06 07 05 05 05

398 380 384 388 386 383 390 390 392 396 393 395

39 37 37 31 31 33 34 31 32 33 34 34

25 20 15 16 14 15 15 15 15 15

459 450 450 437 418 414 402 398 393 397 398 396

361 350 340 344 348 350 356 361 360 366 364 363

Commission services

Table A16

FranceFormer definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 25 30 21 22 22 25

16 Gross savings 37 05 24 14 ndash 04 ndash 22

18 Total resources 453 491 482 482 480 484

22 Tax burden 429 463 451 454 450 456

23 Net lending (+) or net borrowing (ndash) 00 ndash 28 ndash 15 ndash 20 ndash 39 ndash 56

Table A16

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

147 149 154 161 160 160 159 155 150 151 150 152

92 94 85 89 95 117 122 122 125 116 114 113

207 210 205 207 203 181 183 182 182 183 184 183

187 189 184 163 165 163 164 165 165 164

37 38 36 39 38 36 35 35 37 35 35 35

483 490 479 496 496 493 499 494 493 485 482 482

192 190 239 242 242 234 233 232 232 239 240 239

140 141 137 139 138 137 137 135 135 137 138 136

98 99 100 94 93 93 92 94 93 92

141 143 142 141 140 140 140 145 147 147

229 230 185 187 188 184 182 178 178 181 184 184

35 37 36 38 36 35 32 31 31 31 32 33

23 23 15 15 15 14 13 12 13 13 12 12

16 17 16 16 17 17 16 18 18 17

504 504 491 499 496 483 478 470 471 481 486 485

ndash 21 ndash 14 ndash 11 ndash 03 ndash 01 11 21 23 22 04 ndash 04 ndash 03

04 03 08 03 04 04 03 04 06 06

483 490 496 513 518 511 517 512 510 503 502 502

31 32 33 32 30 29 30 32 31 31 30 30

15 09 09 11 13 10 09 09 09 08

540 538 551 554 549 537 535 526 525 535 540 537

460 466 452 464 465 464 470 465 462 455 452 452

Commission services

Table A17

IrelandFormer definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 72 75 56 56 47 50

18 Total resources 346 388 359 367 370 370

22 Tax burden 312 349 336 340 344 345

Table A17

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

153 146 135 137 135 131 131 132 121 122 124 123

152 135 136 141 140 138 137 136 130 118 115 112

52 47 68 63 59 56 56 56 58 57 56 56

50 46 44 42 43 44 45 45 45 44

21 18 28 29 27 25 22 21 25 25 24 23

377 346 367 370 361 350 345 346 335 321 319 313

152 142 165 158 152 145 139 138 148 152 154 154

105 96 102 97 92 85 80 78 82 83 86 85

65 63 60 58 54 52 56 57 58 58

100 95 92 87 85 86 92 95 97 96

144 137 118 114 106 97 87 80 85 88 90 88

56 50 54 46 38 35 25 21 15 13 15 15

45 41 10 10 10 08 08 08 11 09 08 07

21 24 22 22 21 20 21 21 22 22

371 348 367 351 328 307 280 266 280 282 289 285

06 ndash 02 00 18 33 43 65 79 55 39 30 28

18 17 18 16 16 13 14 13 12 11

377 346 394 394 386 372 367 364 352 337 335 328

23 24 23 24 25 27 32 37 46 44 39 39

16 12 11 09 29 11 11 08 10 09

392 367 415 396 371 350 347 319 341 337 341 337

355 329 351 350 342 334 330 331 317 304 303 297

ndash 16 ndash 21 ndash 21 ndash 01 14 23 20 45 12 00 ndash 06 ndash 09

Commission services

Table A18

ItalyFormer definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 35 34 25 26 23 27

18 Total resources 344 390 428 438 445 477

22 Tax burden 317 361 400 409 415 442

Table A18

( of GDP)

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

124 124 121 118 124 153 151 150 145 146 145 145

148 145 148 154 162 145 152 147 151 142 137 136

148 147 148 150 153 128 127 127 126 127 128 128

130 146 149 125 124 124 123 124 125 125

36 37 31 32 32 32 33 30 32 31 30 30

455 453 448 455 472 459 463 455 453 446 440 438

170 159 179 181 182 179 180 183 188 188 189 187

119 113 112 115 116 107 107 106 107 107 108 107

73 73 72 71 72 71 71 70 72 72

106 108 110 108 108 112 117 118 116 115

197 191 167 169 173 170 172 168 166 171 173 174

109 113 115 115 94 83 68 65 64 58 53 51

24 19 15 15 12 13 12 12 12 10 09 09

11 13 13 13 14 13 14 14 14 14

510 491 486 492 474 458 446 441 444 441 438 434

09 04 10 07 05 04

455 453 458 461 484 468 471 462 458 452 451 443

23 22 21 22 22 24 24 24 25 18 21 26

25 16 13 15 16 02 15 16 14 13

546 529 534 532 511 499 489 469 485 477 475 475

421 419 423 429 444 432 435 430 427 419 414 412

Commission services

Table A19

LuxembourgFormer definitions

1980 1985 1990 1991 1992 1993

2 Current taxes on income and wealth 157 176

3 Social contributions 134 124

5 Other current resources 63 57

6 Total current resources 480 506

8 Of which compensation of employees 102 98

11 Social transfers other than in kind 217 208

13 Subsidies 29 31 30 30 29 28

15 Total current expenditure 408 395

16 Gross savings 72 112

18 Total resources 480 506

21 Total expenditure 484 444

22 Tax burden 392 421

23 Net lending (+) or net borrowing (ndash) ndash 04 63 47 18 07 15

Table A19

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

161 162 125 126 127 128 135 141 134 135 133 129

175 179 174 164 156 154 155 165 162 157

125 121 115 112 111 111 121 127 127 124

112 110 105 102 102 103 112 118 117 115

57 54 54 52 48 46 49 49 45 44

482 481 470 456 450 452 459 476 467 454

119 126 185 189 179 168 167 157 168 183 192 196

97 97 93 88 83 78

80 80 77 71 69 65 69 76 79 80

105 109 103 97 98 92 99 107 113 116

165 162 155 148 144 136 144 162 171 176

03 03 04 04 03 04 03 03 03 04 02 02

28 21 18 21 19 18 15 16 16 17 17 16

31 27 29 32 34 31 31 28 28 28

402 403 386 370 363 343 361 393 411 418

80 78 84 86 87 109 99 83 56 36

03 02 03 02 02 02 02 02 02 02

476 475 466 451 445 446 454 472 452 443

42 45 46 47 42 45 45 40 42 46 51 54

15 13 12 12 09 11 ndash 05 14 09 ndash 05

455 455 433 421 410 387 391 447 455 456

425 426 417 404 403 406 410 427 422 410

27 18 21 20 32 31 35 60 63 25 ndash 02 ndash 12

Commission services

Table A110

The NetherlandsFormer definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 30 35 29 31 31 29

16 Gross savings 13 09 ndash 16 03 ndash 09 ndash 03

18 Total resources 507 525 481 506 502 510

22 Tax burden 439 434 429 452 448 462

Table A110

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

124 123 107 112 114 116 122 121 126 127 126 125

136 125 124 129 124 122 122 121 119 120 113 111

184 182 172 166 166 164 171 171 153 150 156 153

160 155 155 153 160 160 142 140 146 143

41 37 60 58 55 50 47 48 52 52 49 46

484 466 463 465 459 452 462 461 451 449 444 435

139 138 240 231 229 227 229 227 232 243 242 244

93 93 108 104 102 101 102 100 101 104 106 106

116 113 110 108 109 106 109 113 112 113

125 119 119 119 120 120 123 130 130 131

260 251 153 148 139 130 125 118 116 118 122 124

57 57 59 56 52 49 45 39 35 32 30 29

25 18 11 12 15 15 16 15 15 15 14 12

11 12 13 13 14 17 16 18 16 16

494 477 474 459 447 434 428 415 414 426 425 425

03 06 04 04 04 05 04 05 04 04

484 466 473 478 471 465 476 474 465 463 459 453

20 19 30 31 29 29 30 32 34 35 36 35

04 ndash 01 ndash 02 00 02 ndash 03 06 05 04 04

521 505 514 496 482 472 469 453 464 475 475 477

438 425 415 417 415 411 424 422 407 403 404 397

ndash 36 ndash 38 ndash 42 ndash 18 ndash 11 ndash 08 07 22 01 ndash 12 ndash 16 ndash 24

Commission services

Table A111

AustriaFormer definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 29 28 28 31 30 31

16 Gross savings 42 31 22 18 27 08

18 Total resources 456 478 471 477 492 499

22 Tax burden 427 448 426 432 444 453

Table A111

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

157 155 143 145 149 149 150 146 147 150 146 149

113 119 120 131 135 136 134 133 151 141 151 153

172 173 174 175 174 172 172 169 169 168 169 168

152 153 153 152 152 149 150 149 148 147

44 45 57 52 38 36 36 35 45 41 41 40

486 492 494 503 495 492 491 482 511 500 506 509

200 198 204 203 197 195 198 192 191 187 193 192

124 124 126 124 115 113 114 110 101 99 100 99

81 81 78 78 79 75 74 70 74 73

124 122 119 117 119 117 117 116 119 119

217 216 195 195 189 185 187 185 188 188 193 193

40 43 44 44 40 39 37 38 37 36 37 36

25 29 29 26 26 28 26 24 26 27 29 27

25 26 25 27 28 26 33 40 31 31

486 496 498 494 477 474 475 465 475 477 483 479

00 ndash 04 ndash 04 09 18 18 16 17 37 24 23 30

02 02 03 01 03 02 02 02 02 02

486 492 520 528 521 517 518 507 522 515 510 507

33 28 31 28 20 19 17 15 12 12 11 11

20 22 21 25 25 20 26 22 27 27

535 542 573 568 541 542 542 524 521 522 523 513

440 447 449 459 467 464 463 455 474 462 473 477

ndash 49 ndash 50 ndash 53 ndash 40 ndash 20 ndash 25 ndash 24 ndash 16 01 ndash 08 ndash 13 ndash 06

Commission services

Table A112

PortugalFormer definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 60 68 14 13 12 13

16 Gross savings ndash 35 ndash 60 ndash 14 ndash 25 08 ndash 20

18 Total resources 278 327 339 352 381 368

22 Tax burden 246 283 313 326 350 341

Table A112

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

134 136 136 140 138 143 148 145 144 151 152 155

88 91 89 95 96 93 98 104 98 97 96 95

115 117 110 109 112 112 114 118 119 122 122 120

101 102 105 105 106 109 110 113 113 112

26 28 41 43 40 40 40 36 37 39 39 39

363 371 376 387 386 390 400 403 398 409 407 409

171 173 186 189 190 189 197 205 208 213 213 210

137 137 136 137 138 140 144 150 152 154 150 145

76 73 78 76 79 84 85 87 87 86

110 117 113 113 118 121 123 126 126 124

148 151 118 119 117 117 119 124 125 130 132 134

61 62 63 54 42 35 32 33 32 30 31 30

12 11 13 15 12 15 17 11 13 14 14 14

16 19 20 21 22 24 22 23 23 23

391 395 396 396 382 377 387 396 400 410 414 413

ndash 28 ndash 23 ndash 21 ndash 09 04 12 13 07 ndash 02 00 ndash 07 ndash 04

19 21 23 16 18 14 19 23 23 23

363 371 396 410 412 410 424 423 421 435 435 437

35 36 37 42 44 40 42 39 41 36 37 36

15 18 20 20 18 12 19 13 16 16

421 427 450 458 448 441 453 452 464 462 471 469

344 347 338 345 348 349 361 367 361 370 369 370

Commission services

Table A113

FinlandFormer definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 32 31 28 34 35 33

18 Total resources 420 470 514 531 537 527

22 Tax burden 383 423 458 466 465 449

23 Net lending (+) or net borrowing (ndash) 33 29 53 ndash 15 ndash 57 ndash 79

Table A113

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

142 135 134 135 142 140 142 136 132 135 135 132

168 167 174 190 185 189 189 214 195 194 187 184

158 147 148 142 134 130 131 122 125 123 121 120

146 140 132 129 131 122 125 123 121 120

67 69 73 68 62 60 54 62 64 63 61 60

535 519 528 536 523 518 516 534 516 515 504 497

218 212 227 231 223 216 216 207 208 216 219 218

153 148 152 155 145 138 138 132 132 134 136 136

85 86 85 81 80 76 73 76 77 77

143 145 138 135 136 132 135 139 141 141

245 228 221 214 198 183 181 165 164 165 168 166

50 52 40 43 43 36 31 29 27 23 22 21

30 32 28 20 18 17 16 15 14 14 14 14

20 22 24 23 24 24 23 24 24 24

564 541 536 530 505 474 468 440 437 441 446 443

02 02 03 03 03 03 03 04 04 04

535 519 555 565 551 543 541 559 542 540 528 520

29 27 27 29 31 29 28 26 27 28 27 27

06 09 03 03 03 02 04 02 02 02

595 569 594 595 564 528 521 489 490 492 495 490

472 455 463 474 467 464 468 478 457 456 446 440

Commission services

Table A114

SwedenFormer definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 42 49 46 49 54 55

16 Gross savings 07 ndash 01 63 14 ndash 33 ndash 66

18 Total resources 561 592 626 596 591 564

22 Tax burden 510 526 570 543 527 500

23 Net lending (+) or net borrowing (ndash) ndash 39 ndash 37 40 ndash 11 ndash 75 ndash 115

Table A114

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

139 134 157 161 163 172 184 163 164 171 175 175

197 201 195 209 209 217 212 212 222 193 197 198

134 137 137 147 145 145 132 149 155 156 154 152

131 142 140 140 127 143 149 150 148 146

83 79 82 78 69 69 61 59 50 50 71 71

553 550 571 595 586 603 589 583 591 569 597 596

253 240 273 279 273 275 275 268 272 280 283 281

170 161 167 172 168 162 158 157 160 163 160 159

84 86 84 83 84 84 85 87 88 88

189 192 189 192 191 185 188 193 195 194

233 218 206 196 189 187 182 175 174 176 185 183

64 66 66 66 63 55 48 41 32 32 27 27

49 47 37 32 27 22 20 16 15 16 16 15

20 17 17 19 18 22 23 23 46 45

617 594 602 590 569 558 543 521 516 527 557 551

02 02 02 02 02 02 02 02 02 02

553 550 604 624 615 631 617 609 618 596 599 597

28 27 40 35 31 32 32 29 30 33 33 33

06 01 06 ndash 07 02 00 01 01 01 01

649 623 678 654 632 608 604 575 572 585 591 585

494 501 496 524 524 541 534 530 547 524 531 530

Commission services

Table A115

United KingdomFormer definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 25 20 11 10 11 11

16 Gross savings ndash 05 ndash 05 24 05 ndash 32 ndash 49

18 Total resources 398 414 383 374 361 351

22 Tax burden 335 354 333 331 322 313

Table A115

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

154 157 131 132 135 134 138 138 136 137 136 135

118 126 149 147 150 162 161 166 167 155 154 155

62 62 75 74 74 75 73 76 76 75 79 81

68 67 68 69 66 69 70 68 72 74

22 22 29 30 27 27 27 25 27 23 21 22

356 367 384 382 386 398 399 404 405 390 390 393

212 209 196 193 184 180 185 187 193 200 207 207

91 84 83 79 75 72 72 72 74 76 80 80

83 81 76 73 73 74 76 77 79 79

113 112 108 107 112 114 117 124 128 128

136 134 154 148 144 137 134 133 137 135 135 134

32 34 37 37 37 36 29 28 24 21 20 21

11 11 08 09 07 06 04 05 06 06 06 06

18 19 20 21 21 23 22 24 24 26

398 397 413 406 392 380 373 376 382 386 392 393

ndash 42 ndash 30 ndash 29 ndash 23 ndash 06 18 26 29 24 04 ndash 02 00

03 03 03 03 03 03 03 03 04 03

356 367 389 386 389 401 403 409 410 394 395 397

18 17 20 15 12 12 11 11 12 13 17 19

12 09 07 06 06 ndash 19 07 07 09 09

423 421 446 430 411 398 391 369 402 406 419 422

319 329 365 361 366 378 379 386 384 371 374 376

ndash 67 ndash 54 ndash 58 ndash 44 ndash 22 02 11 40 08 ndash 13 ndash 25 ndash 25

1) The table is based on ESA 95 definitions which do not necessarily correspond with the former definitions The totals are obtained in ESA 95 as followsLine 6 = line 1 + line 2 + line 3 + line 5Line 7 = line 9 + line 10Line 15 = total of lines 9 to 14Line 16 = line 6 ndash line 15Line 18 = line 6 + line 17Line 21 = line 15 + line 19 + line 20Line 23 = line 18 ndash line 21

Commission services

Table A116

Euro area (1)Former definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 27 30 24 25 24 25

16 Gross savings 10 ndash 06 ndash 02 ndash 05 ndash 12 ndash 18

18 Total resources 417 443 439 447 454 464

22 Tax burden 388 408 408 416 421 430

(1) Due to problems with availability of the data Luxembourg data are not included from 1991 including former East Germany

(2) System is based on ESA 95 definitions which do not necessarily correspond with the former definitions The totals are obtained in ESA 95 as followsLine 6 = line 1 + line 2 + line 3 + line 5Line 7 = line 9 + line 10Line 15 = total of lines 9 to 14Line 16 = line 6 ndash line 15Line 18 = line 6 + line 17Line 21 = line 15 + line 19 + line 20Line 23 = line 18 ndash line 21

Table A116

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

132 131 125 127 129 135 138 136 133 134 134 134

116 117 114 119 121 124 128 130 126 122 120 120

177 177 174 176 175 165 164 162 160 160 161 160

160 164 163 153 152 151 149 149 150 149

35 33 38 38 36 35 34 33 35 34 33 33

460 457 451 459 461 458 463 460 454 449 448 446

181 179 205 205 203 199 199 199 200 203 204 202

117 116 111 112 111 107 107 106 105 106 107 106

86 86 85 82 83 82 82 82 82 82

119 120 118 117 117 117 119 121 121 120

202 201 173 177 176 171 170 167 166 170 172 172

54 56 56 57 51 48 43 41 40 37 36 36

24 23 17 17 15 15 15 14 14 13 13 12

14 15 15 15 16 16 16 17 17 16

475 472 464 470 459 449 443 437 436 440 442 438

07 06 07 05 05 05

460 457 464 472 476 471 476 472 465 461 460 458

27 26 27 26 24 25 25 25 25 24 24 25

17 12 11 13 13 02 14 13 13 13

510 507 515 515 502 494 489 471 481 484 485 482

428 427 422 429 432 430 435 434 425 420 419 418

Commission services

Table A117

EU-15 (1)Former definitions

1980 1985 1990 1991 1992 1993

13 Subsidies 27 29 23 24 23 24

16 Gross savings 08 ndash 06 04 ndash 03 ndash 16 ndash 24

18 Total resources 421 446 439 443 448 453

22 Tax burden 385 405 404 409 412 417

Table A117

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

136 135 128 129 132 137 140 138 135 136 136 136

123 124 125 129 132 137 140 142 140 133 132 132

157 157 157 158 155 146 145 143 142 142 144 144

144 147 144 136 134 133 132 132 134 133

35 34 39 39 36 35 34 33 35 33 33 32

450 450 448 456 455 454 458 456 452 444 444 444

189 186 207 207 203 199 200 200 202 206 208 207

116 114 111 111 108 104 104 102 102 103 105 104

86 85 83 81 81 80 81 81 82 82

121 122 120 119 119 120 122 125 126 125

194 193 172 174 171 166 164 161 161 164 166 166

52 53 54 55 49 46 41 38 37 34 33 33

23 22 17 16 14 14 13 13 13 12 12 11

15 15 16 17 17 18 18 19 19 19

471 468 464 467 454 443 436 430 430 435 438 435

06 05 07 05 05 05 04 05 06 05

450 450 461 468 468 466 470 467 462 455 455 454

26 25 26 25 22 23 23 23 23 22 23 24

16 11 10 11 12 ndash 02 12 12 12 12

504 500 513 510 493 483 477 457 471 474 478 476

416 418 418 425 426 426 430 429 423 415 416 416

Commission services

Table A21

Contributions to the change in the general government gross debt ratio( of GDP)

Former definitions

Belgium 1980 1985 1990 1991 1992 1993

1 Net borrowing (1) 86 89 54 62 69 72

3 Implicit interest rate (2) 92 95 87 82 88 85

4 Nominal GDP growth rate () 88 64 60 48 50 30

Budgetary constraint based on the deficit

5 Deficit (net borrowing) (1) 86 89 54 62 69 72

6 Contribution of nominal GDP growth ndash 56 ndash 69 ndash 73 ndash 58 ndash 61 ndash 37

7 Stock-flow adjustment (3) 52 29 19 ndash 08 08 20

Budgetary constraint based on the primary deficit

8 Primary deficit (4) 27 ndash 14 ndash 50 ndash 38 ndash 37 ndash 35

9 Snowball effect (5) 03 34 32 42 46 69

11 Change in gross debt (6) 83 49 01 21 14 68

12 Level of gross debt (end of year) 783 1218 1277 1298 1312 1380

Denmark

1 Net borrowing (1) 32 20 10 24 22 28

7 Stock-flow adjustment (3) 60 09 14 44 39 98

8 Primary deficit (4) ndash 07 ndash 76 ndash 63 ndash 49 ndash 44 ndash 45

9 Snowball effect (5) 16 35 47 51 45 64

11 Change in gross debt (6) 70 ndash 29 ndash 02 46 40 117

(1) Line 1 = line 5 a minus sign means a surplus(2) Actual interest payments as a percentage of gross debt at the end of t ndash 1(3) Line 7 = line 10 due to a change in definition there are no data for 1996(4) Net borrowing excluding interest payments line 8 = line 1 ndash line 2 A minus sign means a primary surplus(5) Due to a change in definition there are no data for 1996(6) Line 11 = total of lines 5 6 and 7 or 8 9 and 10

Source Commission services Source

Table A11

Former definitions ESA 95 definitions

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

48 39 38 20 08 05 ndash 01 ndash 04 00 03 02

99 88 89 80 76 70 68 66 61 56 50

78 70 68 64 63 61 62 62 57 55 50

54 37 24 49 37 46 50 28 25 30 40

48 39 38 20 08 05 ndash 01 ndash 04 00 03 02

ndash 69 ndash 46 ndash 31 ndash 61 ndash 45 ndash 53 ndash 55 ndash 29 ndash 31 ndash 31 ndash 40

ndash 06 ndash 13 ndash 46 ndash 12 ndash 16 01 03 23 ndash 01 03 00

30 42 57 19 31 17 13 37 30 25 10

1364 1334 1302 1248 1196 1149 1096 1085 1058 1032 994

26 22 10 ndash 04 ndash 11 ndash 32 ndash 25 ndash 30 ndash 19 ndash 16 ndash 20

67 64 61 57 53 48 43 40 37 35 33

92 91 93 93 90 89 86 88 84 79 82

73 46 51 52 35 45 61 35 25 38 41

ndash 18 ndash 32 ndash 19 ndash 04 ndash 17 24 ndash 01 26 29 08 09

14 32 28 25 33 23 13 24 26 18 17

735 693 651 612 562 530 473 454 453 427 400

(1) Line 1 = line 5 a minus sign means a surplus(2) Actual interest payments as percentage of gross debt at end of t ndash 1(3) Line 7 = line 10 due to a change in definition there are no data for 1996(4) Net borrowing excl interest payments line 8 = line 1 ndash line 2 A minus sign means a primary surplus(5) Due to a change in definition there are no data for 1996(6) Line 11 = total of lines 5 6 and 7 or 8 9 and 10

SourceCommission services

Table A22

Contributions to the change in the general government gross debt ratio ( of GDP)

Germany (1)

Former definitions

1980 1985 1990 1991 1992 1993

1 Net borrowing (2) 19 21 20 32 28 35

8 Primary deficit (5) ndash 10 ndash 07 ndash 06 06 ndash 04 02

9 Snowball effect (6) ndash 09 04 22

Greece

1 Net borrowing (2) 26 116 159 114 126 136

8 Primary deficit (5) 07 67 59 21 11 10

9 Snowball effect (6) ndash 23 ndash 35 ndash 25 ndash 60 04 28

11 Change in gross debt (7) ndash 02 87 86 22 64 127

(1) From 1991 including former East Germany(2) Line 1 = line 5 a minus sign means a surplus(3) Actual interest payments as a percentage of gross debt at the end of t ndash 1(4) Line 7 = line 10 due to a change in definition there are no data for 1996(5) Net borrowing excluding interest payments line 8 = line 1 ndash line 2 A minus sign means a primary surplus(6) Due to a change in definition there are no data for 1996(7) Line 11 = total of lines 5 6 and 7 or 8 9 and 10

Table A12

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

26 34 34 27 22 15 ndash 11 28 36 34 29

33 37 37 36 36 35 34 33 32 32 33

74 78 66 62 61 59 56 56 55 54 53

49 38 18 21 31 26 26 20 18 17 28

26 34 34 27 22 15 ndash 11 28 36 34 29

19 61 04 ndash 03 ndash 05 03 17 ndash 23 ndash 12 ndash 06 ndash 09

ndash 07 ndash 04 ndash 03 ndash 09 ndash 14 ndash 20 ndash 45 ndash 05 04 02 ndash 03

11 19 27 24 18 20 18 21 21 22 15

23 77 28 12 ndash 01 03 ndash 10 ndash 07 13 18 03

495 571 598 610 609 612 602 595 609 627 630

99 105 74 40 25 18 19 15 12 11 11

139 128 105 82 78 72 70 63 55 52 49

143 132 107 82 78 73 72 64 56 53 53

134 121 99 107 88 67 78 77 78 75 76

99 105 74 40 25 18 19 15 12 11 11

10 20 50 36 39 41 68 69 44 22 21

09 11 07 ndash 25 ndash 09 06 ndash 06 ndash 12 ndash 22 ndash 21 ndash 22

10 20 50 36 39 41 68 69 44 22 21

ndash 23 08 26 ndash 31 ndash 24 ndash 08 12 08 ndash 21 ndash 39 ndash 40

1079 1087 1113 1082 1058 1051 1062 1070 1049 1010 970

(1) from 1991 including former East Germany(2) Line 1 = line 5 a minus sign means a surplus(3) Actual interest payments as a percentage of gross debt at the end of t ndash 1(4) Line 7 = line 10 due to a change in definition there are no data for 1996(5) Net borrowing excluding interest payments line 8 = line 1 ndash line 2 A minus sign means a primary surplus(6) Due to a change in definition there are no data for 1996(7) Line 11 = total of lines 5 6 and 7 or 8 9 and 10

Table A23

Former definitions

1980 1985 1990 1991 1992 1993

1 Net borrowing (1) 25 62 42 43 40 67

8 Primary deficit (4) 18 43 03 06 ndash 03 17

France

1 Net borrowing (1) 00 28 15 20 39 56

8 Primary deficit (4) ndash 14 00 ndash 14 ndash 09 07 23

9 Snowball effect (5) ndash 10 10 11 16 20 28

Table A13

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

61 70 50 32 30 12 08 02 01 04 01

47 53 54 48 43 36 33 31 29 27 25

86 95 89 74 69 59 56 55 54 52 51

64 78 60 64 69 71 78 70 65 58 61

61 70 50 32 30 12 08 02 01 04 01

ndash 03 01 29 ndash 06 ndash 08 16 12 02 04 10 09

14 17 ndash 04 ndash 16 ndash 13 ndash 24 ndash 25 ndash 30 ndash 28 ndash 22 ndash 24

12 09 17 06 00 ndash 07 ndash 13 ndash 08 ndash 06 ndash 03 ndash 05

612 640 681 666 646 632 606 569 540 525 505

57 48 41 30 27 18 14 15 31 37 35

35 37 38 36 35 32 31 31 31 32 33

82 80 72 65 61 56 56 57 56 56 56

38 34 26 32 44 38 48 39 31 28 37

57 48 41 30 27 18 14 15 31 37 35

ndash 07 10 ndash 02 09 01 ndash 07 00 03 07 06 00

22 11 03 ndash 06 ndash 08 ndash 15 ndash 17 ndash 16 00 05 02

19 21 25 18 10 11 05 10 15 16 11

35 44 25 22 03 ndash 11 ndash 13 ndash 04 21 27 13

496 540 571 593 595 585 572 568 590 617 630

Table A24

Ireland

Former definitions

1980 1985 1990 1991 1992 1993

1 Net borrowing (1) 116 102 22 23 24 23

7 Stock-flow adjustment (3) 02 02 ndash 16 22 ndash 01 83

8 Primary deficit (4) 56 09 ndash 53 ndash 50 ndash 43 ndash 40

9 Snowball effect (5) ndash 43 18 08 39 13 ndash 04

11 Change in gross debt (6) 16 30 ndash 64 ndash 03 ndash 26 42

1 Net borrowing (1) 87 125 110 100 95 94

7 Stock-flow adjustment (3) 10 23 ndash 02 14 28 42

8 Primary deficit (4) 32 45 16 ndash 01 ndash 19 ndash 26

9 Snowball effect (5) ndash 70 ndash 02 04 20 63 89

Table A14

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

56 50 46 38 35 25 21 15 13 15 15

64 64 61 60 62 52 48 43 41 47 49

76 133 103 155 156 157 146 112 120 68 82

ndash 09 03 ndash 09 22 09 39 08 26 05 15 16

ndash 62 ndash 84 ndash 85 ndash 92 ndash 101 ndash 56 ndash 99 ndash 26 ndash 34 00 00

926 843 742 650 549 493 393 368 334 334 333

91 76 71 27 31 18 07 27 25 23 31

109 113 115 94 83 68 65 64 58 53 51

97 98 99 80 72 60 59 61 55 51 51

58 81 64 45 46 33 53 46 31 35 44

91 76 71 27 31 18 07 27 25 23 31

31 10 ndash 07 06 ndash 18 05 08 11 ndash 20 06 00

44 20 41 42 31 31 07 16 25 17 06

57 ndash 06 ndash 11 ndash 19 ndash 39 ndash 14 ndash 43 ndash 11 ndash 28 ndash 06 ndash 14

1239 1233 1221 1202 1163 1149 1106 1095 1067 1060 1047

Table A25

Luxembourg

Former definitions

1980 1985 1990 1991 1992 1993

1 Net borrowing (1) 04 ndash 63 ndash 47 ndash 18 ndash 07 ndash 15

5 Deficit (net borrowing) (1) 04 ndash 63 ndash 47 ndash 18 ndash 07 ndash 15

9 Snowball effect (5) 04 04 00 ndash 01 01 ndash 01

11 Change in gross debt (6) ndash 03 ndash 05 ndash 09 ndash 05 09 10

The Netherlands

1 Net borrowing (1) 41 35 49 28 38 31

9 Snowball effect (5) 10 31 12 20 31 39

11 Change in gross debt (6) 28 46 ndash 03 ndash 02 09 11

Table A15

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

03 03 04 03 04 03 03 03 04 02 02

62 54 66 61 65 53 50 51 66 41 45

75 38 54 112 98 110 129 36 12 32 48

27 23 28 38 38 37 62 64 27 ndash 16 ndash 17

ndash 01 01 01 ndash 03 ndash 02 ndash 02 ndash 04 01 03 00 00

27 23 28 38 38 37 62 64 27 ndash 16 ndash 17

ndash 04 03 05 ndash 01 02 ndash 04 ndash 05 ndash 01 02 ndash 16 ndash 06

54 56 62 61 63 59 55 54 56 40 34

57 57 56 52 49 45 39 35 32 30 29

76 80 75 73 74 71 67 67 64 60 58

50 50 42 59 61 56 76 66 35 35 33

ndash 31 06 ndash 07 ndash 22 01 05 ndash 07 07 04 00 ndash 04

20 21 24 10 08 09 ndash 06 00 14 13 13

ndash 32 09 ndash 20 ndash 53 ndash 32 ndash 37 ndash 73 ndash 29 ndash 02 ndash 02 04

761 770 752 699 668 631 558 528 527 525 528

Table A26

Austria

Former definitions

1980 1985 1990 1991 1992 1993

1 Net borrowing (1) 17 24 24 30 20 42

9 Snowball effect (5) 00 10 ndash 04 03 09 24

11 Change in gross debt (6) 15 20 ndash 08 02 ndash 02 46

Portugal

1 Net borrowing (1) 84 101 49 58 29 59

7 Stock-flow adjustment (3) ndash 38 101 65 51 ndash 16 ndash 24

9 Snowball effect (5) ndash 57 ndash 46 ndash 16 ndash 08 ndash 06 30

11 Change in gross debt (6) ndash 36 80 20 18 ndash 71 33

Table A16

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

49 50 40 20 25 24 16 ndash 01 08 13 06

40 43 44 40 39 37 38 37 36 37 36

68 70 66 60 63 61 59 57 55 56 54

54 42 33 25 45 34 50 23 24 23 35

49 50 40 20 25 24 16 ndash 01 08 13 06

10 14 ndash 18 ndash 47 ndash 08 35 10 21 10 11 00

08 18 22 23 11 16 06 22 21 22 13

27 38 ndash 01 ndash 44 ndash 11 38 ndash 06 05 03 09 ndash 17

647 686 691 647 637 675 668 673 676 685 668

59 56 48 36 32 29 29 43 27 36 33

61 62 54 42 35 32 33 32 30 31 30

107 107 89 73 64 63 64 63 58 56 54

83 79 67 79 86 70 70 64 51 39 45

59 56 48 36 32 29 29 43 27 36 33

ndash 03 11 ndash 21 ndash 28 ndash 27 01 ndash 04 12 26 00 00

ndash 02 ndash 06 ndash 06 ndash 07 ndash 03 ndash 04 ndash 04 11 ndash 04 04 02

14 16 14 ndash 04 ndash 12 ndash 04 ndash 03 00 03 09 05

09 22 ndash 14 ndash 38 ndash 41 ndash 07 ndash 10 23 26 14 07

620 641 629 591 550 543 533 556 581 595 602

Table A27

Finland

Former definitions

1980 1985 1990 1991 1992 1993

1 Net borrowing (1) ndash 33 ndash 29 ndash 53 15 57 79

4 Nominal GDP growth rate () 154 88 55 ndash 45 ndash 25 12

5 Deficit (net borrowing) (1) ndash 33 ndash 29 ndash 53 15 57 79

6 Contribution of nominal GDP growth ndash 15 ndash 13 ndash 08 07 06 ndash 05

8 Primary deficit (4) ndash 43 ndash 47 ndash 67 ndash 04 31 33

11 Change in gross debt (6) 01 07 ndash 04 84 182 163

Sweden

1 Net borrowing (1) 39 37 ndash 40 11 75 115

4 Nominal GDP growth rate () 136 89 100 61 ndash 08 41

5 Deficit (net borrowing) (1) 39 37 ndash 40 11 75 115

6 Contribution of nominal GDP growth ndash 43 ndash 51 ndash 40 ndash 24 04 ndash 25

7 Stock-flow adjustment (3) 50 08 63 103 59 ndash 29

Table A17

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

61 50 30 13 ndash 15 ndash 20 ndash 69 ndash 52 ndash 47 ndash 33 ndash 30

50 52 43 43 36 31 29 27 23 22 21

93 96 78 81 72 66 66 64 53 52 51

60 84 36 85 87 31 86 43 29 31 44

ndash 14 ndash 24 ndash 10 02 04 19 81 62 49 41 39

18 06 23 ndash 02 ndash 07 17 ndash 09 09 10 09 03

15 ndash 17 00 ndash 30 ndash 54 ndash 16 ndash 25 ndash 08 ndash 11 ndash 04 ndash 09

588 571 570 540 486 470 445 438 427 423 414

64 66 66 63 55 48 41 32 32 27 27

95 96 91 89 81 74 68 62 60 54 55

66 76 26 40 44 53 57 32 32 36 49

ndash 26 ndash 32 ndash 13 ndash 19 28 ndash 06 ndash 31 78 08 11 22

19 14 47 35 25 14 07 16 15 09 03

26 ndash 11 ndash 02 ndash 30 ndash 25 ndash 54 ndash 99 16 ndash 19 ndash 15 ndash 14

777 766 735 705 680 627 528 544 524 509 495

Table A28

United Kingdom

Former definitions

1980 1985 1990 1991 1992 1993

1 Net borrowing (1) 34 29 09 23 61 77

7 Stock-flow adjustment (3) 40 01 ndash 07 ndash 04 13 09

Table A18

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

67 54 44 22 ndash 02 ndash 11 ndash 40 ndash 08 13 25 25

32 34 37 37 36 29 28 24 21 20 21

70 73 75 75 75 64 65 60 56 55 56

61 56 60 64 60 50 53 45 51 50 47

ndash 20 ndash 06 ndash 10 ndash 06 00 09 32 ndash 06 02 00 00

35 20 07 ndash 15 ndash 38 ndash 41 ndash 67 ndash 32 ndash 08 04 04

04 08 08 05 07 07 05 06 02 02 03

496 518 523 508 477 452 421 389 384 390 398

Table A29

Euro area (1)

Former definitions

1980 1985 1990 1991 1992 1993

1 Net borrowing (2) 34 49 43 47 48 56

8 Primary deficit (5) 08 05 ndash 05 ndash 04 ndash 07 00

EU-15 (8)

1 Net borrowing (2) 34 45 35 42 50 60

8 Primary deficit (5) 04 ndash 03 ndash 12 ndash 06 ndash 01 08

(1) EU-15 excluding DK S and UK from 1991 including former East GermanyDue to problems with availability of the data Luxembourg data are not included

(2) Line 1 = line 5 a minus sign means a surplus(3) Actual interest payments as a percentage of gross debt at the end of t ndash 1(4) Line 7 = line 10 due to a change in definition there are no data for 1996(5) Net borrowing excluding interest payments line 8 = line 1 ndash line 2 A minus sign means a primary surplus(6) Due to a change in definition there are no data for 1996(7) Line 11 = total of lines 5 6 and 7 or 8 9 and 10(8) Excluding Luxembourg from 1991 including former East Germany

Table A19

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

51 49 43 26 23 14 ndash 01 16 23 25 24

54 56 57 51 48 43 41 40 37 36 36

00 00 81 69 66 60 59 58 55 54 53

44 47 43 22 41 46 49 40 33 31 40

51 49 43 26 23 14 ndash 01 16 23 25 24

00 13 11 ndash 11 ndash 10 09 10 01 ndash 02 04 00

26 25 27 35 18 10 07 12 16 15 09

23 31 24 00 ndash 17 ndash 10 ndash 24 ndash 10 ndash 02 08 ndash 03

700 731 756 755 739 729 705 694 693 700 697

54 50 42 25 17 08 ndash 09 09 19 23 22

52 53 55 49 46 41 38 37 34 33 33

84 83 82 72 68 62 61 59 56 54 54

48 40 50 53 47 52 66 34 34 19 39

54 50 42 25 17 08 ndash 09 09 19 23 22

ndash 04 04 10 01 ndash 06 11 19 ndash 01 ndash 01 ndash 03 00

22 28 21 13 14 07 ndash 03 15 14 22 09

21 29 19 ndash 10 ndash 21 ndash 15 ndash 32 ndash 13 ndash 03 09 ndash 02

674 703 721 711 690 675 643 630 627 636 634

Table A31

Cyclical adjustment of general government receipts expenditures and budget balances

Belgium

Former definitions

1980 1985 1990 1991 1992 1993

Total resources ( of GDP)

1 Actual data 476 504 475 477 478 483

2 Cyclical component 05 ndash 12 11 09 05 ndash 10

3 Cyclically adjusted data 471 516 464 469 473 493

Total uses ( of GDP)

4 Actual data 561 593 529 539 548 555

5 Cyclical component ndash 01 03 ndash 03 ndash 02 ndash 01 02

Net lending (+) or net borrowing (ndash) ( of GDP)

7 Actual balance ndash 86 ndash 89 ndash 54 ndash 62 ndash 69 ndash 72

9 Cyclically adjusted balance ndash 92 ndash 74 ndash 68 ndash 73 ndash 76 ndash 59

mdash as of potential GDP ndash 93 ndash 73 ndash 69 ndash 74 ndash 76 ndash 58

10 GDP at 1995 market prices (annual change) 44 17 31 18 15 ndash 10

11 Potential GDP at 1995 market prices (annual change) 26 18 26 24 23 20

12 Gap between actual and potential GDP ( of potential GDP) 10 ndash 23 23 18 10 ndash 20

Denmark 1980 1985 1990 1991 1992 1993

1 Actual data 508 553 551 547 560 579

2 Cyclical component ndash 01 07 ndash 02 ndash 05 ndash 11 ndash 22

4 Actual data 531 564 561 571 582 607

5 Cyclical component 00 ndash 03 01 02 05 10

9 Cyclically adjusted balance ndash 31 ndash 29 ndash 07 ndash 17 ndash 06 04

mdash as of potential GDP ndash 31 ndash 30 ndash 07 ndash 17 ndash 06 04

10 GDP at 1995 market prices (annual change) ndash 06 36 10 11 06 00

12 Gap between actual and potential GDP ( of potential GDP) ndash 02 13 ndash 04 ndash 09 ndash 21 ndash 39

Table A11

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

489 489 485 491 495 500 496 496 498 504 497 494

493 492 488 498 495 500 492 485 493 504 501 495

537 527 528 529 514 507 501 495 494 504 500 496

01 01 01 02 00 00 ndash 01 ndash 03 ndash 01 00 01 00

536 527 528 527 514 507 503 497 497 504 499 495

ndash 43 ndash 35 ndash 39 ndash 29 ndash 19 ndash 07 ndash 11 ndash 12 ndash 04 01 02 00

32 24 24 12 36 20 32 37 08 07 12 23

20 23 23 20 22 20 22 25 19 18 18 18

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

581 570 580 588 583 587 595 572 580 573 563 562

ndash 04 ndash 01 ndash 01 00 04 04 06 09 05 02 ndash 02 ndash 01

585 571 581 588 580 583 589 563 576 571 565 563

607 592 603 598 580 576 563 547 550 554 547 542

02 01 01 00 ndash 02 ndash 02 ndash 03 ndash 04 ndash 02 ndash 01 01 00

605 591 603 598 581 578 566 551 555 555 546 542

55 28 28 25 30 25 26 29 14 16 15 22

21 22 22 23 23 24 23 23 22 22 21 21

Table A32

Germany (1)

Former definitions

1980 1985 1990 1991 1992 1993

1 Actual data 443 449 421 435 449 453

4 Actual data 471 460 441 468 476 488

12 Gap between actual and potential GDP ( of potential GDP) 23 ndash 19 19 43 40 05

Greece 1980 1985 1990 1991 1992 1993

1 Actual data 263 303 325 333 341 354

2 Cyclical component 08 ndash 04 ndash 01 03 ndash 01 ndash 13

4 Actual data 290 419 484 447 468 490

5 Cyclical component 00 00 00 00 00 00

12 Gap between actual and potential GDP ( of potential GDP) 31 ndash 11 ndash 01 09 ndash 02 ndash 35

(1) From 1991 including former East Germany

Table A12

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

459 456 461 469 466 466 473 470 455 450 454 455

03 02 02 ndash 02 ndash 04 ndash 02 00 06 02 ndash 03 ndash 08 ndash 05

455 454 459 471 470 468 473 464 453 453 462 460

484 490 496 503 494 488 488 459 483 486 489 484

00 00 00 00 00 00 00 ndash 01 00 00 01 00

485 490 496 503 493 488 488 484 483 486 488 484

24 17 17 08 14 20 21 29 06 02 04 21

21 20 20 18 17 16 15 15 14 14 14 14

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

369 381 393 403 424 441 447 470 456 451 460 452

ndash 13 ndash 12 ndash 13 ndash 12 ndash 09 ndash 06 ndash 03 00 04 06 07 09

382 393 405 415 433 447 450 470 452 445 453 443

468 485 494 477 464 466 465 489 470 463 471 462

00 00 00 00 00 00 00 00 00 00 00 00

468 485 494 477 464 466 465 489 475 463 471 462

20 21 21 24 36 34 36 42 41 40 36 38

19 20 20 22 27 26 28 35 32 34 33 33

ndash 33 ndash 33 ndash 33 ndash 31 ndash 22 ndash 15 ndash 07 ndash 01 09 14 17 23

Table A33

Former definitions

1980 1985 1990 1991 1992 1993

1 Actual data 296 342 384 392 409 409

2 Cyclical component ndash 02 ndash 12 14 13 08 ndash 06

4 Actual data 317 404 426 435 449 476

5 Cyclical component 00 01 ndash 01 ndash 01 ndash 01 01

12 Gap between actual and potential GDP ( of potential GDP) ndash 06 ndash 36 42 39 20 ndash 17

France 1980 1985 1990 1991 1992 1993

1 Actual data 453 491 482 482 480 484

4 Actual data 454 520 497 502 518 541

7 Actual balance 00 ndash 28 ndash 15 ndash 20 ndash 39 ndash 56

Table A13

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

398 380 384 388 386 383 390 390 392 396 393 395

ndash 08 ndash 08 ndash 07 ndash 09 ndash 05 ndash 01 03 07 06 03 ndash 01 00

405 387 391 396 391 384 387 383 386 393 394 395

459 450 450 437 418 414 402 398 393 397 398 396

01 01 01 01 01 00 00 ndash 01 ndash 01 00 00 00

458 450 450 436 418 414 403 399 394 397 398 396

24 28 28 24 40 44 42 42 27 20 20 30

27 28 28 29 30 30 31 31 30 30 29 29

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

483 490 496 513 518 511 517 512 510 503 502 502

486 493 499 518 523 511 514 505 505 502 504 504

540 538 551 554 549 537 535 526 525 535 540 537

539 537 550 552 547 537 535 528 527 535 539 537

21 17 17 11 19 34 32 38 21 12 11 23

16 19 19 16 18 20 22 26 25 23 21 23

Table A34

Ireland

Former definitions

1980 1985 1990 1991 1992 1993

1 Actual data 346 388 359 367 370 370

2 Cyclical component 02 ndash 07 09 02 ndash 03 ndash 10

4 Actual data 462 491 381 389 394 393

5 Cyclical component ndash 01 02 ndash 03 ndash 01 01 03

10 GDP at 1995 market prices (annual change) 31 31 76 19 33 27

12 Gap between actual and potential GDP ( of potential GDP) 08 ndash 25 38 08 ndash 12 ndash 37

Italy 1980 1985 1990 1991 1992 1993

1 Actual data 344 390 428 438 445 477

4 Actual data 430 515 538 538 540 571

5 Cyclical component ndash 01 01 ndash 01 00 00 01

Table A14

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

377 346 394 394 386 372 367 364 352 337 335 328

389 351 398 397 381 367 357 350 343 332 337 335

392 367 415 396 371 350 347 319 341 337 341 337

389 366 414 395 373 351 350 324 343 341 340 334

00 ndash 15 ndash 15 02 09 16 06 26 00 ndash 09 ndash 03 01

58 100 100 81 109 88 111 100 57 60 33 45

63 70 70 74 81 86 85 83 80 76 69 66

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

455 453 458 461 484 468 471 462 458 452 451 443

ndash 05 01 01 00 01 01 01 05 04 ndash 02 ndash 05 ndash 04

461 452 457 461 482 467 470 457 455 454 456 447

546 529 534 532 511 499 489 469 485 477 475 475

01 00 00 00 00 00 00 ndash 01 00 00 01 00

546 529 534 532 511 499 489 481 485 477 474 474

ndash 06 01 01 ndash 01 02 01 01 06 04 ndash 02 ndash 05 ndash 04

22 29 29 11 20 18 17 31 18 04 10 21

14 13 13 14 16 18 17 21 21 19 16 18

Table A35

Luxembourg

Former definitions

1980 1985 1990 1991 1992 1993

1 Actual data 480 506

2 Cyclical component

3 Cyclically adjusted data

7 Actual balance ndash 04 63 47 18 07 15

9 Cyclically adjusted balance

mdash as of potential GDP

11 Potential GDP at 1995 market prices (annual change)

12 Gap between actual and potential GDP ( of potential GDP)

The Netherlands 1980 1985 1990 1991 1992 1993

1 Actual data 507 525 481 506 502 510

4 Actual data 548 561 530 534 540 541

Table A15

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

476 475 466 451 445 446 454 472 452 443

455 455 433 421 410 387 391 447 455 456

27 18 21 20 32 31 35 60 63 25 ndash 02 ndash 12

38 14 14 33 83 69 87 89 12 11 11 27

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

484 466 473 478 471 465 476 474 465 463 459 453

ndash 04 ndash 02 ndash 02 ndash 02 02 07 11 12 07 ndash 01 ndash 07 ndash 07

488 469 475 480 469 458 465 462 459 464 466 461

521 505 514 496 482 472 469 453 464 475 475 477

02 02 02 01 ndash 01 ndash 05 ndash 08 ndash 09 ndash 05 01 05 06

518 503 513 495 484 477 477 468 469 474 470 471

26 30 30 30 38 44 40 33 13 03 05 17

26 27 27 28 30 30 30 29 27 23 20 20

Table A36

Austria

Former definitions

1980 1985 1990 1991 1992 1993

1 Actual data 456 478 471 477 492 499

4 Actual data 472 502 496 506 512 541

Portugal 1980 1985 1990 1991 1992 1993

1 Actual data 278 327 339 352 381 368

4 Actual data 362 428 388 410 410 427

12 Gap between actual and potential GDP ( of potential GDP) 23 -69 47 49 28 -21

Table A16

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

486 492 520 528 521 517 518 507 522 515 510 507

00 ndash 02 ndash 02 ndash 03 ndash 05 00 02 06 03 01 ndash 01 00

486 494 522 531 526 517 516 501 519 514 511 507

535 542 573 568 541 542 542 524 521 522 523 513

00 00 00 00 00 00 00 00 00 00 00 00

535 542 573 568 541 542 542 528 521 522 523 513

26 16 16 20 16 39 27 35 07 10 12 20

24 24 24 23 23 22 21 20 19 18 17 16

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

363 371 396 410 412 410 424 423 421 435 435 437

374 378 402 415 413 407 419 415 417 438 444 447

421 427 450 458 448 441 453 452 464 462 471 469

01 01 01 00 00 00 ndash 01 ndash 01 00 00 01 01

420 427 450 458 448 442 453 456 464 462 470 469

10 43 43 35 40 46 38 37 16 05 05 20

28 26 26 26 29 32 31 30 28 26 24 25

-38 -23 -23 -14 -03 10 17 24 13 -08 -26 -31

Table A37

Finland

Former definitions

1980 1985 1990 1991 1992 1993

1 Actual data 420 470 514 531 537 527

2 Cyclical component 05 ndash 02 23 ndash 14 ndash 31 ndash 36

4 Actual data 386 442 461 545 595 606

7 Actual balance 33 29 53 ndash 15 ndash 57 ndash 79

9 Cyclically adjusted balance 26 32 22 04 ndash 15 ndash 29

mdash as of potential GDP 26 31 23 04 ndash 14 ndash 27

10 GDP at 1995 market prices (annual change) 51 31 00 ndash 63 ndash 33 ndash 12

12 Gap between actual and potential GDP ( of potential GDP) 13 ndash 05 48 ndash 26 ndash 59 ndash 70

Sweden 1980 1985 1990 1991 1992 1993

1 Actual data 561 592 626 596 591 564

2 Cyclical component 01 01 12 ndash 05 ndash 22 ndash 21

4 Actual data 600 630 585 607 666 679

5 Cyclical component 00 00 ndash 03 01 06 06

7 Actual balance ndash 39 ndash 37 40 ndash 11 ndash 75 ndash 115

9 Cyclically adjusted balance ndash 41 ndash 39 25 ndash 05 ndash 47 ndash 88

mdash as of potential GDP ndash 41 ndash 39 26 ndash 05 ndash 45 ndash 84

10 GDP at 1995 market prices (annual change) 17 22 11 ndash 11 ndash 17 11

12 Gap between actual and potential GDP ( of potential GDP) 02 02 21 ndash 09 ndash 40 ndash 39

Table A17

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

535 519 555 565 551 543 541 559 542 540 528 520

559 532 568 570 542 529 530 538 535 540 530 522

595 569 594 595 564 528 521 489 490 492 495 490

587 564 589 593 567 533 525 497 493 492 494 489

ndash 28 ndash 33 ndash 21 ndash 23 ndash 25 ndash 03 05 41 42 48 37 33

40 41 41 39 64 49 34 55 07 16 22 29

13 21 21 24 35 37 39 35 35 31 28 28

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

553 550 604 624 615 631 617 609 618 596 599 597

ndash 10 ndash 02 ndash 02 ndash 07 ndash 06 ndash 01 08 16 07 03 ndash 03 ndash 03

562 552 606 631 620 632 609 594 610 593 602 600

649 623 678 654 632 608 604 575 572 585 591 585

03 01 01 02 02 00 ndash 02 ndash 04 ndash 02 ndash 01 01 01

646 622 677 652 631 608 606 579 574 586 590 585

42 40 40 13 24 36 46 44 11 19 14 27

20 25 25 21 23 28 28 29 28 26 25 26

Table A38

United Kingdom

Former definitions

1980 1985 1990 1991 1992 1993

1 Actual data 398 414 383 374 361 351

2 Cyclical component ndash 06 ndash 04 05 ndash 07 ndash 13 ndash 10

4 Actual data 432 443 392 397 422 428

10 GDP at 1995 market prices (annual change) ndash 21 36 08 ndash 14 02 25

12 Gap between actual and potential GDP ( of potential GDP) ndash 15 ndash 10 14 ndash 19 ndash 34 ndash 28

Table A18

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

356 367 389 386 389 401 403 409 410 394 395 397

358 366 388 385 385 397 400 405 409 396 398 401

423 421 446 430 411 398 391 369 402 406 419 422

00 00 00 00 ndash 01 ndash 01 00 ndash 01 00 00 01 01

423 421 446 431 412 399 391 393 402 406 418 421

47 29 29 26 34 29 24 31 21 18 22 26

22 24 24 25 27 29 29 28 28 25 26 26

Table A39

Euro area (1)

Former definitions

1980 1985 1990 1991 1992 1993

1 Actual data 417 443 439 447 454 464

2 Cyclical component 20 07 22 09 06 ndash 05

4 Actual data 450 492 482 493 502 520

EU-15 (2) 1980 1985 1990 1991 1992 1993

1 Actual data 421 446 439 443 448 453

4 Actual data 455 491 474 485 498 514

(1) EU-15 excluding DK SE and UK from 1991 including former East GermanyDue to problems with availability of the data Luxembourg data are not included

(2) Excluding Luxembourg from 1991 including former East Germany

Table A19

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

460 457 464 472 476 471 476 472 465 461 460 458

463 459 466 476 479 471 474 465 462 462 465 462

510 507 515 515 502 494 489 471 481 484 485 482

510 506 515 515 502 494 490 483 483 484 484 481

24 22 22 14 23 29 28 35 15 08 10 23

19 20 20 19 20 21 22 23 22 21 20 21

1994 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

450 450 461 468 468 466 470 467 462 455 455 454

453 452 463 471 470 465 467 460 459 456 460 458

504 500 513 510 493 483 477 457 471 474 478 476

504 500 512 509 493 483 478 471 472 474 477 475

28 24 24 16 25 29 28 35 16 10 12 23

20 21 21 20 21 22 23 24 23 22 21 22

(1) EU-15 excluding DK S UK from 1991 including former East GermanyDue to problems with availability of the data Luxembourg data are not included

Table A41

Current tax burden total economy(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 457 492 466 468 469 475 484 485

DE (1) 417 414 392 408 415 420 425 425

EL 246 289 310 314 319 326 334 340

ES 261 306 354 357 375 365 361 350

FR 429 463 451 454 450 456 460 466

IE 312 349 336 340 344 345 355 329

IT 317 361 400 409 415 442 421 419

LU 392 421

NL 439 434 429 452 448 462 438 425

AT 427 448 426 432 444 453 440 447

PT 246 283 313 326 350 341 344 347

FI 383 423 458 466 465 449 472 455

Euro area (2) 388 408 408 416 421 430 428 427

DK 447 480 476 475 480 495 507 501

SE 510 526 570 543 527 500 494 501

UK 335 354 333 331 322 313 319 329

EU-15 (3) 385 405 404 409 412 417 416 418

(Change in percentage points of GDP)

1980 1985 1990 1991 1992 1993 1994 1995

BE ndash 17 04 05 02 02 06 09 00

DE (1) 04 03 ndash 17 10 07 05 05 00

EL ndash 05 ndash 01 28 04 06 07 08 06

ES 14 08 00 03 18 ndash 10 ndash 04 ndash 11

FR 13 02 ndash 01 03 ndash 04 06 04 06

IE 28 ndash 09 ndash 03 05 04 01 10 ndash 26

IT 17 00 08 08 07 27 ndash 21 ndash 02

LU 06 10

NL 01 ndash 04 ndash 03 24 ndash 04 14 ndash 25 ndash 12

AT 06 09 ndash 05 06 12 09 ndash 12 07

PT 18 ndash 06 06 13 24 ndash 09 03 04

FI 03 17 19 08 ndash 01 ndash 16 23 ndash 17

Euro area (2) 07 02 ndash 03 07 05 09 ndash 02 ndash 01

DK 09 13 ndash 22 ndash 01 05 16 12 ndash 06

SE ndash 02 01 ndash 01 ndash 27 ndash 15 ndash 27 ndash 06 07

UK 19 ndash 05 ndash 04 ndash 03 ndash 08 ndash 10 06 11

EU-15 (3) 07 01 ndash 03 04 03 05 ndash 01 02

(1) From 1991 including former East Germany(2) Excluding Luxembourg from 1991 including former East Germany(3) EU-15 excluding Luxembourg from 1991 including former East Germany

Table A11

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

468 470 475 480 476 475 476 481 477 473

423 431 431 431 438 439 421 415 420 421

344 348 360 381 393 406 389 383 380 375

340 344 348 350 356 361 360 366 364 363

452 464 465 464 470 465 462 455 452 452

351 350 342 334 330 331 317 304 303 297

423 429 444 432 435 430 427 419 414 412

425 426 417 404 403 406 410 427 422 410

415 417 415 411 424 422 407 403 404 397

449 459 467 464 463 455 474 462 473 477

338 345 348 349 361 367 361 370 369 370

463 474 467 464 468 478 457 456 446 440

422 429 432 430 435 434 425 420 419 418

502 507 507 510 523 502 506 501 498 498

496 524 524 541 534 530 547 524 531 530

365 361 366 378 379 386 384 371 374 376

418 425 426 426 430 429 423 415 416 416

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

03 04 06 ndash 05 00 00 06 ndash 04 ndash 04

09 ndash 01 00 07 01 ndash 18 ndash 07 05 01

04 12 21 12 13 ndash 17 ndash 06 ndash 03 ndash 05

03 04 02 07 05 ndash 01 06 ndash 03 ndash 01

12 01 ndash 01 06 ndash 06 ndash 02 ndash 08 ndash 02 00

ndash 01 ndash 08 ndash 08 ndash 03 01 ndash 14 ndash 14 ndash 01 ndash 06

06 15 ndash 12 03 ndash 06 ndash 02 ndash 08 ndash 05 ndash 02

01 ndash 10 ndash 13 ndash 01 03 04 18 ndash 05 ndash 12

02 ndash 02 ndash 04 13 ndash 02 ndash 15 ndash 05 01 ndash 07

10 08 ndash 02 ndash 01 ndash 09 20 ndash 12 11 04

07 02 02 12 06 ndash 06 09 ndash 01 01

11 ndash 07 ndash 03 04 10 ndash 21 ndash 01 ndash 09 ndash 06

07 03 ndash 02 05 ndash 02 ndash 08 ndash 06 00 ndash 01

06 ndash 01 03 13 ndash 21 04 ndash 05 ndash 03 00

28 01 16 ndash 07 ndash 04 17 ndash 22 06 ndash 01

ndash 04 05 12 00 07 ndash 01 ndash 13 03 02

06 01 00 04 ndash 01 ndash 06 ndash 08 01 ndash 01

Table A42

Social contributions received general government(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 149 171 169 175 178 181 175 174

DE (1) 166 171 165 175 178 184 189 191

EL 94 116 115 111 110 119 121 124

ES 127 127 129 132 140 143 140 131

FR 191 208 206 207 209 211 207 210

IE 44 51 50 52 53 53 52 47

IT 129 135 143 146 149 154 148 147

LU 134 124

NL 175 198 164 173 178 178 184 182

AT 144 146 155 156 162 168 172 173

PT 80 86 101 105 111 117 115 117

FI 109 114 129 136 146 150 158 147

Euro area (2) 158 166 163 167 171 177 177 177

DK 16 25 23 23 24 25 28 26

SE 148 136 150 150 144 134 134 137

UK 60 68 62 62 61 61 62 62

EU-15 (3) 140 146 145 148 152 157 157 157

1980 1985 1990 1991 1992 1993 1994 1995

BE 00 05 02 06 03 03 ndash 06 ndash 02

DE (1) 03 01 ndash 03 01 04 06 05 02

EL 04 02 03 ndash 04 ndash 01 10 02 03

ES 01 00 03 03 09 03 ndash 04 ndash 09

FR 09 02 01 01 02 02 ndash 03 02

IE 04 ndash 01 01 02 01 00 ndash 02 ndash 04

IT 01 00 03 02 03 05 ndash 06 ndash 01

LU 04 ndash 02

NL 03 ndash 02 ndash 17 09 06 00 06 ndash 02

AT 04 03 09 01 06 06 04 01

PT 03 ndash 05 05 04 06 07 ndash 03 02

FI 02 09 14 08 09 05 08 ndash 11

Euro area (2) 03 01 00 02 04 05 00 00

DK 02 00 01 00 01 01 03 ndash 02

SE 04 ndash 03 04 ndash 01 ndash 06 ndash 09 00 03

UK 02 ndash 01 ndash 03 00 ndash 01 01 01 00

EU-15 (3) 02 00 01 01 04 04 00 01

Table A12

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

168 167 165 166 164 161 164 166 165 164

188 194 197 193 190 187 185 184 186 185

126 129 133 136 136 140 139 140 140 139

130 132 131 130 131 133 136 135 135 135

205 207 203 181 183 182 182 183 184 183

68 63 59 56 56 56 58 57 56 56

148 150 153 128 127 127 126 127 128 128

125 121 115 112 111 111 121 127 127 124

172 166 166 164 171 171 153 150 156 153

174 175 174 172 172 169 169 168 169 168

110 109 112 112 114 118 119 122 122 120

148 142 134 130 131 122 125 123 121 120

174 176 175 165 164 162 160 160 161 160

26 26 26 26 32 33 32 27 26 26

137 147 145 145 132 149 155 156 154 152

75 74 74 75 73 76 76 75 79 81

157 158 155 146 145 143 142 142 144 144

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

ndash 01 ndash 02 01 ndash 02 ndash 02 02 03 ndash 02 00

06 02 ndash 04 ndash 03 ndash 03 ndash 01 ndash 01 01 ndash 01

03 04 03 01 03 00 00 00 ndash 01

02 ndash 01 ndash 01 01 02 03 00 00 00

02 ndash 04 ndash 22 02 ndash 01 00 02 01 ndash 01

ndash 05 ndash 04 ndash 03 ndash 01 00 02 ndash 01 00 ndash 01

03 03 ndash 25 ndash 01 ndash 01 ndash 01 01 01 00

ndash 04 ndash 06 ndash 03 ndash 01 00 10 06 00 ndash 03

ndash 06 00 ndash 02 07 00 ndash 18 ndash 03 06 ndash 03

00 ndash 01 ndash 02 00 ndash 03 00 ndash 01 01 ndash 02

00 03 00 01 04 01 03 ndash 01 ndash 01

ndash 06 ndash 08 ndash 04 02 ndash 09 02 ndash 02 ndash 03 ndash 01

02 ndash 01 ndash 11 ndash 01 ndash 02 ndash 02 00 01 ndash 01

00 00 00 06 00 ndash 01 ndash 05 00 00

10 ndash 03 01 ndash 13 17 06 01 ndash 02 ndash 02

ndash 01 01 01 ndash 03 03 01 ndash 01 05 02

01 ndash 03 ndash 09 ndash 02 ndash 02 ndash 01 ndash 01 02 00

Table A43

Current taxes on income and wealth (direct taxes) general government (Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 180 191 167 163 162 162 174 178

DE (1) 125 123 109 113 116 112 108 111

EL 46 46 54 55 54 57 68 72

ES 67 82 116 116 120 115 110 110

FR 82 89 87 92 88 90 92 94

IE 115 131 131 137 141 149 152 135

IT 97 130 143 144 146 161 148 145

LU 157 176

NL 152 123 150 163 153 161 136 125

AT 125 140 116 122 127 128 113 119

PT 56 78 79 88 98 90 88 91

FI 142 165 177 176 169 152 168 167

Euro area (2) 107 115 117 120 120 121 116 117

DK 251 278 283 285 290 301 306 303

SE 209 203 226 192 199 195 197 201

UK 134 145 138 128 121 114 118 126

EU-15 (3) 118 127 127 127 126 125 123 124

1980 1985 1990 1991 1992 1993 1994 1995

BE ndash 08 00 02 ndash 04 ndash 01 00 12 05

DE (1) 01 04 ndash 15 08 03 ndash 03 ndash 04 03

EL 06 ndash 03 09 01 ndash 01 03 11 05

ES 09 02 ndash 01 00 04 ndash 05 ndash 05 00

FR 06 ndash 01 00 04 ndash 03 02 03 02

IE 13 ndash 03 05 06 03 08 03 ndash 17

IT 11 04 01 01 02 15 ndash 12 ndash 03

LU ndash 05 10

NL 01 ndash 02 16 13 ndash 09 08 ndash 26 ndash 11

AT 02 07 ndash 10 06 05 01 ndash 15 06

PT ndash 01 01 01 09 10 ndash 09 ndash 02 03

FI 01 06 12 ndash 01 ndash 08 ndash 17 16 ndash 01

Euro area (2) 04 02 ndash 03 04 00 01 ndash 04 00

DK 10 11 ndash 17 02 05 11 05 ndash 03

SE ndash 09 ndash 03 ndash 17 ndash 34 06 ndash 04 02 04

UK 07 02 02 ndash 10 ndash 08 ndash 07 04 08

EU-15 (3) 04 02 ndash 03 01 ndash 01 ndash 01 ndash 03 02

Table A13

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

167 166 171 176 171 173 176 176 173 169

111 115 112 115 120 125 111 108 110 112

74 71 78 95 99 108 96 94 93 90

101 103 105 102 102 105 105 109 106 106

85 89 95 117 122 122 125 116 114 113

136 141 140 138 137 136 130 118 115 112

148 154 162 145 152 147 151 142 137 136

175 179 174 164 156 154 155 165 162 157

124 129 124 122 122 121 119 120 113 111

120 131 135 136 134 133 151 141 151 153

89 95 96 93 98 104 98 97 96 95

174 190 185 189 189 214 195 194 187 184

114 119 121 124 128 130 126 122 120 120

304 306 303 299 308 296 299 297 295 296

195 209 209 217 212 212 222 193 197 198

149 147 150 162 161 166 167 155 154 155

125 129 132 137 140 142 140 133 132 132

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

ndash 01 04 06 ndash 05 02 03 00 ndash 03 ndash 04

ndash 03 07 17 04 09 ndash 13 ndash 01 ndash 02 ndash 03

01 02 ndash 03 01 03 00 05 ndash 03 00

05 06 22 05 01 02 ndash 09 ndash 02 00

05 00 ndash 03 ndash 01 ndash 01 ndash 06 ndash 13 ndash 03 ndash 03

06 08 ndash 16 07 ndash 04 04 ndash 09 ndash 06 ndash 01

04 ndash 05 ndash 10 ndash 08 ndash 02 01 10 ndash 02 ndash 06

05 ndash 05 ndash 03 00 ndash 01 ndash 01 01 ndash 07 ndash 02

11 04 01 ndash 03 ndash 01 19 ndash 11 10 02

06 01 ndash 03 05 06 ndash 06 ndash 01 ndash 02 ndash 01

16 ndash 05 04 00 25 ndash 19 ndash 01 ndash 07 ndash 03

05 02 03 04 02 ndash 03 ndash 05 ndash 02 00

02 ndash 03 ndash 04 09 ndash 12 03 ndash 02 ndash 02 01

13 01 08 ndash 06 01 10 ndash 29 04 01

ndash 02 03 12 00 04 01 ndash 12 ndash 01 01

Table A44

Taxes linked to imports and production (indirect taxes) general government (Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 122 120 122 121 121 123 126 122

DE (1) 129 123 121 122 124 127 131 127

EL 105 125 139 146 153 147 143 142

ES 63 91 103 103 109 101 106 103

FR 149 156 149 145 143 143 147 149

IE 153 168 156 152 152 144 153 146

IT 93 95 113 118 118 127 124 124

LU 125 149 149 147 153 159 161 162

NL 117 117 119 119 123 124 124 123

AT 158 163 157 155 156 157 157 155

PT 122 137 130 129 137 129 134 136

FI 131 141 149 150 147 145 142 135

Euro area (2) 122 125 126 126 127 130 132 131

DK 180 178 170 167 166 169 173 172

SE 131 160 165 172 158 146 139 134

UK 158 160 156 160 156 153 154 157

EU-15 (3) 129 133 133 134 133 134 136 135

1980 1985 1990 1991 1992 1993 1994 1995

BE ndash 04 ndash 02 01 ndash 01 00 02 03 ndash 04

DE (1) ndash 01 ndash 03 ndash 01 03 02 03 04 ndash 04

EL ndash 15 01 17 07 08 ndash 06 ndash 04 ndash 01

ES 02 06 ndash 02 00 05 ndash 07 05 ndash 03

FR 01 01 ndash 01 ndash 04 ndash 02 01 04 02

IE 11 ndash 06 ndash 09 ndash 03 00 ndash 08 09 ndash 07

IT 06 ndash 04 02 06 ndash 01 09 ndash 03 00

LU 08 02 01 ndash 02 06 05 03 00

NL ndash 04 00 ndash 01 00 03 02 00 ndash 01

AT 00 ndash 02 ndash 03 ndash 02 01 01 ndash 01 ndash 02

PT 19 02 00 ndash 01 08 ndash 07 05 02

FI ndash 01 01 ndash 03 01 ndash 03 ndash 02 ndash 03 ndash 07

Euro area (2) 01 ndash 01 00 01 01 02 02 ndash 02

DK ndash 04 03 ndash 07 ndash 03 ndash 01 03 04 ndash 01

SE 02 06 10 06 ndash 13 ndash 12 ndash 07 ndash 05

UK 08 ndash 03 ndash 01 04 ndash 03 ndash 03 01 03

EU-15 (3) 02 ndash 01 00 01 ndash 01 01 02 ndash 01

Table A14

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

122 127 129 129 132 131 126 130 130 130

114 114 114 116 122 120 119 118 120 120

136 140 143 144 151 152 148 144 143 141

102 102 105 111 117 117 114 117 118 119

154 161 160 160 159 155 150 151 150 152

135 137 135 131 131 132 121 122 124 123

121 118 124 153 151 150 145 146 145 145

125 126 127 128 135 141 134 135 133 129

107 112 114 116 122 121 126 127 126 125

143 145 149 149 150 146 147 150 146 149

136 140 138 143 148 145 144 151 152 155

134 135 142 140 142 136 132 135 135 132

125 127 129 135 138 136 133 134 134 134

169 173 175 182 181 172 173 175 175 174

157 161 163 172 184 163 164 171 175 175

131 132 135 134 138 138 136 137 136 135

128 129 132 137 140 138 135 136 136 136

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

05 02 00 03 ndash 01 ndash 05 03 01 ndash 01

00 00 02 06 ndash 02 ndash 02 ndash 01 02 00

00 03 06 06 00 ndash 03 03 01 01

07 00 00 ndash 01 ndash 05 ndash 05 01 ndash 01 01

02 ndash 02 ndash 04 00 01 ndash 11 01 02 ndash 02

ndash 03 06 29 ndash 02 ndash 01 ndash 06 01 ndash 01 ndash 01

04 03 01 06 ndash 01 05 00 00 ndash 02

03 04 00 01 ndash 04 01 04 ndash 05 04

04 ndash 02 06 05 ndash 04 ndash 01 07 01 03

01 07 ndash 02 02 ndash 06 ndash 04 03 00 ndash 02

02 02 06 03 ndash 02 ndash 03 01 00 00

03 02 07 ndash 01 ndash 10 01 02 ndash 01 ndash 01

05 02 08 13 ndash 21 01 07 04 00

00 03 ndash 01 04 00 ndash 03 01 ndash 01 ndash 01

02 02 05 03 ndash 02 ndash 03 01 00 00

Table A45

Other current resources general government (Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 26 23 18 19 18 18 15 15

DE (1) 23 31 26 26 31 30 30 27

EL 19 17 17 22 25 31 38 42

ES 39 42 37 41 40 50 42 36

FR 32 38 40 39 41 41 37 38

IE 33 39 23 25 25 24 21 18

IT 24 29 29 30 33 36 36 37

LU 63 57

NL 64 88 49 52 48 46 41 37

AT 28 29 44 44 48 46 44 45

PT 20 27 29 31 36 31 26 28

FI 38 51 59 68 76 80 67 69

Euro area (2) 30 37 33 34 36 37 35 33

DK 61 71 75 72 80 84 75 68

SE 73 93 84 82 91 89 83 79

UK 45 41 27 25 23 22 22 22

EU-15 (3) 35 40 35 35 37 37 35 34

1980 1985 1990 1991 1992 1993 1994 1995

BE 05 ndash 01 01 01 ndash 01 00 ndash 03 01

DE (1) 01 01 00 ndash 01 05 ndash 01 00 ndash 03

EL 03 01 01 05 03 06 07 05

ES 06 04 03 04 ndash 01 10 ndash 08 ndash 06

FR 03 02 04 ndash 01 02 00 ndash 04 01

IE 01 02 00 03 ndash 01 ndash 01 ndash 03 ndash 03

IT ndash 01 05 01 02 02 04 00 01

LU 08 05

NL 06 06 02 03 ndash 04 ndash 02 ndash 06 ndash 04

AT 04 01 15 ndash 01 04 ndash 02 ndash 01 01

PT ndash 06 ndash 06 02 02 05 ndash 04 ndash 05 02

FI 01 02 04 09 08 04 ndash 13 03

Euro area (2) 02 02 02 01 02 01 ndash 02 ndash 01

DK 10 ndash 01 00 ndash 03 08 04 ndash 09 ndash 06

SE 04 03 00 ndash 02 08 ndash 02 ndash 06 ndash 04

UK 03 02 ndash 02 ndash 02 ndash 01 ndash 01 00 00

EU-15 (3) 03 02 01 00 02 01 ndash 02 ndash 01

Table A15

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

31 32 30 30 28 29 30 30 28 28

35 34 32 31 30 28 31 30 29 28

29 29 34 29 29 32 36 36 36 34

41 42 40 37 37 34 36 34 34 35

36 39 38 36 35 35 37 35 35 35

28 29 27 25 22 21 25 25 24 23

31 32 32 32 33 30 32 31 30 30

57 54 54 52 48 46 49 49 45 44

60 58 55 50 47 48 52 52 49 46

57 52 38 36 36 35 45 41 41 40

41 43 40 40 40 36 37 39 39 39

73 68 62 60 54 62 64 63 61 60

38 38 36 35 34 33 35 34 33 33

68 71 67 66 60 58 61 57 54 53

82 78 69 69 61 59 50 50 71 71

29 30 27 27 27 25 27 23 21 22

39 39 36 35 34 33 35 33 33 32

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

01 ndash 03 00 ndash 01 01 01 00 ndash 02 00

ndash 01 ndash 02 ndash 01 ndash 01 ndash 02 03 ndash 01 ndash 01 ndash 01

00 05 ndash 06 00 03 04 00 ndash 01 ndash 02

01 ndash 02 ndash 02 ndash 01 ndash 03 02 ndash 02 00 01

03 ndash 02 ndash 02 ndash 01 00 01 ndash 01 ndash 01 00

01 00 00 01 ndash 02 01 00 ndash 01 ndash 01

ndash 02 ndash 03 ndash 04 ndash 03 01 04 00 ndash 03 ndash 03

ndash 05 ndash 14 ndash 03 00 ndash 01 10 ndash 03 00 ndash 01

02 ndash 03 00 ndash 01 ndash 03 01 02 ndash 01 01

ndash 04 ndash 06 ndash 03 ndash 06 08 02 ndash 01 ndash 02 ndash 01

00 ndash 02 ndash 01 ndash 01 ndash 01 02 ndash 01 ndash 01 ndash 01

03 ndash 05 00 ndash 07 ndash 02 03 ndash 04 ndash 03 ndash 01

ndash 04 ndash 09 00 ndash 08 ndash 02 ndash 09 00 21 00

Table A46

Total current resources general government(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 476 504 475 477 478 483 489 489

DE (1) 443 449 421 435 449 453 459 456

EL 263 303 325 333 341 354 369 381

ES 296 342 384 392 409 409 398 380

FR 453 491 482 482 480 484 483 490

IE 346 388 359 367 370 370 377 346

IT 344 390 428 438 445 477 455 453

LU 480 506

NL 507 525 481 506 502 510 484 466

AT 456 478 471 477 492 499 486 492

PT 278 327 339 352 381 368 363 371

FI 420 470 514 531 537 527 535 519

Euro area (2) 417 443 439 447 454 464 460 457

DK 508 553 551 547 560 579 581 570

SE 561 592 626 596 591 564 553 550

UK 398 414 383 374 361 351 356 367

EU-15 (3) 421 446 439 443 448 453 450 450

1980 1985 1990 1991 1992 1993 1994 1995

BE ndash 07 03 06 02 01 05 06 00

DE (1) 04 03 ndash 19 12 13 04 06 ndash 03

EL ndash 02 00 28 09 08 13 16 11

ES 17 12 03 07 17 01 ndash 12 ndash 18

FR 19 05 04 00 ndash 02 05 ndash 01 07

IE 29 ndash 07 ndash 03 08 04 ndash 01 07 ndash 30

IT 16 04 07 10 07 32 ndash 22 ndash 03

LU 15 16

NL 07 02 ndash 01 25 ndash 04 07 ndash 25 ndash 18

AT 10 10 10 05 16 07 ndash 13 06

PT 15 ndash 07 08 13 29 ndash 14 ndash 05 09

FI 04 19 27 17 07 ndash 10 08 ndash 16

SE 02 04 ndash 03 ndash 30 ndash 05 ndash 27 ndash 12 ndash 02

EU-15 (3) 10 04 ndash 02 04 05 06 ndash 03 00

Table A16

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

488 493 494 500 495 494 495 501 495 491

448 457 455 455 462 460 446 441 445 445

365 369 388 403 415 432 419 414 411 404

374 378 380 380 386 389 390 395 393 394

479 496 496 493 499 494 493 485 482 482

367 370 361 350 345 346 335 321 319 313

448 455 472 459 463 455 453 446 440 438

482 481 470 456 450 452 459 476 467 454

463 465 459 452 462 461 451 449 444 435

494 503 495 492 491 482 511 500 506 509

376 387 386 390 400 403 398 409 407 409

528 536 523 518 516 534 516 515 504 497

451 459 461 458 463 460 454 449 448 446

568 577 571 574 581 558 565 556 550 549

571 595 586 603 589 583 591 569 597 596

384 382 386 398 399 404 405 390 390 393

448 456 455 454 458 456 452 444 444 444

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

09 ndash 02 00 07 ndash 02 ndash 14 ndash 06 04 00

05 02 00 06 03 01 05 ndash 02 01

17 ndash 01 ndash 02 06 ndash 06 ndash 01 ndash 08 ndash 03 00

02 ndash 09 ndash 11 ndash 05 01 ndash 11 ndash 13 ndash 02 ndash 06

02 ndash 06 ndash 08 10 ndash 02 ndash 10 ndash 02 ndash 04 ndash 09

12 ndash 01 04 10 03 ndash 05 11 ndash 02 01

09 ndash 06 03 07 ndash 23 07 ndash 09 ndash 06 ndash 01

24 ndash 09 17 ndash 14 ndash 05 08 ndash 22 28 ndash 01

ndash 02 04 12 01 05 01 ndash 16 01 03

Table A47

Interest payments (Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 59 103 104 100 106 106 99 88

DE (1) 19 30 25 26 32 32 33 37

EL 20 49 100 93 115 126 139 128

ES 04 19 39 37 43 50 47 53

FR 14 28 29 29 32 33 35 37

IE 60 94 74 72 67 63 56 50

IT 55 80 94 101 114 120 109 113

LU 12 10 04 04 03 03 03 03

NL 37 62 58 59 60 60 57 57

AT 24 35 40 42 42 43 40 43

PT 26 74 78 76 70 60 61 62

FI 10 18 14 19 26 45 50 52

Euro area (2) 26 44 49 50 55 56 54 56

DK 37 93 73 73 67 73 67 64

SE 40 81 48 50 53 58 64 66

UK 47 50 31 27 27 28 32 34

EU-15 (3) 30 48 47 47 52 53 52 53

1980 1985 1990 1991 1992 1993 1994 1995

BE 09 08 03 ndash 04 06 00 ndash 07 ndash 11

DE (1) 02 00 ndash 01 02 06 00 01 04

EL 02 06 25 ndash 07 22 11 13 ndash 12

ES 01 07 00 ndash 02 05 08 ndash 04 06

FR 01 02 02 00 03 01 02 02

IE 03 08 01 ndash 02 ndash 05 ndash 04 ndash 07 ndash 06

IT 03 00 07 07 13 06 ndash 11 04

LU 04 ndash 05 ndash 01 00 00 00 ndash 01

NL 04 02 00 02 01 00 ndash 03 00

AT 02 02 01 02 00 01 ndash 03 03

PT 02 08 18 ndash 02 ndash 06 ndash 09 00 01

FI 01 02 00 05 07 19 05 02

Euro area (2) 03 02 02 02 06 01 ndash 02 02

DK 04 03 01 00 ndash 06 06 ndash 06 ndash 03

SE 10 08 ndash 03 02 03 06 06 02

UK 03 01 ndash 06 ndash 04 00 01 03 03

EU-15 (3) 03 02 01 01 05 01 ndash 01 02

Table A17

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

93 89 80 76 70 68 66 61 56 50

37 37 36 36 35 34 33 32 32 33

112 105 82 78 72 70 63 55 52 49

52 54 48 43 36 33 31 29 27 25

36 38 36 35 32 31 31 31 32 33

54 46 38 35 25 21 15 13 15 15

115 115 94 83 68 65 64 58 53 51

04 04 03 04 03 03 03 04 02 02

59 56 52 49 45 39 35 32 30 29

44 44 40 39 37 38 37 36 37 36

63 54 42 35 32 33 32 30 31 30

40 43 43 36 31 29 27 23 22 21

56 57 51 48 43 41 40 37 36 36

64 61 57 53 48 43 40 37 35 33

66 66 63 55 48 41 32 32 27 27

37 37 37 36 29 28 24 21 20 21

54 55 49 46 41 38 37 34 33 33

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

ndash 04 ndash 09 ndash 04 ndash 06 ndash 02 ndash 02 ndash 05 ndash 05 ndash 06

00 00 00 ndash 01 ndash 01 ndash 01 ndash 01 00 00

01 ndash 06 ndash 05 ndash 07 ndash 03 ndash 02 ndash 03 ndash 02 ndash 01

02 ndash 02 ndash 01 ndash 03 ndash 01 00 00 01 01

ndash 08 ndash 07 ndash 04 ndash 10 ndash 04 ndash 05 ndash 02 02 00

00 ndash 04 ndash 01 ndash 02 01 ndash 01 ndash 01 01 ndash 01

ndash 09 ndash 12 ndash 08 ndash 02 00 ndash 01 ndash 01 01 ndash 01

ndash 01 ndash 02 ndash 08 ndash 07 ndash 07 ndash 09 00 ndash 04 ndash 01

00 00 ndash 01 ndash 07 ndash 01 ndash 04 ndash 04 ndash 01 01

01 ndash 05 ndash 03 ndash 06 ndash 02 ndash 02 ndash 03 ndash 01 00

Table A48

Final consumption expenditure of general government(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 173 167 139 143 142 146 145 145

DE (1) 199 196 178 190 195 196 194 195

EL 135 161 151 142 137 143 138 153

ES 129 142 150 156 164 169 162 160

FR 177 191 177 179 185 194 192 190

IE 182 169 142 151 154 153 152 142

IT 150 166 174 174 175 175 170 159

LU 145 137 125 121 123 120 119 126

NL 168 152 140 139 141 143 139 138

AT 174 184 184 187 191 199 200 198

PT 133 140 150 167 168 174 171 173

FI 176 198 208 238 243 228 218 212

Euro area (2) 173 179 171 176 180 184 181 179

DK 270 256 256 257 258 268 259 257

SE 285 271 264 264 271 263 253 240

UK 217 212 203 212 216 215 212 209

EU-15 (3) 186 189 180 186 190 192 189 186

1980 1985 1990 1991 1992 1993 1994 1995

BE 02 01 ndash 03 04 ndash 01 04 ndash 01 00

DE (1) 05 00 ndash 05 ndash 06 06 01 ndash 02 01

EL 00 07 01 ndash 09 ndash 05 06 ndash 05 16

ES 06 03 04 06 09 04 ndash 06 ndash 02

FR 06 ndash 01 00 03 05 09 ndash 02 ndash 01

IE 16 ndash 01 04 09 03 ndash 01 ndash 01 ndash 11

IT 01 01 07 00 01 00 ndash 05 ndash 10

LU 06 03 06 ndash 04 02 ndash 03 ndash 02 07

NL ndash 02 ndash 05 ndash 03 ndash 01 02 02 ndash 04 ndash 01

AT 00 03 06 03 04 08 01 ndash 02

PT 07 02 05 16 01 06 ndash 03 01

FI 02 09 14 30 06 ndash 16 ndash 09 ndash 07

DK 16 ndash 06 ndash 04 02 01 10 ndash 08 ndash 02

SE 06 ndash 02 12 00 08 ndash 08 ndash 10 ndash 12

UK 16 ndash 08 05 09 05 ndash 01 ndash 03 ndash 03

EU-15 (3) 06 ndash 01 01 02 04 02 ndash 03 ndash 02

Table A18

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

214 217 212 211 212 212 217 221 225 2254

198 200 195 192 191 191 190 191 191 1885

153 145 151 153 154 157 153 158 155 1522

181 180 175 175 174 176 175 176 178 177

239 242 242 234 233 232 232 239 240 2391

165 158 152 145 139 138 148 152 154 1537

179 181 182 179 180 183 188 188 189 1865

185 189 179 168 167 157 168 183 192 196

240 231 229 227 229 227 232 243 242 2435

204 203 197 195 198 192 191 187 193 1918

186 189 190 189 197 205 208 213 213 2103

227 231 223 216 216 207 208 216 219 218

205 205 203 199 199 199 200 203 204 202

258 259 255 260 258 253 259 261 261 260

273 279 273 275 275 268 272 280 283 281

196 193 184 180 185 187 193 200 207 207

207 207 203 199 200 200 202 206 208 207

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

03 ndash 05 ndash 01 01 00 05 05 04 00

ndash 08 06 02 01 03 ndash 04 05 ndash 03 ndash 03

ndash 01 ndash 04 ndash 01 00 02 ndash 01 01 02 ndash 01

03 00 ndash 08 ndash 01 ndash 01 00 06 01 ndash 01

ndash 07 ndash 06 ndash 07 ndash 05 ndash 01 10 04 03 ndash 01

02 01 ndash 03 01 03 05 ndash 01 01 ndash 02

ndash 09 ndash 02 ndash 02 02 ndash 02 05 11 ndash 01 01

ndash 01 ndash 06 ndash 01 02 ndash 06 ndash 01 ndash 04 07 ndash 01

03 01 ndash 01 07 08 03 05 00 ndash 02

04 ndash 09 ndash 07 01 ndash 09 01 08 03 00

00 ndash 03 ndash 04 00 00 01 03 01 ndash 01

01 ndash 04 05 ndash 02 ndash 06 06 03 00 ndash 01

06 ndash 06 02 00 ndash 07 04 08 03 ndash 01

ndash 04 ndash 09 ndash 04 04 03 06 08 07 01

Table A49

Compensation of employees general government(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 134 130 112 115 116 120 120 121

DE (1) 108 104 95 101 104 106 103 102

EL 94 114 125 115 109 109 106 113

ES 94 102 107 111 118 118 113 112

FR 134 144 130 131 134 140 140 141

IE 118 115 99 105 107 108 105 96

IT 111 118 127 126 125 124 119 113

LU 102 98

NL 124 106 93 92 94 96 93 93

AT 116 124 117 118 120 125 124 124

PT 102 102 118 128 138 142 137 137

FI 121 139 144 168 173 162 153 148

Euro area (2) 117 119 114 116 118 119 117 116

DK 180 174 177 177 178 181 175 173

SE 202 183 181 183 188 180 170 161

UK 128 122 115 117 118 107 91 84

EU-15 (3) 123 123 118 120 122 121 116 114

1980 1985 1990 1991 1992 1993 1994 1995

BE 03 00 ndash 01 03 01 04 00 01

DE (1) 02 ndash 01 ndash 03 ndash 02 03 02 ndash 03 ndash 01

ES 05 02 04 04 07 00 ndash 05 ndash 01

FR 03 00 ndash 01 01 03 06 00 01

IT 05 ndash 02 08 00 ndash 01 ndash 02 ndash 04 ndash 07

LU 04 01

AT 00 01 ndash 04 02 02 04 00 ndash 01

PT 06 00 04 10 10 04 ndash 05 01

FI ndash 01 06 08 24 05 ndash 11 ndash 09 ndash 05

EU-15 (3) 04 ndash 01 01 01 02 ndash 01 ndash 05 ndash 02

Table A19

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

119 119 117 116 116 114 116 120 120 120

90 89 87 85 84 82 80 79 79 78

113 107 116 116 117 117 116 122 121 119

113 113 109 107 106 105 104 102 103 103

137 139 138 137 137 135 135 137 138 136

102 97 92 85 80 78 82 83 86 85

112 115 116 107 107 106 107 107 108 107

97 97 93 88 83 78 81 88 92 93

108 104 102 101 102 100 101 104 106 106

126 124 115 113 114 110 101 99 100 99

136 137 138 140 144 150 152 154 150 145

152 155 145 138 138 132 132 134 136 136

111 112 111 107 107 106 105 106 107 106

173 173 171 175 174 170 172 175 175 176

167 172 168 162 158 157 160 163 160 159

83 79 75 72 72 72 74 76 80 80

111 111 108 104 104 102 102 103 105 104

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

ndash 01 ndash 02 ndash 03 ndash 01 ndash 02 ndash 02 ndash 01 00 ndash 01

03 01 ndash 09 00 ndash 01 01 00 01 ndash 02

ndash 04 ndash 02 ndash 01 01 ndash 02 01 03 02 01

01 01 02 05 06 02 02 ndash 04 ndash 05

00 ndash 02 04 ndash 01 ndash 04 03 02 01 01

00 ndash 03 ndash 03 ndash 01 ndash 02 00 01 01 ndash 01

Table A410

Total current uses general government(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 513 562 511 522 529 534 519 509

DE (1) 419 424 408 423 434 448 449 456

EL 264 377 419 397 411 433 440 451

ES 277 339 368 380 402 426 413 403

FR 417 486 457 467 484 507 504 504

IE 395 451 367 379 382 380 371 348

IT 390 459 485 495 516 531 510 491

LU 408 395

NL 494 517 497 503 511 513 494 477

AT 413 447 449 459 465 491 486 496

PT 313 387 353 377 373 388 391 395

FI 346 405 422 505 558 577 564 541

Euro area (2) 405 449 441 452 467 482 475 472

DK 500 544 549 557 563 589 588 574

SE 554 593 563 581 624 631 617 594

UK 403 420 358 369 393 400 398 397

EU-15 (3) 412 452 435 447 463 477 471 468

1980 1985 1990 1991 1992 1993 1994 1995

BE 08 01 ndash 01 10 07 06 ndash 15 ndash 10

DE (1) 06 ndash 04 04 14 11 14 01 07

EL 06 31 21 ndash 22 14 22 07 11

ES 18 18 09 12 22 24 ndash 13 ndash 09

FR 09 05 03 10 17 23 ndash 03 01

IE 32 06 04 12 04 ndash 02 ndash 09 ndash 23

IT 10 01 13 10 21 15 ndash 22 ndash 19

LU 14 ndash 06

NL 08 ndash 12 04 07 08 02 ndash 19 ndash 17

AT 02 09 07 09 07 26 ndash 06 10

PT 38 ndash 09 32 24 ndash 04 15 03 04

FI ndash 03 18 30 82 53 19 ndash 13 ndash 23

SE 18 13 12 19 42 07 ndash 14 ndash 23

UK 22 ndash 07 ndash 01 11 24 07 ndash 02 ndash 01

EU-15 (3) 11 01 06 12 17 14 ndash 06 ndash 03

Table A110

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

507 508 489 483 474 468 473 479 478 472

449 462 456 450 450 446 444 449 452 447

433 422 402 402 398 405 392 387 380 373

392 391 376 368 358 356 351 353 353 351

491 499 496 483 478 470 471 481 486 485

367 351 328 307 280 266 280 282 289 285

486 492 474 458 446 441 444 441 438 434

402 403 386 370 363 343 361 393 411 418

474 459 447 434 428 415 414 426 425 425

498 494 477 474 475 465 475 477 483 479

396 396 382 377 387 396 400 410 414 413

536 530 505 474 468 440 437 441 446 443

464 470 459 449 443 437 436 440 442 438

573 568 549 546 532 516 520 522 518 514

602 590 569 558 543 521 516 527 557 551

413 406 392 380 373 376 382 386 392 393

464 467 454 443 436 430 430 435 438 435

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

13 ndash 06 ndash 06 00 ndash 04 ndash 02 05 03 ndash 04

ndash 11 ndash 19 00 ndash 04 08 ndash 14 ndash 05 ndash 07 ndash 07

ndash 02 ndash 15 ndash 07 ndash 11 ndash 01 ndash 05 02 00 ndash 02

ndash 15 ndash 12 ndash 13 ndash 06 ndash 13 ndash 01 11 ndash 01 00

ndash 04 ndash 17 ndash 03 01 ndash 10 09 02 06 ndash 04

ndash 05 ndash 19 ndash 04 ndash 14 ndash 16 04 03 ndash 04 ndash 04

Table A411

Gross saving general government(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE ndash 37 ndash 58 ndash 36 ndash 45 ndash 50 ndash 51 ndash 30 ndash 20

DE (1) 24 25 13 12 14 05 10 00

EL ndash 01 ndash 74 ndash 94 ndash 64 ndash 70 ndash 79 ndash 71 ndash 71

FR 37 05 24 14 ndash 04 ndash 22 ndash 21 ndash 14

IE ndash 49 ndash 63 ndash 08 ndash 12 ndash 12 ndash 10 06 ndash 02

IT ndash 46 ndash 69 ndash 57 ndash 57 ndash 71 ndash 54 ndash 54 ndash 39

LU 72 112

NL 13 09 ndash 16 03 ndash 09 ndash 03 ndash 10 ndash 11

AT 42 31 22 18 27 08 00 ndash 04

PT ndash 35 ndash 60 ndash 14 ndash 25 08 ndash 20 ndash 28 ndash 23

FI 74 65 92 26 ndash 21 ndash 50 ndash 29 ndash 22

Euro area (2) 10 ndash 06 ndash 02 ndash 05 ndash 12 ndash 18 ndash 15 ndash 15

DK 07 09 02 ndash 10 ndash 04 ndash 10 ndash 07 ndash 05

SE 07 ndash 01 63 14 ndash 33 ndash 66 ndash 64 ndash 43

UK ndash 05 ndash 05 24 05 ndash 32 ndash 49 ndash 42 ndash 30

EU-15 (3) 08 ndash 06 04 ndash 03 ndash 16 ndash 24 ndash 20 ndash 17

1980 1985 1990 1991 1992 1993 1994 1995

BE ndash 15 02 07 ndash 08 ndash 06 ndash 01 21 10

DE (1) ndash 02 06 ndash 22 ndash 02 02 ndash 09 04 ndash 10

EL ndash 08 ndash 31 07 30 ndash 06 ndash 10 09 00

ES ndash 05 10 ndash 06 ndash 05 ndash 05 ndash 24 02 ndash 08

FR 09 ndash 01 01 ndash 10 ndash 19 ndash 18 02 06

IE ndash 03 ndash 13 ndash 07 ndash 04 00 02 17 ndash 08

IT 06 02 ndash 07 01 ndash 14 17 ndash 01 16

LU 01 22

NL ndash 02 14 ndash 06 18 ndash 12 06 ndash 06 ndash 01

AT 08 01 03 ndash 04 09 ndash 19 ndash 08 ndash 04

PT ndash 24 02 ndash 24 ndash 11 33 ndash 28 ndash 07 05

FI 06 01 ndash 03 ndash 66 ndash 47 ndash 29 21 07

Euro area (2) 01 03 ndash 09 ndash 04 ndash 07 ndash 06 03 01

DK ndash 18 22 ndash 17 ndash 12 06 ndash 06 03 03

SE ndash 19 ndash 10 ndash 15 ndash 49 ndash 47 ndash 34 02 21

UK ndash 03 06 ndash 03 ndash 19 ndash 38 ndash 17 08 11

EU-15 (3) ndash 01 04 ndash 08 ndash 08 ndash 12 ndash 08 03 03

Table A111

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

ndash 20 ndash 15 05 17 21 27 22 22 18 19

ndash 01 ndash 05 ndash 01 05 12 14 02 ndash 08 ndash 07 ndash 02

ndash 68 ndash 53 ndash 15 01 17 26 27 27 30 30

ndash 18 ndash 13 04 12 29 32 39 42 39 43

ndash 11 ndash 03 ndash 01 11 21 23 22 04 ndash 04 ndash 03

00 18 33 43 65 79 55 39 30 28

80 78 84 86 87 109 99 83 56 36

ndash 11 06 13 18 34 46 37 23 20 10

ndash 04 09 18 18 16 17 37 24 23 30

ndash 21 ndash 09 04 12 13 07 ndash 02 00 ndash 07 ndash 04

ndash 07 06 18 44 48 94 79 73 58 54

ndash 14 ndash 11 02 09 20 23 18 09 06 08

ndash 05 09 22 28 49 42 45 33 32 35

ndash 31 05 18 45 46 62 75 42 40 45

ndash 29 ndash 23 ndash 06 18 26 29 24 04 ndash 02 00

ndash 16 ndash 12 01 12 22 26 21 10 07 09

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

04 20 12 04 06 ndash 05 00 ndash 05 02

16 38 15 16 09 01 00 03 00

06 17 08 17 04 06 03 ndash 03 04

01 35 03 16 ndash 03 ndash 05 ndash 05 ndash 03 02

13 10 ndash 01 ndash 02 01 20 ndash 13 00 06

12 13 08 01 ndash 06 ndash 09 02 ndash 06 03

14 13 07 21 ndash 07 03 ndash 12 ndash 02 03

36 13 27 01 16 13 ndash 33 ndash 02 05

Table A412

Gross fixed capital formation general government(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 44 25 13 14 14 16 16 14

DE (1) 35 23 22 26 28 27 26 23

EL 21 37 28 31 35 33 31 33

ES 18 36 49 48 40 41 39 37

FR 33 32 35 35 35 32 31 32

IE 54 37 20 21 20 22 23 24

IT 32 37 33 32 30 26 23 22

LU 65 40 44 45 51 50 42 45

NL 32 23 20 21 20 20 20 19

AT 43 36 32 32 32 32 33 28

PT 42 32 32 33 37 39 35 36

FI 38 37 37 38 35 28 29 27

Euro area (2) 33 30 30 31 30 29 27 26

DK 33 21 16 15 19 18 18 18

SE 41 30 23 22 26 10 28 27

UK 25 21 23 21 20 18 18 17

EU-15 (3) 32 28 29 29 29 27 26 25

1980 1985 1990 1991 1992 1993 1994 1995

BE 02 ndash 03 ndash 01 01 01 01 01 ndash 02

DE (1) 01 ndash 01 ndash 01 00 02 ndash 01 ndash 01 ndash 02

EL ndash 05 02 ndash 02 03 04 ndash 02 ndash 02 02

ES 01 07 06 ndash 01 ndash 08 01 ndash 02 ndash 03

FR 01 02 02 ndash 01 00 ndash 03 ndash 01 01

IEIE 06 00 03 01 ndash 01 02 02 00

IT 05 01 ndash 01 00 ndash 02 ndash 04 ndash 03 ndash 01

LU 09 ndash 03 01 06 ndash 01 ndash 08 03

NL 03 ndash 02 00 01 00 ndash 01 00 ndash 01

AT ndash 02 ndash 01 ndash 01 01 00 00 01 ndash 05

PT 05 ndash 03 00 01 04 03 ndash 04 02

FI ndash 01 01 06 01 ndash 03 ndash 07 01 ndash 02

Euro area (2) 02 01 01 00 ndash 01 ndash 02 ndash 01 ndash 01

DK ndash 03 02 ndash 01 ndash 01 04 ndash 01 ndash 01 00

SE ndash 01 ndash 02 00 ndash 01 05 ndash 16 18 ndash 01

UK ndash 02 ndash 01 05 ndash 02 00 ndash 02 ndash 01 00

EU-15 (3) 01 00 01 ndash 01 00 ndash 02 ndash 01 ndash 01

Table A112

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

18 16 16 16 18 18 15 17 15 15

23 21 19 19 19 18 17 16 16 16

32 32 34 36 35 41 39 38 40 39

37 31 31 33 34 31 32 33 34 34

33 32 30 29 30 32 31 31 30 30

23 24 25 27 32 37 46 44 39 39

21 22 22 24 24 24 25 18 21 26

46 47 42 45 45 40 42 46 51 54

30 31 29 29 30 32 34 35 36 35

31 28 20 19 17 15 12 12 11 11

37 42 44 40 42 39 41 36 37 36

27 29 31 29 28 26 27 28 27 27

27 26 24 25 25 25 25 24 24 25

18 20 19 17 17 17 19 17 17 17

40 35 31 32 32 29 30 33 33 33

20 15 12 12 11 11 12 13 17 19

26 25 22 23 23 23 23 22 23 24

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

ndash 01 ndash 01 00 02 00 ndash 03 02 ndash 02 00

00 02 02 ndash 01 06 ndash 01 ndash 01 02 ndash 01

ndash 06 00 03 00 ndash 02 00 01 01 01

ndash 01 ndash 03 ndash 01 01 02 ndash 01 ndash 01 00 00

01 01 02 05 06 09 ndash 02 ndash 05 00

01 00 02 00 00 01 ndash 06 02 05

01 ndash 05 03 00 ndash 05 02 04 05 03

02 ndash 02 00 01 02 02 01 01 ndash 01

ndash 02 ndash 09 ndash 01 ndash 01 ndash 02 ndash 03 00 00 00

04 02 ndash 04 02 ndash 03 03 ndash 05 00 00

01 03 ndash 03 ndash 01 ndash 02 01 02 ndash 01 ndash 01

ndash 01 ndash 02 00 01 00 00 ndash 02 01 01

02 ndash 01 ndash 02 00 00 02 ndash 02 00 00

ndash 04 ndash 04 01 00 ndash 03 02 02 00 00

ndash 05 ndash 03 01 ndash 01 00 01 01 04 01

Table A413

Total uses general government(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 561 593 529 539 548 555 537 527

DE (1) 471 460 441 468 476 488 484 490

EL 290 419 484 447 468 490 468 485

ES 317 404 426 435 449 476 459 450

FR 454 520 497 502 518 541 540 538

IE 462 491 381 389 394 393 392 367

IT 430 515 538 538 540 571 546 529

LU 484 444

NL 548 561 530 534 540 541 521 505

AT 472 502 496 506 512 541 535 542

PT 362 428 388 410 410 427 421 427

FI 386 442 461 545 595 606 595 569

Euro area (2) 450 492 482 493 502 520 510 507

DK 531 564 561 571 582 607 607 592

SE 600 630 585 607 666 679 649 623

UK 432 443 392 397 422 428 423 421

EU-15 (3) 455 491 474 485 498 514 504 500

1980 1985 1990 1991 1992 1993 1994 1995

BE 09 ndash 02 ndash 01 10 09 07 ndash 18 ndash 09

DE (1) 07 ndash 05 03 25 09 11 ndash 03 05

EL 00 32 45 ndash 37 21 22 ndash 22 17

ES 22 26 10 09 14 28 ndash 18 ndash 09

FR 11 06 07 05 17 23 ndash 01 ndash 02

IE 40 06 02 08 05 ndash 01 00 ndash 25

IT 12 13 19 00 02 31 ndash 25 ndash 17

LU 25 ndash 15

AT 03 09 07 11 06 29 ndash 06 08

PT 43 ndash 08 34 22 ndash 01 17 ndash 05 06

DK 32 ndash 07 ndash 08 10 11 25 00 ndash 15

SE 10 12 09 21 60 13 ndash 31 ndash 26

UK 21 ndash 11 15 06 24 07 ndash 05 ndash 03

EU-15 (3) 12 02 10 11 13 16 ndash 10 ndash 04

Table A113

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

528 529 514 507 501 495 494 504 500 496

496 503 494 488 488 459 483 486 489 484

494 477 464 466 465 489 470 463 471 462

450 437 418 414 402 398 393 397 398 396

551 554 549 537 535 526 525 535 540 537

415 396 371 350 347 319 341 337 341 337

534 532 511 499 489 469 485 477 475 475

455 455 433 421 410 387 391 447 455 456

514 496 482 472 469 453 464 475 475 477

573 568 541 542 542 524 521 522 523 513

450 458 448 441 453 452 464 462 471 469

594 595 564 528 521 489 490 492 495 490

515 515 502 494 489 471 481 484 485 482

603 598 580 576 563 547 550 554 547 542

678 654 632 608 604 575 572 585 591 585

446 430 411 398 391 369 402 406 419 422

513 510 493 483 477 457 471 474 478 476

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

01 ndash 15 ndash 07 ndash 06 ndash 07 ndash 01 10 ndash 04 ndash 04

ndash 17 ndash 13 02 ndash 01 24 ndash 19 ndash 07 08 ndash 09

ndash 19 ndash 24 ndash 22 ndash 03 ndash 28 21 ndash 03 03 ndash 04

ndash 02 ndash 21 ndash 11 ndash 10 ndash 20 16 ndash 08 ndash 02 00

ndash 18 ndash 14 ndash 10 ndash 03 ndash 17 11 11 00 02

ndash 05 ndash 27 01 ndash 01 ndash 18 ndash 03 02 01 ndash 10

Table A414

Net lending (+) or net borrowing (ndash) general governments(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

DE (1) ndash 29 ndash 11 ndash 20 ndash 32 ndash 28 ndash 35 ndash 26 ndash 34

ES ndash 25 ndash 62 ndash 42 ndash 43 ndash 40 ndash 67 ndash 61 ndash 70

FR 00 ndash 28 ndash 15 ndash 20 ndash 39 ndash 56 ndash 57 ndash 48

IE ndash 116 ndash 102 ndash 22 ndash 23 ndash 24 ndash 23 ndash 16 ndash 21

LU ndash 04 63 47 18 07 15 27 18

NL ndash 41 ndash 35 ndash 49 ndash 28 ndash 38 ndash 31 ndash 36 ndash 38

AT ndash 17 ndash 24 ndash 24 ndash 30 ndash 20 ndash 42 ndash 49 ndash 50

PT ndash 84 ndash 101 ndash 49 ndash 58 ndash 29 ndash 59 ndash 59 ndash 56

FI 33 29 53 ndash 15 ndash 57 ndash 79 ndash 61 ndash 50

Euro area (2) ndash 34 ndash 49 ndash 43 ndash 46 ndash 48 ndash 56 ndash 51 ndash 49

DK ndash 32 ndash 20 ndash 10 ndash 24 ndash 22 ndash 28 ndash 26 ndash 22

SE ndash 39 ndash 37 40 ndash 11 ndash 75 ndash 115 ndash 96 ndash 73

UK ndash 34 ndash 29 ndash 09 ndash 23 ndash 61 ndash 77 ndash 67 ndash 54

EU-15 (3) ndash 34 ndash 45 ndash 35 ndash 41 ndash 50 ndash 60 ndash 54 ndash 50

1980 1985 1990 1991 1992 1993 1994 1995

EL ndash 02 ndash 33 ndash 17 45 ndash 12 ndash 10 37 ndash 06

ES ndash 09 ndash 09 ndash 06 ndash 02 03 ndash 27 06 ndash 09

FR 08 ndash 01 ndash 03 ndash 05 ndash 18 ndash 18 00 09

IE ndash 12 ndash 13 ndash 05 ndash 01 ndash 01 01 07 ndash 05

IT ndash 02 ndash 09 ndash 12 10 05 01 03 15

LU ndash 11 30 ndash 29 ndash 10 08 11 ndash 09

PT ndash 28 01 ndash 26 ndash 09 30 ndash 31 01 03

Euro area (2) ndash 03 00 ndash 11 ndash 04 ndash 02 ndash 08 06 02

Table A114

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

ndash 43 ndash 38 ndash 20 ndash 08 ndash 05 01 04 00 ndash 03 ndash 02

ndash 35 ndash 34 ndash 27 ndash 22 ndash 15 11 ndash 28 ndash 36 ndash 34 ndash 29

ndash 102 ndash 74 ndash 40 ndash 25 ndash 18 ndash 19 ndash 15 ndash 12 ndash 11 ndash 11

ndash 21 ndash 01 14 23 20 45 12 00 ndash 06 ndash 09

21 20 32 31 35 60 63 25 ndash 02 ndash 12

ndash 42 ndash 18 ndash 11 ndash 08 07 22 01 ndash 12 ndash 16 ndash 24

ndash 53 ndash 40 ndash 20 ndash 25 ndash 24 ndash 16 01 ndash 08 ndash 13 ndash 06

ndash 23 ndash 10 04 11 32 25 30 19 16 20

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

05 19 12 03 06 03 ndash 04 ndash 03 01

00 07 05 07 26 ndash 39 ndash 08 02 05

27 34 16 07 ndash 01 05 02 01 01

17 18 02 19 04 06 01 ndash 04 04

19 16 08 ndash 02 24 ndash 33 ndash 12 ndash 06 ndash 03

05 44 ndash 04 13 11 ndash 20 02 01 ndash 08

ndash 02 13 ndash 02 04 25 03 ndash 38 ndash 27 ndash 10

13 20 ndash 05 01 08 18 ndash 09 ndash 06 08

07 12 04 03 00 ndash 14 16 ndash 09 03

45 12 40 ndash 09 21 11 ndash 35 ndash 03 04

Table A415

Net lending (+) or net borrowing (ndash) excluding interest general government(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE ndash 27 14 50 38 37 35 51 49

DE (1) ndash 09 18 06 ndash 06 04 ndash 02 07 04

EL ndash 07 ndash 67 ndash 59 ndash 21 ndash 11 ndash 10 40 23

ES ndash 18 ndash 43 ndash 03 ndash 06 03 ndash 17 ndash 14 ndash 17

IE ndash 56 ndash 09 53 50 43 40 40 29

LU 07 72 51 21 11 19 30 21

NL ndash 04 26 08 31 23 29 20 19

AT 08 11 16 12 22 01 ndash 09 ndash 07

PT ndash 58 ndash 27 29 18 41 01 02 06

FI 43 47 67 04 ndash 31 ndash 33 ndash 11 02

Euro area (2) ndash 08 ndash 05 05 03 07 00 03 07

DK 07 76 63 49 44 45 41 42

UK 13 21 22 04 ndash 34 ndash 49 ndash 35 ndash 20

EU-15 (3) ndash 04 03 12 06 01 ndash 08 ndash 02 03

1980 1985 1990 1991 1992 1993 1994 1995

BE ndash 07 13 10 ndash 12 ndash 01 ndash 02 16 ndash 02

EL 00 ndash 27 09 38 10 01 50 ndash 18

FR 09 01 ndash 01 ndash 05 ndash 15 ndash 16 02 10

IT 01 ndash 09 ndash 06 17 19 07 ndash 08 18

Euro area (2) 00 01 ndash 09 ndash 02 04 ndash 08 04 03

DK ndash 11 23 ndash 13 ndash 14 ndash 04 00 ndash 04 01

EU-15 (3) 00 03 ndash 12 ndash 06 ndash 04 ndash 09 05 06

Table A115

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

49 50 60 68 65 69 70 61 53 48

02 03 09 14 20 45 05 ndash 04 ndash 02 03

10 31 42 53 54 51 49 43 41 39

ndash 14 04 16 13 24 25 30 28 22 24

33 44 53 58 45 65 27 13 09 06

39 44 67 52 50 58 38 34 30 20

25 23 36 34 38 62 65 29 00 ndash 10

17 38 41 41 52 61 36 21 15 05

ndash 09 04 20 14 13 22 38 29 24 30

08 06 07 03 04 04 ndash 11 04 ndash 04 ndash 02

01 13 29 51 51 98 79 70 54 50

05 14 25 25 29 41 23 14 11 12

42 51 61 65 80 68 70 56 51 53

ndash 08 36 46 77 61 75 77 42 35 39

02 12 25 29 33 48 27 15 10 11

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

01 10 08 ndash 03 04 01 ndash 09 ndash 08 ndash 05

01 07 05 06 25 ndash 40 ndash 09 02 05

21 11 11 01 ndash 03 ndash 02 ndash 06 ndash 02 ndash 02

05 23 ndash 15 ndash 02 08 ndash 21 ndash 04 ndash 04 ndash 10

13 16 ndash 06 ndash 01 08 17 ndash 10 ndash 05 06

ndash 02 01 ndash 04 01 00 ndash 15 15 ndash 08 02

Table A416

General government consolidated gross debt(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 786 1223 1292 1309 1325 1382 1359 1340

DE (1) 312 407 423 404 429 470 493 570

EL 250 536 796 822 878 1101 1079 1087

ES 170 427 440 447 471 588 611 639

FR 198 308 351 358 396 453 484 546

IE 752 1096 1015 1029 1002 963 905 827

IT 582 819 972 1006 1077 1181 1238 1232

LU 94 97 44 38 48 57 54 56

NL 460 701 770 769 778 790 764 772

AT 362 492 572 575 572 618 647 692

PT 323 616 583 608 545 591 621 643

FI 115 162 143 226 406 560 580 571

Euro area (2) 347 521 583 588 621 673 696 732

DK 365 700 578 625 663 780 735 693

SE 403 624 423 513 652 712 738 736

UK 533 528 340 344 392 454 485 518

EU-15 (3) 379 530 541 550 591 647 669 703

1980 1985 1990 1991 1992 1993 1994 1995

BE 83 49 01 17 16 57 ndash 23 ndash 19

DE (1) 20 06 16 10 26 40 23 77

EL ndash 02 77 76 26 56 223 ndash 22 08

ES 18 52 18 07 24 116 24 28

FR ndash 14 18 10 06 38 57 31 62

IE 17 31 ndash 67 14 ndash 27 ndash 39 ndash 58 ndash 79

IT ndash 28 67 19 33 71 105 57 ndash 06

LU ndash 03 ndash 05 ndash 09 ndash 06 09 09 ndash 03 03

NL 27 46 ndash 03 ndash 01 09 12 ndash 27 09

AT 15 20 ndash 08 02 ndash 03 47 29 45

PT ndash 33 74 19 25 ndash 63 47 30 22

FI 01 07 ndash 04 84 180 154 20 ndash 09

Euro area (2) 09 31 14 18 33 53 23 36

SE 47 ndash 06 ndash 17 90 139 60 26 ndash 02

UK ndash 05 ndash 18 ndash 26 03 49 62 32 33

EU-15 (3) 13 21 08 19 41 56 22 34

Table A116

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

1340 1302 1248 1196 1149 1096 1085 1058 1032 994

570 598 610 609 612 602 595 609 627 630

1087 1113 1082 1058 1051 1062 1070 1049 1010 970

639 681 666 646 632 606 569 540 525 505

546 571 593 595 585 572 568 590 617 630

827 742 650 549 493 393 368 334 334 333

1232 1221 1202 1163 1149 1106 1095 1067 1060 1047

56 62 61 63 59 55 54 56 40 34

772 752 699 668 631 558 528 527 525 528

692 691 647 637 675 668 673 676 685 668

643 629 591 550 543 533 556 581 595 602

571 570 540 486 470 445 438 427 423 414

732 756 755 739 729 705 694 693 700 697

693 651 612 562 530 473 454 453 427 400

736 735 705 680 627 528 544 524 509 495

518 523 508 477 452 421 389 384 390 398

703 721 711 690 675 643 630 627 636 634

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

28 12 ndash 01 03 ndash 10 ndash 07 13 18 03

26 ndash 31 ndash 24 ndash 08 12 08 ndash 21 ndash 39 ndash 40

25 22 03 ndash 11 ndash 13 ndash 03 21 27 13

05 ndash 01 02 ndash 04 ndash 05 ndash 01 02 ndash 16 ndash 06

ndash 20 ndash 53 ndash 32 ndash 37 ndash 73 ndash 29 ndash 02 ndash 02 04

19 ndash 10 ndash 21 ndash 15 ndash 32 ndash 13 ndash 03 09 ndash 02

Table A417

Cyclically-adjusted total resources of general government(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 471 516 464 469 473 493 493 492

DE (1) 434 457 414 418 432 451 455 454

EL 255 307 325 330 342 367 382 393

ES 298 354 370 378 401 416 405 387

FR 453 501 475 478 477 489 486 493

IE 344 395 350 364 373 380 389 351

IT 335 395 422 434 446 487 461 452

NL 506 529 472 498 499 513 488 469

AT 451 483 467 470 487 499 486 494

PT 273 344 327 339 373 374 374 378

FI 414 473 491 544 569 563 559 532

Euro area (2) 397 436 417 438 449 469 463 459

DK 509 546 556 553 570 597 581 568

SE 560 591 614 600 613 585 562 552

UK 403 418 378 381 373 361 358 366

EU-15 (3) 406 441 421 438 446 460 453 452

1980 1985 1990 1991 1992 1993 1994 1995

BE ndash 16 04 03 05 05 20 00 ndash 01

DE (1) 07 03 ndash 30 02 14 19 05 ndash 02

EL 02 ndash 05 33 05 12 24 15 11

ES 19 13 00 08 23 14 ndash 10 ndash 18

FR 22 07 03 03 ndash 01 12 ndash 03 08

IT 15 02 08 13 12 41 ndash 26 ndash 09

NL 09 ndash 02 ndash 06 26 01 15 ndash 25 ndash 19

AT 10 10 05 03 16 13 ndash 14 08

PT 12 ndash 09 07 12 34 01 01 04

DK 26 06 ndash 20 ndash 03 17 28 ndash 16 ndash 14

UK 32 ndash 06 03 04 ndash 08 ndash 13 ndash 03 09

EU-15 (3) 15 02 ndash 03 06 08 14 ndash 06 ndash 01

Table A117

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

488 498 495 500 492 485 493 504 501 495

459 471 470 468 473 464 453 453 462 460

405 415 433 447 450 470 452 445 453 443

391 396 391 384 387 383 386 393 394 395

499 518 523 511 514 505 505 502 504 504

398 397 381 367 357 350 343 332 337 335

457 461 482 467 470 457 455 454 456 447

475 480 469 458 465 462 459 464 466 461

522 531 526 517 516 501 519 514 511 507

402 415 413 407 419 415 417 438 444 447

568 570 542 529 530 538 535 540 530 522

466 476 479 471 474 465 462 462 465 462

578 586 579 583 590 565 577 572 565 563

606 631 620 632 609 594 610 593 602 600

388 385 385 397 400 405 409 396 398 401

463 471 470 465 467 460 459 456 460 458

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

10 ndash 03 05 ndash 09 ndash 07 08 12 ndash 04 ndash 06

09 18 15 03 20 ndash 18 ndash 07 08 ndash 11

03 ndash 28 ndash 13 00 08 ndash 03 05 ndash 10 ndash 08

ndash 03 00 11 04 05 04 ndash 13 02 03

Table A418

Cyclically-adjusted total uses of general government(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

BE 562 591 531 541 549 553 536 527

DE (1) 473 458 443 469 478 488 485 490

EL 290 419 484 447 468 490 468 485

ES 316 403 427 436 449 476 458 450

FR 454 517 499 503 519 540 539 537

IE 463 489 384 390 393 390 389 366

IT 432 514 539 539 540 571 546 529

NL 548 558 537 540 542 538 518 503

AT 472 502 496 506 512 541 535 542

PT 362 426 389 412 411 426 420 427

FI 389 441 469 541 583 592 587 564

Euro area (2) 451 490 484 494 503 519 510 506

DK 531 567 559 569 577 599 607 592

SE 600 630 588 605 660 673 646 622

UK 431 442 393 396 419 426 423 421

EU-15 (3) 455 489 476 485 498 512 504 500

1980 1985 1990 1991 1992 1993 1994 1995

DE (1) 06 ndash 05 06 27 09 10 ndash 03 05

EL 00 32 45 ndash 37 21 22 ndash 22 17

ES 22 26 10 09 13 27 ndash 18 ndash 09

FR 10 05 07 04 16 21 ndash 01 ndash 02

IT 12 13 19 00 01 31 ndash 25 ndash 17

NL 17 ndash 14 06 03 03 ndash 04 ndash 20 ndash 15

AT 03 09 07 11 06 29 ndash 06 08

FI 00 17 33 71 43 09 ndash 05 ndash 23

SE 09 13 07 17 55 13 ndash 27 ndash 23

EU-15 (3) 11 03 11 10 13 15 ndash 09 ndash 04

Table A118

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

528 527 514 507 503 497 497 504 499 495

496 503 493 488 488 484 483 486 488 484

494 477 464 466 465 489 475 463 471 462

450 436 418 414 403 399 394 397 398 396

550 552 547 537 535 528 527 535 539 537

414 395 373 351 350 324 343 341 340 334

534 532 511 499 489 481 485 477 474 474

513 495 484 477 477 468 469 474 470 471

573 568 541 542 542 528 521 522 523 513

450 458 448 442 453 456 464 462 470 469

589 593 567 533 525 497 493 492 494 489

515 515 502 494 490 483 483 484 484 481

604 599 582 578 565 551 554 554 546 542

677 652 631 608 606 579 574 586 590 585

446 431 412 399 391 393 402 406 418 421

512 509 493 483 478 471 472 474 477 475

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

08 ndash 10 ndash 06 12 03 08 ndash 02 08 ndash 01

Table A419

Cyclically-adjusted net lending (+) or net borrowing (ndash) of general government(Percentage of GDP)

Former definitions

1980 1985 1990 1991 1992 1993 1994 1995

FR ndash 01 ndash 16 ndash 24 ndash 25 ndash 43 ndash 51 ndash 53 ndash 44

1980 1985 1990 1991 1992 1993 1994 1995

DE (1) 00 08 ndash 35 ndash 25 06 09 08 ndash 07

EL 02 ndash 38 ndash 12 42 ndash 09 02 37 ndash 06

FR 12 01 ndash 05 ndash 02 ndash 17 ndash 08 ndash 02 09

IE ndash 09 ndash 15 ndash 16 09 06 10 10 ndash 15

IT ndash 04 ndash 11 ndash 11 13 10 10 ndash 01 08

AT 07 01 ndash 02 ndash 07 11 ndash 17 ndash 07 01

PT ndash 31 ndash 01 ndash 28 ndash 10 35 ndash 15 07 ndash 03

FI ndash 05 02 02 ndash 18 ndash 19 ndash 14 01 ndash 05

Euro area (2) 00 ndash 01 ndash 14 ndash 04 02 04 04 00

DK ndash 01 09 ndash 10 ndash 12 08 06 ndash 24 01

UK 14 04 ndash 11 00 ndash 31 ndash 20 01 11

Table A119

ESA 95 definitions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

ndash 39 ndash 29 ndash 19 ndash 07 ndash 11 ndash 12 ndash 04 01 02 00

ndash 15 02 09 16 06 26 00 ndash 09 ndash 03 01

ndash 21 ndash 23 ndash 25 ndash 03 05 41 42 48 37 33

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

10 10 12 ndash 04 ndash 02 08 05 01 ndash 02

19 14 ndash 03 14 ndash 01 08 04 00 03

16 10 ndash 02 05 ndash 01 01 ndash 11 ndash 02 02

17 07 08 ndash 10 20 ndash 26 ndash 09 06 04

14 22 ndash 10 ndash 01 ndash 01 25 ndash 07 ndash 04 07

ndash 01 ndash 02 21 08 36 02 06 ndash 11 ndash 04

12 10 09 19 ndash 10 09 ndash 05 01 02

51 11 34 ndash 21 11 22 ndash 30 05 04

12 15 05 07 00 ndash 02 ndash 04 00 00

Table A51

Gross domestic product at current market prices (Billion EUR)

1980 1985 1990 1991 1992 1993 1994

BE 877 1095 1553 1635 1743 1845 1984

DE (1) 5940 8392 12151 14327 15617 16708 17637

EL 350 536 662 731 770 798 844

ES 1591 2263 4017 4437 4633 4259 4251

FR 4911 7022 9576 9872 10405 10894 11393

IE 152 273 372 386 414 425 461

IT 3232 5621 8678 9396 9512 8490 8634

LU 38 52 87 97 104 118 130

NL 1281 1754 2318 2444 2584 2777 2938

AT 572 886 1273 1366 1470 1585 1681

PT 215 322 563 655 755 736 763

FI 378 720 1077 998 839 736 844

Euro area (2) 19499 28884 42240 46247 48741 49253 51429

DK 493 791 1051 1085 1137 1185 1280

SE 927 1370 1876 2001 1972 1694 1798

UK 3855 6027 7807 8361 8281 8235 8781

EU-15 (3) 24774 37071 52973 57694 60130 60368 63289

Table A52

Gross domestic product at constant market prices (Annual percentage change)

1980 1985 1990 1991 1992 1993 1994

BE 44 17 31 18 15 - 10 32

DE (1) 13 22 57 51 22 - 11 24

EL 07 25 00 31 07 - 16 20

ES 13 23 38 25 09 - 10 24

FR 16 15 26 10 15 - 09 21

IE 31 31 76 19 33 27 58

IT 35 30 20 14 08 - 09 22

LU 08 29 52 86 18 42 38

NL 12 31 41 25 17 09 26

AT 22 24 47 33 23 04 26

PT 46 28 40 44 11 - 20 10

FI 51 31 00 - 63 - 33 - 12 40

Euro area (2) 20 23 36 25 15 - 08 24

DK - 06 36 10 11 06 00 55

SE 17 22 11 - 11 - 17 11 42

UK - 21 36 08 - 14 02 25 47

EU-15 (3) 13 25 30 18 12 - 03 28

Table A11

Gross Domestic Product at current market prices (Billion EUR)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

2116 2125 2161 2237 2356 2475 2543 2607 2686 2794

18802 18782 18635 19164 19786 20300 20712 21082 21430 22036

899 980 1071 1090 1181 1231 1309 1411 1516 1632

4469 4805 4956 5255 5652 6093 6516 6939 7338 7787

11881 12246 12411 12976 13551 14201 14756 15208 15627 16205

508 577 707 777 898 1029 1145 1282 1369 1482

8390 9711 10300 10689 11080 11665 12201 12583 13021 13598

138 143 154 169 189 213 221 223 231 242

3173 3245 3327 3517 3741 4026 4292 4440 4594 4745

1798 1824 1816 1893 1972 2070 2119 2168 2218 2297

826 883 939 1004 1080 1156 1230 1292 1343 1403

992 1007 1083 1157 1200 1302 1358 1397 1441 1504

53855 56183 57406 59757 62496 65549 68181 70411 72583 75482

1378 1442 1492 1541 1624 1718 1778 1828 1897 1971

1899 2134 2185 2214 2360 2601 2449 2554 2644 2767

8677 9366 11715 12705 13700 15594 15970 16591 15982 16529

65809 69125 72798 76216 80180 85462 88378 91385 93106 96748

Table A12

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

24 12 36 20 32 37 08 07 12 23

17 08 14 20 21 29 06 02 04 21

21 24 36 34 36 42 41 40 36 38

28 24 40 44 42 42 27 20 20 30

17 11 19 34 32 38 21 12 11 23

100 81 109 88 111 100 57 60 33 45

29 11 20 18 17 31 18 04 10 21

14 33 83 69 87 89 12 11 11 27

30 30 38 44 40 33 13 03 05 17

16 20 16 39 27 35 07 10 12 20

43 35 40 46 38 37 16 05 05 20

41 39 64 49 34 55 07 16 22 29

23 14 23 29 28 35 15 09 10 23

28 25 30 25 26 29 14 16 15 22

40 13 24 36 46 44 11 19 14 27

29 26 34 29 24 31 21 18 22 26

24 16 25 29 28 34 16 11 13 24

Table A53

Potential (1) GDP at constant market prices (Annual percentage change)

1980 1985 1990 1991 1992 1993 1994

BE 26 18 26 24 23 20 20

DE (2) 20 23 28 27 25 23 21

EL 22 08 16 21 18 17 19

ES 18 24 29 28 28 27 27

FR 27 20 23 19 17 14 16

IE 39 27 43 49 54 54 63

IT 30 24 24 21 19 12 14

NL 18 21 28 29 28 26 26

AT 24 22 27 27 26 25 24

PT 34 23 35 42 32 28 28

FI 31 32 19 09 00 00 13

Euro area (3) 26 20 28 25 23 19 19

DK 14 20 14 14 14 15 20

SE 21 19 23 18 14 11 20

UK 16 23 27 19 19 18 22

EU-15 (4) 24 20 27 24 22 19 20

(1) For Germany Spain and Austria the trend GDP rather then potential GDP is taken(2) From 1991 including former East Germany(3) Excluding Luxembourg from 1991 including former East Germany(4) EU-15 excluding Luxembourg from 1991 including former East Germany

Table A54

Gap between actual and potential (1) GDP at constant market prices ( of potential GDP)

1980 1985 1990 1991 1992 1993 1994

BE 10 ndash 23 23 18 10 ndash 20 ndash 08

DE (2) 23 ndash 19 19 43 40 05 08

EL 31 ndash 11 ndash 01 09 ndash 02 ndash 35 ndash 33

ES ndash 06 ndash 36 42 39 20 ndash 17 ndash 20

FR 02 ndash 28 21 12 10 ndash 13 ndash 08

IE 08 ndash 25 38 08 ndash 12 ndash 37 ndash 42

IT 30 ndash 16 17 10 ndash 01 ndash 22 ndash 13

NL 03 ndash 09 24 20 09 ndash 08 ndash 09

AT 15 ndash 16 17 24 21 01 02

PT 23 ndash 69 47 49 28 ndash 21 ndash 38

FI 13 ndash 05 48 ndash 26 ndash 59 ndash 70 ndash 45

Euro area (3) 13 ndash 24 22 24 16 ndash 12 ndash 08

DK ndash 03 13 ndash 09 ndash 11 ndash 18 ndash 33 01

SE 02 02 21 ndash 09 ndash 40 ndash 39 ndash 19

UK ndash 15 ndash 10 14 ndash 19 ndash 34 ndash 28 ndash 05

EU-15 (4) 08 ndash 20 20 16 07 ndash 15 ndash 08

Table A13

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

23 20 22 20 22 25 19 18 18 18

20 18 17 16 15 15 14 14 14 14

20 22 27 26 28 35 32 34 33 33

28 29 30 30 31 31 30 30 29 29

19 16 18 20 22 26 25 23 21 23

70 74 81 86 85 83 80 76 69 66

13 14 16 18 17 21 21 19 16 18

27 28 30 30 30 29 27 23 20 20

24 23 23 22 21 20 19 18 17 16

26 26 29 32 31 30 28 26 24 25

21 24 35 37 39 35 35 31 28 28

20 19 20 21 22 23 22 21 20 21

23 25 26 26 24 24 22 21 20 20

25 21 23 28 28 29 28 26 25 26

24 25 27 29 29 28 28 25 26 26

21 20 21 22 23 24 23 22 21 22

Table A14

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

05 ndash 05 ndash 08 ndash 05 00 14 05 ndash 07 ndash 17 ndash 11

ndash 33 ndash 31 ndash 22 ndash 15 ndash 07 ndash 01 09 14 17 23

ndash 21 ndash 25 ndash 15 ndash 02 09 20 17 07 ndash 02 00

02 ndash 01 03 03 02 13 10 ndash 05 ndash 11 ndash 09

ndash 06 ndash 04 05 18 28 33 18 ndash 02 ndash 17 ndash 20

04 04 08 07 10 14 06 02 ndash 03 ndash 02

ndash 04 ndash 12 ndash 10 ndash 02 15 30 13 06 ndash 05 ndash 05

01 02 10 10 05 08 02 ndash 05 ndash 09 ndash 09

List of contents of European Economy

Basic editions

1 November 1978bull Annual Economic Report 1978ndash79bull Annual Economic Review 1978ndash79

2 March 1979bull European monetary system

mdash Texts of the European Council of 4 and 5 December 1978

3 July 1979bull Short-term economic trends and prospectsbull The European monetary system

mdash Commentarymdash Documents

5 March 1980bull Short-term economic trends and prospectsbull Adaptation of working time

6 July 1980bull Short-term economic trends and prospects mdash

Borrowing and lending instruments looked atin the context of the Communityrsquos financial instruments

8 March 1981bull Economic trends and prospects mdash

The Communityrsquos borrowing and lending operations recent developments

9 July 1981bull Fifth medium-term economic policy programme

mdash The main medium-term issues an analysis

11 March 1982

bull Economic trends and prospects mdash Unit labour costs in manufacturing industry and in the whole economy

12 July 1982

bull Documents relating to the European monetary system

13 September 1982

bull The borrowing and lending activities of the Community in 1981

14 November 1982

bull Annual Economic Report 1982ndash83bull Annual Economic Review 1982ndash83

15 March 1983

bull Economic trends and prospects mdash Budgetary systems and procedures mdash Industrial labour costs mdash Greek capital markets

16 July 1983

bull Business investment and the tax and financial environment mdash Energy and the economy a study of the main relationships in the countries of the European Community mdash The foreign trade of the Community the United States and Japan

17 September 1983

18 November 1983

19 March 1984

bull Economic trends and prospects mdashIndustrial labour costs mdash Medium-term budget balance and the public debt mdash The issue of protectionism

20 July 1984bull Some aspects of industrial productive

performance in the European Community an appraisal mdash Profitability relative factor prices and capitallabour substitution in the Community the United States and Japan 1960ndash83 mdash Convergence and coordination of macroeconomic policies some basic issues

21 September 1984bull Commission report to the Council and to

Parliament on the borrowing and lending activities of the Community in 1983

23 March 1985bull Economic trends and prospects 1984ndash85

24 July 1985bull The borrowing and lending activities of

the Community in 1984

25 September 1985bull Competitiveness of European industry

situation to date mdash The determination of supply in industry in the Community mdash The development of market services in the European Community the United States and Japan mdash Technical progress structural change and employment

27 March 1986bull Employment problems views of businessmen

and the workforce mdash Compact mdash A prototype macroeconomic model of the European Community in the world economy

28 May 1986bull Commission report to the Council and to

29 July 1986bull Annual Economic Review 1986ndash87

30 November 1986

bull Annual Economic Report 1986ndash87

31 March 1987

bull The determinants of investment mdash Estimation and simulation of international trade linkages in the Quest model

32 May 1987

bull Commission report to the Council and to Parliament on the borrowing and lending activities of the Community in 1986

33 July 1987

bull The economy outlook for 1988 and budgetary policy in the Member States mdash Economic trends in the Community and Member States

34 November 1987

35 March 1988

bull The economics of 1992

36 May 1988

bull Creation of a European financial area

37 July 1988

bull Commission report to the Council and to Parliament on the borrowing and lending activities in the Community in 1987

38 November 1988

39 March 1989

bull International trade of the European Community

40 May 1989

bull Horizontal mergers and competition policy in the European Community

41 July 1989

bull The borrowing and lending activities of the Community in 1988 mdash Economic convergence in the Community a greater effort is needed

42 November 1989

43 March 1990

bull Economic transformation in Hungary and Poland

44 October 1990

bull One market one money

45 December 1990

bull Stabilisation liberalisation and devolution

46 December 1990

47 March 1991

bull Developments on the labour-market in the Community mdash Quest mdash A macroeconomic model for the countries of the European Community as part of the world economy

48 September 1991

bull Fair competition in the international market Community State aid policy mdash The ecu and its role in the process towards monetary union

49 1993

bull Reform issues in the former Soviet Union

50 December 1991

51 May 1992

bull The climate challenge Economic aspects of the Communityrsquos strategy for limiting CO2 emissions

52 1993

bull The European Community as a world trade partner

53 1993

bull Stable money mdash sound finances Community public finance in the perspective of EMU

54 1993

bull Annual Economic Report for 1993

55 1993

bull Broad economic policy guidelines and convergence report

56 1994

57 1994

bull Competition and integration mdash Community merger control policy

58 1994

bull 1994 broad economic policy guidelines mdash Report on the implementation of macrofinancial assistance to third countries

59 1995

60 1995

bull 1995 broad economic policy guidelines

61 1996

62 1996

63 1997

64 1997

65 1998

bull Commissionrsquos recommendation concerning the third stage of economic and monetary union mdash Convergence report 1998 mdash Growth and employment in the stability-oriented framework of EMU

66 1998

67 1999

bull 1999 Annual Economic Report

68 1999bull 1999 broad economic policy guidelines

69 1999bull The EU economy 1999 review

70 2000bull 2000 broad economic policy guidelines mdash

Convergence report 2000 mdash Proposal for a Council decision for the adoption by Greece of the single currency on 1 January 2001

Investing in the future

Reports and studies

1-1993

bull The economic and financial situation in Italy

2-1993

bull Shaping a market economy legal system

3-1993

bull Market services and European integration the challenges for the 1990s

4-1993

bull The economic and financial situation in Belgium

5-1993

bull The economics of Community public finance

6-1993

bull The economic and financial situation in Denmark

1-1994

bull Applying market principles to government borrowing mdash Growth and employment the scope for a European initiative

2-1994

bull The economic and financial situation in Germany

3-1994

bull Towards greater fiscal discipline

4-1994

bull EC agricultural policy for the 21st century

5-1994

bull The economics of the common agricultural policy (CAP)

6-1994

bull The economic interpretation between the EU and eastern Europe

7-1994

bull The economic and financial situation in Spain

1-1995

bull The economic and financial situation in the Netherlands

2-1995

bull Report on the implementation of macrofinancial assistance to the third countries in 1994

3-1995

bull Performance of the European Union labour market

4-1995

bull The impact of exchange-rate movements on trade within the single market

1-1996

bull The economic and financial situation in Ireland Ireland in the transition to EMU

2-1996

bull The CAP and enlargement mdash Economic effects of the compensatory payments

3-1996

bull Ageing and pension expenditure prospects in the western world

4-1996

bull Economic evaluation of the internal market

1-1997

bull The economic and financial situation in Portugal in the transition to EMU

2-1997

bull The CAP and enlargement mdash Agrifood price developments in five associated countries

3-1997

bull The European Union as a world trade partner

4-1997

bull The welfare state in Europe mdash Challenges and reforms

5-1997

bull Towards a common agricultural and rural policy for Europe

6-1997

bull The joint harmonised EU programme of business and consumer surveys

1-1998

bull Getting environmental policy right mdash The rational design of European environmental policy

2-1998

bull The economic and financial situation in Austria

3-1998

bull Income benefits for early exit from the labour market in eight European countries mdash A comparative study

1-1999

bull The economic and financial situation in Finland

2-1999

bull Income insurance in European agriculture

3-1999

bull State aid and the single market

4-1999

bull Liberalisation of network industries

5-1999

bull Italyrsquos slow growth in the 1990s

6-1999

bull Generational accounting in Europe

1-2000

bull The report on the implementation of the 1999 broad economic policy guidelines

2-2000

bull Public debt and fiscal policy in EMU

3-2000

bull Public finances in EMU mdash 2000

4-2000

bull Performance of the European Union labour market mdash Joint harmonised EU programme of business and consumer surveys

1-2001

bull Current issues in economic growth

2-2001

bull Report on the implementation of the 2000 broad economic policy guidelines

3-2001

4-2001

bull The budgetary challenges posed by ageing populations

5-2001

bull The efficiency defense and the European system of merger control

Special editions

Special issue 1979bull Changes in industrial structure in the European

economies since the oil crisis 1973ndash78 mdash Europe mdash its capacity to change in question

Special edition 1990bull The impact of the internal market by industrial

sector the challenge for the Member States

Special edition No 191bull The economics of EMU

Special edition No 291bull The path of reform in central

and eastern Europe

Special edition No 192bull The economics of limiting CO2 emissions

New numbering

1-2002bull Report on the implementation of the 2001

broad economic policy guidelines

2-2002bull Economic forecasts mdash Spring 2002

3-2002bull Public finances in EMU mdash 2002

4-2002bull 2002 broad economic policy guidelines

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Special Report No 12002

bull Responses to the challenges of globalisation

bull European integration and the functioning of product markets

New numbering

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BELGIQUEBELGIEuml

DANMARK

DEUTSCHLAND

ELLADAGREECE

ESPANtildeA

FRANCE

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ITALIA

LUXEMBOURG

NEDERLAND

PORTUGAL

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ARGENTINA

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ISSN 0379-0991

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httpeuropaeuintcommeconomy_finance

R-03-003-E

KCAR03003ENC_002pdf

European Economy


Acknowledgements

Contents

Summary and main conclusions

Part I


Summary









31 Introduction



322 The data used






421 Introduction




Part II


Summary


11 Introduction




13 The use of enforcement mechanisms since spring 2002 ()


132 Portugal

133 Germany

134 France












31 Introduction


33 Debt dynamics in EU countries ()



41 Introduction


421 Main elements



431 Reliability


433 Timeliness






Part III


Summary

1 Introduction



















53 Public-private partnerships



533 Public-private partnerships and budgetary practices in EMU

Part IV


Summary

1 Introduction












41 Introduction

42 Tax increases

43 Expenditure cuts




Part V

Meeting the EUrsquos budgetary requirements national expenditure rules and fiscal relations across levels of government

Summary

1 Introduction










24 Conclusions







34 Case studies

341 Spain

342 Germany

Part VI


1 Belgium

2 Denmark

3 Germany

4 Greece

5 Spain

6 France

7 Ireland

8 Italy

9 Luxembourg

10 The Netherlands

11 Austria

12 Portugal

13 Finland

14 Sweden

15 United Kingdom

Part VII

Resources






2 Glossary

3 References


Statistical annex

Statistical annex
