Transcript Evaluating the Efficiency and Effects of Public Spending

If You Want to Cut, Cut, Don't Talk:
The Role of Formal Targets in Israel's Fiscal
Consolidation Efforts 1985-2008
Adi Brender
Research Department, Bank of Israel
IMF Conference: Fiscal Rules for Israel
Background
 Since the 1985 stabilization, governments
repeatedly stated a commitment to fiscal
consolidation.
 Since 1992 Israel’s fiscal policy is formally
guided by multiyear deficit targets.
• Performance with respect to the targets and
the actual fiscal position varied over time.
• This paper focuses on the contribution of
formal targets and policy design to
performance.
The Logic of Multiyear Targets
• The original decision-maker takes most of
the political “heat” for constraining the
“deficit bias”.
• Subsequent governments tend to adhere to
the predetermined rule:
– the “price” has already been paid
– abandoning it could get the government blamed
for hurting macroeconomic performance.
• Market participants understand the “game”;
Hence, the policy is credible from the outset.
Underlying Questions
• Does the public really like deficits?
– No such evidence in the literature
– Doesn’t really make sense (rationality).
• Can macro-fiscal targets be met without
external constraints (SGP, US guarantees).
• More reasonable to think of the “Deficit bias”
as a micro phenomenon with macro
consequences.
Pre-Specified Measures or Macro Targets?
Policy-makers need to confront interest groups
on specific budget items.
Setting macro-fiscal targets leaves the “real
battle” - approving and implementing the
required measures - to future policy-makers.
• The micro component is a key difference
between monetary and fiscal targets.
Israel’s Experience 1985-2008
Examine 4 sub-periods separately: :
• Post 1985 consolidation: no quantitative
macro-fiscal targets.
• Early 1990s: Mass immigration, adoption
of formal targets.
• 1993-2003: Fiscal targets and strong
expenditure dynamics.
• 2003-2008: Expenditure restraint and formal
expenditure ceiling.
The 1985 Stabilization
•
•
•
•
Following repeated failures of government
programs and intensifying crises.
No quantitative medium-term targets.
Substantial Immediate one-off measures.
Pre-specified medium-term programs to cut
expenditures:
1. Defense
2. Product subsidies
3. Producer subsidies
•
Legislated tax-rate reductions after the
initial phase.
Components of the Decline in General Government Deficit: 1980-1990
1980-1984
Average
1985
57.4
1989
1990
65.5
1986
1987
1988
(Percent of GDP)
63.4
57.5
54.0
50.4
50.3
39.3
40.9
43.8
42.7
40.6
37.0
36.4
69.2
64.5
59.7
57.3
56.3
55.6
54.8
o/w Defense
19.5
18.5
15.9
14.5
12.9
12.1
12.4
Subsidies
8.9
6.2
4.2
4.2
4.1
3.4
2.7
Investment
2.3
1.8
2.0
2.4
2.6
2.5
2.7
Interest
10.9
12.6
11.6
10.3
9.3
9.1
8.7
Other
27.6
25.5
26.1
26.1
27.5
28.4
28.4
-11.8
1.0
3.7
0.1
-2.3
-5.2
-4.6
Total Revenue
o/w taxes
Total Expenditure
General government balance
1991: Introduction of Deficit Targets
• In 1990 and 1991 Israel absorbed 380,000
immigrants (8% of the population).
• The direct annual fiscal cost of absorption in
these two years amounted to 3.5% of GDP.
• The underlying surplus in 1991 – excluding
one-off absorption costs - was 0.8% of GDP.
• To show that once absorption expenses
phase-out other expenditures will not rise, a
balanced budget target was adopted for 1995.
Why Multiyear Targets
• To persuade the markets that the large deficit
in 1991 and 1992 is temporary.
• Insufficient track record of commitment to
long-term fiscal consolidation.
• The target was written into a law –to overcome
time inconsistency before the scheduled
elections in 1992.
• Consistent with the emerging international
norm of the time.
First Government Change - 1992
• The new government, elected in 1992,
immediately raised the target.
• Also: adopted expansionary medium-term
policies: raised wages, transfer payments,
road infrastructure and public consumption.
• Policy costs were not fully visible until 199596 due to faster-than-expected decline in
immigration.
Key Components of the Change in the General Government Balance 19901994
1991
1992
1993
1994
50.4
49.7
49.2
48.2
36.1
36.6
36.9
37.7
7.4
6.3
5.9
4.7
53.4
54.3
53.5
51.3
11.4
10.3
10.4
9.1
Interest
7.9
7.2
6.9
6.4
absoption related1
3.8
3.4
1.6
0.5
30.3
33.3
34.6
35.3
General government balance
-3.0
-4.6
-4.3
-3.1
General government balance
excluding absortion costs
0.8
-1.2
-2.8
-2.6
Total Revenue
o/w taxes
bilateral transfers
Total Expenditure
o/w Defense
Primary Civilian exp.
The Era of Revised and Missed
Targets: 1995-2003
• Following the first change subsequent
governments kept changing the targets
almost every year.
• The targets were almost always missed.
• Nevertheless, all the governments insisted
on presenting multiyear targets with a low
deficit (1-1.5 percent of GDP) at the final
year – usually after the next scheduled
elections.
Table 3: Budget Rules and Targets 1991-2003
Decision year
Deficit Target
(in percent of GDP)
1992 – 6.2%
1991
1993 – 3.2%
Notes
Adoption of declining deficit law. The deficit was
specified in term of the domestic balance.
1994 – 2.2%
1995 – 0.0%
1994 – 3.0%
Upward revision of the annual and medium-term
deficit targets.
1993
Will be reduced each
year over the next 3
years.
1994
1995 – 2.75%
-
1995
1996 – 2.5%
-
1997 – 2.8%
Moving from domestic deficit to overall deficit,
including Bank of Israel's "realized profits".
1998 – 2.4%
1996
1999 – 2.0%
2000 – 1.75%
2001 – 1.5%
1999
2000 – 2.5%
2001 – 2.25%
2002 – 2.0%
2003 – 1.5%
2000
2001 – 1.75%
2002 – 1.5%
2003 – 1.25%
Downward revision. The deficit was redefined
during the fiscal year to exclude the Bank of
Israel’s "profits".
2002 – 2.4%
2003 – 2.0%
Upward revision. The target for 2002 was
increased to 3.0% before the budget was approved.
2001
2002
2004 – 1.5%
2005 – 1.0%
2003 – 3.0%
2004 – 2.5%
2005 – 2.0%
2006 - 1.5%
2007 – 1.0%
From 2007 onwards 1%.
Central Government Performance With Respect to the Offcial Deficit Targets
7
percent of GDP
6
5
4
3
2
1
0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Years
Actual
Modified Actual
Target
Despite a decade of declining deficit targets, the target for 2003
was similar to that of 1993.
The 2003 Consolidation Program
Background
• Deep recession, military conflict, surging
yields on government debt.
• Failed stabilization in the preceding year.
• A decade of missed fiscal targets.
Consequently – to gain market confidence:
• Need for a front-loaded program.
• Need measures to sustain the consolidation
over the medium-term.
Projected Budget Balance Before and After the 2003 Adjustment Program
2003
2004
2005
(in percent of GDP)
1
2006
Before the program: no adjustment
Central government balance
-6.0
-7.0
-7.1
-7.2
After the adjustment program
Central government balance
-5.4
-5.1
-4.4
-3.7
-5.4
-4.1
-3.7
-3.2
…
-3.5
-2.4
-1.5
-5.3
-3.6
-1.8
-0.9
2
After the 2004 budget
Central government balance
Ex-post balance projection in early 2004
Actual balance
1All
3
the scenarios assumed the same interest rate and 4 percent annual growth. All
figures are adjusted to the current GDP definition.
2 Based on specific measures adopted with the 2004 budget.
3 An estimate based on the measures adopted until early 2004 and actual growth
for 2004-2006.
The Role of Targets: 2003 Consolidation
• In 2003 the deficit target was abandoned.
• Expenditure ceiling: introduced in 2005 but
was changed several times. In no year was
the budget in accordance with the ceiling.
• Actual expenditure was well below the budget
due to administrative measures affected
since 2003.
• Since 2006: tax cuts offset expenditure cuts.
Performance:1985-2008
• Targets can be effective even if they are
missed, by setting a guideline to policy.
• However, the dismal performance between
1993 and 2003 shows that missing the
targets was not just a technicality.
• The key to that failure was the inability, or
unwillingness, to tackle the expenditure
dynamics set by previous governments.
20
09
20
07
20
05
20
03
20
01
19
99
19
97
19
95
19
93
19
91
19
89
19
87
70
65
60
55
50
45
40
35
30
25
20
19
85
percent of GDP
General Government Expenditure and Taxes
Years
Taxes
Excl. one-off absorption cost
Overall expenditure
Lessons from 23 Years of Attempted
Consolidation
• The key to success: tackling expenditure dynamics.
• Pre-specified medium-term measures to cut
expenditures succeeded in reducing the deficit.
• Announcing macro targets without specifying the
measures did not work. They were changed by each
new cabinet and sometimes also within cabinets’
term-in-office.
• Good news: Once specific measures were
introduced, they survived government changes
Lessons (Cont.)
• Bad News: successful programs were
implemented in times of crisis and after failed
attempts with less comprehensive ones.
(consistent with OECD experience)
Paraphrasing Winston Churchill:
"You can trust the government to do the right
thing, after exhausting every other possibility“
• Role of external constraint: US aid in 1985
and loan guarantees in 2003.
Conclusion
• Policy credibility and sustainability should be
evaluated based on the expected impact of its
specific measures – not stated macro targets.
• Macro-fiscal targets may help coordination – but
alone, they are not building credibility.
Looking forward: Need for clear long-term target
and multiyear budget framework:
- Bypassing the target with long-term programs.
- An expenditure ceiling without a long-term target,
makes tax cuts a “free-play”.
Share of Central Government Expenditure in GDP- Alternative Scenarios: 2008-2013
40.0
(Percent of GDP)
38.0
36.0
34.0
32.0
30.0
2008
2009
1.7% annual increase in exp. ceiling
2010
2011
2012
2013
Exp. growth in line with specific decisions