Fiscal (Golden) Rules in the Constitution

The Financial Stability Pact or the so-called “fiscal board” was introduced in Parliament at the beginning of the summer and will be put to vote shortly after the elections in late October. As expected some new texts are proposed both in the Constitution (see here) and in the Law for the Structure of the State Budget or the Organic Budget Law (see here). This particular formula was the most likely structure, because it provides maximum strength to the new texts without the need to record specific details (numbers, formulas) in the Constitution itself. Further debate on the introduction of the fiscal board in Bulgaria is clearly ahead, so this is a good time to take one more look at the idea itself, as well as the proposal in question.

What is a “fiscal board“?

The term “fiscal board” actually represents a set of fiscal rules – they can refer to budget balance (for example, no large deficits), expenditures (e.g. a cap on public spending), revenues (for example, establishing special rules in regard to the introduction of new taxes or the increase of existing taxes) and debt (e.g. a cap on public debt). In other words, these are rules that ensure greater stability and some kind of protection against unreasonable politicians. In theory, these rules ensure prudent government.

Why do we need it?

The need for such prudence (and rules) in state finances is more than obvious – all the problems we see in Europe, led by the current protests in Greece and Spain, clearly show what the lack of common sense (and rules) in fiscal policy can cause. Seemingly well-settled and developed economies are on the brink of collapsing because of reckless government spending. The euro, the common European currency, is under threat, and the reason is quite clear – it’s called debt crisis. That’s what the fiscal rules should protect us from – not coincidentally, these are already in force at European level and are quickly becoming part of the national legislation of an increasing number of countries.

What is proposed?

The so proposed fiscal rules in Bulgaria cover almost all of the issues stated above. However, there is a considerable difference between what Djankov first offered in February and what is now introduced in Parliament. Following the release of the original version (see here) of the “Financial Stability Pact”, we gave our recommendations (see “Simpler and Clearer Fiscal Rules“). It is now clear that the main proposals of the IME have found their place in the final text. Obviously, the public debate and the negotiations with other political parties have been somewhat successful. Here are the parameters:

Rules on public expenditure – the consolidated expenditure cannot exceed 40% of GDP. The original version included a 37% cap and didn’t include the contribution in the total EU budget, expenditure on account of EU assistance and national co-financing. Such a distinction is no longer made, and the rule refers to all expenditures – this was one of the proposals of the IME. Still, this issue will undoubtedly be debated again in Parliament, and the discussion will likely focus on both the specific percentage, as well as the scope of expenditures.

Rule for certain direct taxes – New taxes on income and profits or changes in tax rates of existing taxes will be adopted by a majority of two thirds of all MPs. Once again we have a revision of the original proposal, which used the general term “direct taxes” and not a specific distinction like “taxes on income and profits.” The difference is that direct taxes also include other taxes, which are obviously not a subject to the fiscal rules – such as the property taxes determined by municipalities. This was also included in the proposals of the IME.

Rules regarding budget balance – the deficit of the consolidated fiscal program may not exceed 2% of the GDP of the country. This rule was quite different in the previous version, as the budgetary position was determined according to the economic cycle – there was no fixed limit. The idea to have a fixed cap and not a formula apparently prevailed – it was again part of the proposals of the IME.

Public debt rules – there is no such rule in the proposed texts. The reason is that such a rule already exists – the Government Debt Law contains a rule, which generally prevents the consolidated public debt from exceeding 60% of GDP. There is definitely room for further discussions on the development of these rules and the reduction of the debt limit. Although this is clearly not the most pressing issue (problem), now is the most appropriate time to adress it – together with the other fiscal rules.

The so proposed fiscal rules are needed. The texts fielded in parliament are clearer and simpler than the original draft, which is important – only this way they can be understood, widely supported and then, of course, respected. The debate on the various parameters will continue, but generally speaking the focus of the rules is clear – t o prevent the public sector from growing, to reduce deficits and to preserve the lower corporate and income taxes. These rules, together with the existing rules on public debt must ensure the stability and sustainability of our public finances.

What provides additional force to the fiscal rules is the fact that they are actually protected from the simple majority in Parliament. If someone decides to change them, he will have to obtain the support of two thirds of the MPs – this is not an absolute guarantee, but it still gives some security. Interestingly enough, according to the proposed amendments to the Constitution, the rule of vote by two thirds of the MPs will apply to the budget balance and taxes on profits and income, but not to the size of the public sector – i.e., if going forward someone decides to raise the VAT or to redistribute more than 40% of GDP, a simple majority vote will be enough to amend the text of the law. In other words, the government apparently leaves a door for a more active fiscal policy if needed or simply deemed necessary. Perhaps it would have been better not to leave such a possibility, since the size of the state is directly related to economic growth and the dependence is clear – the smaller the state, the higher the growth.

Potential problems

The municipalities stand out as a potential problem as far as the issue of fiscal rules is concerned – they can influence both spending and the deficit. The state of the municipal budgets and the fact that there are municipalities with blocked accounts makes us wonder whether local authorities are reasonable enough and whether and to what extent their policies could affect the general government balance. That’s why we recently proposed introducing similar rules for municipalities – not only regarding taxes, expenditures, debt and deficits (such rules for municipalities do exist in some form or another), but also clear rules determining what happens in the case of a total local budget collapse, blocked accounts etc.

There is also an additional issue in regard to municipalities and it is linked with the process of decentralization – shifting more taxation powers to municipalities suggests further steps regarding the taxation of profits and income on the local level. If the fiscal rules are adopted in their current form, the transfer (full or partial) of these taxes to municipalities becomes unlikely – in other words we will have to think of other ways to ensure some kind of a financial autonomy at the local level.

The issues surrounding municipalities, however, should not impede “the fiscal board.” Long-term stability and sustainability of public finances is of fundamental importance for the country’s economy. The references to the currency board are not random – sound money and sound public finances are the key to success.