a new budget rule for germany? christian kastrop federal ministry of finance, germany “die rolle...

Bundesministerium der Finanzen

Berlin

A new budget rule for Germany? Christian Kastrop

Federal Ministry of Finance, Germany

“Die Rolle des Parlamentariers imHaushaltszyklus”

Berlin, 22. Juni 2007


Berlin

Outline

• Status quo and problems of the existing budget rule

• Why a reform now?

• Criteria for a new budget rule

• Proposals for a new budget rule and their compatibility with the criteria

• Federal aspects of a reform


Berlin

Status quo

• Article 115 of the German Constitution

• Net borrowing limited to (gross) public investment

• Exception to the rule only in case of a “disturbance of the macroeconomic equilibrium”


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Problems of the status quo

• Marked increase in the central government's indebtedness could not be prevented => room for manoeuvre reduced as interest payments increased.

• Article 115 not so much in line with the objective of long-term sustainability

• Methodological criticism of Article 115– investment concept– exception rule– no enforcement during execution


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Increase of public debt according to governmental levels

Indebtedness (% of GDP)

0

10

20

30

40

50

60

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Länder and communities

Federation (incl. special funds)


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Why a reform now?Favourable conditions for a reform

• Short term: cyclical improvement of the fiscal stance and compliance with the existing budget rules (German Constitution and SGP).

• Medium term: structural improvement of revenues (substitution of one-off measures by tax revenues).

• Also: Länder are looking for early-warning system for distressed budget cases (Federalism Commission II).

Guarantees acceptance by the public.

Grand coalition may have the majority to change the constitution.


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Criteria for a budget rule• Limit of net borrowing

• Consideration of business cycle

• Compatibility with SGP

• Sustainability of public finances

• Future viability

Essential criteria for every budget rule

• Technical feasibility

• Legal feasibility

• Transition to new budget rule

• Consideration of federal aspects

Special aspects in case of Germany


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Proposals for a new budget rule

• SGP-consistent budget rule – short: SGP-model

• Budget rule similar to Swiss model but with net investment concept=> proposal of the German Council of Economic Experts (CEE) – short: CEE-model

• Soft modification of existing budget rule


Berlin

Soft modification of existing rule• Marginal restriction of investment concept

• Exception to the rule: restriction of net borrowing to amount equal to 3 % of tax revenues

Pro• Relatively easy to put through from political point of view, also in the Länder• No transition rule necessary

Contra• Almost no improvement to existing rule concerning especially exception to the

rule.• Compatibility with SGP (3 % deficit and structurally balanced budget) not

guaranteed as not primary objective of the rule. • No consideration of business cycle


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Limit of net borrowingInvestment concept (Golden Rule)…

• Intergenerational equivalence principle makes sense• but:

– net investment concept difficult to implement (correct depreciation?),

– difference between public investment and consumption,

– how to handle education expenditure (no/weak correlation with output, depreciation rate, allocative distortion)?,

– discussion of investment could widen debt limit,

– demographic change and pay-as-you-go-benefit system increase sustainability gap and therefore counteract intergenerational equivalence principle,

– productivity of private investment (as a substitute) is neglected,

– only limited analogy to private sector concerning return on investment.


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Limit of net borrowing … versus structurally balanced budget

• avoids most of the problems in conjunction with investment concept,

• reduces public debt in the medium term and leads to sustainable public finances,

• consistent with the reformed SGP,

• structural deficit is restricted to zero in the medium term can be achieved by adequate composition of expenditures and

revenues,

nevertheless, expenditures must be shifted to the ones that are most efficient and with highest quality persists.


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Limit of net borrowingSGP-model

• Structurally balanced budget, but deficit of central government max. 0.25% of GDP (about € 6 bn).

– Reason: sufficient flexibility for one-off effects with reforms.

– Size: SGP allows max. deviation of 0.5% of GDP of overall budget (“close to balance”), Federation with social security gets half of it. => Quantitatively very similar to net investment concept.

CEE-model

• Net borrowing up to net investment, i.e. increase of public wealth minus realisation and depreciation of public property

• Depreciation data from SNA


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Consideration of the business cycleBoth models

• Symmetrical consideration in both concepts according to automatic stabilizers

SGP-model

• Cyclical adjustment according to production function approach as for SGP

CEE-model

• Cyclical adjustment by HP-filter as in Swiss model


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Compatibility with SGPBoth models: 3 % deficit criterion guaranteed

SGP-model to a large extent:• Aim of a structurally balanced budget supported• Adoption of the agreed method of cyclical adjustment of fiscal

balances

CEE-model partially:• Aim of a structurally balanced budget might not be observed• Cyclical adjustment more restrictive than production function

method applied in SGP


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Intergenerational justice

Both models

• In the long run, public debt in percent of GDP will be reduced to far below of 60 %

• Debt reduction can be used to cover implicit liabilities

• Important contribution to long-term sustainability of public finances.


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Future viability

Both models

• Decreasing public indebtedness relative to GDP opens room for manoeuvre to shift expenditures towards tasks relevant to the future

• Improvement of quality of public finances


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Legal feasibilityBoth models • Change of constitution (Art. 115) necessary • Budget rule has to be observed, non-conformity with the constitution

would be detected immediately in budget draw-up.• Exceptions only in extreme cases, two-thirds majority of lower and

upper house of parliament as high parliamentary barrier.

SGP-model • Rule only for draw-up of budget. => Practicability!

CEE-model • Rule also for execution of budget: Balancing fund as memory and as

buffer if exceeding of rule is established ex post.• If balancing fund exceeds certain amount, tax increases (Federation)

are automatically established.


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Technical feasibilitySGP-model

• Estimation of output gap by production function approach as for SGP.

• Cyclical component for maximum (cyclical) fiscal balance:Budget sensitivity × output gap

• Cyclical components of the budget according to SGP: tax revenues, social security contributions, labour market expenditures.

• Federation and social security take about 70 % of cyclical fiscal balance – as measured by tax revenues.

• Not prone to disputes as method of cyclical adjustment agreed by EPC


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Technical feasibilityCEE-model

• Cyclical adjustment method easier to implement: HP-filter (with λ = 100) can be calculated more easily than production function method.

• Cyclical factor: potential GDP/GDP

• But: rule more demanding because of balancing fund


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Transition to the new budget rule

Both models

• New budget rule can be introduced only when budget is balanced.

SGP-model • Reduction of net borrowing according to accepted obligation

of annual reduction within SGP: reduction of central government’s deficit by 0.25% of GDP p.a. (approx. € 6 bn)

CEE-model • Less restrictive: annual reduction of central government’s

deficit by € 3 bn until 2014.


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Existing rule vs. alternative budget rules

Net borrowing of Federation (bn Euro)

24 23

32

39 40

3128

20 19 19 18

11

5 7

11

4

0

7 6

1

810

-3-1

6

14 13 13

54

1 2 3

-5

0

5

10

15

20

25

30

35

40

45

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

actual/planned, adjusted to base effects from 2006 CEE-model SGP-model


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Federal aspects of a reform

• Länder themselves started discussion about a reform, voicing different proposals.

• Very heterogeneous starting conditions (from distressed to balanced budgets) may hinder quick and unanimous decision.

• In the Länder, only tax revenues are cyclical, but these are almost evenly distributed by the financial equalization scheme between the Federal Government and the Länder.

• But: debt problem remains essentially a problem of the Federation as the Länder have been – in the aggregate – reducing their net debt.


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Federal aspects of a reformFiscal balances (Maastricht definition) by governmental levels

- in % of GDP* -

-2,4

-1,6

-1,9

-1,0

-1,8

-2,2

-1,5-1,7

-1,3

-1,1

-1,5

-2,0

-2,2

-2,4-2,3

-1,3

-0,4

-0,9

-1,1

-1,3 -1,4

-1,1 -1,1

-0,5

-0,2-0,1

-1,3

-1,7

-1,8

-1,3

-1,0

-0,4

-3,0

-2,5

-2,0

-1,5

-1,0

-0,5

0,0

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Bund i.w.S. (einschl SR und SV)Länder und Gemeinden

*Differences due to rounding.

February 2007Länder and communitiesFederation (incl. social securitiy & special funds)


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Federal aspects of a reform

SGP-model • Länder may adopt the rule, but need not to. • Modifications are at the Länder’s discretion as long as they

are compatible with SGP.

CEE-model • Modifications for sanctions: instead of automatic tax

increases, at the level of the Länder, revenues have to be used for repayment.

• Because of fiscal equalization scheme, there is no exception to the rule in case of severe economic downturns.


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Formulation of a new Article 115

(1) The Federation draws up a balanced budget (SGP) while taking into account the cyclical position (SGP, CEE) and net investment (CEE).

(2) Exceptions are only allowed for extreme cases and require two-thirds majority of lower and upper house of parliament (CEE).

(3) Details are laid down in federal law.


Berlin

Perspectives

• Current discussion

• When will a decision be made?

• What are the chances for realisation?

a new budget rule for germany? christian kastrop federal ministry of finance, germany “die rolle...

Documents

balanced budget

existing budget rulewhy

new budget ruleproposals

discussion of investment

sgpmodelbudget rule

restriction of net borrowing

german constitutionnet

cyclical improvement