Europe's public finance problems are not just down to irresponsible bankers. Politicians have played their part too. Poland has devised a way to tackle the problem by making its fiscal rules 'politician-proof'
Poland and Britain have much in common. In both countries, fiscal rules have been ranked highly in comparison to the rest of the EU. But they have still failed to ensure sound fiscal policy.
Poland’s debt will hit 58.9 per cent of GDP in 2014 and the UK’s is now forecast to peak at over 100 per cent.
This cannot continue. A report published by the UK's Office for Budget Responsibility earlier this month showed that the country's public finances are not likely to be sustainable in the longer term, and immediate action is needed to close a fiscal gap of £19 billion.
Around the world, governments have turned to fiscal rules to stop their overspending. Poland has recently decided to revise its rules with an amended Public Finance Act.
It is designed to overcome many of the practical challenges that plagued its previous debt limits by implementing an expenditure rule and debt brake to manage and guide government budgeting.
The new framework recognises that, while fiscal rules are important
constraints on government decisions to tax the public, they require certain key features if they are to be resilient.
Firstly, there needs to be guidance during the financial 'good times', and well before debt reaches any threshold set by fiscal rules. In Poland, public debt thresholds provided insufficient guidance for policy makers when debt was below the debt ‘ceiling’ and this encouraged procyclical fiscal expenditure.
With debt running close to the threshold in the good times the government was unable to both comply with the rule and ease policy when the crisis struck. As Ben Gummer MP has noted in the UK, there is a difference between theory and practice when it comes to fiscal responsibility.
A major problem with the UK’s fiscal rules was that they were too inflexible to cope with the onset of the financial crisis: as the government reached for fiscal stimulus the rules fell by the wayside. There will be always be times when fiscal rules are unsuitable or unsatisfactory, but the Polish approach accounts for this by weaving into the legislation an 'escape clause.'
This allows the fiscal rules to be overridden when sticking to them would cost the government more than abandoning them. Importantly, these situations must be defined in advance so that governments cannot use fiscal constraints as mere rules of convenience.
Thirdly, the rules must be comprehensive in their coverage of government expenditure. The UK’s fiscal rules, for instance, did not apply to capital spending. There are good theoretical reasons to exclude capital expenditure but it leaves the rules open to accounting manipulations.
By contrast, the Polish rules will require interest and principal payments to be covered by current budget surpluses and revenues from property sales. This prevents the re-classification of government spending as capital expenditure to circumvent the rules.
Finally, any fiscal rules must be difficult to fudge. The UK and Poland have both previously used rules determined on the basis of the output gap (an estimated value), rather than measured economic activity. Output gap estimates can vary among economists, which allows for disagreement over when a rule has been met.
Fiscal rules based on measured government spending and debt are less open to interpretation and manipulation. Poland’s rules meet this challenge by constraining total, nominal expenditure.
It may not be fancy but it ensures that the new Polish system will be transparent, comprehensible, and comprehensive. In a word, it will be ‘politician-proof’.
Papatya Sutcliffe works at Reform, an independent, non-party, think tank
