Czech Proposal on a New EU Fiscal Rule

Fiscal rules are no new arrangement in public finance management, although over the years their underlying concepts have undergone significant changes. In essence, the pursuit of a small and annually balanced budget using the so-called classical approach is a fiscal rule. Fiscal rules began to enter legislation approximately 150 years ago and as recently as 1990 only seven countries had incorporated fiscal rule formally (Pirdal, 2017). The International Monetary Fund (IMF, 2017) currently registers fiscal rules in 96 countries and five multinational monetary unions, including the Euro area. Today, more than a hundred rules operate in the European Union alone, of which about half place restraints on the budget balance.

Since its inception, the European fiscal framework has undergone many changes, responding to general needs, as well as to individual Member States and the legal interpretations of the European Commission. The European Fiscal Board has recently criticised many aspects of the framework in its current form (EFB, 2019). It has shown that many Member States have missed the opportunity to build up fiscal reserves in good times and, on the contrary, have been pro-cyclical. Although compliance with the rules is far more common today than before the Great Recession, the rules are different. In consequence of the crisis, several flexibility clauses have been adopted, without which countries were not able to stand the conditions of the rules before the Great Recession. The European Fiscal Board also points to the excessive complexity of the overall framework and proposes “a simple medium-term debt ceiling and one operational target, namely, a ceiling on the growth rate of primary expenditure net of discretionary revenue measures, and an escape clause triggered on the basis of independent economic judgement.” (EFB, 2019, p. 7) The dynamics of potential output then determines the growth of primary expenditures.

Currently, there is a general shift towards expenditure rules as an operational component, complemented by other ones, such as the debt rule. Numerous studies (e.g. Andrle et al., 2015, Cordes et al., 2015, Eyraud et al., 2018, Claeys et al., 2016, Darvas et al., 2018, or Bénassy-Quéré et al., 2018) incline to expenditure rule. Even the Organization for Economic Co-operation and Development (OECD, 2016) proposed in its euro area economic survey a system based on a choice between the balance or expenditure operational rule, leaving the decision to each country.

In our proposal of the European fiscal rule, we prefer to return to a simpler and more transparent form of the fiscal rule, that at the same time will stand up to a complex economic environment. The simplicity of the rule must go hand in hand with its stability between fiscal policy settings and its ex-post assessment as well as countercyclical setting. A transparent rule should be easy to replicate and monitor. This requires the rule based on observed and publicly available aggregates or such benchmark can be easily derived. In the European context, the design of the rule complicates the fact that many member states have incorporated a structural balance rule or convergence towards a certain level of the structural balance (the medium-term budgetary objective) in their legal systems.

Despite all the shortcomings associated with the structural balance calculations, we still consider the institute of the medium-term budgetary objective to be a suitable countercyclical instrument, taking into account also explicit and implicit liabilities of the general government. Efforts to meet all of these requirements have shaped our proposal. It draws also on the practical experience of the Ministry of Finance of the Czech Republic with, in some respects, similarly grounded national fiscal rule that originally drew its inspiration from the Swiss fiscal rule at the federal level. Moreover, this proposal brings several enhancements and additions stemming from the European context.

The basic idea behind the proposed rule is that the expenditure should grow at most as the dynamics of trend revenue adjusted for the value of medium-term budgetary objective and excessive past errors. The aim of the rule is a structural balance at a level of at least of the medium-term budgetary objective. In other cases, an automatic correction takes place, reducing expenditure growth in the forthcoming years by an excessive accumulation of past errors. Apart from the limit set on total expenditure, current expenditure is not allowed to grow at the expense of capital expenditure during the times of fiscal consolidation.