National stability pact: fiscal planning council’s decision only a tiny step forward

National stability pact: fiscal planning council’s decision only a tiny step forward

At its March 21 meeting the German council for fiscal planning decided to implement at the national level the stability target (nearly balanced overall budget in 2004) agreed with the Ecofin Council. The main elements of the decision on the “national stability pact” are the following:

1. The federal government will curb spending in 2003 and 2004 by an average 0.5% compared with 2002. The federal states and municipalities will put a cap on spending growth (no more than 1% on average).

2. All three levels of government have agreed on a reduction of net borrowing and a limit on the fiscal burden from both existing and new budget expenditures.

3. Article 51a of the “Haushaltsgrundsätzegesetz” (law on the basic budgetary rules) which foresees balanced budgets and gives additional competences to the fiscal planning council will take effect before the end of the current government’s term in office. According to Art. 51a, the fiscal planning council is to make recommendations regarding joint spending policy and budget discipline. Failure to comply with these recommendations will trigger concrete suggestions from the council on how to return to budget discipline; this will put pressure on the “offenders”.

4. Distribution of the overall deficit for 2004 between the Länder and municipalities on the one hand and the federal government and the social security system on the other is to be at a ratio of 55:45. This ratio is also to be applied in the years 2005 and 2006.

How can this decision be assessed? A positive aspect is the obvious effort to actually achieve a balanced budget in 2004 by introducing new domestic regulations. However, the tools chosen for a comprehensive and sustainable national stability pact are not very convincing as yet and are proof of a short-term orientation or an unrealistically positive assessment of the parties involved.

A national stability pact for fiscal reasons must meet two requirements: first, a stability programme must be drawn up – in line with EU principles – to achieve a balanced budget in an appropriate period of time. Second, regulations must be introduced on the vertical and horizontal distribution of the overall budget deficit among regional authorities and para-fiscal bodies, in case a balanced budged is (temporarily) not achieved. Moreover, adequate sanctions must be defined for non-compliance with the targets. (see also: National stability pact – a way to achieve sound public finances )

The first element is to be achieved by adjusting spending plans of the central and state governments. In order to balance the budget, however, real GDP growth of 2.5% would be required in both 2003 and 2004 as only this rate would ensure sufficient tax revenues. These goals look attainable against the backdrop of the current positive growth forecasts. Should growth turn out weaker, though, balancing the budget by 2004 will hardly be possible as further spending cuts would not be acceptable for cyclical reasons.

The second aspect was not considered at all in the recent decision. To be sure, it foresees vertical distribution of the overall maximum deficit (0.5%) for the 2004-2006 period among state/municipal governments and the central government/social security system at a 55:45 ratio – but the overall budget is planned to be nearly balanced in this period anyhow. In addition, the fiscal planning council seems to assume that from 2007 the overall budget deficit will generally be balanced as it does not foresee any regulation or stability pact for this time at all. This is the only possible explanation for the fact that there is no regulation regarding the horizontal distribution of the deficit among the Länder: if no deficit is expected, there is no need to discuss its distribution. This is underscored by the fact that no previously defined sanctions are laid down – apart from recommendations by the fiscal planning council.

Hence, the decision of March 21, 2002 does not contain the key elements of a long-term stability pact and leaves numerous problems unresolved – at least for the period after 2006. We therefore consider the pact to be a fair-weather agreement which can only work if the hoped-for economic upswing materialises.

Jörn Quitzau

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