Mind the Gap – International Comparison of Cyclical Adjustment of the Budget

Cyclically adjusted budget balance (CAB) is a widely cited and widely used concept in the evaluation of fiscal situations. The key idea behind it involves the identification of potential levels of economic variables. There are two recently used methods: the aggregate approach and the unconstrained disaggregate approach. In this paper we apply them on USA, Japan and 25 EU member countries to demonstrate that both approaches could be the source of considerable bias. While the aggregate approach cannot cope with different shocks, the unconstrained disaggregate method involves systematic bias and do not contain theoretical consideration. In order to avoid these distortions we present an alternative framework, which is able to incorporate the advantages of both approaches. Combining arbitrary output gap and constrained multivariate HP filter induces theoretically motivated disaggregation where we also exploit the implication of production function parameterisation. We found that the price effect resulting from the composition effect of different deflators could play an important role in evaluation of the fiscal position. To display the importance of composition effect we analyse the cyclical components of Finnish, Hungarian and Italian budget balances more in detail.cyclically adjusted budget deficit, price gap, business cycles, constrained multivariate HP filter

The Role of General Government in Hungary

The objective of this study is to present the changes in the general government’s role in the distribution and generation of income and in the functions of the state. The period under study is 1991-1997, with an emphasis on the fiscal adjustment which occurred during the years 1995-1996. In relation to this, a separate chapter addresses international experiences in fiscal consolidation and its theoretical aspects. In the period under study, the general government had a certain stabilizing impact. Up to 1993, overspending by the government retarded economic decline and following the commencement of economic growth the adjustment program which became necessary owing to the unsustainability of the external and internal equilibrium put the brakes on growth in the short term. Based on international experience, the most important factor for success is to be sought in the structure of the adjustment. This study concentrates on the presentation of structural changes, and particularly the structure of primary expenditures and revenues, even though its point of departure was the changes in the level of total expenditures and revenues of the general government. Between 1990 and 1997, the volume of the primary levels declined by nearly one quarter and the rearrangements which were effected within this were even more significant. It can be established that the decline was most vigorous on the expenditures side, in the case of expenditures on wages and transfers (particularly with respect to households). According to international experience, the savings achieved precisely in this area can be a guarantee for the lasting success of fiscal adjustment. However, the fiscal retrenchment of 1995-1996 in Hungary does not present us with a clear picture. Personal income tax was increased, there were tax increases of a one-off nature and cuts in public investment, too. This kind of measures were identified as less successful ones by international studies. According to statistics using the prime cost approach, the role of the public sector in income generation declined, as wage costs declined. Were it possible to take quality criteria into account when specifying performance, the picture would be different. According to international experience, some public sectors do not contribute to income generation even at prime cost, and in these areas it is possible to reduce spending without suffering any deterioration in performance. A counterexample can be provided by the tax administration, where a very close correlation can be demonstrated between wages and efficiency. The impact of the Hungarian measures, particularly with respect to changes in the number of persons employed, cannot be evaluated negatively in this respect. In addition to an institutional approach to general government, it is also important to take functional aspects into account - that is to say, it is necessary to the fiscal transparency to demonstrate quasi-fiscal activities performed outside the general government. (This study does not undertake to do so.)

The exception proves the rule? Fiscal rules in the Visegrád countries

This article gives an overview of the national fiscal rules in force or recommended for introduction in the Visegrád countries. In the article, we review the various potential elements of the regulation framework, in particular the debt rule as a limit, the balance target, the expenditure rule as an instrument and the fiscal council as a supporting entity for the entire framework. We establish on the one hand that the more a rule covers the scope of fiscal policy, the more effective it becomes. On the other hand, it is highlighted that filtering out the effect of exogenous factors – such as the economic cycle – is also important in ensuring that the rules restrict fiscal policy in such a way as to simultaneously prevent procyclical measures. The difficulty resides in the fact that the effects of exogenous factors and fiscal policy are difficult to distinguish. Resolving this issue may be one of the tasks of the fiscal council.fiscal frameworks, fiscal rule, fiscal council.

Act one, act first – the law on fiscal responsibility

The Law on Fiscal Responsibility adopted late 2008 is a new element in Hungarian fiscal policy, although not without precedent. Under the law, the Parliament and the Government limit themselves to prevent high fiscal deficits and a further increase in public indebtedness, experienced in recent years. Budget planning turns into a three-year process, hardening over time. As a first step, the targeted primary (non-interest) budget balance is subject to the requirement that the stock of government debt cannot rise in real terms. However, ex post, the law allows for deviations in fiscal performance-including those reflecting the effect of so-called automatic stabilizers-attributable to factors beyond the control of the authorities. This means that the actual deficit is not necessarily equal to the deficit path consistent with the real debt limit, but it may fluctuate around this trend over the medium term. In addition, the law prescribes observance of the pay-go principle. Finally, it provides for the establishment of an independent Fiscal Council entrusted with monitoring compliance with the rules and with transparency standards. We evaluated the law according to the Kopits–Symansky criteria applied in the international literature. In most aspects, the law exhibits favourable properties, consistent with the criteria, although inevitably at the expense of simplicity. The assessment suggests that the law would benefit from extending coverage of the rules to local governments. Moreover, enforceability of the rules would be strengthened if the law were adopted by a qualified legislative majority.fiscal rules, budget planning, Fiscal Council.

Quo vadis, deficit? How high the tax level will be when the economic cycle reverses?

The economic recession dampened tax revenues, causing deterioration – partly temporary, partly permanent – in the general government balance. The fiscal position can be assessed realistically if we can determine the level of revenue and deficit in the medium run. In order to do this, we prepare estimates of the trends of the macroeconomic variables determining tax bases and of the elasticity between tax revenues and tax bases. Trends in macroeconomic variables can be determined in three ways. Results from the macroeconometric model are more reliable and consistent. The simple time series method (ECB) is acceptable if it relies on prior estimation – e.g. one derived from the model – of the trends of macroeconomic variables. The Multivariate Hodrick-Prescott filter method (MVHP) only requires exogenously given potential GDP, and is thus suitable for simulation and for determining the uncertainty surrounding the estimate. Our model-based results show that the deficit for 2010 would be 2.8% lower if – over the medium term – there were convergence with the potential GDP forecast by the model. From 2011 this negative cyclical component will diminish by an annual 0.4-0.5%. If potential GDP is 1% lower, from 2011 tax revenues would approach a lower medium-term tax level 0.28-0.29% faster based on the MVHP method. If potential GDP is 1% higher, convergence to a higher tax level would be 0.30-0.31% slower.cyclically adjusted budget deficit, business cycles, constrained multi variate HP filter

From those lying facts to the underlying deficit

Developments in the headline budget balance are distorted by temporary factors. The most significant of these factors are the business cycle and creative accounting. Adequate information and estimates are available, allowing us to filter out these factors using a so-called adjustment for self-reversal. Expenditures and revenues adjusted in this way, however, continue to fluctuate, as fiscal policy measures can, in part, also turn out to be temporary in retrospect. We filter out this effect by using a four-year moving average (covering a full election cycle), instead of taking individual pieces of information into account. Moving averages are calculated in a forward-looking manner, for the three subsequent years in addition to the current year. This allows temporary effects in the past to be captured and renders their identification easier over the forecast horizon. Based on our results, the deficit indicators obtained using the adjustment for self-reversal and the adjustment for policy reversal are similar; the latter method, however, yields a higher deficit for the period 2010–2012, due to the tax cuts (phasing out of temporary taxes) announced for 2013. Overall, however, both adjusted indicators deviate substantially from the headline indicator, highlighting the significance of the adjustment.structural deficit, underlying deficit, cyclical adjustment, temporary measures, creative accounting

The reversal of the pension reform 1998 from a short-term perspective

The private pension pillar established in 1998 has generated equally important short-, medium- and long-term effects. This article addresses the short- and medium-term time horizons, which differ from one another. In the short term, the government lost contribution revenues, while its pension expenditures did not decrease. However, since this shortfall in state revenues did not influence the consumption and savings decisions of households, in this analysis the short-term indicators of fiscal impact on demand disregard the impact of lost revenues. In the medium term, however, the rechanneling of contributions increased public debt and household savings. Consequently, similarly to official statistics, our household indicators and our medium-term fiscal indicator (augmented SNA deficit) take into account the effect of lost revenues. As the vast majority of members returned to the state pension pillar in 2011, for the purposes of our analysis, we could well assume that the private pension pillar never existed. Accordingly, the difference between our medium-term fiscal indicator and the short-term indicator disappears. As a result, we have changed our household indicators retroactively in such a way as if the contributions and the returns they yielded had always belonged to the state. This was necessary because the official statistics do not spread this amount over time, but account for it in full for 2011 as a capital transfer between households and the general government, which renders evaluation of the developments extremely difficult.pension reform, savings, pension funds, statistical correction, net lending, deficit.

Tax evasion and tax changes in Hungary

Tax evasion reduces the efficiency of the economy as unequal opportunities of tax evasion leads to an inefficient distribution of resources. In Hungary, based on data for 2005–2006, tax evasion resulted in a transfer of 7.9 per cent of GDP from taxpayers to tax evaders. Following measures aimed to reduce tax evasion, this transfer was estimated to be 6.7 per cent of GDP in 2006 and 2007. Underlying reasons for tax evasion are the different burdens on labour and capital incomes. According to international experience, either the control of splitting labour and capital incomes or bringing their contribution burdens closer to one another can help in this situation. The effect of administrative measures is often temporary, because they do not improve tax-compliance attitude. A positive change in taxpayers’ attitude is an especially difficult task; one of its possible means can be a shift in the tax burden in favour of local taxes.taxation, tax evasion, hidden economy.

Apples and oranges? A comparison of the public expenditure of the Visegrád countries

In this article, the average expenditure of Hungary is compared to that of the other three Visegrád countries. In Hungary, this expenditure is higher by 10 % of GDP, but one-quarter of this is attributable to higher interest expenses, and one-third to revenue factors which simultaneously increase both revenues and expenses. These revenue factors have a neutral impact in terms of the deficit, but they distort the comparison in respect of the levels of expenditure. For example, the tax content of public expenditures, the sales and fee revenues collected directly to cover the expenditures, and the size of EU subsidies – flowing through the budget – vary considerably from one country to the next. Two-thirds of the remaining 4-percentage point difference appears in relation to households’ cash transfers (pensions, family allowances). Hungary spends more on public services and economic subsidies, but less on the current and capital expenditure of healthcare institutions.government expenditure, public spending, Visegrad countries.

Structural challenges towards the euro: fiscal policy

Broad theoretical consensus and vast empirical evidence reinforce the view that prudent fiscal policy – also advocated by the fiscal institutions of the eurozone – can support the stable long term growth. After presenting some general principles of the optimal fiscal policy, the paper analyses the questions of fiscal convergence necessary for the successful eurozone entry and membership of Hungary. The paper calculates the consolidation necessary to reach the 2008 deficit target set by the Convergence Program. Taking into account of not only the level of the government debt but also the relatively progressed state of the interest rate convergence, the potential reduction attainable in the interest balance is moderate. The main result of the paper is that the necessary consolidation measures are required to reduce the primary balance by approximately 3 percent. In case of cutting public expenditure it would require approximately 4 percent reduction taking into account the revenue content of those expenditures. The structure of macroeconomic growth is not expected to facilitate fiscal consolidation – as wage and consumption growth, which have major influence on the development of relevant tax-bases, are expected to be moderate – and no improvements in the balance are expected as a result of the EU accession. International experience, especially fiscal consolidations of eurozone member states, however, show that structural – i.e. quality-improving and sustainable – measures and the reform of the institutional framework are essential determinants of successful consolidations. Temporary measures and deficit reductions by creative accounting do not foster macroeconomic stabilization and their eventual reversal is highly probable.Fiscal Consolidation, Optimal Debt Policy, Maastricht Criteria.