The end of the pact could turn out to be a blessing


The end of the stability and growth pact will be a victory rather than a defeat if it leads to new ways of monitoring and controlling fiscal policy. John explains the need for governments to delegate responsibility for setting taxes.

The collapse of the stability and growth pact has left European fiscal policy in disarray. But this is not only a crisis for the European Union. Acrimonious debate in Brussels reflects hard choices at the national level. And not just in France and Germany. Gordon Brown, Britain’s finance minister, is struggling to balance the books ahead of next week’s pre-Budget statement. His US counterparts do not even try. The US has a growing federal deficit, plans for deep tax cuts and fiscal crisis in almost all 50 states.

Private-sector accountants have had a rough time recently but public-sector accountants have also been under pressure. France and Germany have at least been open in their breach of the EU’s budgetary rules. Had it not been for smart footwork by the people who manage its public finances, Italy would have been arraigned too. And Mr Brown has kept Britain’s public debt low by taking large amounts of public borrowing off-balance-sheet through the private finance initiative.

Only the US, home of Arthur Andersen, could have invented dynamic scoring. Since tax cuts are sure to promote growth, the deficits they seem to create are really revenue enhancements. Sounds familiar? This comes from the people who told you that the more money a dotcom was losing, the better were its prospects.

Around the world, monetary policy has gained credibility as fiscal policy has lost it. Inflation has been defeated but budgets are in crisis.

The difference is the level of political involvement. Politicians have willingly disengaged from the day-to-day management of monetary policy to set a framework within which central banks can perform that task. Central banks have used this autonomy to build authority and expertise. But politicians have engaged not just with the substance of fiscal policy but also with its presentation. US budget projections are based on fantastic assumptions, politically imposed.

A political fix that establishes more flexible parameters to replace the Maastricht criteria will not deal with this underlying problem. Fiscal policy needs a framework with moral authority, flexible when appropriate, rigid when necessary and independently monitored. Mechanisms of fiscal policy should enjoy the respect commanded by the Federal Reserve Board and the Bank of England’s monetary policy committee.

The idea of a fiscal policy commission seems to have originated with Alan Blinder, the US economist*, and has recently been developed in Europe by CESifo, the economic research organisation**. Expertly staffed and politically independent, such a body could gradually establish the same legitimacy as agencies of monetary policing. Its primary task would be to define the level – not the structure – of taxation needed to finance expenditure decisions. It would consider whether public accounts did indeed reflect a true and fair view. And as it gained credit for its independence, securities markets would make it hard for governments to ignore what it said.

The EU’s common currency requires both supranational and national supervision of fiscal policy. For the eurozone as a whole, a European fiscal policy commission should stand alongside the European Central Bank and perhaps operate under its auspices. Its brief would be to assess the consistency of national fiscal policies with the ECB’s inflation targets.

But it will be effective only if supported by similar bodies in individual member states. Governments will never delegate responsibility for setting tax rates. But they could, and should, delegate responsibility for judging the overall tax level appropriate to planned expenditure. As with monetary agencies, the best fiscal agencies would impose competitive pressure on the weaker and enhance their skills.

The end of the stability pact will be a victory rather than a defeat if it leads to new ways of monitoring and controlling fiscal policy. Such mechanisms are needed in Brussels, Paris and Berlin. They are needed even more in New York and Washington.

* ‘Is government too political?’, Foreign Affairs, 1997 ** EEAG Report on the European Economy 2003

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