Independent Fiscal Policy

Today’s Financial Review column.

Eminent economist Brad Delong despaired at news of George W Bush’s second electoral victory four years ago:

The American political system . . . appears incapable of setting out the central fiscal [or budgetary] policy issues in ways that give voters a chance to make informed judgments . . . even between candidates whose programs are serious and those whose programs are mathematically impossible jokes.

Bereft of any magic plan, Delong conceded one glimmer of hope. Though monetary policy was still far from perfect, the new commitment to central bank independence had delivered a record period of strong and stable growth.

Delong proposed a similar shift in fiscal policy with an independent Fiscal Stabilisation Board having some role in managing the fiscal stance the budget deficit or surplus just as central banks now manage the monetary stance interest rates. Deputy Governor of the US Fed, Alan Blinder had outlined similar ideas.

Back then Australia had already been the first country to debate the issue. Keen to entrench continuing reform and alarmed at Howards apparent lack of economic reform vision, the Business Council of Australia (BCA) proposed a suite of macroeconomic reform policies including more independent fiscal policy.

It argued that both budgetary responsibility and flexibility would be enhanced if parliaments legislated to enable small across-the-board changes to be made to company and personal income tax rates. This power could then be exercised with some input from an independent Central Fiscal Authority. Of course, as now, governments could change the fiscal stance using tax and spending changes of their own choosing. But the scope for across-the-board tax changes would sit in the background rather like interest rates do today, both broadening the options available to manage the macroeconomy and constraining the government to deliver responsible and appropriate policy.

The BCA was agnostic about how much independence to give the Authority. After all, the simple provision of public advice as the Productivity Commission provides on tariff changes would usefully raise the cost of political irresponsibility.

But after a generation in which reform became a national policy reflex, a Great Complacency was setting in. I remember the delegation that put these ideas to political leaders on both sides their thoughts already turning to their next electoral auction. Independent fiscal policy advice would cramp their style. The conversation turned to more immediate concerns. BCA delegates left the meeting wondering who had come up with this idea anyway. It was your correspondent dear reader; now older, humbler, but (alas), no wiser.

And so it was that when company tax revenue came a gusher with the resources boom, it mainly funded improvised giveaways rather than further reform.

But with this idea, as with so much else, the landscape is changing fast. During booms more independent fiscal policy hamstrings politicians’ natural passion for pleasing their constituents. But when downturns threaten, at least within reason, it sets those passions free! In downturns politicians should spend more and tax less. But paradoxically they find it hard to do the right thing because voters, pundits and the markets take it for the usual expediency.

But, as Government Ministers compete to see how often they can say decisive, while dilly dallying daily around that other d word, “deficit”, how much easier their life might be with a respected, independent agency lending its authority to all that must be done; from reassuring the public and the markets of the appropriateness of even quite large deficits if they prove necessary, to ensuring that any fiscal stimulus is timely, temporary and well targeted? Oh and getting the government’s shoulder back to the fiscal wheel once recovery proves sufficiently robust.

In the long run most commentators suggest that independent fiscal and monetary agencies be separate with some coordinating mechanisms. But, given the need for speed and – yes – decisiveness while we’re thinking all that through, the Government could make Australia and international exemplar once again with a simple letter to the Reserve Bank Governor.

Dear Glenn,

Please work with us on our fiscal strategy.

And publish a regular report on how we’re going.

Love, Kevin

When the BCA argued for macroeconomic reform, we quoted John F Kennedy: the time to fix the roof is when the sun is shining. Alas, sun-drenched, we regressed to our lucky country ways. The perfect storm might do more to concentrate the mind.

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derrida derider
derrida derider
13 years ago

I’ve always thought this proposal politically unrealistic and anti-democratic to boot.

Monetary policy is overwhelmingly a technical question for managing inflation. Handing over control of it from elected politicans to unaccountable technocrats does not reduce accountability much, and gets rid of some credibility-destroying games coming up to elections (credibility of course really matters to monetary policy).

But all that is definitely not the case for fiscal policy. What we tax and how we spend is not merely, or even mainly, a question of short-run macroeconomic management but of what sort of a society we want. Even just in macroeconomic terms there are important questions of intergenerational effects which are inherently value-driven, and therefore ought not to be decided by faceless bureaucrats. And you can’t change tax and spending policy without changing distribution – putting that in the hands of unaccountable technocrats is just not gonna wash with either the elected pollies or their voting public.

NPOV
NPOV
13 years ago

I have to say I’m with dd.

In fact I’m more interesting in going the opposite direction – looking at ways in which voters can more directly have some say over taxing & spending – in other words, more direct say over “what sort of society we want”.

Here’s one guy’s idea on how this might work.

Sinclair Davidson
Sinclair Davidson
13 years ago

Nick – my understanding of this proposal has been much as what DD suggests. If all you want is ‘independent scrutiny’ then we’ve got heaps of that already. The official opposition for one and the pages of the Financial Review for another. Not to mention pesky bloggers and those awful voters …. Much like NPOV I’d prefer greater voter involvement in spending decisions – perhaps a survey at the back of the Taxpack would be a good start.

NPOV
NPOV
13 years ago

“A survey at the back of the Taxpack” is pretty much what that linked-to post suggests.

Sinclair, I have to ask, it doesn’t concern you that voters are more likely to press for further expansions in government spending if they have more say over it?
That would certainly be my expectation – based partly on the fact that when at various times I’ve asked those that generally don’t have an issue with higher taxes why they don’t voluntarily maximize their own taxes the response as invariably been something along the lines of “because I don’t get enough say over how those taxpayer dollars are spent”.

Sinclair Davidson
Sinclair Davidson
13 years ago

Nick – for a whole host of other reasons the PC should be closed down, and the ACCC, AQUIS etc. but that debates not going anywhere.

NPOV – no it doesn’t worry me, although I’d prefer a different outcome. There is a market for ideas and those of us on the small government side of things need to convince people that we are correct. People don’t want to be bamboozeled into small government, they need to be convinced. Bear in mind also that good government is not cheap government – if people had a greater say over spending etc. and a greater apprecation for the trade-offs over time, I suspect, we’d get better outcomes.

NPOV
NPOV
13 years ago

Sinclair, an entirely reasonable position! Though the idea that small government is somehow “correct” doesn’t make much sense to me – I personally don’t particularly care much about the size of the government, only the degree to which it’s doing its job well. All else being equal, of course it’s preferable to have government do what it does at maximal efficiency (i.e. minimal taxing and spending), but I personally doubt a government could deliver the level of services that we as a society expect while significantly shrinking its revenue base. If you personally want smaller government, I can assume that means you wish to see the government provide less services than it does now – a position I think you’d have a hard time convincing many voters to share.

Sinclair Davidson
Sinclair Davidson
13 years ago

If you personally want smaller government, I can assume that means you wish to see the government provide less services than it does now – a position I think youd have a hard time convincing many voters to share.

Yep, there is no rest for the wicked :)

Fred Argy
Fred Argy(@fred-argy)
13 years ago

I have my own doubts about its practicality too. Imagine trusting the Reserve Bank to offer advice on fiscal policy when, up to about June 2008, it has all its forecasts wrong, wrong and wrong again.

NPOV
NPOV
13 years ago

So is the only purpose of the independent body to set the size of any surplus and/or deficit? Meaning that the government itself was free to increase/reduce taxation or spending in any way it wanted providing the resulting budget balance target was met? How often would you see such a body meeting to set targets, and would governments be obliged to adjust their budgets mid-year if necessary?

NPOV
NPOV
13 years ago

Ok, so let’s say such a Fiscal Stabilisation Board meets today and decides that there should be budget deficit of $5B for the current fiscal year – for that to be meaningful the government is effectively mandated to adjust taxation/spending to meet that target – but I don’t see how that’s compatible with being “free as they are now to adjust their budgets whenever they like”: if they didn’t like the advice of the board, could they not simply put off adjusting the budget until the board revised its target?

NPOV
NPOV
13 years ago

Except there’s a fairly major difference – the RBA directly sets the interest rate, and the government doesn’t have to do anything further – and as you say, if it doesn’t like it, it has to make a fairly extraordinary intervention…whereas with a “surplus/deficit target” announced by a Fiscal Stabilisation Board, the government has to act specifically in order for it to be met, and it could take as long as 12 months to determine whether they’d actually achieved the target.
I don’t think that’s a show-stopper, but I suspect it would significantly limit the ability of FSB to actually achieve much.

Does anyone of anywhere in the world something like this has been tried?

Tel_
Tel_
13 years ago

People don’t feel upset by the idea of an independent judiciary and an independent police force. In theory at least, the reserve bank are both judge and police with regards to fiscal matters, keeping an eye on government spending and making sure the monetary consequences of government actions are well understood.

It is a difficult role, and some of the RBA calls seem a bit arbitrary. Then again, the police and courts are called on to make difficult judgements every day and no one seems concerned over that. We have had crazy screw ups like the Dr Haneef affair (clearly caused by government using the police force for political purposes) with very little public outcry. If the RBA had involved itself in a similar level of tomfoolery, we would hear howling for vengeance and the sound of heads falling into baskets.

NPOV
NPOV
13 years ago

I’m not sure I’d say there was “very little” public outcry over the Haneef affair – considering it really only involved a single person, who was not even an Australia citizen, I was actually (pleasantly) surprised at how much fuss there was over the matter. Unfortunately my electorate still chose to re-elect the minister responsible, but there’s evidence that the whole affair definitely cost the Liberal party some support.

pedro
pedro
13 years ago

Tel, the idea of the independent judiciary is a bulwark against government and in support of the rule of law. Plus, the judiciary interprets and enforces the law made (or allowed to remain) by politicians. The RBA’s monetary policy role is somewhat analagous and thus requires independence.

But the idea that politicians should not be in control of spending is a different matter. Having an independent body play such an intrinsically political role, even if only advisory, creeps me out a bit. We already have nonsense going on with claims that the opposition should not be challenging institutions like the Treasury.

Fred Argy
Fred Argy(@fred-argy)
13 years ago

My reactions to your viewpoint are straightforward.

Firstly, I presume that the RBA would be expected to exert considerable moral suasion on the Government. That would make it very costly for the Government to say no.

Secondly, the RBA is very often prone to error, as we saw this year.

Thirdly, I share with DDD the belief that you are giving excessive (antidemocratic) power to the RBA.

And finally, it should be the Governments role to assume its full set of fiscal responsibilities. If it is so concerned about deficits to do anything about them, the Government would then have to accept the blame for obviously failing to do its job well. That is the way democracy usually works.

pedro
pedro
13 years ago

Nick I was referring to the advisory capacity and I hope I understand your point the difference between deciding spending and deciding the fiscal balance because of macro-stimulatory issues, but it still seems too much of a control over the political decisions and as earlier noted there is plenty of commentary already.

Plus, can the fiscal balance be considered independently from the nature of the spending. A deficit is one thing, a deficit for pointless spending another. Couldn’t such an advisory be used to justify something like pouring more money into car manufacturing, for example?

There is a considerable difference between government taxing and spending and monetary stability. It’s much easy to see when my money is taken in taxes and spent on carmakers.

pedro
pedro
13 years ago

I hope the government remains shy of running deficits for recurrent spending. By all means do so where necessary, but in the commentariat, willingness to run a deficit is starting to sound like the new hairychestedness. If, say, you manage to get through Xmas without resorting to the credit card, that would be a good thing. Surely the same applies now.

Tel_
Tel_
13 years ago

But the idea that politicians should not be in control of spending is a different matter. Having an independent body play such an intrinsically political role, even if only advisory, creeps me out a bit.

I’m in control of my own spending in as much as to say that if I have money in my pocket then I can choose where and when to spend it, and what I want to buy. I’m not able to conjure more money into my pocket any time it suits me, so there is a ceiling on my spending that is beyond my control. I would feel comfortable with government being subject to the same rules that I have to live under.

My personal feeling is that a balanced budget should always be the target, so the only job of an independent Fiscal Stabilisation Board would be to provide transparency and an independent audit. I appreciate that in boom years there will be a natural tendency for the system to run in surplus while in recession years the tax input will fall away and the social security burden will increase — thus the perfectly balanced budget is not always practically achievable. Many people have trouble remembering what happened last year, or planning for next year so one possibly useful role of a Fiscal Stabilisation Board would be to help such people get a feeling for the larger picture.