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Public finance Course 1 Framework and tools

Public finance Course 1 Framework and tools. Introduction. What is public finance ? Study of the taxing and spending activities of a government Something misleading: because not financial (= not related to money) Economics of the public sector, public economics

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Public finance Course 1 Framework and tools

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  1. Public finance Course 1 Framework and tools PSE – Public Finance – Sandrine Duchêne

  2. Introduction What is public finance ? • Study of the taxing and spending activities of a government • Something misleading: because not financial (= not related to money) • Economics of the public sector, public economics “micro” functions : allocation of resources, distribution of income “macro” functions : use of taxing, spending and monetary policies to affect overall level or GDP or unemployment => usually taught in separates courses (A. Epaulard). Here special look : linkages between public finances and the business cycles (European framework for public finance analysis) PSE – Public Finance – Sandrine Duchêne

  3. Introduction Not in our field, but quite important => regulatory policies, which have important effects on resource allocation Sometimes, goals can be achieved by regulation or by tax and spending instruments. 3 examples: Environmental considerations : caps, permits, market instruments, taxation Labor market : economists admit that regulation/institutions can have a great influence on employment : labor contract, labor duration/ tax cuts diminishing labor costs Purchasing power : direct subsidies (especially to the poor)/ stimulating concurrence on the goods markets. PSE – Public Finance – Sandrine Duchêne

  4. Introduction Program I The « macro » framework : why monitoring public finance ? Data, facts and concepts Public finance and the business cycle Do we care about long term ? Are budgetary rules useful ? II The « micro » tools and main issues for reforms Tax policy: some theoretical concepts Reforming our tax system: some issues Public expenditure: public goods, education, social insurance PSE – Public Finance – Sandrine Duchêne

  5. Introduction Chapter I-1 Data, facts, and concepts The role of the public sector: current issues Public finance in EMU: an overview Example: the French situation (what is the problem ?) To practice: some calculation Concepts and data; procedures. PSE – Public Finance – Sandrine Duchêne

  6. 1- Role of the public sector/current issues What is public finance ? By tradition (Musgrave), three roles devoted to the public sector : • Allocation : Public good provision • Redistribution : social transfers, progressivity in the tax system • Stabilization : “automatic stabilizers” Do these 3 objectives conflict ? The answer is yes. • Trade-off efficiency/equity • Room for macroeconomic stabilization when there are pressures for a fiscal adjustment ? PSE – Public Finance – Sandrine Duchêne

  7. 1- Role of the public sector/current issues Illustration: Public expenditure breakdown PSE – Public Finance – Sandrine Duchêne

  8. 1- Role of the public sector/current issues Allocation Justifications for the State intervention in the provision of public goods are well known: the very nature of public goods, externalities, endogenous growth … justice, defense, security, education, health…but also direct interventions to corporations and individuals. Questions : • Cost/effectiveness of public policies? Efficiency of public spending? • What is the good production model? Distinguishing between financing and producing (delegation, agencies models): education, health, defense are concerned. • Public intervention proper area? Public coverage for expenditure (education, health). • Quality of public finance, allowing better growth in the long term? • Public policy evaluation PSE – Public Finance – Sandrine Duchêne

  9. 1- Role of the public sector/current issues Distribution Social insurance, horizontal and vertical distribution. Difficult to disentangle from the third function (stabilization): insurance aims at avoiding hysteresis effects in bad times (unemployment insurance, on-the-job training, minimum benefits) Current re-visited (old) questions : • Justification for the public action? “Minimalist” State avoiding economic distorsions, flat tax in Eastern European countries… • Rooms for manoeuvre: how to deal with the increase in the age-related expenditures? • Acceptable inequities in a society? Efficiency/equity dilemma. Fiscal competition issues. • “New” social contract: “rights and duties” issues PSE – Public Finance – Sandrine Duchêne

  10. 1- Role of the public sector/current issues Stabilization Size and effectiveness of automatic stabilizers Justifications for discretionary action along the business cycle Questions • Effectiveness of automatic stabilizers revisited in the context of fiscal retrenchments (keynesian/non-keynesian effects). Effectiveness of discretionary policies has been questioned • At the European level, leave enough margins to let automatic stabilizers play (“mimimum benchmark”) • Fiscal policy in the current crisis and discretionary policy: framework has to be adapted PSE – Public Finance – Sandrine Duchêne

  11. 2- Public finance in Europe : an overview The budgetary framework: initial framework (up to 2005) • Treaty (Maastricht 1992, then Amsterdam 1997) • Member states have to avoid excessive deficits, with respect to deficit and debt reference values • These references are defined in an annexed protocol (n°20): 3% of GDP and 60%. • Stability and Growth Pact endorsed in 1997: • Two regulations: preventive arm, corrective arm • Stability programs • Definition of medium term objectives (MTO): “close to balance or in surplus” PSE – Public Finance – Sandrine Duchêne

  12. 2- Public finance in Europe : an overview Main Issues for the conduct of fiscal policies in Europe • One common fiscal framework = common rules • Treaty and the reference values • Stability and Growth Pact (amended in 2005) • Addressing heterogeneous situations (as concerns deficit levels, cyclical conditions or sustainability conditions) • In the short run, enforce the whole play of automatic stabilizers (preventive arm of the Pact), better interpret the cyclical conditions (preventive and offensive arm), prevent “pro-cyclical biais”. This view is currently challenged by the huge economic downturn (Pact is suspended) • In the long run, address the problem of an increasing age-burden : achieving budgetary consolidation (stability programs) PSE – Public Finance – Sandrine Duchêne

  13. 2- Public finance in Europe : an overview The initial budgetary framework: strongly critized • From a theoretical point of view: lack of economic bases. Nominal targets independent on cyclical conditions, and on specificities of the countries (“one size fits all”) • From a practical point of view (crisis in 2003) Economic reflexion had already started in 2001-2002, continued till 2005. Reformed SGP in 2005 • Better attention paid to cyclical evolutions (course 2) • Better attention paid to the long term and sustainabitity questions, with linkage to the MTO(course 3) PSE – Public Finance – Sandrine Duchêne

  14. 2- Public finance in Europe : an overview Fiscal heterogeneity in Europe: crossing data on the level of public deficit and debt : PSE – Public Finance – Sandrine Duchêne

  15. 2- Public finance in Europe : an overview Consolidation efforts in 2007: dispersion PSE – Public Finance – Sandrine Duchêne

  16. 2- Public finance in Europe : an overview PSE – Public Finance – Sandrine Duchêne

  17. 2- Public finance in Europe : an overview Long term sustainability conditions PSE – Public Finance – Sandrine Duchêne

  18. 3- The French situation : what is the problem ? France: the pathologic case? A brief look at some facts • Public deficit: still high, around 3% • Public debt: increasing • Public expenditure: high compared to other countries (reflects social choices) • Tax ratio: high level in the context of fiscal competition All these elements are linked together • Expenditure monitoring is not stringent enough (compared to GDP evolutions) • No room for fiscal adjustments • No room for significant tax cuts PSE – Public Finance – Sandrine Duchêne

  19. 3- The French situation : what is the problem ? PSE – Public Finance – Sandrine Duchêne

  20. 3- The French situation : what is the problem ? PSE – Public Finance – Sandrine Duchêne

  21. 3- The French situation : what is the problem ? Public expenditure: long term trend and composition PSE – Public Finance – Sandrine Duchêne

  22. 3- The French situation : what is the problem ? Expenditure level : a French exception ? • High level, compared to other countries • Stability since 10 years PSE – Public Finance – Sandrine Duchêne

  23. 3- The French situation : what is the problem ? Since 20 years, public expenditure in line with GDP growth => no room for budgetary adjustment PSE – Public Finance – Sandrine Duchêne

  24. 3- The French situation : what is the problem ?(iii) Public receipts Tax ratio Source : OCDE PSE – Public Finance – Sandrine Duchêne

  25. 4- Some calculation • Assumptions • GDP = 2000 Md€ • Expenditure level = 50% of GDP • Receipts level = 48% of GDP • Debt level = 60% of GDP • Nominal interest rate : 5% Question 1 You just have been elected at the Presidency. You are discovering the budgetary situation. § What is the current deficit ? The primary balance ? PSE – Public Finance – Sandrine Duchêne

  26. 4- Some calculation PSE – Public Finance – Sandrine Duchêne

  27. 4- Some calculation Question 2 You are building the budget law for 2008. You forecast : GDP growth : 2,5% Inflation rate : 1,5% Suppose the public receipts are in line with GDP growth. Just after your election, you meet your “peers” at the Ecofin Council. You claim that you will respect the Pact. So you announce that you intend to reduce public deficit by ½ percentage point of GDP next year. § What must be the for the growth rate of public expenditure ? § What will be the deficit and debt ratio next year ? § What is the stabilizing deficit ? PSE – Public Finance – Sandrine Duchêne

  28. 4- Some calculation Notations B: general government balance (Md€) b: general government balance (% of GDP) [Public deficit = - b] R: public receipts (Md€) r: public receipts (% of GDP) S: public spending or public expenditure (Md€) s: public spending or public expenditure (% of GDP) g: GDP growth in real terms π: inflation of GDP g+ π: GDP growth in nominal terms gs: spending growth in real terms PSE – Public Finance – Sandrine Duchêne

  29. 4- Some calculation Equation for deficitvariation : First order approx 0,5 in Europe, 0,35 in the US PSE – Public Finance – Sandrine Duchêne

  30. 4- Some calculation Very practical« back on the envelop » formula GDP growth in real terms Expenditure growth in real terms = MARGIN for deficit reduction If gs<g : deficit reduces If gs>g : deficit increases Here :0,5=(2,5-gs)*0,5 Gs=2,5-1=1,5 PSE – Public Finance – Sandrine Duchêne

  31. 4- Some calculation Equation for debt accumulation : Stab def = 60%*0.04=2,4 Def =1,5 Debt variation = -0,9 PSE – Public Finance – Sandrine Duchêne

  32. 4- Some calculation Question 3 Your administration presents you the “technical” forecasts. Clearly the claimed evolution of expenditure is not realistic : medium term trend is rather 2% in volume per year. § What will the “true” deficit be ? § What can you do (to make the public finance forecast more presentable) ? To help you, you use the “elasticity” of the receipts with respect to GDP PSE – Public Finance – Sandrine Duchêne

  33. 4- Some calculation PSE – Public Finance – Sandrine Duchêne

  34. 4- Some calculation Equation for deficitvariation : PSE – Public Finance – Sandrine Duchêne

  35. 4- Some calculation PSE – Public Finance – Sandrine Duchêne

  36. 4- Some calculation Question 4 In addition you are fulfilling you campaign engagements. You decide tax cuts to support activity and employment : “paquet fiscal” amount = 1 point of GDP%. § What do you do ??? § Describe several options : ð“technical” ð“fulfilling European commitment” (expenditure/elasticity options) PSE – Public Finance – Sandrine Duchêne

  37. 4- Some calculation PSE – Public Finance – Sandrine Duchêne

  38. 4- Some calculation Question 5 Finally you decide announce a stabilization of the deficit next year, at its current level. You choose 1,2 for the elasticity of receipts with respect to GDP. § Describe the key figures of the forecasts § Prepare your arguments for the journalists ! PSE – Public Finance – Sandrine Duchêne

  39. 4- Some calculation PSE – Public Finance – Sandrine Duchêne

  40. 4- Some calculation Question 6 Bad luck, GDP growth collapses during 2008. Finally : • GDP growth is 1%. • Elasticity (which is a bit cyclical) is 0,8. • Expenditure rate is 2% in real terms. • What is deficit and debt ratio ? • You decide privatizations during the year (1% of GDP) : what are the final deficit and debt ratio ? PSE – Public Finance – Sandrine Duchêne

  41. 4- Some calculation PSE – Public Finance – Sandrine Duchêne

  42. 4- Some calculation Conclusion In April 2009, you notify the 2008 results to the European Commission • Observing that you are above 3%, the Commission launches the excessive deficit procedure against your country. • Well done !! PSE – Public Finance – Sandrine Duchêne

  43. 5- Concepts, data, and procedures What is a budget? Distinguishing budget preparation (ex ante), vote, and execution (ex post) • Juridical dimensions: authorization, vote by the Parliament. Strictly defined and bounded. Main issues: to allow information and control from the Parliament. • Procedure dimensions: elaboration of the budget law, voting rules and procedures. Technical questions: bottom-up or top-down procedures? How to better involve the Parliament? • Questions about accounting systems: reliability of the figures, accrued/cash presentations. Defining principles inspired by the rules applied to the private sector (if possible?) PSE – Public Finance – Sandrine Duchêne

  44. 5- Concepts, data, and procedures Two Finance laws voted each year (october-december) • budget law for the state • Social Security budget law • 3 types: LFI, LFR (“collectifbudgétaire”) , loi de règlement Two organic laws establishing the budgeting rules, recently revised • LOLF (2001), “ordonnance de 1959” • Organic law for the Social Security (2005) Local budget are adopted by the local executives. • Financial autonomy delivered by our constitution, but limited • Vote of tax rates (but not tax bases), expenditure, debt PSE – Public Finance – Sandrine Duchêne

  45. 5- Concepts, data, and procedures Principles for budgeting: the four “classic” principals 1- “Annualité” • authorization is given for one year. • Strongly criticized for a form of short sight (at the broad level, in the global monitoring of public finance/ at the “micro” level, for the managers who are in charge of structural reforms) • Current issues: pluriannuality. In september 2008 vote of a multi-annual budget for the state, covering a 3-year period (2009-2011) 2- “Unité” • One document for one procedure. • To ensure transparency and coherence of the budgeting elements. To make the political choices or trade-offs more explicit. (exceptions: comptesspéciaux du trésor, budgets annexes). • Current issues: “débudgétisations”. PSE – Public Finance – Sandrine Duchêne

  46. 5- Concepts, data, and procedures Principles for budgeting (continued) 3- “Universalité” • Double design • Avoiding contraction between receipts and expenditures, describing all the flows in the budget law • No receipt affected to some identified expenditure • Current issues: affectation of receipts can be justified : environmental taxes ; willingness to pay (health care) 4- “Spécialité” • Budgetary credits have to be affected to a precise expenditure • Specialisation by nature or objective of the public expenditure • Current issues: adoption of the new budget constitution (LOLF) in 2001, fully applied in 2006 PSE – Public Finance – Sandrine Duchêne

  47. 5- Concepts, data, and procedures Emergence of new budgetary guidelines 1- “Sincérité” • Ex ante: growth forecasts, receipts forecasts, realist evaluations for expenditures. Respecting budgeting rules (“charte de budgetisation”) • Ex post: accounts (LOLF) • Guidelines for budgetary transparency (IMF, OECD) 2- Equilibrium • 1959: an abstract reference (“equilibreéconomique et financier”). • Golden rule for the local governments • Since Maastricht: a juridical constraint, enshrined by the SGP=> margins for interpretation. A target for the medium term. • Currently debated: reforming the budget constitution and introducing an equilibrium constraint (for the State or the Social Security) 3- Performance/efficiency of public expenditure PSE – Public Finance – Sandrine Duchêne

  48. 5- Concepts, data, and procedures The LOLF innovation • A new architecture for the budget • Missions (34)/programmes/actions, reflecting economic concerns • Better reflecting the government priorities of public policies, and have a complete view of the amounts devoted to certain objectives • Role of the Parliament enforced: examines the whole budget, and not only additional measures. Better reporting of the government to the Parliament • Introduction of performance indicators for each program • Better implication of the public managers • Reform of the public accounts, certification process by the Cour des Comptes PSE – Public Finance – Sandrine Duchêne

  49. 5- Concepts, data, and procedures Budget law is composed of two parts • First part: « conditions générales de l’équilibre financier » – authorization to perceive taxes – debt authorization – fiscal measures applying to the year – spending ceilings – Equilibrium article • 2d part: – vote on the different expenditures (vote unity=mission) Evaluative/limitative expenditures or receipts Joined documents: text in itself+ “bleus” (“voies et moyens”, missions, RESF)+ “jaunes”, report on expenditure evolutions, report on taxes PSE – Public Finance – Sandrine Duchêne

  50. 5- Concepts, data, and procedures Elaboration of the budget laws • Actors • Direction du Budget/Direction de la sécuritésociale: central role • Matignon: coordination between the Ministry of Finance and the ministries, crucial arbitration role • DGTPE (macro and public finance forecasts) • Direction de la législationfiscale: fiscal measures • The « spending » ministries/ Social security agencies • Main issues: • Ensure coherence between both processes (PLF and PLFSS) => creation of the Ministry of Public Accounts steps up in this direction. • Allow discussions at the technical level between administrations PSE – Public Finance – Sandrine Duchêne

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