lueber swiss debt brake,, pol econ of fiscal deficits
TRANSCRIPT
The political economy of
public debt and budget deficits
The Swiss debt brake as a model
for sustainable fiscal policy
2
Master Thesis
Author: Benjamin Lueber
Technical University Dresden
Study program: International Relations,
Global Political Economy
Supervisors: Prof. Dr. Alexander Kemnitz,
Patrick Zwerschke
July 19, 2016
Student number: 3799471
3
Abstract
English
The debt containment rule adopted in Switzerland in 2003, called the debt brake, is a
Swiss made fiscal rule. The Swiss debt brake has been very successful in reducing
Switzerland’s federal public debt levels, thus leading the federal budget on a
sustainable path. The debt brake as a model for sustainable fiscal policy, however, must
be viewed in light of Switzerland’s specific political context and its unique institutions
that support the Swiss fiscal framework. The most notable political factors include a
general culture of fiscal conservatism, which also becomes evident with the
constraining elements of government expenditure at the cantonal and municipal level,
and a strong parliamentary majority for reining in the growth of federal government
expenditure since the 1990s. The debt brake is the culmination of previous efforts to
constrain public spending and its design is a good reflection of the policymakers’
shared preference for the primacy of automatic stabilizers over discretionary fiscal
policy. The constrains of direct democracy on public spending on Switzerland’s federal,
cantonal, and municipal government level does not singularly limit spending, but
profits from the existence of a federal structure with strong fiscal autonomy and fiscal
referendums in place.
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Abstract
German/Deutsch/Allemand/Tedesco
Die Schweizer Schuldenbremse, eingeführt im Jahr 2003, ist das Kind von deutlichen
Schweizer Einflüssen; im Gegensatz beispielsweise zu den supranationalen
Fiskalregeln des Europäischen Stabilitätspakts. Die Bestimmungen der Fiskalregel
führten zu einer nachhaltigen Fiskalpolitik. Die Schuldenbremse als Erfolgsmodell für
Fiskalregeln bedarf allerdings eines genauen Verständnisses seiner landesspezifischen
Erfolgsgrundlagen. Als die wesentlichsten politischen Faktoren gelten: eine
konservative Kultur hinsichtlich staatlicher Ausgaben, welche sich auf kantonaler und
kommunaler Ebene institutionalisiert hat, und eine seit den neunziger Jahren
vorherrschende starke parlamentarische Mehrheit zur Eindämmung der Ausgaben des
Bundeshaushalts. Die Schuldenbremse ist das letzte Element einer schrittweisen
Verstärkung der Mittel zur Schuldenbegrenzung. Die sehr restriktive Fiskalregel
funktionierte auch deshalb, weil seine Ausgestaltung der passende Ausdruck des
politischen Willens einer Präferenz für das Primat von automatischen Stabilisatoren,
verbunden mit einer Abkehr der aktiven Fiskalpolitik, ist. Der direkten Demokratie
wird in der Mehrzahl der Studien ein zu hoher mäßigender Einfluss auf die
Staatsausgaben auf föderaler, kantonaler und Gemeindeebene zugesprochen, da dieses
institutionelle Mittel nur dank anderer Elemente wie einer starken Ausprägung von
Finanzautonomie der Kantone und Gemeinden diese Wirkung ausüben kann.
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Acknowledgements
I would like to express my deep gratitude to my master thesis advisors, Professor Dr.
Alexander Kemnitz and PhD student Patrick Zwerschke. I am thankful for their
academic and personal support during the process of writing my master thesis.
While conducting studies on the topic of my thesis, I was able to speak to people
involved with the legislative and executive branches of the government as well as
academia. First, I am grateful for the opportunity to speak with Leo Müller, President
of the Finanzkommission of the CVP (Christian Democratic People’s Party of
Switzerland) and member of the Swiss National Council (Nationalrat). I would also like
to thank Adrian Martínez, economist in the fiscal-policy section of the Swiss Ministry
of Finance (Eidgenössisches Finanzministerium), for his expert advice and for sharing
his insights on Swiss fiscal policy, particularly on the debt brake. Professor Gebhard
Kirchgässner of the University of St. Gallen has published several influential scientific
articles on Swiss fiscal policy and has kindly shared his wide knowledge about this
subject with me. Finally, I would like to thank Dr. Frank Bodmer, who was formerly
employed at the Eidgenössisches Finanzministerium and who published several
scientific investigations on the Swiss debt brake, for a fruitful discussion on the most
important aspects of the functioning of the Swiss debt brake.
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List of Illustrations
Figure 1: Gross public debt for the Eurozone, UK, and US, 1970–2004. ..................... 12
Figure 2: General government net lending for the Euro area and OECD countries
(1970–2010). ................................................................................................................. 13
Figure 3: EU countries: Precrisis fiscal performance and national fiscal rules. .......... 17
Figure 4: Budget planning and the use of medium-term budget frameworks (MTBFs).
Average three-year-ahead forecast error. ..................................................................... 21
Figure 5: Cyclically adjusted budget (CAB) balance, CHF million (1980-2012). ......... 31
Figure 6: Budget deficits/surpluses and business cycles, 1970-2000. The red lines
indicate real GDP growth; the blue lines show the balance of the federal budget
(million CHF) ................................................................................................................ 32
Figure 7: Switzerland: Debt-to-GDP ratio of the federal government, cantons, and
communes, 1980-1999. ................................................................................................ 33
Figure 8: Switzerland: International comparison of general government debt ratio (in
percentage of GDP). ...................................................................................................... 33
Figure 9: “Iceberg” metaphor for the Swiss debt brake as the most visible part of the
much larger Swiss fiscal framework. ............................................................................ 35
Figure 10: Correlation between the fiscal stance and the output gap ......................... 39
Figure 11: Ideal development of public expenditure under the provisions of the debt
brake. ............................................................................................................................ 43
Figure 12: Switzerland, gross federal debt (1980–2011). LHS: left-hand side; RHS:
right-hand side. Gross federal debt levels started to decline in 2005, two years after
the introduction of the debt brake due to an economic recession. .............................. 46
Figure 13: Fiscal impulse of the federation and social insurances (1951–2007).
Vertical axis left side: fiscal impulse as a percentage of GDP; right side: real GDP
growth (in percentage points). ..................................................................................... 47
Figure 14: Investment spending (1980–2011). The cyclical nature of investment
spending stopped and steadied under the debt brake. ................................................ 49
Figure 15: Decentralization across the world (98 countries – average 1972–2000);
subnational and expenditure shares. ........................................................................... 52
Figure 16: Swiss parties and their number of votes won (as a percentage of the total
amount of seats) in the elections for the Swiss federal parliament (Nationalrat). ......61
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List of abbreviations
EU
European Union
GDP
Gross domestic product
IMF
International Monetary Fund, international organization based in Washington D.C.
MTBF Medium-term budget framework
MTEF Medium-term expenditure framework
OECD
Organisation for Economic Co-operation and Development, international organization based in Paris
PFM
Public financial management
SGP Stability and Growth Pact of the European Union
UK
United Kingdom
US
United States of America
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List of Contents
1. Introduction ...................................................................................................................... 10
2. Fiscal institutions and their effects on fiscal performance ................................................12
Fiscal institutions’ background and motivation ....................................................................12
Fiscal transparency, fiscal councils, and fiscal rules as the three main ingredients of public
financial management ........................................................................................................... 13
The role and modalities of fiscal rules ...................................................................................16
Fiscal rules and their effects and fiscal outcome ...............................................................16
Ensuring the effectiveness of fiscal rules: A question of institutional environment .........19
3. Political economy of fiscal deficits .................................................................................... 23
Why fiscal planners must be political economists ............................................................... 23
Preference heterogeneity between policymakers and voters ............................................... 24
Heterogeneity of interests across politicians ....................................................................... 25
Heterogeneity of interests across social groups or regions .................................................. 26
Smart reforms of the budget process as an instrument against the common pool problem26
Two forms of fiscal governance: The delegation and contracts approaches ........................ 28
4. Swiss debt brake as a case study for analyzing the effect of political context on the
performance of fiscal rules ....................................................................................................... 30
Background and rationale of the introduction of the Swiss debt brake ............................... 30
Deterioration of public debt levels across all federal levels .............................................. 30
The institutional context of the debt brake ....................................................................... 34
Political culture: Fiscal conservatism as a strong norm in Swiss society ............................ 36
Structural reforms as a means of tackling the procyclical stance of federal fiscal policy .... 38
Characteristics and optimization of the Swiss budget process ............................................ 40
Characteristics of the Swiss debt brake as a type of fiscal rule .............................................41
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The operation of the mechanism .......................................................................................41
Enforcement: The functioning and importance of the compensation account ................... 44
Effect and relative success of the fiscal rule since its introduction .................................. 45
Reforms of the budget process resulting from the debt brake ............................................. 49
5. The effect of political context on the performance of the Swiss debt brake ...................... 51
The unique characteristics of the Swiss institutional system and their influence on public
spending ................................................................................................................................ 51
Political environment ............................................................................................................ 51
Fiscal federalism ................................................................................................................ 51
Direct democratic elements .............................................................................................. 53
Primacy of automatic stabilizers .......................................................................................... 56
Made in Switzerland: Political context and the Swiss debt brake ........................................ 62
6. Conclusion ........................................................................................................................ 64
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1. Introduction
Before the 2015 parliamentary elections in the United Kingdom (UK) in 2015, the
British Labour Party made fiscally responsible behavior its top priority in the election
campaign. The Budget Responsibility Lock, as the fiscal plan is called in the Labour
manifesto, puts a premium on the national finances by making the plan the basis of all
proposed campaign plans. The commitment to sound public finances is on the cover of
the manifesto, and Ed Miliband, leader of the Labour Party at the time, said his party
was the “party of fiscal responsibility.”1 The party pledges to bind its policies to fiscally
prudent behavior and to achieving deficit reduction every year.2 This focus on solid
public finances is indicative of the heightened importance of fiscal responsibility in
politics and society. Not only in Britain, but also in the majority of countries, both
politicians and the public have realized the relevance of sustainable fiscal policy. But
how can those in power materialize their electoral promises or make efforts to assert
control of public finances? This is the leading question behind this study.
In Switzerland, a fiscal rule called the Swiss debt brake has largely been responsible for
a strong reduction of federal public debt since its introduction in 2003. The fiscal rule,
which requires expenditures to equal revenue, has gained considerable attention
among policymakers and international organizations such as the Organisation for
Economic Co-operation and Development (OECD) and the International Monetary
Fund (IMF) because if its success. For this reason, a better understanding of why and
how this fiscal rule was able to put public finances in Switzerland on a sustainable path
could potentially help other countries to improve their unique fiscal frameworks and
budgetary processes. This study will thus analyze the Swiss debt brake as a model for
controlling public finances and achieving more effective fiscal policies.
The first chapter of this study will introduce the current state of thinking on fiscal
institutions (such as fiscal rules) as well as technical aspects related to the
improvement of public financial management. The discussion provides the necessary
background for understanding the manner in which the design of fiscal institutions
(such as the Swiss debt brake) may increase a country’s fiscal performance. The second
chapter provides theoretical input for assessing how the Swiss debt brake was
1 Buchsteiner (2015): 5 2 The Labour Party (2015)
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successful in changing the spending behavior of the political actors responsible for
federal expenditure. Enhancing fiscal policy requires theoretical insights relating to
political economy, since it is as much a political as an economic question.
Subsequently, the Swiss debt brake as a fiscal policy instrument will be studied
regarding the motivation behind its introduction and the structural reforms following
from compliance with its provisions. Thus, this chapter’s analysis will provide
important explanations on the particular conditions that created the necessary political
commitment to the rule, thereby contributing to the rule’s success. Lastly,
Switzerland’s political context will be analyzed in order to determine how its
institutions served to constrain public spending. Another reason for this case study is
the absence of a good understanding of which Switzerland’s political factors made the
rule function. This analysis also makes a general contribution to the assessment of
institutions’ effects on public expenditures; the most relevant institutions for public
spending in Switzerland include its strong federal structure, direct democracy, and a
tradition of power sharing.
This study thus strives to contribute to the evolution of fiscal policy. While the benefits
to the economy via more effective fiscal policy are straightforward, better fiscal
performance is not only a matter of economics and economic welfare: ensuring all
citizens’ trust and belief in public finance forms a major part of democracy (and indeed
of every political system). The debate over effective fiscal policies should not neglect
the way in which citizens consider sustainable fiscal policy to be a central issue for
future generations and a general question of responsible government and legitimacy.
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2. Fiscal institutions and their effects on fiscal
performance
Fiscal institutions’ background and motivation
In the course of the last few decades, spurring public debt as a percentage of gross
domestic product (GDP) has been a common concern for most advanced economies.
As illustrated in figure 1, debt levels have accumulated from the late 1970s onward in
most of Europe as well as in the United States of America (US). Pointing to the same
trend, figure 2 demonstrates how governments since the 1970s have consistently run
budget deficits. These numbers are a reflection of a phenomenon called deficit bias.
Although countries have strengthened their fiscal frameworks and have increased their
knowledge about fiscal policy, the quest for sustainable finances will remain a sensitive
issue for the near future.3 This has led many countries to launch structural reforms in
an effort to achieve fiscal discipline and to reduce debt levels to a sustainable level;
these efforts may be summarized as institutional budget reforms.
Figure 1: Gross public debt for the Eurozone, UK, and US, 1970–2004.
Wyplosz (2005): 65
3 See also: Wyplosz (2005): 64-65. In contrast with the evolution of monetary policy, Wyplosz is very
negative on the state and performance of fiscal policy and fiscal rules in the year 2005. He regards it as
“no surprise […] that debts and deficits continue to flourish in many countries.”
13
It is important to note that fiscal discipline does not demand budgets to be balanced
each year, but deficits do need to be matched by budget surpluses, which is why
focusing on business cycles has proven to be beneficial. In addition, achieving a
sustainable fiscal policy does not necessarily require lowering public debt in absolute
terms: the imperative is to keep the development of public debt stable in relation to
GDP. The growth of public debt must not be higher than GDP growth. The factors
related to the proper implementation of fiscal institutions to reach the goal of solid
fiscal finances will be the focus of this paper.
Figure 2 General government net lending for the Euro area and OECD countries (1970–2010).
Hagemann (2011): 77
Fiscal transparency, fiscal councils, and fiscal rules as the three main
ingredients of public financial management
The management of a country’s public finances is an essential task of government.
Fiscal policy is the means and primary tool by which governments can influence
macroeconomic stability, growth, and income distribution. Due to the key importance
of budgetary policy, numerous studies by international organizations such as the IMF
and the OECD, as well as those conducted within academia, have investigated
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institutional budget reforms and best practices for achieving sustainable public
finances.
The proper institutional arrangements that support fiscal policy may be summarized
by the term public financial management (PFM). According to North, PFM is defined
as:
“PFM is concerned with the laws, organizations, systems and procedures
available to governments wanting to secure and use resources effectively,
efficiently and transparently.”4
For example, fiscal sustainability as a key goal of fiscal policy will be strengthened if
budget institutions are properly put in place.5 PFM accordingly is of strong relevance,
since it has a clear bearing on the effectiveness of fiscal policy. Specifically, researchers
have identified three categories of institutional reforms of PFM: fiscal transparency,
fiscal councils, and fiscal rules.6 The transparency of fiscal accounts is strongly linked
with effective fiscal policy; the requirements of fiscal transparency are
“comprehensiveness, quality, and timeliness” in reports on public finances.7 Put
differently, public fiscal reports must be understandable, thus putting citizens in a
position where they can hold the government accountable for fiscal policy.
Furthermore, reports must be reliable and must not leave room for the manipulation
of fiscal positions.8
Fiscal disclosure has improved in recent years, since countries have tried to implement
a “set of internationally accepted standards for fiscal transparency.”9 With good fiscal
transparency in place, it is possible to strongly mitigate fiscal risk; because the financial
crisis has revealed large gaps in fiscal transparency, however, standards and practices
related to fiscal transparency have been refined in recent years.10
Second, various considerations of supporting mechanisms for fiscal policy have
emphasized the importance of fiscal councils. As a result of the allegedly positive effects
of such councils, Canada, Ireland, Portugal, Sweden, and the UK have introduced such
4 Allen, Hemming, Potter (2013b): 1 5 Allen, Hemming, Potter (2013b) 6 Hemming (2013c): 36 7 IMF (2012): 3 8 Ibid. 5 9 IMF (2013): 39 10 IMF (2012): 3
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councils in the past few years.11 Both the growing number and the prominence of fiscal
councils have stemmed from their endorsement by international organizations such as
the IMF and the OECD as well as the positive effects illustrated by existing fiscal
councils.12 It should be clear, however, that as with fiscal institutions in general, the
role and modalities of fiscal councils have to be adapted to a country’s unique political
and economic configurations.13 By focusing on the Swiss debt brake, this paper will
provide further analytical backing for this specific argument. Thus, the various fiscal
councils in existence have different mandates, rights, and functions.14
Fiscal councils can potentially have a strong role to play in enforcing fiscal rules.15
Because they are independent and publicly funded, they can inform public debates in
a neutral manner; their analysis of fiscal developments can facilitate budget
preparation and can also prevent politicians from making unrealistic promises by
providing input on the budgetary effects of proposed spending programs.16
Before introducing the third component—fiscal rules—it should be stressed that all
three sets of institutional reforms are linked. In other words, the success and potential
of fiscal rules do not work in isolation and will depend to a large extent on the degree
of fiscal transparency and the configuration of fiscal councils.17 The analysis of the
Swiss debt brake and the Swiss fiscal framework as a whole in the following chapters
will also serve to highlight this central argument. One should also not expect that fiscal
rules will miraculously put public finances on a sustainable path.18 Similarly, the
effectiveness of fiscal rules will be enhanced if they operate within a framework. A
strong argument in favor of framework-based rules is that they are more aligned with
the particular economic conditions and political culture of a country.19 We should bear
11 Hagemann (2011): 76 12 Hagemann (2011): 82 13 Hemming (2013c) 14 IMF (2013): 44 15 Ibid.
16 Frankel, Schreger (2012): 268-270 17 Kopits, Symansky (1998): 1; Schick (2010) makes a similar argument on page 48 of his article, but puts more emphasis on political commitment and disciplined budget procedures. As will be shown in the chapter on the analysis of the Swiss fiscal framework, the Swiss debt brake serves as a neat example of a disciplined budget procedure. It has improved the Swiss fiscal framework decisively with regards to establishing a disciplined budget procedure. 18 Kopits, Symansky (1998): 17 19 Schick (2010): 44
16
in mind that more variance is to be found in fiscal rules than in monetary or exchange-
rate rules; fiscal rules are also more complex.
Fiscal rules constrain fiscal policy because they track the numerical development of a
certain fiscal indicator and require political decisions in case inconsistent fiscal policies
are enacted. Fiscal rules may be grouped into four different categories: expenditure
rules, budget-balancing rules, debt rules, and revenue rules; the rules are classified
according to the fiscal indicators or target variables they use. The first category,
expenditure rules, are also called “ceilings” because they predetermine a given level of
government expenditure before budget preparations begin. The second type (budget-
balancing rules) limit government spending by capping spending to the amount of
revenues; those rules may require the budget to be balanced over a business cycle,
meaning that budget deficits must be subsequently matched by surpluses.20 Third, debt
rules are limits that apply to the amount of government debt; these limits may be set
in nominal terms or as a ratio to GDP.
The role and modalities of fiscal rules
Fiscal rules and their effects and fiscal outcome
In most developed countries, fiscal rules have been established against the background
of such rules’ potential role in reaping the benefits of solid finances; it appears that EU
countries with national fiscal rules in place have generally achieved better fiscal
performance than those without. Graph 3 shows the average structural balance of 27
EU countries over the time period of 2002 to 2007. The effect of these rules on sound
fiscal outcomes can yield positive results through macroeconomic stability, fiscal
responsibility, and overall policy credibility.21 Macroeconomic stability is largely
strengthened through the following channels. Fiscal rules that increase fiscal discipline
can provide stability, because the very notion of fiscal sustainability implies that fiscal
policies may be maintained indefinitely; unsustainable fiscal policy, in contrast, will
have negative implications on the economy by creating an atmosphere of uncertainty.
This occurs because businesses and consumers will ultimately expect the government
20 Wyplosz (2005): 69 21 Kopits, Symansky (1998): 6
17
to introduce changes to fiscal policy.22 Alongside other negative effects, this type of
situation might lead companies to withhold investments, as occurred in 2013, when
the US government experienced a deadlock in negotiations on a debt-reduction plan.23
Figure 3: EU countries: Precrisis fiscal performance and national fiscal rules.
IMF (2013): 43
Fiscal rules may also serve as a deterrent of procyclical fiscal policy, thereby weakening
fluctuations of the business cycle; such rules may then support a key element of fiscal
policy, which is the stabilization of production and employment. Although most
governments understand the need for countercyclical fiscal policy, actual practice has
shown that most countries will increase their government spending when more
revenue becomes available during economic upswings. Fiscal rules may therefore lack
the required political commitment to correct the imbalance that was described above
as deficit bias. Fiscal expenditure rules, for example, leave less room for political
22 European Central Bank (2009): 17 23 New York Times (2014). The Article called “Uncertainty in Washington poses long list of economic perils” describes the negative effect of uncertain US fiscal policy on US businesses and economic growth. The Business Roundtable (a representation of the main executives of the nation’s biggest companies) is quoted as using their leverage to achieve stability in tax and fiscal policy.
18
bickering because they clearly set a ceiling for spending. Violation of the expenditure
rule is also made more difficult, since the rule’s operations are transparent.24
It is equally important to emphasize the correlation between persistent fiscal deficits
and high debt (on one side) and economic growth on the other. The main result of an
empirical study by Rogoff and Reinhart (“Growth in a Time of Debt,” published in
2010) was that countries with levels of public debt over roughly 90 percent of GDP will
experience significantly lower levels of economic growth. 25 Their study served as a
strong reference in the public debate over public finances and elevated public debt
levels at the time of the paper’s publication. For example, advocates of austerity
measures during the Eurozone debt crisis used the Rogoff/Reinhart investigation as
part of their scientific evidence in favor of austerity.26 Fiscal rules, when they are
effective, create fiscal space, thus allowing for fiscal policy responses to economic
crises, natural disasters, or other obligations.27 If countries that lack fiscal buffers
spend money in response to critical situations, the chances will be even higher that
fiscal sustainability or the stability of the economy will be compromised.28
Another significant advantage of fiscal rules is that they can lead to lower borrowing
costs for public debt on the capital market. This financial gain is materialized indirectly
through fiscal responsibility, as perceived by financial actors.29 One reason many
emerging economies have introduced fiscal rules is because they want to reinforce the
image that they are fiscally disciplined, which will then allow them to profit from open
capital markets.
24 Anderson, Sheppard (2009): 20 25 Rogoff, Reinhart (2010) 26 In 2013, Jens Weidmann, president of the German Bundesbank, defended the need for fiscal consolidation in the European Union and argued against critics who raised doubts about the scientific value of the study by K. Rogoff and C. Reinhart. Source: http://www.zeit.de/wirtschaft/2013-04/weidmann-rogoff-reinhart-studie 27 Hemming (2013c): 32-33 28 Marcel (2013): 10 29 Hemming (2913c): 29-34
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Ensuring the effectiveness of fiscal rules: A question of institutional
environment
This section discusses fiscal rules and the conditions related to their effects on fiscal
performance. As was briefly noted earlier, the specific contributions of fiscal rules and
fiscal institutions in general on fiscal outcomes are difficult to assess.30 Stated another
way, causality between good fiscal rules and the effects of those rules is difficult to
ascertain. Although data might indicate correlations, empirical studies may be flawed
due to the “endogeneity” problem. In other words, the fiscal rules themselves might
only be expressions of the already-established preference and commitment to sound
public finances that are shared by voters and politicians alike.31 Indeed, in cases where
fiscal discipline is maintained without restraints by rules, fiscal rules might be
redundant; alternatively, fiscal rules will lose their strength when governments do not
provide proper enforcement and commitment over a medium time frame.32
Despite the reservations enumerated above, it is possible to make a few valid points
about the design and performance of fiscal rules. As a general rule, fiscal rules fare
better when governments maintain good formulation and good operation of the rules.
Fiscal rules must first be applied before the budget is approved; apart from this
commonality, fiscal rules feature different characteristics. Allen Schick, professor and
leading scholar in the field of budget policy and budget processes, has identified five
criteria regarding the improvement and evaluation of fiscal rules:
i. The time frame should be lengthened from a single year to the medium term;
ii. Baseline projections (or forward estimates) should be created of future
budgetary conditions;
iii. Estimates should be made of the impact of policy changes on future budgets;
iv. (Procedures should be enacted for monitoring budget out-turns and for taking
corrective action when necessary; and)
v. Enforcement mechanisms should be put in place to prevent opportunistic
politicians from breaching the rules.33
30 Anderson, Sheppard (2009): 21 31 Millar (1997): 18-19 32 Anderson, Sheppard (2009): 21 33 Schick (2003): 8-9
20
First, the performance of fiscal rules will be jeopardized if budget-making is
constrained by a short-term focus (annual or biennial), since this can allow
governments to evade fiscal pressures by shifting expenditures to the following fiscal
years or by gaining short-lived increases in government income. Governments can
avoid this short-term focus by extending the time frame, for example by applying a
medium-term expenditure framework (MTEF). This framework imposes limits on
expenditures for each fiscal year during a three- to five-year time frame.
Second, fiscal rules’ performance will be strengthened by using medium-term budget
frameworks (MTBF); these enhance fiscal-policy planning in several ways, one of
which is to provide an improved perspective of future budgetary conditions (ii). The
path of public expenditure will be more clearly delineated under such frameworks, thus
allowing for more accurate projections of fiscal developments. Baseline projections
show how the budget develops when current spending policies are maintained when
operating under certain demographic, macroeconomic, microeconomic, and other
assumptions, which allows governments to measure the impact of different policy
proposals on the budget balance. Governments can also use these projections to trace
future fiscal pressures, including any significant changes in demographics, such as
aging (iii). MTBFs can thus be seen as a support element for fiscal rules.34
In addition, a 2013 study by Harris et al. provided evidence that countries with strong
and binding MTBFs, as is the case with Sweden and the UK, are more accurate in
predicting expenditure and revenue levels.35 Figure 4 provides an illustration of the
differences in forecasting errors between EU countries; the numbers in the graph
demonstrate how forecasting expenditures and revenue improve due to the existence
of binding MTBFs. EU member countries with indicative (or no) MTBFs, in contrast,
generally show more forecasting errors. It would appear to be good practice to make
long-term fiscal projections of ten years or more; in addition, reports on fiscal
projections should be announced every year.36
34 Schick (2003): 8-9 35 Harris et al. (2013): 145 36 Anderson, Sheppard (2009): 8-10
21
Figure 4: Budget planning and the use of medium-term budget frameworks (MTBFs). Average three-
year-ahead forecast error.
IMF (2013): 38
The intelligent design of fiscal rules is essential with enforcement mechanisms; the
general advice is that fiscal constraints must dovetail with the prevailing political
culture.37 For example, fiscal rules that are formulated as hard constraints will have no
value if they ignore political realities. This argument seems to favor country-specific
rules over supranational rules. As an external constraint on fiscal policy, for example,
the EU’s Stability and Growth Pact (SGP) is a uniform rule for all EU member states:
all member states must comply with its specifications regardless of their political
commitment and political culture. The performance of supranational rules can be
improved, however, if they are combined with national fiscal rules that are more
binding.38 Empirical evidence on the fiscal performance of EU countries with
additional fiscal rules in place supports this argument. Figure 3 demonstrates the
difference in average structural balance from 2002-2007.
Finally, it is important to consider the question of which fiscal aggregate should be
targeted. As was discussed earlier, fiscal rules may be categorized into four types;
among these four types, choosing expenditure rules is arguably the best option,
because doing so has several advantages. First, expenditure rules are more credible.
37 Schick (2010): 36-37 38 Ibid. 43
22
Credibility comes from increased transparency, since the operation of the rules is easier
to monitor and follow. Second, expenditure rules allow for improved verification.
Third, it has been brought forward that expenditure rules correlate better with
macroeconomic stabilization than deficit rules.; while deficit rules work procyclically
in fiscal expansions and fiscal recessions, expenditure rules work countercyclically.
Part of their explanation for this is that expenditure rules do not infringe on the
operation of automatic stabilizers.39 Fourth, Anderson and Sheppard (who were
officials at the OECD at the time of their study’s publication) argue that spending rules
are more effective in ensuring fiscal responsibility.40 The crucial test of fiscal rules is
whether or not they create budget surpluses in good economic conditions. A 2013 study
by the IMF supports this argument; it concurs that fiscal constraints must be strong
under favorable economic circumstances. The study adds that fiscal policy must have
more flexibility in unfavorable economic circumstances. Because spending rules are
less rigid in terms of deficits, such rules provide policymakers with more flexibility in
terms of fiscal policy.41
39 Anderson, Sheppard (2009): 20-21 40 Ibid. 41 IMF (2013): 41-44
23
3. Political economy of fiscal deficits
Why fiscal planners must be political economists
The preceding discussion on the design of fiscal institutions, with its special focus on
fiscal rules, has highlighted several key issues related to the way in which well-designed
fiscal institutions can lead to improved fiscal performance. In this sense, the analysis
yielded several insights into the ways that political factors shape the effect of fiscal
institutions. Yet these considerations took a somewhat technocratic approach by
discussing institutional budgetary reforms without having a firm grasp of the
underlying political realities. Public finance managers have become better about
incorporating the necessary political elements in recent years. In order to provide a
more comprehensive picture of the design of fiscal institutions, this chapter will
present the most relevant theoretical concepts and arguments on the topic that have
been put forth to date. It should be noted, however, that these theoretical ideas taken
together do not represent one unified theory (which might be called the “political
economy theory of fiscal deficits”); still, it is crucial to understand the theoretical
arguments for the implementation of fiscal rules as a means to address each country’s
unique fiscal problems.
A reasonable starting point for investigating the underlying causes of deficit bias is
politicians’ propensity for spending public money. For this reason, electoral pressures
are generally considered to be a major root cause of deficit spending, since one could
argue that politicians will not resist the popular effects of government spending. Put
simply, stimulating the economy brings votes. As researchers have moved ahead in
examining this argumentation, however, they have shown that statement to be both
vague and simplified. Theoretical classifications that narrow down the politico-
institutional determinants of government budgets—as Marcela Eslava did in her survey
study on “the political economy of fiscal deficits”—distinguish between three kinds of
preference heterogeneities. Eslava makes the general point that preference
heterogeneities lead to conflicts of interest. According to Eslava, preference
heterogeneities can be classified in three different ways:
i. Preference heterogeneity between policymakers and voters,
ii. Heterogeneity of fiscal preferences across politicians, and
24
iii. Heterogeneity of fiscal preferences across social groups or regions42
Preference heterogeneity between policymakers and voters
A central element in the first grouping of theoretical models is the assumption of
opportunism as a key driving force of politicians’ excessive use of public money. But
transforming fiscal-policy measures into better chances of staying in office is only a
feasible option as long as stimulus packages remain popular among the electorate: in
other words, such transformations rest on the premise of “fiscal illusion.” According to
this concept, voters favor current spending because voters underestimate the future
costs of spending programs. This early theoretical concept has lost much of its
explanatory power, however; one of its shortcomings is the assumption that the
electorate does not learn the basic lesson of the implicit future costs of deficit spending
nor of the short-lived nature of the engineered economic expansion.43
This assumption is also inconsistent with studies that have demonstrated that voters
support conservative fiscal policies. In many cases, governments that embark on fiscal-
adjustment programs will align with voters’ fiscal preferences. The majority of studies
have suggested that office holders who choose to rein in deficits will be more likely to
be rewarded at the polls.44 Another factor that needs to be taken into account is that
fiscal contraction need not stifle economic activity, which should have a positive effect
on the public’s perception of fiscal adjustments.45 Some have argued that when
governments introduce structural reforms during periods of fiscal tightening they build
the foundation for dynamic economic activity, thus increasing the popularity of these
reforms among voters. The UK’s achievement of solid economic growth from 2013-
2015 after implementing a fiscal-adjustment that started in 2010 is a good illustration
of this point.46
42 Eslava (2011): 646 43 Ibid. 647 44 Ibid. 650 45 Ibid.; See also Alesina et al (1998) for a more extensive study. The authors studied episodes of fiscal adjustment in 19 countries from 1960-1995 and did not find general evidence for fiscal adjustments causing economic downturns. 46 According to Eurostat, the country manifested economic growth rates in these years of 2.3, 2.9 and 2.3 per cent of GDP, respectively.
25
Still, the opportunism theory remains valuable in countries whose citizens have a
limited understanding of the government’s budget. The government’s ability to
monitor fiscal policy is conditioned by the “government’s accounting practices, media
development, and the sophistication of voters,” not to mention low transparency as a
general element.47 Alt and Lassen argue that fiscal expansions before elections are
more likely to take place in countries with low levels of budget transparency.48 In
general, empirical studies tend to support the argument that pre-electoral spending
increases in political environments with the lack of monitoring capacity described
earlier.49 In her survey study, Eslava summarizes that politicians adapt fiscal policy as
a response to upcoming elections in the form of changes in the composition of
spending; she argues that under certain conditions, policymakers shift financial
resources between spending categories because some expenditures will have a more
positive impact on voters.50
Heterogeneity of interests across politicians
Theoretical models in this grouping operate under the premise that budget decision
makers who run fiscal deficits are motivated by competition with other political parties
(which hold different views of spending priorities). One explanation focuses on office
holders’ strategic use of fiscal deficits as a way to limit the fiscal room that is available
to opposing political parties. Within this logic, the prospect of losing at the polls
increases the probability of budget deficits; the level of polarization or degree of
partisanship in a political system thus plays a crucial role. Not surprisingly, several
investigations of fiscal preferences of left- and right-wing governments have been
conducted; evidence in this field tends to attribute a higher propensity for fiscal deficits
to left-leaning governments, because leftist ideology generally considers that a key task
of the government is to take an active role in income redistribution. In other words,
left-wing ruling parties are more likely to assume a larger role in steering and
intervening in the economy.51
47 Eslava (2011): 648 48 Alt, Lassen (2006) 49 Eslava (2011): 650 50 Ibid. 651-652 51 Leachman et al. (2007): 372-374
26
Left-wing governments are also more likely to use fiscal-policy tools to target and
reduce unemployment. It is generally known that right-wing governments, on the
contrary, are more fiscally conservative. Countering inflation, for example, will be of
more importance to such parties, because higher inflation creates more “uncertainty
[about] the return on financial and physical capital.”52 For the strategic reasons
mentioned above, however, right-wing governments may nevertheless feel urged to use
deficits to constrain the spending possibilities of a possible rival party that will succeed
the conservative party’s time in power.53
Heterogeneity of interests across social groups or regions
Finally, conflicts of interest may arise through different fiscal preferences across social
groups or regions. In effect, this problem stems from central revenue being
administered and distributed in a way that benefits certain social groups, while the
costs are shared by all taxpayers.54 This is known as the “common pool resource”
problem, where the common pool represents government revenue. Jürgen von Hagen
uses the common pool problem as the starting point for ways to alleviate the inherent
challenges of budget processes. His thinking has influenced strategies to modify budget
processes in a manner that will ultimately lead to more effective controls of public
finances.
Smart reforms of the budget process as an instrument against the
common pool problem
This section provides additional analyses of the budget process and demonstrates how
political dynamics are contained in the budget process and display themselves during
the process’s various phases. This analytical step also shows more precisely how fiscal
institutions (such as fiscal rules) have the capacity to enable changes. Von Hagen and
Harden have characterized the budget process in three phases: the executive planning
stage, the legislative approval stage, and the implementation stage; to these three
52 Leachman et al. (2007): 372 53 Eslava (2011): 652-655 54 Ibid. 655-569
27
stages, the ex post accountability stage, in which the final budget documents are
scrutinized, could also be added. Formulating the budget is ultimately a political
exercise; as Wildavsky argues, it is a result of “political interest groups [that engage in
bargains] over conflicting goals, make side payments, and try to motivate one another
to accomplish their objectives.”55 Because these actions have become formalized in the
budget process, the process is a specification of the different dynamics involved in
preparing and implementing the budget.56
During the first stage, the executive department of the government proposes and plans
the budget; the budget is then passed to the legislature, where debate, amendment, and
voting take place. The final phase is the implementation of the budget by the respective
bureaucratic departments. The executive planning stage, as its name implies, sets
spending and deficit targets, all the while reconciling the interests of all of the actors
involved. An important note is that fiscal rules must already be respected at this stage,
which means that the fiscal targets that are written into the fiscal rules should already
be observed. Provisions of fiscal rules should also be directed toward facilitating
agreement between spending ministries/departments;57 this is the case when the rules
strengthen the public’s collective interest in achieving a balanced budget versus the
incentives of the respective ministries/departments.58 The procedures that govern
budgetary voting will have decisive leverage over the final budget outcome;
participants in the process will generally pay particular attention to restraining
spending decisions that depart from the agreed-upon budget. It would thus seem
advisable to strengthen the role of the finance minister in overseeing and controlling
government expenditures during the fiscal year.59
55 Wildavsky (1975): 4. The academic work of political scientist Aaron Wildavsky on the budget process has had a seminal influence on the field. His work has helped understanding the politics in budget making and the budget process and guided later work on the political economy of public debt. 56 Von Hagen, Harden (1995): 771-772 57 Hallerberg, Yläoutinen (2010): 47 58 Von Hagen, Harden (1995): 775 59 Hallerberg, Yläoutinen (2010): 47
28
Two forms of fiscal governance: The delegation and contracts
approaches
Hallerberg and Yläoutinen’s 2010 study is a good example of how analyses of the
effective implementation of fiscal institutions can be enriched by including
considerations of political economy. Their study incorporates the specific rules, norms,
and institutions that are in place in different Eastern European countries as a means
of examining which fiscal rules and institutions can be successfully combined with the
existing form of government. The paper builds on previous work that distinguished
between two forms of fiscal governance, with the effectiveness of their established
mechanisms depending largely on the respective configurations of the political system.
A central result of their study is that fiscal performance is weakened when countries do
not opt for the best form of fiscal governance to adopt for their unique situations.60
The two forms of fiscal governance are the delegation and contracts approaches; each
has different guidelines for modeling the budget process. The delegation form of fiscal
governance emphasizes the centralization of the budget process as a key requirement;
in this approach, budgeting power is placed in the hands of a “fiscal entrepreneur,” who
is usually the finance minister. Ideally, such ministers’ authority will allow them to
fulfill the following responsibilities: 1) assuming the function as head negotiator of the
diverging interests between spending departments, 2) setting the budget outline, 3)
ensuring that other participants in the process stick to the fiscal plan, 4) monitoring
the executive members of government, and 5) punishing or sanctioning spending
decisions that are not in accordance with the determined budget plan. To be clear,
these functions demand the presence of hierarchical structures within the government
as well as between government and the legislature.61
Although the literature lends much credence to the benefits of centralizing the
budgetary process on the balancing of the budget, strong objections could be raised
that the effects of such centralization will be counterproductive in those countries with
political traditions of power sharing or the existence of coalition governments. A
contracts form of fiscal governance would arguably be a better solution for these
60 Hallerberg, Yläoutinen (2010) 61 Von Hagen, Harden (1995); Von Hagen (2006): 470-473.
29
political settings, because concentrating budgetary capacity in one ministry contradicts
the idea of power sharing in a ruling coalition.62
This approach instead works with contracts as a way to make the agreements of the
fiscal plan more binding: more specifically, the ruling parties will agree to a multi-
annual fiscal plan. This form of fiscal governance essentially provides an adequate
mechanism for improving the bargaining process; its main advantage lies in its ability
to mitigate distributional conflicts between the parties, because it sets boundaries for
the spending authorities. These limits can then be defined in the coalition agreement,
for example. At the beginning of the budgeting process, the cabinet (which will include
members from different parties) decides to set a spending cap for each individual
ministry. In this approach, the responsibility and power to monitor compliance with
the spending limits are in the hands of the legislature, which in general plays a larger
role than the executive branch in this form of fiscal governance. An additional
observation may be made about the trade-offs between these two approaches.
Hallerberg and Yläoutinen have argued that hierarchical institutions, as the modus
operandi within the delegation approach, are more effective in targeting persistent
deficits and achieving overall fiscal discipline.63 In contrast, Alesina and Perotti note
that the contract approach’s key strength is its ability to reconcile the interests of
different partisan groups: in this approach, budget outcomes do not merely include the
interests of the governing majority.64
62 Von Hagen (2002): 275-278 63 Hallerberg, Yläoutinen (2010): 46-53 64 Alesina, Perotti (1995): 17
30
4. Swiss debt brake as a case study for analyzing the effect
of political context on the performance of fiscal rules
Background and rationale of the introduction of the Swiss debt brake
Deterioration of public debt levels across all federal levels
The numbers and data on the development of public finances in Switzerland reveal
trends that are similar to the acceleration of public debt for most other advanced
economies from roughly the 1970s on. Figure 5 tracks the development of the cyclically
adjusted budget balance for the Swiss federal budget between 1980 and 2012. The data
reveals that the deficit bias pervaded fiscal policy in Switzerland as well as in these
other nations; the numbers also demonstrate a strong increase in federal debt levels
from the 1990s on. In the Swiss federal system, the cantonal and municipal levels (the
two layers of government below the federal level) demonstrated a similarly negative
fiscal performance as the federal level. Figure 6 shows that strong budget deficits
occurred against the background of an economic recession that started around 1990,
from which the Swiss economy emerged only around 1998. Economic growth was
remarkably low during that entire decade, with average growth rates of less than 0.4
percent per year.65 Including all three government layers of the Swiss federal system,
the gross debt-to-GDP ratio saw a steep rise from 31 percent of GDP in 1990 up to 54
percent of GDP in 1998.66 The share of federal government debt was at approximately
25 percent (see figure 6).
65 Bodmer (2006): 310 66 Danninger (2002): 4
31
Figure 5: Cyclically adjusted budget (CAB) balance, CHF million (1980-2012).
The graph clearly demonstrates the improvement of the Swiss budget balance from the year 2003 on.
Beljean and Geier (2013): 119
The fiscal situation seems less severe, however, when compared with other countries’
states of public debt at the time (see figure 7); Switzerland’s fiscal record scores well in
international comparisons, and its fiscal situation would have permitted the country to
join the Euro zone had it desired to do so. The EU Growth and Stability Pact requires
Euro zone candidates to have a debt-to-GDP ratio of less than sixty percent.
Although debt-to-GDP ratios were below the OECD average,67 the resoluteness in
response to the fiscal malady was not. The Swiss debt brake, which represents a forceful
restraint on fiscal policy, is the culmination of a series of previous attempts and
deliberations on regulating fiscal policy. The fiscal expenditure rule went into effect in
67 Bodmer (2006): 310
32
2003 and is called “debt brake” because its target is to put a brake on the accumulation
of debt.
Figure 6: Budget deficits/surpluses and business cycles, 1970-2000. The red lines indicate real GDP
growth; the blue lines show the balance of the federal budget (million CHF)
Beljean (2001): 35
33
Figure 7: Switzerland: Debt-to-GDP ratio of the federal government, cantons, and communes, 1980-
1999.
Communes is a different word for municipalities, meaning the lowest urban administrative division. In
Switzerland, they possess considerable powers of self-government and jurisdiction. Danninger (2002):
4
Figure 8: Switzerland: International comparison of general government debt ratio (in percentage of
GDP).
Danninger (2002): 4; slightly modified.
34
The institutional context of the debt brake
The introduction of the debt brake, and the stringent and restrictive quality of that debt
brake, must be seen in light of previous Swiss measures that aimed to achieve solid
finances. The growing realization of the role of structural imbalances in promoting
fiscal deficits played a central role in policymakers’ strong resolve to find rules-based
responses. Since 1958, a specific article of the Swiss constitution demands the
reduction of federal debt.
The constitutional provision, however, was unable to stop the rise of public debt in the
wake of the long economic recession of the 1990s. Similarly, other policy measures that
aimed to constrain fiscal policy proved to be ineffective, although they did provide a
good foundation for the introduction of the debt brake. In 1995, the government
implemented a fiscal rule that increased the voting requirements in parliament for new
spending items; this rule, called the “expenditure brake,” is still binding on spending
decisions and works alongside the debt brake. In the three years following the
introduction of that brake, the Swiss government enacted legislation on a budgetary
goal for the year 2001 as well as a fiscal-adjustment program for 1998. The latter
consisted of specific consolidation measures that aimed to reduce the structural deficit
to 2 percent by the year 2001.
The budget is considered to be in a structural deficit if the budget is in permanent
deficit, regardless of whether the general economic conditions are improving or
deteriorating. In this case structural reasons are responsible for the accumulation of
debt. In other words, favorable economic conditions will not lead to a balanced budget.
One could argue that the fiscal consolidation that Switzerland achieved thus provided
fertile ground and a good transitioning phase for the introduction of the debt brake in
2002. For example, the policy programs were stringent in demanding a reduction of
the structural deficit.
35
Figure 9: “Iceberg” metaphor for the Swiss debt brake as the most visible part of the much larger Swiss
fiscal framework.
In addition, the move toward a federal debt brake must be assessed against the
increased utilization of debt brakes that was initiated at the cantonal level in the
1990s.68 Because the cantonal governmental level has considerable spending authority,
the institutional reforms may have stimulated thinking about the proper technical
design of a debt brake at the federal level. According to an empirical study performed
in 2002, fiscal rules that have been established at the cantonal level have had a
significant effect on constraining public finances in the time frame from 1980 to
1998.69
68 Kirchgässner (2013): 123-124 69 Schaltegger (2002)
Budget Objective 2001
Previous constitutional requirement regarding budget balance and debt
reduction (since 1958)
Previous expenditure brake ("Ausgabenbremse," 1995)
Debt stabilization plan 1998
Constitutional limits on federal tax increases
Parallel fiscal institutions on lower levels of government (cantons and communes) with considerable fiscal autonomy:
- Most cantons provide for fiscal and budget referendums
(influence on public finances through direct democracy and the elaborate federal structure; positive effects on fiscal transparency)
- Debt brakes were established in some cantons before the debt brake was introduced on the federal level (e.g., St.Gallen 1929; Freiburg and Basel-
Stadt)
Other
elements of the
Swiss fiscal
framework
Surface of
the water Tip of the iceberg. The
most visible part of the
Swiss fiscal framework.
36
Political culture: Fiscal conservatism as a strong norm in Swiss society
The Swiss political culture also seems to have been a driving force behind the search
for improved fiscal performance. In comparison with other OECD countries, public
finances in Switzerland were not particularly worrisome during the 1990s. Yet
according to Swiss standards, the debt-to-GDP ratio had reached a critical level at the
time, which was widely considered to be unacceptable.70 One example was the rise of
federal public debt from 11.8 percent of GDP in 1990 to 27 percent in 1998, which some
described as an “explosion” of public debt.71 Swiss academics and politicians alike
found drastic words to signal the need to reverse the tendency toward debt
accumulation. As can be seen in figure 8 above, the majority of countries in Europe had
higher levels of public debt than Switzerland.
In 1999, the Swiss Federal Council adopted a policy document of guiding principles for
fiscal policy that established two central goals of fiscal policy: a balanced budget over
the business cycle and the elimination of the structural deficit. While it is true that the
relevance of this document is limited, it is important to note that the policy document
was worked out by all of the members of the Federal Council together. Its importance
should not be understated, since this basic agreement over the management of the
country’s public finances now serves as the foundation for fiscal measures; it also
managed to capture a consensus view of the guiding principles and therefore helped
build a consensus for the strict fiscal measures that were adopted in the years that
followed.
The political-culture component should not be overlooked: growing concern over
rising levels of public debt arguably permeated not only Swiss society but also the ranks
of policymakers. It would seem plausible that this culture was at least partially
responsible for the deliberations that were enacted to create institutional mechanisms
to target the budget deficits. Graph 16 (page 59) shows how the right-wing Swiss
People’s Party (Schweizerische Volkspartei, or SVP) found success during federal
elections in the 1990s. One of the SVP’s positions is small government size (i.e.,
controlling or stabilizing the growth of government expenditures). It is quite evident
70 Bodmer (2006): 310 71 Frey (2007): 21
37
that growing frustration with the public finances was also an element that could be
seen in official documents that were published in the 1990s.72
Polls show that sound fiscal policy consistently enjoys broad support among the Swiss
people. Voters’ control and supervision of the government’s finances fit well with the
limited authority of the Swiss government to tax its citizens. Legislative changes to
increase the most decisive types of taxes (direct federal taxes and value-added taxes)
consistently face strong barriers, since they require constitutional amendments,
although this anti-taxation element—a fiscal institution in itself—has provided for an
asymmetry between spending and revenue.”73 A “revenue brake” in its effect, it has
arguably contributed to the deficit bias because it strengthened the incentive “towards
excessive expenditure”.
The expenditure-limiting mechanism (i.e., the debt brake) was brought to an
obligatory referendum in 2001 after being prepared by the federal council and
parliament, because the Swiss political system requires that amendments to the
constitution be approved through a referendum. In a strong manifestation of domestic
support for prudent fiscal policy, the referendum was approved by an overwhelming
majority (84.7 percent) of voters. The successful referendum resulted in a
constitutional amendment, thus embedding the debt brake in the constitution. The
transcription of the fiscal rule in the Swiss constitution is a distinctive element that
may be compared with the design of fiscal rules in most other countries.74
The involvement of Swiss citizens in the creation of the debt brake is important to
consider. Direct democracy has shown strong potential to contribute to the
effectiveness of the Swiss debt brake (and to fiscal rules in general). The major impact
of the citizens’ involvement may be to ensure compliance with the rule and to
strengthen the rule’s credibility. Beljean and Geier (officials at the Swiss Ministry of
Finance) suggest that enforcement of Switzerland’s political architecture depends on a
bottom-up channel as opposed to top-down approaches, as is the case under the SGP
of the European Monetary Union. The authors argue that the public inclination for
72 See for example Bundesrat (1997): 206. (The Bunderat is the federal government of Switzerland.) The Budget Objective is said to be the “logical response” to “very concerning federal budget problems.” See also chapter 13 page 211 and following in which sustained budget deficits are decried and regarded as connected with multiple negative effects. They would also lead to a loss of trust of citizens and companies in the state. 73 Beljean, Geier (2013): 132 74 Bundesrat (1997): 212
38
solid public finances serves as a strong and continuous support of the stipulations of
the debt brake. According to these officials, this is especially true due to the absence of
a constitutional court (such as the Supreme Court in the USA) that could rule on and
oversee the government’s budgetary practices.75
Structural reforms as a means of tackling the procyclical stance of
federal fiscal policy
Prior to the adoption of the debt brake, the fiscal policy of the federal government has
exhibited strong procyclical tendencies. According to an empirical study published in
2010 (covering the time period between 1951 and 2007), Swiss federal fiscal policy
delivered the preferred anticyclical effect in only 60 percent of cases.76 This finding was
supported by a 2002 study by Joumard and Giornio on the effectiveness of public
spending in Switzerland.77 As illustrated by graph 10, Switzerland had applied
procyclical fiscal policy in each decade in the time period from 1970-2000. Compared
to other OECD countries that were included in the study, fiscal policy performed poorly
at all governmental levels during that time.
The defining characteristic of procyclical fiscal policy is that it intensifies the
fluctuations of a business cycle. Fiscal policy should instead be anticyclical, thus
smoothing business output in order to provide macroeconomic stability. Among other
benefits, such policies can limit the negative consequences of unemployment. Although
the harmful effects of procyclical fiscal policy are known in theory, governments during
economic upswings seem to find it difficult to resist spending the additional revenue
they have at their disposal. Procyclical fiscal policy also contributed to the deterioration
of public accounts in the 1990s. For example, the persistent budget deficit of that
decade started during an economic upturn in 1990, when the influx of revenue was
converted into new spending items and projects.78 During economic recessions,
procyclical fiscal policy will deepen the recession, because spending cuts cannot be
avoided. This description fits the case of Switzerland in the 1990s, when the
government was confronted with a prolonged economic recession.
75 Beljean, Geier (2013): 131-133 76 Schaltegger (2010) 77 Joumard, Giornio (2002) 78 Beljean, Geier (2013): 115
39
Figure 10: Correlation between the fiscal stance and the output gap
Journard, Giornio (2002): 12
In a 2001 study, Martin analyzed the use of fiscal stimulus in Switzerland from 1970
through 2007 and found evidence for the claim that Swiss public finances served to
reinforce economic cycles during this time period. According to the author, a common
theme of Swiss fiscal policy is that expenditures react to increases in revenue.79 In
addition, the anticyclical effect of automatic stabilizers was undermined because of
long delays in collecting income.80
“Automatic stabilizers” is the label used for government spending that rises and falls
in response to economic conditions. In times of economic recessions, expenditure-side
79 Martin (2001): 45-48 80 Danninger (2002): 16
40
automatic stabilizers (such as unemployment insurance and other social insurances)
kick in, automatically providing fiscal stimulus, working anticyclically while doing so.
Characteristics and optimization of the Swiss budget process
The following section focuses on the characteristics of the budgetary process in
Switzerland. The Swiss case shows that fiscal-policy rules and measures failed before
the enactment of the debt brake because they left the budgetary process untouched.
The political culture and institutions of Switzerland fit the model of consociational
democracies (i.e., those with profound regional differences, such as Belgium or
Malaysia). In such democracies, the theory holds that political stability is maintained
despite the existence of established clefts between political forces that represent
different factions of society.81 The concept of consociational democracy is related to the
question of why effective governance might be achieved in these kinds of political
scenarios that would otherwise appear ripe for factionalism or even civil war. Part of
the answer is that political elites in Switzerland were able to accommodate their
differences; as a result, these elites created and designed political institutions in such
a way that these institutions could cope with and incorporate the fragmented nature of
the political system.
Four different official languages and strong regional identification are only two
examples of fragmentation in Switzerland. In a small country with 26 cantons, local
political autonomy is strong.82 Accordingly, these characteristics of the political system
translate into the budgeting process, which in Switzerland might be even more
influenced by the system of consensus than in other OECD countries that have a strong
tradition of consensus, because shared decision making is firmly grounded in the Swiss
constitutional structure. For example, the structure provides for cantonal vetoes and
popular votes as a powerful means to counter the tendencies of majority rule.
Before reforms were enforced under the provisions of the Swiss debt brake,
hierarchical elements were strikingly absent during the different stages of the
budgeting process. Budgetary matters (like government policies in general) were
81Bohn (1980) 82 Mueller (2011)
41
driven by the political desire to achieve consensus. The political system works without
a prime minister and without a coalition agreement. The executive branch, the Swiss
Federal Council, is composed of seven members who all enjoy equal powers, at least in
principle.
During the first stage of budget creation (the executive planning stage) before the
arrival of the debt brake, political bargaining started with the announcement of the
seven Swiss ministries’ spending desires. (The seven include foreign affairs, interior
affairs, justice and police, defense, finance, economic affairs and education and
research, and environment, including transportation, energy and communication).
Because the Finance Ministry did not hold any special authority in the process, it could
not interfere. The proposed spending decisions were then added together to form an
aggregate budget. In the next step, the budget was handed over to parliament, where
amendments could be introduced with simple majorities in both chambers.83
Characteristics of the Swiss debt brake as a type of fiscal rule
The operation of the mechanism
The expenditure-limiting mechanism, or the debt brake, has two central objectives: the
first is the medium-term control of public debt by avoiding budget deficits, while the
second aims to achieve the necessary flexibility to absorb any fluctuations of the
business cycle. Each year fiscal planning under the provisions of the debt brake
prescribes the application of the rule. The debt brake could essentially be classified as
an expenditure rule, because its target variable is the level of expenditures for each
fiscal year. The government (i.e., the department of finance) pre-determines an
expenditure ceiling and stipulates the maximum amount of spending that will be
possible for all seven ministries. The second objective (flexibility) is still met by
allowing for budget deficits if the economy is in a downswing; the underlying restrictive
bias of the mechanism is not violated in such cases, however, because the debt brake
guarantees that income and expenditure will be kept in balance over the course of the
business cycle. When the economy is performing well, surpluses are required.
83 Bodmer (2006): 311-312
42
The restrictive quality of the debt brake becomes clearer with a formal presentation of
the basic debt brake formula:
�̅� = 𝑘t𝑅t 𝑤𝑖𝑡ℎ 𝑘t = 𝑦t∗
𝑦t
The formula describes that for any calculation period (t) the level of expenditure (G)
must not exceed the amount of revenues (R) after multiplication by the business cycle
adjustment factor (k). Thus, business activity is accounted for in the formula. For the
calculation of the business cycle adjustment factor (k), predictions of trend output (yt)
and actual output (y) are used. If the numbers of trend output are higher than actual
output, the economy is in recession. This is expressed by the factor k being larger than
1. While deficits (cyclical deficit) are allowed in this case, (cyclical) budgetary surpluses
are “required” if the factor k is smaller than 1.84
Without including a variable for economic fluctuations, expenditure (G) would follow
the changing path of revenue. This would be the scenario demanded by overall balance
or debt rules. Policy planners in Switzerland wanted to overcome the shortcomings of
such rules, which lie in the compulsory reaction to output shocks. The Swiss debt brake,
in contrast, allows a different path for expenditure. This is illustrated by graph 11,
which shows how spending is decoupled from the variations in government income.
The intention for spending levels is instead oriented toward trend-line GDP. The debt
brake should ideally keep expenditure fluctuations within a tighter boundary, as shown
by the linear development of expenditure in the graph. In addition, the shaded areas
in the graph demonstrate when surpluses are required and deficits are permitted.
84 Beljean, Geier (2013): 118
43
Figure 11: Ideal development of public expenditure under the provisions of the debt brake.
Eidgenössisches Finanzdepartment (2016); text translated.
That being said, expenditure rules such as the debt brake have an important
implication. The reduced availability of discretionary fiscal policy as a fiscal tool and
its reliance on the use of automatic stabilizers could be interpreted as a disadvantage.
Discretionary fiscal policy describes the types of expenditure that are available to
governments as an instrument for manipulating economic activity. Under the
provisions of the debt brake, however, the use of fiscal stimulus is compromised, if not
given up almost completely. Because automatic stabilizers instead retain a primary
role, governments must emphasize the smooth functioning of automatic stabilizers.
In this sense, fiscal policy acquires a certain passiveness and a willingness on the part
of politicians (or spending agencies) to place trust in the role of automatic stabilizers
as the primary means of expenditure adjustment.85 In choosing the means of
implementation as described above, Swiss politicians and voters have expressed their
preference for automatic stabilizers over discretionary fiscal policy. One specific
motivation for this choice is the presumed superiority of automatic stabilizers in
ensuring the stabilization of the economy and a sustainable development of the
85 Compare Beljean, Zurbrügg (2009): 16
44
federation’s public finances.86 The technical design of the debt brake thus incorporates
the intention to allow automatic stabilizers to work in full. The mechanism facilitates
the functioning of automatic stabilizers, since it provides for a flexible response to the
swings of business activity. Even when revenue diminishes, significant expenditure-
side automatic stabilizers (such as unemployment insurance) are allowed to work in
full because expenditure moves in relation to structural (i.e., cyclically adjusted)
revenue.
Finally, it must be added that the legal text of the debt brake provides a framework for
fiscal responses in exceptional circumstances. These stipulations make the fiscal rule
more stringent because they hinder opportunistic politicians from providing excuses
to escape from the fiscal constraints. The particular clause specifies that unforeseen
events such as deep recessions allow for deviation from the expenditure ceiling;
spending can be raised if it is accepted by qualified majorities in both houses. Such
spending constitutes extraordinary expenditure and is registered in a special
amortization account. As a general rule, debits on this account have to be cleared
within six years.
Enforcement: The functioning and importance of the compensation
account
With the introduction of the debt brake, a compensation account was created that
carries an important enforcement mechanism. Its intention is to control the actual
amounts of federal money spent and to implement sanctions if the final budget
outcome exceeds the expenditure limit set when the budget was approved. After the
end of the fiscal year, the balance of the compensation account allows for inferring
compliance with the debt brake. More precisely, when actual data on revenue and GDP
growth is available, the balance of the account is determined by the accumulated
difference between the amounts of actual revenue and actual expenditures. If the
account shows a debit, the law requires corrective action in terms of lowering the
expenditure ceiling. In this way the expenditure ceiling al1so becomes binding for the
budget execution stage. In cases where a surplus on the account exists (due to
86 Bundesrat (2013): 25-28. This chapter also explains reasons why the government turned away from procyclical fiscal policy. (“Abkehr von einer prozyklischen Fiskalpolitik”).
45
underspending or overcollecting), the credit on the account cannot be used for
additional spending but is instead intended for debt reduction. The compensation
account also serves another important purpose: it counteracts the willful and
deliberate manipulation of budget forecasts.87 Revenue forecasts, for example, can be
overestimated in order to increase the expenditure ceiling. The compensation account,
however, takes away this incentive because estimation errors will become evident.
Effect and relative success of the fiscal rule since its introduction
After more than ten years in existence, it is possible to draw several conclusions about
the fiscal performance of the debt brake and to adequately assess and evaluate the
brake. In general, the debt brake has proven to be effective. The relative success of the
expenditure-limiting mechanism will be measured in the following section against its
two main objectives described earlier. In terms of its first objective, the accumulation
of debt in relative terms has not only been stopped but has even been reduced. Figure
12, which illustrates gross federal debt levels from 1980 to 2011, demonstrates this
remarkable performance. After a difficult start (from 2003 to 2005), the debt brake
contributed to setting debt levels on a clear downward trajectory: as a percentage of
GDP, federal debt levels were reduced from 28.2 percent at the end of 2002 to 19.5
percent in 2012.88 While successful compliance with the rule was initially
overshadowed by economic stagnation and falling revenue, the existence of the rule
proved to be beneficial because it prompted a quick response by policymakers, who
worked out a consolidation program in order to meet the brake’s legal requirements
and to overcome the various fiscal challenges they faced. In this sense, the debt brake
manifested its usefulness in spurring quick fiscal responses to fiscal deficits.
87 Danninger (2002): 5-6 88 Numbers on federal debt levels in Switzerland can be found at www.de.statista.com
46
Figure 12: Switzerland, gross federal debt (1980–2011). LHS: left-hand side; RHS: right-hand side.
Gross federal debt levels started to decline in 2005, two years after the introduction of the debt brake
due to an economic recession.
Beljean and Geier (2013): 116
The debt brake also proved to be an effective impediment to the procyclical tendencies
of Swiss fiscal policy, meaning that the second objective of the brake (i.e., achieving the
necessary flexibility to absorb fluctuations of the business cycle) was largely met.
Switzerland achieved significant budget surpluses during the economic boom period
from 2005-2008 (see graph 5) due to its debt brake; in 2008 the nation achieved a
budget surplus of 2.3 percent of GDP.89 The crucial point here is that the debt brake
was able to avoid the use of revenue increases for permanent expenditure increases;
this puts fiscal development in stark contrast with the financial situation during the
89 IHS Global Insight (2011): 17
47
1990s. As graph 5 shows, the cyclically adjusted budget balance exhibited a positive
balance from 2006 to 2012 (the last date included).
In addition, the intention of the debt brake was to attribute a larger role to the fiscal
impulse of automatic stabilizers (as compared to the discretionary use of fiscal
stimulus). The Swiss scholars Christoph A. Schaltegger and Martin Weder analyzed the
composition of fiscal impulse in 2010; their results are presented in graph 13, which
illustrates the composition of the fiscal impulse from the years 1951–2007.90 The
graph distinguishes between those elements of the fiscal impulse that stemmed from
discretionary measures and those that stemmed from automatic stabilizers. The
authors found that the introduction of the debt brake resulted in automatic stabilizers
delivering a stronger fiscal impulse; a comparison between the years 1991–2000 and
2001–2007 also reveals a diminished use of discretionary fiscal stimulus.91 Although
more recent statistical investigation would be necessary to allow for a better correlation
with the introduction of the debt brake in 2003, it would appear that Swiss
policymakers adhered to the envisioned role of a less-active fiscal-policy intervention.
Figure 13: Fiscal impulse of the federation and social insurances (1951–2007). Vertical axis left side:
fiscal impulse as a percentage of GDP; right side: real GDP growth (in percentage points).
Schaltegger and Weder (2010): 52
90 Schaltegger, Weder (2010) 91 Schaltegger, Weder (2010): 153-155
48
Switzerland consequently entered the financial crisis in 2008 with solid public
finances, thus enabling the country to weather the global economic turbulence without
jeopardizing its fiscal situation. The health of the public finances at the time speaks to
the advantages of fiscal space; in particular, the Swiss government was able to launch
several economic stimulus packages in late 2008 and early 2009 without having to be
concerned with financial stability. The debt brake provided a stable financial
environment during the crisis because it strengthened confidence in the long-term
soundness of the Swiss federal public finances; the consistent generation of surpluses
was a strong demonstration of compliance with the rule.
On another level, the effect of the debt brake on the level of investments requires closer
scrutiny; one line of criticism against expenditure rules holds that expenditures will be
stabilized at the cost of investment spending. Two theoretical arguments could be
raised to support this claim. First, in contrast to entitlement spending (such as social
security), investment spending is part of discretionary fiscal policy and is therefore
more prone to expenditure cuts. Second, because the benefits of investment projects
usually materialize in the future, opportunistic politicians might withdraw from
investment spending since such spending has no immediate costs.92 More specifically,
Dur et al. have argued (in their 1997 study) that public debt rules “shift strategic
manipulation to public investment.”93
The experience of the debt brake, however, shows that Switzerland achieved its fiscal
targets without stifling investment spending. Graph 14 shows that since the
introduction of the Swiss debt brake in 2003, investment spending as a percentage of
GDP was approximately 1 percent on average during this whole period. The graph also
reveals that public spending developed in a much more stable manner and with fewer
fluctuations than was the case from 1980 to 2003. In addition, the numbers on
investment spending as a percentage of total expenditure weaken the argument that
meeting the constraints of the expenditure ceiling would only be possible by crowding
out expenditures for investment purposes.
92 Beljean, Geier (2013): 126. Krogstrup, Wyplosz (2009) 93 Dur et al. (1997): 12
49
Figure 14: Investment spending (1980–2011). The cyclical nature of investment spending stopped and
steadied under the debt brake.
Beljean and Geier (2013): 128
Reforms of the budget process resulting from the debt brake
The debt brake has also been responsible for profound changes in the Swiss budgeting
process. The Swiss government introduced elements of centralization to the system,
which essentially created a top-down budgeting process. The changes overall have
followed the predicaments of the “delegation” form of fiscal governance described
earlier; this is remarkable, because the “contracts” form of fiscal governance would
seem to be a more appropriate solution for the Swiss political system. Policymakers did
not likely make a conscious choice for a particular form of fiscal governance, however,
since the changes have mainly stemmed from the strict requirements of the maximum
expenditure amounts. The expenditure target puts the finance minister in a top
position in which he or she is able to “enforce fundamental budgetary targets.”94
Because the debt brake requires the determination of binding fiscal targets at the
beginning of the process, the various spending ministries and offices have a reduced
ability to bargain over the allocated level of expenditures. The rule requires the various
94 Beljean, Geier (2013): 123
50
parties involved to pay strict attention to spending amounts, because ultimately the
sum of expenditures may not pass the expenditure ceiling; any room for maneuvering
is thus constrained, which causes the parties involved to become more disciplined.
It would appear that the transformation to a top-down budgeting process has
eliminated the previous incentives for bargaining between the seven spending
ministries; in this sense, the debt brake represents a radical transformation from the
previous bargaining that occurred during the budgeting process. The strict
requirements of the debt brake have given more power to the finance ministry for
disciplining the other six ministries.
To conclude this section, the implicit transformation to a top-down budgeting process
could thus be considered a critical reform that has made for a strong commitment to
compliance with the expenditure ceiling.
51
5. The effect of political context on the performance of the
Swiss debt brake
The unique characteristics of the Swiss institutional system and their
influence on public spending
The argument was presented earlier that political context is important to consider
when examining the introduction of fiscal rules; a political-economy approach was
thus used to better understand the modalities of the proper implementation of fiscal
rules. The following section will present the features of the institutional arrangement
in Switzerland that have exhibited a dominating influence on the functioning of fiscal
rules and will present several characteristics of the Swiss budgeting system that have
been highlighted in the academic literature.
As we saw, the debt brake was on balance able to live up to its purpose and intentions.
This section will seek to measure the particular influence of the political context of
Switzerland for its success. Doing so will allow for an analysis of the particular political
elements that distinguish the Swiss scenario.
Political environment
Fiscal federalism
The Swiss political environment has three main features—direct democracy,
federalism, and a tradition (and system) of achieving consensus—all of which are
aspects that will inevitably influence the working of a fiscal rule. A 2006 OECD study
that focused on improvements of the Swiss fiscal framework argued that the nation’s
institutional system (with elements of direct democracy and federalism) generally has
a constraining effect on spending.95 Fiscal federalism in Switzerland is more
pronounced than in other federal countries: the country has the second-highest level
of decentralization among OECD countries, with only around one quarter of public
expenditure accounted for by the federal government (see figure 15). Less than one
third of federal expenditure is used for the tasks of the federation; the rest is transferred
95 OECD (2006): 68
52
to the cantons and municipalities, social security funds, and other semi-autonomous
public institutions. The federal budget could thus be described as a “transfer” budget.
This characteristic could be seen as another central feature of the Swiss budgeting
system.
The Swiss cantons provide for many public services, with education, health, and social
expenditures amounting to almost 60 percent of the cantonal budgets.96 This
considerable degree of fiscal autonomy is a characteristic of all Swiss government
levels. One particular result of the federal system, which also has beneficial
implications for direct democracy, is that the elaborate federal system narrows the
distance between policymakers and voters.
Figure 15: Decentralization across the world (98 countries – average 1972–2000); subnational and
expenditure shares.
IMF (2006): 6
96 Funk, Gathmann (2013): 302
53
Direct democratic elements
The Swiss political system grants citizens direct popular rights, which allows for fiscal
referenda at both the cantonal and local levels. Switzerland has a firm tradition of
including its citizens in the political decision-making process. At the cantonal level, two
types of constitutional or statutory clauses serve as institutional mechanisms to allow
citizens to influence public spending: direct popular rights and formal fiscal restraints.
According to Funk and Gathmann, budget referenda “represent an important and
direct tool to influence fiscal policy.”97 While budget referenda in Switzerland are not
exclusively based on public expenditures, they do focus primarily on issues that are
related to public spending.98
The majority of cantons provide for mandatory budget referenda that stipulate that
new government programs exceeding a certain financial sum must be put to a
referendum; in addition, any changes to the constitution also lead to mandatory
referenda. Popular rights include the possibility of starting a referendum to introduce
amendments to the constitution. Finally, Swiss citizens have the legal means to initiate
referenda against all federal laws and executive orders; the necessary requirement is
to collect 50,000 signatures in no fewer than 100 days after the publication of the
contested legal document. One might ask if fiscal referenda could be considered
institutions that reduce government spending in Switzerland. Their long existence as
an institution of direct democracy has certainly made them an important element of
the Swiss fiscal framework.
From a theoretical perspective, direct democracy and fiscal federalism constrain public
expenditure in the following way. Part two of this thesis provided theoretical input on
the conditions in which voters’ preferences can shape fiscal outcomes. At this point we
should ask how these theoretical considerations square with the findings on the Swiss
institutional mechanisms for direct democracy. It would appear that the existing
channels of direct involvement increase voters’ sophistication. Part two discussed the
idea that when voters lack sophistication—or when they lack control and monitoring
powers—the opportunistic use of deficit spending will be more likely to occur. As we
saw in part two, fiscal illusion can be a contributing factor to budget deficits. It would
97 Funk, Gathmann (2013): 302 98 Ibid.
54
seem plausible that citizens’ involvement in expenditures will decrease the effect of
fiscal illusion, because citizens have a clearer picture of what is involved in the
spending. Similarly, the direct democratic elements support a sense of civic
responsibility that is particularly strong at the local and cantonal levels.99 It also seems
plausible that Switzerland’s fiscally conservative political culture developed as a result
of its citizens’ involvement in the nation’s fiscal policy. The empirical results of Funk
and Gathmann’s 2013 study, in which the authors compared data from cantons that
have mandatory budget referenda with those that lack these kinds of referenda,
support this argument.100 The common pool problem discussed earlier also seems to
become less of a problem under such circumstances. Spending policies such as pork-
barrel projects101 will become less feasible, since citizens will be more informed of the
details of spending items.
Because direct democracy is one of the best-known features of the Swiss political
system, several studies have focused on this form of democracy’s relation to (and effect
on) the constraining of fiscal policy. A consensus appears to have emerged within the
scientific debate that direct democratic elements increase the effectiveness of fiscal
rules. For example, Kirchgässner and Feld argue that direct democracy is the most
important factor in constraining Swiss fiscal policy; they consider direct democracy to
be more important than any institutional solutions to addressing the common pool
problem, such as centralization of the budget process.102 The authors also recommend
the adoption of direct democratic elements in other European countries as a means of
strengthening the effectiveness of fiscal rules.103 Schaltegger similarly argues that the
functioning of fiscal rules is critically dependent on direct popular rights, and
especially on fiscal referenda.104 These findings appear to demonstrate that the
prevailing form of fiscal governance in Switzerland draws from direct democratic
elements that constrain fiscal policy. It should be noted that Beljean and Geier argue
that the functioning of the debt brake in Switzerland depends on a political bottom-up
channel: it is the popular Swiss fiscal-prudence stance that has continuously ensured
99 OECD (2006): 68 100 Funk, Gathmann (2013): 311 101 The term pork barrel or pork barrel politics captures the notion that politicians use spending for a particular part of the population, or particular constituents, in return for achieving political support or popularity. 102 Feld, Kirchgässner (2001) 103 Schaltegger (2002) 104 Ibid.: 364-365
55
the credibility of the debt brake.105 In other words, the form of fiscal governance is
supported by (and depends on) direct democratic elements. These considerations
suggest that either the “contracts” or “delegation” approach in their forms would be
inadequate for explaining the functioning of the Swiss debt brake.
The present study, however, views direct democracy as only one factor among a
broader set of political factors and institutions that originally provided the fertile
ground for the success of the Swiss debt brake. As a result, the introduction of direct
democratic rights (such as fiscal referenda) in other European countries or other
advanced economies would not on their own improve these countries’ fiscal
performance if their whole fiscal frameworks were weak or otherwise failed to provide
good foundations (such as fiscal transparency and fiscal planning). Direct democracy
in Switzerland should receive less credit in regulating Swiss fiscal policy than has
generally been the case in most studies to date on this causal relationship.
Feld and Matsusaka’s 2003 statistical investigation found that mandatory budget
referenda in Switzerland reduced government spending by 19 percent for the median
canton.106 Their statistical investigation was undertaken for the period 1980–1998 and
distinguished between cantons with mandatory and optional referenda; in 1996,
budget referenda were mandatory in 17 of Switzerland’s 26 cantons.
Funk and Gathmann’s 2013 empirical study similarly investigated the effect of direct
democracy on fiscal outcomes in Switzerland; they concluded that the effect of direct
democratic institutions on fiscal policy has been overstated in previous studies. Still,
their study did support these earlier studies’ findings that direct democracy constrains
government spending.107 Policymakers have also put forth proposals to strengthen the
fiscal framework in Switzerland by installing fiscal referenda at the federal level (rather
than only the cantonal or municipal levels).108 These policy recommendations provide
further support for the effective link between fiscal referenda and public-spending
constraint. But, as was argued earlier, these earlier studies have most likely assumed
the existence of other conducive fiscal-framework elements in Switzerland or they have
implicitly included these elements in the setups of their statistical investigations. The
105 Beljean, Geier (2013): 132 106 Feld, Matsusaka (2003) 107 Funk, Gathmann (2013) 108 OECD (2006): 71; Frey (2007): 27
56
present thesis finds that without elements such as a political culture of fiscal
conservatism in place, direct democracy would have had less of a positive impact on
constraining fiscal policy.
This analysis has shown that the Swiss political environment is characterized by
effective control mechanisms for public spending at both the cantonal and municipal
levels; one could argue that these fiscal constraints have become more relevant in light
of the nation’s strong fiscal autonomy. This institutional characteristic has likely
influenced the efforts and moves toward constraining public finances at the federal
level. One reason for this is that the absence of fiscal constraints at the federal level has
become more difficult to justify.
The institutional elements of the combination of fiscal federalism and direct
democracy have provided an institutional context that created a supportive
environment for the functioning of the Swiss debt brake at the federal level. The
institutional channels that are in place at the sub-federal levels form a parallel and
supporting movement to the efforts to constrain federal expenditures. A 2002 study by
the OECD found that since 1993, a restrictive fiscal policy was followed in Switzerland
at the federal, cantonal, and municipal levels of government.109 As such, this
environment formed part of the institutional context in which the debt brake was able
to thrive.
In conclusion, the preceding analysis strongly suggests that in Switzerland, fiscal
federalism by itself does not constrain public spending. Rather, the analysis suggests
that only in combination with direct democratic institutions (such as the use of fiscal
referenda) does the federal structure possess the capability to constrain public
spending.
Primacy of automatic stabilizers
The third key characteristic of the Swiss budgetary system is the classification of
Switzerland as a consociational democracy, in which negotiation and compromise play
an essential role in all political processes. It was mentioned earlier that the
109 OECD (2002): 11
57
introduction of the debt brake introduced elements of centralization to the Swiss
budgetary process; in this way, the budgeting process was transformed (to a certain
extent) along the lines of the delegation form of fiscal governance. The results would
have a profound impact on delegating authority to the finance minister, which in turn
led to stronger fiscal discipline by all of the other spending ministries.
One interesting question to ask is how the tradition of achieving consensus helped to
institutionalize the political commitment to the expenditure ceiling that had been set
by the debt brake. One could argue that this system made it easier to stick to the debt
brake, since the parties involved were accustomed to working in consensus. One reason
for this is that all of the political players involved place trust in the political agreements,
since this is the modus operandi they are accustomed to. Because consensus-based
decision making is such a key principle, it will thus become difficult for any one
individual in the federal parliament to violate the consensus view. This, in turn, will
reduce the potential conflicts of interest that inevitably arise from different preferences
between politicians. This situation was described earlier in the theoretical
considerations section of chapter two, which stated that budget deficits generally result
from politicians’ tactical and strategic motives. The logic of such motives, however, are
lost within the confines of the consensus-oriented budgeting process in Switzerland.
It would appear that the evolution of the concept and contours of fiscal policy among
policymakers played a central role in this success: in particular the reorientation of the
priorities of fiscal policy toward other goals. In other words, discretionary fiscal policy
as a policy instrument was reconsidered, ultimately no longer being really at disposal
as a policy instrument with the introduction of the debt brake (and the subsequent
commitment to that brake). As a result, a different understanding of the role of fiscal
policy emerged that made it more acceptable to assume a passive role in fiscal policy,
which in turn increased the commitment to binding fiscal-policy choices to the
demands of an expenditure rule.
A consensus emerged among Swiss policymakers and academics during the 1990s on
the limited purpose and usefulness of discretionary fiscal measures.110 As a result, the
use of discretionary fiscal policy would enjoy less and less political support from then
on. The question of why the use of discretionary fiscal policy lacked support is complex
110 Frick et al. (2012): 40
58
and deserves more attention; several factors seem to have played a role. First, previous
fiscal-policy experiences served to shape the new understanding: by the 1990s, the
policymakers had realized the limited use of discretionary fiscal policy as a
countercyclical tool. Second, as was suggested in chapter 4, the frustration with the
procyclical nature of fiscal policy due to discretionary fiscal policy was pronounced
among policymakers, which certainly made it easier for them to reduce the role of
discretionary fiscal policy. Third, the government deemed monetary policy to be more
appropriate for assuring countercyclical policy (see chapter 4). Fourth, fiscal policy
should give preference to automatic stabilizers, since they are better able to provide
stabilization than other tools.111 One could argue that the primacy of automatic
stabilizers relates to a redefinition of fiscal policy objectives in the 1990s that made the
maintenance of fiscal discipline a key objective.
Fifth, some have described the influence of discretionary fiscal measures to stimulate
the economy as being weak. According to Schaltegger, for example, calculations of the
long-term-multiplier effect based on economic models was always below 1.112 Because
Switzerland has a small and open economy, the active use of fiscal policy measures has
had limited benefits in terms of fiscal response to economic crises. This might have
been an additional reason for Switzerland to diminish the role of discretionary fiscal
policy. For example, Frick et al. have argued that the Swiss economy saw strong profits
from fiscal stimuli that had been implemented in other countries during the world
financial crisis that started in 2008.113
Previous government efforts to achieve a balanced budget are indicative of the shared
political commitment to sustainable public finances. The primary legal text on
measures related to a balanced budget, Switzerland’s Budget Objective 2001 (from
1997), also hints at the consensus among policymakers at the time for a different role
for fiscal policy to take in the future.114 The plan delineated the way in which fiscal
policy would be tied to rules in order to be bound to the parameters of the new
understanding of fiscal policy; the plan has also demonstrated how the government
chose a gradual path for increasing the soundness of the Swiss fiscal framework. Part
of the purpose of the fiscal measures that were taken in the Budget Objective 2001
111 Schaltegger (2010): 170-171 112 Schaltegger (2010): 170 113 Frick et al. (2012) 114 Bundesrat (1997)
59
(“Haushaltsziel 2001”) were to serve as preparation for the more restrictive
introduction of the debt brake. One component of the Budget Objective 2001 was the
adoption of a stabilization plan in 1998. Similarly to the objective of the debt brake, the
main aim of this plan was to control expenditures. With the adoption of this fiscal plan,
and the achievement of a balanced budget in 2000, the main players had already shown
the political will to implement consolidation programs.
It must be emphasized again that the debt brake is the culmination of consistent and
intensive efforts by the Swiss government. Already in the 1990s, the Swiss government
had demonstrated the political willingness to pursue consolidation programs. The
provisions of the Budget Objective 2001 already showed how the Swiss authorities
intended to implement strong fiscal policy measures.
As part 2 has shown, however, politicians’ behavior is not determined by economic
considerations alone but rather by opportunistic incentives such as using public money
in order to increase their chances of remaining in office. A stronger explanation would
therefore point to the idea that because of the specific Swiss political system, the
opportunistic use of deficit spending was no longer a useful instrument. One could
argue that consensus as the usual and accepted principle in the decision-making
process made it more difficult for a single party to break the rule. Another important
factor is that voters’ fiscal preferences were locked in due to their strong vote in favor
of fiscal discipline. As a result, the parties involved likely realized that deficit spending
did not represent a good way to win elections. And once the consensus became
institutionalized (and the centralization of the budget process had added an element of
discipline to the ministries), it became very costly for any single minister to deviate
from the agreed-on rule. One reason for this is that the expenditure ceiling in
Switzerland is transparent, and thus any ministers who “spoiled the party” would risk
great damage to their political factions in the face of strong voter disapproval.
One of the most important points to bear in mind is that voters’ fiscal preferences
became part of the process. In other words, the new budgeting system made it possible
for their preferences to influence policymakers’ fiscal decisions. It would appear that
political commitment was already high before the debt brake was introduced. Since the
introduction of the debt brake, compliance with the rule has profited from broad
60
acceptance by the “major players in the Swiss budget process.”115 Getting all political
parties onboard and complying with the predetermined expenditure levels was
certainly facilitated by the step-by-step approach to a rigorous and strict expenditure
rule.
A clear parliamentary majority has emerged in favor of fiscal discipline since the 1990s;
the rise of the aforementioned Swiss People’s Party (SVP) certainly played a part in
this. One of its strongest political demands was to have a balanced budget at the federal
level: a demand that echoes across Swiss culture and society. SVP and two other Swiss
parties located near the center of the political spectrum are grouped together as
bürgerliche or “civic parties”;116 the other two are the Christian Democratic People’s
Party (CVP) and the Free Democratic Party (FDP). The legislative push for balanced
budgets and a reduction of the absolute number of federal debt levels (which then
culminated in the debt brake) are arguably the outcomes of the shared interests of
these three civic parties. Their influence in parliament was abetted by the weakness of
the other two left-leaning Swiss parties, the Social Democratic Party (SP) and the Green
Party (GPS). As graph 16 demonstrates, since the 1990s, the civic parties have
possessed a two-thirds majority.117
115 OECD (2005): 57 116 Bürgerliche Partei or “civic party” is a political term probably exclusively used in German speaking or Scandinavian countries. The term means to ascribe parties influenced by their bourgeois or middle-class origin. 117 I want to thank Leo Müller (CVP), President of the Finanzkommission in the Swiss Parliament, for providing me with information on the Swiss budget process and budget politics.
61
Figure 16: Swiss parties and their number of votes won (as a percentage of the total amount of seats)
in the elections for the Swiss federal parliament (Nationalrat).
Longchamp (2011)
The fiscal rule also aligned with voters’ fiscal preferences and came into being through
strong voter acceptance. This point arguably contributed to maintaining and enforcing
policymakers’ political commitment. Compliance with the debt brake was also
increased, because the stakes of escaping the clauses of the debt brake were raised.
Breaking the constitutional rule would have had severe repercussions, since a policy
change away from the debt brake would have required the voters’ approval in a
referendum. The stakes have been raised for Swiss political parties, because it has
become hard for them to justify non-compliance in the face of a strong political culture
that demands fiscal discipline. It has also become difficult for a single ministry to
ignore the expenditure ceiling. Non-compliance is made even more difficult because
transparency makes it easy to recognize ministries that do not play by the rules, which
means that any party that does so will be punished in the next election. These points
also serve as a good illustration of how opportunistic incentives for incumbent
62
politicians’ use of deficit spending have been effectively undermined by the Swiss debt
brake.
Made in Switzerland: Political context and the Swiss debt brake
The government’s fiscal preferences were also well transcribed and integrated into the
design of the debt brake, the technical design of which is a very precise reflection and
implementation of the shapes that fiscal policy should take according to Swiss
policymakers; for example, their preference for how automatic stabilizers would work
was translated into the design of the fiscal rule. Another point that should be taken into
account is that the political parties together adopted the stipulations of the expenditure
rule; in other words, the fiscal rule was the creation of all of the political parties. This
aspect thus follows the “contracts” form of governance.
This point supports the argument that national rules are more effective than
supranational rules, since the former are generally the product of the particular
political motivations of a given country; in contrast to supranational rules, they are the
outcome of political will. Politicians in other countries could arguably find the rigid
nature of the debt brake to be a straitjacket. In Switzerland, however, the voters and
the broad majority of legislators deemed a forceful response to taking control of the
structural causes of persistent budget deficits to be both acceptable and necessary. One
indicator of a broader move toward fiscal constraints may be found in the Swiss
institutional environment, which features a political culture that is conducive to
conservative fiscal policy. The present study’s analysis of the institutional
environment—one that features both fiscal federalism and direct democracy as two
strong institutional characteristics—has shown that the Swiss preference for control of
public money has been firmly established. In this sense, the fiscal preferences for
conservative public finances are not only a strong element of political culture but have
also been translated into specific institutions.
This analysis has shown how political context has had a strong influence on the gradual
increase in the strictness of the Swiss fiscal framework. The intentions behind the
implementation of the fiscal rule were not predominantly economic motivations, such
as macroeconomic stability, fiscal responsibility, or overall policy credibility. In other
63
words, this analysis has found that political commitment to a fiscal rule will be frail if
that commitment is created mainly because of economic benefits, which suggests that
the political players must adopt the fiscal measures so that they may take root in the
country’s political system. The analysis also suggests that the debt brake was successful
in Switzerland because the Swiss political class embraced it for political reasons. As a
result, this analysis cautions against a predominant focus on economic and technical
aspects of a fiscal rule.
This argument is supported by the fact that policymakers’ efforts toward a strict fiscal
rule were not directed primarily toward the improvement of public financial
management and fiscal policy; these sorts of motivations and considerations were not
the main driving forces for abandoning the use of discretionary fiscal policy. This
explanation serves to highlight the argument that fiscal rules should not be created out
of economic motives alone or because of recommendations by international
organizations such as the IMF or the OECD. This would help to explain why (rule-
based) improvements of monetary policy are generally easier to implement in
countries than improvements of fiscal policy.118 The evolution of monetary policy is
likely more of a technical issue than the evolution of fiscal-policy. The standardization
of monetary policy in the EU (via the European Monetary Union) by 19 eurozone
countries underlines the fact that finding common rules without considering country
differences is simpler to do with monetary policy than it is with fiscal policy.
118 Wyplosz (2005): 64-65
64
6. Conclusion
This study has demonstrated significant results related to the various factors that have
allowed the Swiss debt brake to fulfill its mandate. Above all, the success of the debt
brake has depended on three points:
1. the gradual increase of the fiscal framework and commitment to sound public
finances, which resulted in a solid architecture of fiscal institutions;
2. the shared interest and preference for the passive role of fiscal policy and the
primacy of automatic stabilizers by the broad majority of the political
leadership; and
3. designing and implementing the fiscal rule in a manner that incorporates the
shapes fiscal policy should take according to Swiss policymakers.
First, the successful control of public expenditure cannot be attributed to the debt
brake as a single fiscal rule. Although the debt brake deserves the most credit among
all of the pieces in the set of fiscal institutions, the foundation of its success was paved
before its introduction. Careful analysis has revealed that the debt brake can be seen
as the expression and outcome of several institutions and factors that have
strengthened fiscal discipline. In this sense, this result should be viewed as a caution
of the dangers of implementing a rigid fiscal rule in countries with weak fiscal
frameworks and the lack of a conducive political context.
Second, the political leadership in Switzerland (which has always been consensus
oriented) converged on a consensus belief in the role of fiscal policy. It seems likely
that the consensus on a passive role of fiscal policy already manifested itself during the
end of the nineties when the wish for decisive action was shown by the measures
introduced by the Budget Objective 2001. Moving discretionary fiscal policy to the
margins and leaving fiscal policy intervention to automatic stabilizers did not
encounter significant opposition. The design of the debt brake accordingly transformed
the primacy of automatic stabilizers into specific obligations; the acceptance of these
obligations had thus already been established by that point. Legislation for stricter
expenditure control was also facilitated by the strong majority of the three “civic
parties” in the federal parliament, which pushed for balanced budgets.
65
Third, the technical design of the Swiss debt brake is a very precise reflection of the
shapes that fiscal policy should take according to Swiss policymakers. For example, the
preference for the working of automatic stabilizers was translated into the design of
the fiscal rule.
Finally, this study supports the existing arguments that hold that the choice between
the delegation and contracts approaches should depend on the political characteristics
of a country. In a similar sense, the study suggests the importance of examining
politico-institutional factors for the successful adoption of fiscal rules. The study thus
supports a political-economy approach toward the subject of sustainable public
finances; its results stress that policymakers should have a proper understanding of a
country’s particular institutional environment (including the quality and quantity of
its fiscal framework and fiscal institutions) before they contemplate making any
changes. The policy implication for countries that wish to control their public debt is
thus that policymakers should demonstrate that they have this proper understanding
before adopting a given type of fiscal rule. In some scenarios, for instance, introducing
gradual improvements of the fiscal framework will be more advisable than starting off
with a strong fiscal rule.
66
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