Power over fiscal policy must be taken away from politicians

 

OPINION:Twice in a generation the political class has mismanaged the public finances. Radical change is needed to ensure it never happens again, writes Dan O'Brien 

HAD THE public finances been well managed during the years of extraordinary plenty, the Government would now be in a position to mitigate the effects of recession by cutting taxes and increasing spending. Such steps would have the additional effect of boosting confidence by providing reassurance that those at the helm are capable of navigating a course back to stability and growth.

But the public finances were grossly mismanaged during the boom years. As a result, the Government and its finances are now a part of the problem rather than the solution. This is as appalling as it is tragic.

The need for radical change in the way the public finances are managed would be moot if the current crisis was the result of unforeseeable events at home or unprecedented developments abroad. But the fiscal crisis can be attributed to neither.

The precipitous deterioration in the public finances pre-dates even the beginnings of the international credit crunch. Irrefutable proof of the home-grown nature of the fiscal fiasco is provided by comparison with peer countries that have faced the same international environment.

A majority of euro zone members have registered a narrowing of budget imbalances since 2006. Ireland has not only bucked the trend, but the deterioration in its public finances has been far worse than that recorded in any euro zone country over the past quarter century.

If this extraordinary failure was a one-off event, then one could possibly make the case that the lessons of today will be learned and not repeated. But it is no such thing. It is the second time in a generation that the country has inflicted such harm upon itself.

In the 1970s and early 1980s, the world suffered its deepest slump since the 1930s. Countries everywhere faced similar challenges. Some rose to those challenges. Others muddled through. Three rich countries - Belgium, Ireland and Italy - floundered.

Prior to 1987, Ireland floundered most. By 1985 it was alone among the Organisation for Economic Co-operation and Development countries to have a public debt greater than its GDP.

Belgium and Italy have dysfunctional political systems. Belgium is corrupt, grossly over-governed and unable to overcome its communal tensions. Italy is inherently ungovernable.

Ireland's problems are not nearly of the same order as those of Belgium and Italy, but to fail so catastrophically to manage the public finances twice in a generation does demonstrate a grave deficiency in the Irish system.

The answer would seem to lie in the calibre of elected representatives. School teachers, publicans and small-town accountants are deeply rooted in their local communities and ensure the political system avoids the kind of disconnection with voters that many other mature democracies suffer. This is the enduring strength of Ireland's system. But it is also its greatest weakness. Such people are rarely even remotely qualified to run a finance ministry.

How to maintain the strengths while curing the ills? The answer is to depoliticise aspects of fiscal policy in much the same was as has been done with monetary policy across the world. This would allow qualified people to have a far greater input into the management of the public finances and curb the sort of "If I have it, I'll spend it" insanity that has led to the current predicament.

It seems hard to believe now that elected representatives in many countries once controlled interest rates. The result, to a greater or lesser extent, was the abuse of that power. Interest rates were cut before elections to generate artificial booms. They had to be tightened afterwards to squeeze inflation out of the system. It was a recipe for boom and bust cycles.

The misuse and abuse of fiscal policy in Ireland over decades has had the same boom-bust effect. Real human misery has been, and is now, the result.

Today, independent but accountable central banks manage monetary policy. They do not always get it right, but nobody argues for a return to old ways. This must now be the direction for fiscal policy.

What does a depoliticised fiscal policy look like? First, and as is the case in other countries where moves in this direction have been made, it would be fundamentally different from monetary policy, which is a largely technocratic function.

Deciding on the level of taxation and spending is the central contested issue in stable democracies. There can and should be no constraints on any political party offering either higher spending or lower taxes. There must, however, be constraints on any government attempting to do both unsustainably. Three separate functions can readily be depoliticised without having any effect on voters' right to choose the level of tax and spending.

The first is forecasting. Where governments base their budgets on in-house forecasts for economic growth and tax revenues, the outlook is almost always rosier than independent forecasters. By making more optimistic assumptions and ignoring risks, governments can spend more and tax less.

Instead of the Department of Finance generating its own economic forecasts and projections, the entire function should be handed to the Economic and Social Research Institute, with additional safeguards to further bolster its independence.

The minister and his officials would then base budgets on a given set of assumptions and would not be able to succumb to the temptation to massage the figures for political ends.

The second function ripe for depoliticisation is the evaluation of spending programmes before implementation. Ireland lags far behind the European norm in this regard. Subjecting spending proposals to scrutiny is needed both to ensure that the objective is not political (eg decentralisation) and is being achieved at the lowest cost to the taxpayer.

Such a function would require a new free-standing institution peopled by auditors and economists. To be effective it would need statutory powers to amend, delay and perhaps even block proposals for which a minister cannot make a coherent and costed case.

The final function that lends itself to depoliticisation is the auditing of spending after it has taken place. The Comptroller and Auditor General in Ireland already does this, but his office is less resourced and has fewer statutory powers than in many other jurisdictions. It should be beefed up and given more and sharper teeth.

The political class has shown that it simply cannot be trusted to manage the public finances responsibly in the current framework. Real checks and balances are needed to constrain future finance ministers from repeating the recklessness of many of their predecessors.

• Dan O'Brien is a senior editor at the Economist Intelligence Unit