Structural Balance and 'Structural Effort'

Abstract

The evolution in the public balance reflects both fiscal policy decisions and the impact of cyclical evolutions. In attempting to characterize the orientation of fiscal policy, it is a priori natural to adjust for the impact of the economic cycle on the public finances. This exercise is important as much for the management of public finances as for the conduct of macroeconomic policy.

There seems to be no dispute regarding either the utility of the calculation or its methodological base. The method used, which is broadly common to all the international organizations, consists of evaluating the cyclical component of the general government balance on the basis of measurement of the economy's position in the cycle (captured by taking the output gap). The so-called 'structural' balance is then obtained by deducting this cyclical component from the observed balance.

In practice, however, measurement of the structural balance raises a certain number of difficulties. In the first place, it turns out to be sensitive to the measurement of the economy's position in the cycle, which may be differently assessed by different institutions. These differences in the diagnosis of the cyclical situation then have an impact on the construction of the absolute level of the structural balance. In addition, the calculation method is based on a set of assumptions that are more or less open to question. In particular, it assumes that 'spontaneous' tax revenue evolves in line with activity. While this property seems to be verified econometrically over the long term, it constitutes a very strong conventional assumption for the short term and one that is not verified in practice.

This latter difficulty has an important consequence, namely that it substantially blurs the interpretation of the structural balance when attempts are made to identify the portion of the evolution in the public balance that is attributable to discretionary decisions on the part of the authorities. This means that the concept of structural balance is a very imperfect measure for characterizing the orientation of fiscal policy. It is in fact conceived as the 'residual' between the observed balance and its cyclical component, the result being that any factor that does not explicitly appear in the cyclical balance is, by construction, of a structural nature. This is true in particular for the interpretation of short-term fluctuations in the elasticity of revenue: the calculation conventions used in the method lead to interpreting these fluctuations entirely as part of the variations in the structural balance, whereas in fact, by their very nature, they lie outside the control of the fiscal authorities and therefore are not subject to discretionary decision.

What is probably a more satisfactory measure of the discretionary component of public finances has been proposed in the 'Economic, Social and Financial Report' annexed to the 2004 Budget Bill, using the notion of 'structural effort'. This 'structural effort' singles out two factors: the gap between the growth in public expenditure and potential growth, which may be called the "structural expenditure effort" and the new measures relating to compulsory levies collected by the whole of general government. In fact, the structural effort in any case merely identifies a part of the factors relating to the evolution in the structural balance and an accounting breakdown makes it possible to move from one concept to the other by means of certain adjustments: elasticity effect, timelag between "chargeable event" and collection of certain taxes (personal income tax and corporation tax), and the evolution in revenue excluding compulsory levies.

An approach of this kind is still open to improvement. The simplest would be to adjust the discretionary expenditure effort to allow for that part of spending that can be regarded as 'automatic', in particular interest charges and unemployment-related expenditure. This adjustment marginally modifies the calculation.

At a more fundamental level, however, the method remains asymmetrical in its treatment of expenditure and revenue. On the revenue side, the structural effort does indeed single out the new measures taken by public decision-makers - in the legal sense. On the other hand, for lack of an evaluation of the "new measures" on the expenditure side, reasoning of a statistical nature is adopted by comparing growth in expenditure with potential growth. However, the reference to potential growth as the yardstick for distinguishing discretionary expenditure from non-discretionary expenditure seems to be highly conventional.