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Prudence, Scope for Reducing Program Spending and Policy Rules on Medium-Term Fiscal Planning

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Patrick Georges
Nicolas Moreau

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Abstract

This paper shows that managing the risk of a budget deficit has (at least) two elements, the level of fiscal prudence, and the scope for discretionary measures (e.g., scope for reducing program spending). These two elements jointly determine the probability of a deficit outcome. The magnitude of the scope is limited by a multi-year pre-commitment to a minimum level (a "floor") of fiscal measures (program spending and taxes) that is "irreversible" or permanent for the purpose of medium-term fiscal planning. The policy implications of the paper are twofold. First, one has to know how much scope is available for reducing program spending in order to provide estimates of "adequate" levels for fiscal prudence. There is, however, little consensus about how much scope is available. Second, the timing and magnitude of the enrichments of permanent tax and spending measures should be linked to the occurrence of favourable fiscal developments that raise the scope for discretionary measures. This strategy would enhance the fiscal authority’s pre-commitment to permanent measures without substantially increasing the risk of a deficit outcome.

Ce papier montre que la gestion du risque d’un déficit budgétaire comporte (au moins) deux éléments: le niveau de prudence fiscale et la marge de manœuvre disponible pour des mesures budgétaires discrétionnaires (e.g., potentiel de réduction des dépenses de programmes). Ces deux éléments déterminent conjointement la probabilité d’observer un déficit budgétaire. Le potentiel de réduction des dépenses de programmes est limité par un engagement à un niveau minimum (« plancher») de dépense de programme au cours d’un horizon temporel à moyen terme (10 ans). Cet engagement est, par définition, irrévocable, ce qui permet d’assurer un niveau minimum de dépenses permanentes au cours de l’horizon temporel considéré. Deux principales implications politiques découlent de ce papier. Premièrement, il est important de connaître la marge de manœuvre disponible pour des mesures budgétaires discrétionnaires de façon à allouer un niveau adéquat de prudence budgétaire. Cependant, il n’existe pas de consensus concernant cette marge de manœuvre discrétionnaire (en particulier le potentiel de réduction des dépenses). Deuxièmement, le moment (ou « timing ») et la taille des enrichissements des mesures permanentes de dépenses (ou de taxations) devraient être associés à la présence de développements budgétaires augmentant la marge de manœuvre discrétionnaire. Cette stratégie permettrait d’améliorer la mise en œuvre de mesures budgétaires permanentes sans toutefois faire augmenter de façon substantielle le risque d’observer un déficit budgétaire.

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Paper provided by Department of Finance Canada in its series Working Papers-Department of Finance Canada with number 2002-10.

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Handle: RePEc:fca:wpfnca:2002-10

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