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Press Release: Policy Insight 121 'The Commission’s New Expenditure Benchmark'

The European Commission has proposed a new revision of the Stability and Growth Pact (SGP), which aims to shift the focus to longer-term sustainability rather than annual public finances. The new proposal also moves away from budget balance assessments and instead emphasises the expenditure benchmark as the central measure. This Policy Insight by Charles Wyplosz (Graduate Institute, Geneva, and CEPR) argues that while the proposal's long-term view aligned with sustainability is a step in the right direction, the shift to the expenditure benchmark may undermine this progress. The Insight also examines how the SGP's previous benchmarks failed to establish fiscal discipline and suggests that the proposed changes could help deliver debt discipline among euro area Member States.

Central takeaways from the Policy Insight include:

  • The expenditure benchmark, introduced in the 2011 reform of the SGP as a complementary measure to the cyclically adjusted budget deficit (CAB), has weaknesses such as ignoring cyclical government revenues, focusing exclusively on cyclical unemployment spending, and being based on potential growth rate forecasting, which is imprecise.
  • It also relies on changes in discretionary revenues provided by Member States, but the measurement of these revenue changes – equivalently of windfalls or shortfalls – is imprecise and bound to be subject to challenge. It may also incentivise governments to resort to tax reliefs.
  • The expenditure benchmark was developed to capture windfalls and shortfalls caused by cyclical fluctuations that affect the budget and to prevent creative accounting, but these fluctuations do not affect debt sustainability in the long run and are typically ignored in CAB estimates.
  • The target for adjusted expenditure growth, or benchmark, is arbitrary as it doesn't account for individual country circumstances. The size of the public sector should be decided democratically at the national level, not by a European rule. The CAB is beneficial as it avoids such policy considerations.
  • Even though the adjustment methods have different impacts across time and countries, the CAB and the benchmark expenditure measures do not differ in any statistically significant way.
  • The expenditure benchmark’s estimates of average GDP require forecasting GDP growth four years ahead, which is a highly imprecise and untransparent procedure, with no available comparative estimates.
  • Replacing the year-by-year approach with a medium to long-term framework fails to recognise that the expenditure benchmark, which arbitrarily sets the path of public expenditure growth over time, is designed to carry out the same approach.
  • The new proposal goes some way towards clearing the “sedimentation of reforms” that have accumulated over the years. The shift to the expenditure benchmark, however, with its semi-convoluted nonstandard concepts (fiscal effort, adjusted net expenditure), will nullify this positive effect with its complexity. In contrast, the CAB is simple to grasp.

Overall, the Policy Insight demonstrates that there is substantial risk that the improved version of the SGP will be undermined by a construction that is both deeply technical, confusing and could become a serious weakness for discussing fiscal discipline with Member States.