We need to remember the old saying about borrowed bread March 19, 2015

Raul Eamets
Chairman of the Fiscal Council of Estonia

The coalition agreement needs to stick to the principle that nominal balance must be maintained in the budget over the next four years.

There is a saying that you should mend your sledge in the summer and your carriage in the winter, and this tells us that it is already time to set out the broad lines of the state budget for next year. Although the budget balance was better than expected at the end of last year, this does not mean that money had appeared out of thin air and that it could be used lightly for increased spending in the years ahead.

Firstly some part of the surplus came from social insurance funds, and the government cannot directly use that reserve to cover its costs in the future. Secondly, tax revenues within the budget grew by a very rapid 8% in 2014, which was faster than GDP growth, so much slower growth should be expected in future. Equally, it is not impossible that the forecasts of nominal growth in the economy that have been used up to now were too optimistic. The world around us is an unstable place and the impact of this on foreign trade and global prices is hard to predict.

The coalition agreement

It is now time for the coalition agreement to be decided, and the starting point for this should be that nominal balance must be maintained in the budget over the next four years. If it is not, there is a danger that the fiscal rules will be breached, as four years is long enough for there to be no real difference between structural and nominal budget balance.

It is not possible to increase spending, cut revenues and maintain a balanced budget all at the same time.

Every long-term spending promise, such as raising child support, pensions or defence spending faster than previously planned, must be accompanied by a corresponding long-term rise in income or a reduction in other spending. Making the sums add up by using hastily passed tax rises in the calculation of income and expenses for one year or by using temporary one-off measures is just not good enough.

The typical political party used its election manifesto to argue for rises in various social benefits while at the same time wanting to reduce the tax burden on labour. However, it is not possible to increase spending (on benefits), cut revenues (from taxes) and maintain a balanced budget all at the same time. Furthermore, the promises of the parties tend to come with such high costs that they could not be financed by simply shuffling the structure of normal government expenses. Major cuts will be needed in current spending, or new sources of tax revenue will be needed to offset the tax cuts that have been envisaged. A large part of the income in our state budget comes from support measures from the European Union and I am not convinced that child benefit can be funded from EU support programmes, unless maybe through some legal subterfuge, but EU funds play a major role in financing certain costs for building infrastructure or for science and suchlike. It is also important to think for the long term, as fixed spending by the state cannot be left relying on support funds.

Government bonds

There has been a lot of talk recently about Estonian sovereign bonds, as the European Central Bank has started its large-scale purchasing programme for such bonds. This has raised the question of whether Estonia should issue bonds so that the central bank would have something to buy. The suggestion may seem logical at first glance, and as there certainly are major pieces of infrastructure that need to be built, public opinion would very probably support such borrowing.

Unfortunately, things are not as simple as they may at first appear. Since the European debt crisis, the European Union has tightened its control over the fiscal policy of member states a great deal. Additional injections of funds can be made through loans only if there will be some additional revenues at some stage that will cover the loan. The strategy for the state budget 2015–2018, which was updated last year, calls for the general government budget to be not only in structural balance but also in nominal balance from 2016.

It is to be hoped that the parties that enter the coalition stick to that target and accept it. The EU has given a reminder of the old Estonian saying that borrowed bread and fires of sawdust do not last very long...

Fiscal rules

The state budget law requires next year’s budget for the whole general government sector to be at least in structural balance.

On top of that the government needs to stay within the framework agreed by the European Union, which sets conditions that are mostly not repeated by our own laws. The EU rules also focus on the rate at which spending is growing and require additional spending to be covered by additional income.

Published: 16.03.2015
Published in: Eesti Päevaleht