Positive culture of austerity: Switzerland's 'debt brake'
Since the early 2000’s, Switzerland’s fiscal institutions have been successful in keeping the overall levels of taxation and spending at moderate levels. The country’s high fiscal strength is based on manageable levels of government debt and existing reserve buffers. Between 2007 and 2013, the general government debt decreased by 5 %, reaching a level of 46% of the GDP, more than 40 % lower than the OECD average. Nearly a decade has passed since the introduction Switzerland’s debt brake, a key institutional mechanism for managing public finances which subjects the Confederation's fiscal policy to a binding rule. At the federal level, the debt brake is less than fifteen years old, but has already played a significant role in Switzerland’s financial regulation and contributes significantly to the country’s fiscal discipline. It was originally designed for the overall management of the federal budget, preventing structural deficits and sudden increases in state debt. Switzerland’s “debt brake rule”, which mandates the federal budget to maintain a balanced structural position, has delivered a sizable reduction in public debt. Since its introduction in 2003, the debt brake has been able to reduce federal debt by around CHF 20 billion thanks to increasing structural surpluses. Under the rule, general government debt as a share of GDP has remained on a declining path. Automatic stabilizers operating through taxes and unemployment benefits also help to dampen the business cycle. The legal requirements relating to the compensation account mean that budgetary underruns may only be used to reduce debt. Politicians have no alternative option of using savings for tax cuts or expenditure increases. In addition, the rule has some built-in flexibility to allow extraordinary spending under the “exceptional financial circumstances” clause, which will most likely be used for migration-related spending in 2017. Despite the brake’s overwhelming fiscal success, the federal government is now considering relaxing the debt break, a move that could undo much of the progress made to date. A group of experts now has until July 2017 to examine how structural surpluses could be used to increase the expenditure ceiling.
Exposing hidden debt
Avenir Suisse sees the potential relaxing of the debt break as a threat to a healthy budget and low inflation. Switzerland’s spending cap has helped the country avoid the fiscal crisis affecting so many other European nations. Nevertheless, the Swiss system isn’t perfect and Avenir Suisse researchers, Fabian Schnell and Marco Salvi, remind us that the debt brake is only applied to the explicit part of the national debt that is only visible in the regular state account. The vast majority of new state debt is generated by the government’s social welfare contribution, accumulated outside the actual federal budget. The spending cap does not cover some social insurance programs, so outlays will increase in this area as the population ages — though Switzerland is still in good shape since a large share of its health and pension expenses are handled by the private sector. Since the federal government expects this social welfare contribution to increase by a further CHF 5 billion by 2030, ignoring this in the debt calculations distorts the view of a balanced budget. State authorities are actively working on effective measures to generate new financial resources to cover future age-related costs. Some of these will need to include raising retirement ages and VAT rates. Rapid implementation of these proposals will help ensure the sustainability of the social safety net and prevent changes to the debt break.
The Swiss debt brake does not require a balanced budget in the traditional sense. Tax receipts tend to increase rapidly when the economy is doing well and fall off when the economy stumbles. To smooth out the ups and downs, Switzerland’s debt brake limits spending growth to average revenue increases over a multiyear period. Despite the well-intentioned objective of a structural balance, some aspects of the rule could lead to some under-spending. In the event of a severe recession, discretionary fiscal expansion would be an important instrument. With moderate public debt, negative borrowing costs, and broadly balanced budgets, Switzerland has ample fiscal space to respond to a prolonged recession with discretionary fiscal stimulus in order to support growth and inflation.
A Swiss model for the world?
The Swiss debt brake is the ideal model for other countries lacking fiscal discipline to embrace. As emphasized by Avenir Suisse’s Daniel Müller-Jentsch, “Switzerland came up with the blueprint for what I am sure will be the standard fiscal model of the future.”
Although the debt break is already part of many governments’ policies in the form of typical numerical fiscal rules, the mechanism needs to be used for more than just to stave off the immediate economic threat of becoming overwhelmed by a wave of accumulated state debt. Rapidly ageing populations and expanding welfare costs associated with unemployment and health insurance threaten to add a fresh financial burden to developed economies. When the financial crisis broke out in 2008, the ability of highly indebted states to keep up with massive interest payments was hampered by rapidly decreasing tax revenues. Central banks and governments around the globe were forced to print more money to bail out their retail banks and various sectors of the economy. Germany applied its own adapted version of the Swiss debt brake in 2009, followed by Spain and other European countries. At Germany’s request, the 17 Eurozone countries have also been forced to implement some sort of debt breaks in a desperate attempt to reform their monetary and fiscal policies. A significant development here is the Stability and Growth Pact of the EU, which obliges member countries in principle to stay within the limit of 3% of GDP for the annual budget deficit, and a maximum of 60% of GDP for total government debt.
New Culture of fiscal management
The Swiss debt brake’s most important contribution, however, cannot be measured in figures or attributed to monetary policy models. The introduction of the debt break has fundamentally changed the political culture in Switzerland and many other fiscally conservative states. In the early 1990s fiscal policy was oriented more towards the demands of the public sector and less towards the available financial resources. The actual fiscal balance was only given (at least for a long time) marginal attention. Fiscal discipline was widely accepted but was only one part of a broader social and economic rejuvenation in the post-Cold War era. The Washington Consensus maintained that the size of the state budget (and its debts) should be reduced and instead governments should focus on creating incentives for private sector growth.
Today, however, the administration, the government and the parliaments believe it is self-evident that expenditures must develop in the medium term in line with revenue. Fiscal federalism, as an important element in the cantons, protects against overcrowding access to the tax side. Self-restraint and cautious balancing of the expansion of state services have become the norm in most developed economies- which does not mean that the concrete use of funds is not to be disputed. The problem is that such a "state culture", as it has developed in a surprisingly short time, is a relatively fragile construct; moreover, it is diametrically opposed to the logical interests of politics and administration.
Putting a break on Switzerland’s debt break?
The success does not come without its challenges. Even small loopholes in the debt brake (as the Federal Council is now considering) can potentially lead to negative consequences. Despite great fiscal discipline, it does not take much to revert back to bad habits and increase public spending to prop up the bloated welfare state. In such cases, the economic risks would be much greater than the benefits from the allegedly greater fiscal flexibility. Ultimately, there is no immediate need for reducing the restrain of the debt brake. More significantly, the state needs to manage all aspects of welfare spending to ensure the sustainable financial stability of the federal budget.