DS.17.03.143

by: Geert Langenus and Barbara Coppens (Economics and Research Department, National Bank of Belgium) 1 This presentation reflects the views of the authors and not necessarily those of the National Bank of Belgium

and the High Council of Finance.

Sub-national fiscal governance in Belgium: role of the High Council of Finance and new challenges1

9th Annual meeting of the PBO-IFI Network, Scottish Parliament, 7 April 2017

2

Plan of the talk

1. Intro: the Belgian fiscal landscape

2. Fiscal surveillance for Belgian sub-national governments: – current situation – effectiveness and challenges

3. Concluding thoughts: way forward?

3

Reminder: Belgium for beginners

4

Reminder: Belgium for beginners

1 Apart from 3 municipalities in the east of Belgium (German language area, about 100,000 inhabitants; blue stripes).

Walloon Region (French language area1): 3.6 mn inhabitants

Flemish Region (Dutch language area): 6.5 mn inhabitants

Brussels Capital Region (officially bilingual area): 1.2 mn inhabitants

5

Reminder: Belgium for beginners

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Reminder: Belgium for beginners

► More complicated in institutional terms!

► The central government: ● federal government

(most important taxes, defence, justice, etc.) ● social security system

(unemployment, pensions, etc.)

► The sub-national level: ● 6 (5) 1 “State” governments:

■ 3 Regions: Flemish, Walloon and Brussels Capital Region (in charge of e.g. economic policy, land use, employment, agriculture, housing, etc.)

■ 3 (language) Communities: Flemish, French and German-speaking Community to some extent non-territorial (in charge of e.g. education and cultural policies)

● a thick layer of local governments (10 provinces, 589 municipalities, 195 police districts, etc.)

1 Flemish regional and community institutions are merged.

7

Expenditure decentralisation – State spending (state spending in % of total government expenditure)

The ‘federal’ EU countries

10

15

20

25

30

35

40

45

50

55

60

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

2015

Canada Switzerland US

Other federal countries

Source: OECD.

10

15

20

25

30

35

40

45

50

55

60

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

2015

BE AT DE ES

8

federal government social security regions and communities local government

Belgium – Primary expenditure breakdown: shift from federal government / social security to regions and communities (% of final primary expenditure of general government)

Source: NAI.

20.6

41.3

24.1

14.0

1995

21.4

39.9

24.7

14.0

2005

16.7

36.8

32.6

13.8

2015

9

Most recent phase in devolution: 6th State Reform, SR6 (2014)

► Further devolution of federal competences: ● Regions

■ labour market policy ■ tax abatements in the field of mortgages, investment in energy savings, and service

vouchers ● Communities

■ family allowances ■ care for the elderly ■ other health care expenditures

● total = close to 5 % of GDP (at unchanged policy) ● p.m. bulk of social security (pensions, most of the health care, unemployment

benefits) remains at the central level!

► Reform of the financing of the Regions and Communities: ● financing the new powers and revision of the existing grant system ● special provisions for the Brussels Capital Region (additional funding linked to

inflows of commuters, presence of international organisations, role of capital city) ● new solidarity mechanism (makes up 80 % of the difference between the

population's share and the Region's share in federal income tax) ● extending regions' fiscal autonomy

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Reform of the financing of the Regions

► Own regional taxes already existed: e.g. road, inheritance and gift taxes; withholding tax on immovable property shared with local authorities

► In addition to those regional taxes Regions get tax autonomy in the Personal Income Tax (PIT) system ● 2015 figure; roughly ¼ of current personal income tax

► principle: federal PIT partly replaced by regional PIT

► Regional PIT technically levied as a percentage of the federal PIT (tax-on-tax surcharge)

► The Regions will have the competence to: ● set their own tax brackets themselves ● set the level of the additional percentage per tax bracket ● allow tax cuts

► But without any substantial reduction in the progressiveness specified by the federal government ● in practice: specific constraints for reduction on the highest tax brackets ● to avoid tax competition for the highest incomes

Regional tax surcharge instead of a “clean” split rate?

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What about the federal government?

► Regions and communities contribute to fiscal adjustment ● pension contributions for their staff (before they did not pay any contributions in

the federal pension scheme) ● explicit ‘fiscal consolidation contributions’ (0,6 % of GDP) ● longer term: grants only partly linked to economic growth

► The federal government remains fully competent for ● taxes on company profits ● VAT ● excise duties ● withholding tax on income from movable property of individuals

► The federal government retains the main competences regarding PIT ● defining the tax base, setting the tax rate and collecting the PIT ● the Regions cannot invoke any conflict of interest at the Constitutional Court

regarding the PIT ● the tax autonomy of the Regions is defined under a strict framework to avoid tax

competition

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Vertical fiscal imbalances decline but do not disappear

Sources: NAI, NBB. 1 Region and community are merged. 2 Corrected for the partial registration of the regional PIT in ESA 2010.

0

10

20

30

40

50

60

70

2014 2015 2

Impact of SR6: tax autonomy in the three regions (share of own revenue in total regional revenue, percentages)

0

10

20

30

40

50

60

70

0

10

20

30

40

50

60

70Flemish Community 1 Walloon Region Brussels Capital Region

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Current experiences with greater tax autonomy?

► Very early!

► All regions have reformed – or announced reforms of – the mortgage tax abatement and real estate taxation in general ● very significant reduction in the Flemish Region as of 2015 ● minor reduction in the Walloon Region as of 2016 ● abolition in the Brussels Capital Region as of 2017 but in the context of general

overhaul of real estate taxation and shifting part of the burden to owners that rent out their property

► Other changes have been very limited! ● no changes to PIT tax brackets ● minor changes to some transferred tax abatements announced

(e.g. deductibility of service vouchers in Brussels Capital Region)

► In general, gradual and only parametric reforms of new competences (e.g. family allowances)

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Plan of the talk

1. Intro: the Belgian fiscal landscape

2. Fiscal surveillance for Belgian sub-national governments: – current situation – effectiveness and challenges

3. Concluding thoughts: way forward?

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Two fiscal councils

Federal Planning Bureau ● macro projections for the budget ● operationally independent ● checks and balances within

National Accounts Institute (participation of NBB)

High Council of Finance (PB Section) ● budget recommendations for each

government (sub-)entity ● fiscal surveillance ● Chairman + 3 Members from NBB

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High Council of Finance / PB Section

► Members with five-year renewable mandates ● PB section: 6 members proposed by federal government institutions (among

which, 3 by the NBB), and 6 members proposed by regions and communities ● current Chairman of HCF-PB = Jan Smets, NBB Governor

► Old history but current form / mandate closely linked to devolution process and the European budgetary framework ● ensure that greater spending autonomy does not jeopardise fiscal sustainability ● Monitoring institution as required by the TSCG ● mostly ‘moral authority’, one explicit sanction mechanism (that is never and will

never be used): recommendation to the federal Finance Minister to curtail borrowing by regions/communities

► Public reports but in practice no automatic impact in the budget cycle ● e.g. government does not even have to acknowledge these reports or explain any

deviations from them (situation before the new role, after see below) ● no specific relationship with Parliament

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High Council of Finance / PB Section – Secretariat

► Currently no own staff, work outsourced to selected staff of the federal Ministry of Finance that form the secretariat and prepare the reports

► Early 2016 governments agreed upon a change of the secretariat ● “Federal” secretariat of the section was enlarged with 6 members who originate

from the budget administrations of the regions and communities but secretariat members are not detached to the HCF-PB

● Federal members of the secretariat, also 6, are to be selected among the staff of the federal Ministry of Finance and the federal Ministry of Budget

► This reform is still in a transitional phase and will probably be revised following the EC report on the implementation of the Fiscal Compact ● The draft amendments envisage a dedicated secretariat for the HCF-PB, which

would only follow the instructions of the HCF-PB chair (EC, 2017)

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Plan of the talk

1. Intro: the Belgian fiscal landscape

2. Fiscal surveillance for Belgian sub-national governments: – current situation – effectiveness and challenges

3. Concluding thoughts: way forward?

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Sub-national governments not the key source of fiscal deficits

-6

-5

-4

-3

-2

-1

0

1

2

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Federal government & social security Regions and communities Local government

exceptional deficit for R&C due to ESA 2010 recording of regional PIT

Budget balances by sub-sector (percentages of GDP)

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Outcome 2015 for the 4 main regions and communities versus structural and nominal objectives

-0.08

-0.06

-0.04

-0.02

0.00

0.02

0.04

0.06

0.08

FlemishCommunity

FrenchCommunity

WalloonRegion

BrusselsCapitalregion

Objective HCF-PB ² own objective ³ outcome

-0.20

-0.15

-0.10

-0.05

0.00

0.05

FlemishCommunity

FrenchCommunity

WalloonRegion

BrusselsCapitalregion

Structural evolution (percentages of GDP)

Nominal budget balances¹ (percentages of GDP)

Sources: illustrative exercise HCF-PB, HCF-PB report, July 2016. 1 Nominal budget balance outcome for the Regions is corrected for the partial registration of the regional PIT in ESA 2010. 2 Indicative nominal budget balance objective derived from the structural balance. 3 Required structural evolution derived from their own nominal budget balance objective.

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Challenge 1: Budget coordination remains vulnerable... – 1

► No hierarchy between federal government and regions and communities

► No permanent fiscal rules governing regions and communities ● deficit restrictions for local authorities (golden rule type)

► Consensual /contractual approach to fiscal coordination

► Only structural feature = Dec 2013 Cooperation Agreement (between federal government and regions and communities) ● imposes compliance with EU fiscal framework: i.e. convergence to MTO ● essentially a formalisation of the pre-existing procedures ● monitoring role of HCF-PB strengthened = monitoring institution for the TSCG

■ Determination of a significant deviation for each (sub)-entity from the budgetary targets agreed upon in the concertation committee (trigger for the automatic correction mechanism)

● “Belgian feature”: recommendation of specific budget targets for each government (sub-entity) in preparation of the stability programme ■ Recommendation of targets has to be both in nominal and structural terms for each level of

government ■ however: recommendations on the budget targets still need to be “ratified” in the

intergovernment Concertation Committee

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Challenge 1: Budget coordination remains vulnerable… – 2

► No new specific Cooperation Agreements on budget targets since 2013 ● Regions and Communities only ‘take note’ of stability programme submitted by the

federal government ● Ownership of general government objectives across government levels?

► Result: the HCF-PB section has not been able to perform its monitoring task as foreseen in the Cooperation Agreement of dec 2013 ● The absence of commonly agreed budget targets means there is no legal basis to

determine a significant deviation by each level of government (HCF – PB report, July 2016)

● Evaluation of each level of government purely illustrative for 2015 results

► Difficulties to reach agreements on budgetary targets are (partially) linked to uncertainty following the Sixth Reform of the State ● Such as uncertainty concerning the calculation of the instalments of the regional

tax autonomy and the exact budgetary impact of certain transferred competences

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… as also reflected by synthetic indicators

Fiscal Rules Indicator for State governments: dimensions reflecting fiscal discipline incentives (standardised, 1 to 10, higher outcomes are more desirable)

0

1

2

3

4

5

6

7

8

Aus

tralia

Aus

tria

Bel

gium

Can

ada

Ger

man

y

Italy

Mex

ico

Spa

in

Sw

itzer

land

Restraining the size of the public sector Ensuring debt sustainability

Source: OECD Fiscal Decentralisation database.

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Challenge 2: Structural balances for sub-national governements ► Cooperation Agreement of Dec 2013 requires a recommendation for the budgetary

targets of each level of government in both nominal and structural terms ● In line with the EC CAB methodology ● Sum of structural balances of each level of government = structural balance of

the general government ● Recommendation for the general government has to comply with preventive arm European

budgetary framework (minimum structural improvement each year)

► Current approach HCF- PB secretariat: ● General government cyclical component broken down by level of government

■ no determination of an output gap by level of government ■ (OECD / EC) elasticities of specific revenue items applied to regional revenues

● Is this accurate enough to reflect true cyclicality in regional revenues (other tax bases)? ● One-offs by level of government: currently very complicated due to the introduction of

the SR6 and the regional PIT ● Adaptions were made to take into account “Belgian” idiosyncrasies such as the transfers

between the federal state and regions and communities under the Special Finance Act (“linked to economic growth”)

► However: this structural framework is currently not reflected in the regional budget processes (even if they approved 2013 Cooperation Agreement)

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Challenge 3: HCF – PB: independence?

► Bipartisan / multipartisan composition vs. purely non-partisan institutions in other countries: ● “The appointment process of the chairman, the deputies and the members ...

raises doubts about the High Council’s independence.” (Burret and Schnellenbach, Sachverständigenrat WP 08, 2013)

● “Membership ... carved up between the six traditional political parties” (Coene and Langenus, 2013)

● “The HCF appears to be tightly attached to the Ministry of Finance, which provides logistical resources, budget and staff.” (EC, 2017)

● “… the current legal and institutional framework establishes close interdependencies with the Ministry of Finance and other institutions and governments who nominate the HCF-PB members, thereby weakening the HCF-PB's ability to act as an autonomous entity providing independent, unbiased monitoring.” (EC, 2017)

► Essentially: HCF-PB = Committee of Wise (Wo)Men that is not insensitive to political feasibility constraints ● impact has waned after euro adoption (prior to new role as of 2014, too early to

judge)

► Belgian authorities have committed to (rather vague) ‘amendments’ of the mandate and legal framework

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Plan of the talk

1. Intro: the Belgian fiscal landscape

2. Fiscal surveillance for Belgian sub-national governments: – current situation – effectiveness and challenges

3. Concluding thoughts: way forward?

27

Concluding thoughts: way forward?

► Challenge 1 – budget coordination ● Ensure that budgetary norms, ownership of stability programmes are not

conditional upon an agreement in the Concertation Committee ● (Further) move away from the ‘contractual’ approach

■ Upgrade the Dec 2013 Cooperation Agreement to a genuine internal Stability Pact ● An explicit ‘no-bail-out’ clause – although sufficient tax autonomy needs to be

ensured ■ May require more systemic reform to state structure (e.g. Communities can not levy

taxes)

► Challenge 2 – structural balances by level of government ● Further research to adapt CAB framework to Belgian and region-specific

elements (look at different tax bases) ● Better adapted framework, more ownership?

► Challenge 3 – independence, HCF PB and secretariat ● Minimum: secure a detached, fully autonomous secretariat under the instructions

of the HCF-PB chair (cf. EC Recommendation) ● But let’s be bold: move from a multi-partisan to a non-partisan institution

(appointment procedures of Members, involvement of foreigners, etc.) ● Examples of other institutions in the IFI Network can provide inspiration…

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Back-up

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SR6: Reform of the financing of the Communities

► Funding of budget allocations based on distribution keys that generally reflect expenditure needs for specific competences ● a grant based on a distribution key for pupils (15.6 billion euro) ● flat-rate distribution keys will be used for the new competences

child allowance: 0-18 year-olds care for the elderly: over-80s health care: population

► An allocation shared out according to the regional part in federal personal income tax (8.5 billion euro¹)

► Transitional arrangements

1 This is the amount before the contribution to the fiscal consolidation is deducted.