Christopher Worthington: Govts failing at most basic task

Government failures are visible in Greece. Photo / AP

Christopher Worthington, senior economist at Gareth Morgan Investments, suggests a body could be set up to balance budgets.

The European crisis is lurching from bad to worse with Italy and Spain joining Greece, Ireland and Portugal in a state of fiscal emergency. At the same time, United States Republicans are trying to engineer their own crisis by refusing to increase the US Treasury's authority to increase debt to pay for spending.

Balancing tax and spending is the most basic task of governing and yet time and again governments fail miserably to do so. It now seems that default and austerity is as inevitable as death and (ever-higher) taxes.

Am I exaggerating? The governments capable of consistently running a balanced budget are a dwindling few. Matters will get worse, not better, over the next 30 years as ageing populations expand the costs of health and superannuation promises while eroding the tax base. It may not be this year, but Greece is seemingly the future for much of Europe, the United States and Japan.

Of course, these countries are all democracies. As H.L. Mencken once noted: "Democracy is the theory that the common people know what they want and deserve to get it good and hard." So sharing the blame with the politicians are the voters who time and again reward the policy plan of spend now and pay later.

Let's look at Greece in detail: Greece is completely insolvent and no realistic assessment would argue anything but. Greece is in this mess because the Government used EU membership, and the kudos associated with it, to borrow cheaply for more than a decade and used that money to fund a massive expansion in the public payroll.

Now the money is being cut off and Greece has to cut all those jobs and raise taxes. But it turns out it can't raise taxes - its tax department is somewhere between incompetent and corrupt. (There is an object lesson in here for those who think that government debt is nearly risk-free because governments retain the ultimate power to tax.)

And so the Greeks are marching on the streets protesting the cruel caprices of reality, that borrowers won't lend to people who can't repay. This is about as productive as protesting against gravity or the changes of the season.

The credit crisis, or global finance, is not to "blame" for the fiscal crises unfolding. Recessions are inevitable - prudent governments run surpluses and reduce debt in the good times. The Greeks and their ilk have been tottering on the edge of the cliff for some time.

Most people accept the philosophy behind the role of governments in modern society - market outcomes are sometimes inefficient or inequitable and governments can address this. But fewer seem willing to accept that governments also fail us "good and hard", despite the frequent reminders.

We're all familiar with how often political (or any social) bodies end up dysfunctional. This would be true even if their incentives to perform weren't badly flawed (with the focus on short-term electoral cycles) and governing didn't require cobbling together a voting coalition of disparate interests.

The solution is institutional design that limits governments' ability to do the public harm. We already have the precedent for such an institution in independent central banks.

History has shown that the government of the day can't be trusted with direct control over the printing presses, because the temptation to prime the economy in election years (even if inflation inevitably results) is too much.

Controlling inflation requires credibility, something governments lack, so we've turned monetary control over to an institution that has a single goal (stable inflation), a long-term focus and can build and defend its credibility.

I propose that a similar institution is required to ensure that budgets are balanced (on average). We need an independent body that has the power to assess and reject budget plans that are not consistent with long-term solvency.

Balanced budget amendments have been tried (largely unsuccessfully) in American states. But the problem is that these rules are normally heavily stacked in the political right's favour - often by making it near impossible to raise taxes. They are also too rigid to allow for the fact that the budget position should vary with the cycle so as not to accentuate slumps and booms.

So the ideal "fiscal authority" would have power to choose a level of fiscal stimulus consistent with the economic cycle. It would also have a politically neutral approach to balancing the budget - if the government of the day is unable to propose a balanced plan, then all spending should be frozen in nominal terms and each year taxes raised by 0.5 per cent across the board, until the fiscal authority reaches its target budget position.

On a limited scale, New Zealand already devolves some fiscal responsibility to semi-autonomous bodies. Pharmac acts as a check on rising drug costs and ACC adjusts its levies regularly to ensure that its liabilities will remain funded.

Luckily New Zealand governments have shown over the last 20 years a reasonable capacity to run a tight fiscal ship regardless of the party in charge. Few policy proposals are made these days without some explanation of how it would be paid for over the medium term.

But even in New Zealand we continue to have explicit (superannuation) and implicit (public healthcare) liabilities where it is clear that higher taxes or spending cuts will be needed over the next 20 years. No politician is yet willing to commit to a path for addressing this reality.

It seems far better to put in place additional protection against fiscal recklessness now when we don't need it, than need it and not have it at some later date.