The Quality of Public Finances

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The ‘quality of public finances’ (QPF) is a manifold concept. Originally, the idea to explore qualitative aspects of fiscal policy stemmed from the notion that concentrating solely on quantitative aspects, in particular the Maastricht criteria, is not comprehensive enough and could possibly result in suboptimal outcomes including unwanted side-effects.

Therefore, right from the beginning, the task of the Economic Policy Committee’s QPF-Working Group has been to explore the links between the qualitative and the quantitative sides of fiscal policies. This first section on methodology and data issues prepares the ground for this analysis. Here, also the fundamental question of defining the concept is addressed.

The first paper by the Economic Policy Committee (2006) reflects the first two years of the Working Group on QPF.

During that time, the Working Group concentrated mainly on the expenditure side of the budget. In that respect, the work on quality covered three elements: investigating the role of budgetary institutions in identifying and implementing expenditure priorities; analyzing and monitoring trends in the composition of public expenditure; and measuring the efficiency of public expenditure.

In the meantime, as the second paper by the Economic Policy Committee (2007) on "Work accomplished and the way forward" points out, also the composition and qualities of tax revenues have become an important issue of QPF-analysis yet this is a nascent branch at the moment.

Thus, the paper on the quality of public finances and growth by Afonso, Ebert, Schuknecht and Thone (2005) concentrates on the linkages between the level and composition of public expenditure and its financing via revenue and deficits on the one hand, and economic growth on the other hand.

In general, the authors find that fiscal policies are of high quality and support growth if they fulfil five requirements: They

(1) provide for an institutional environment supportive to growth and sound public finances,

(2) limit commitments to the essential role of government in providing goods and services,

(3) set growth promoting incentives for the private sector and make efficient use of public resources,

(4) finance government activities and where appropriate private sector activities with an efficient and stable tax system, and (5) support macroeconomic stability through stable and sustainable public accounts.

In their paper, Afonso and colleagues also provide a survey of different empirical studies which shows that an objective and unambiguous overall catalogue of “high quality”-expenditure items cannot be established. Yet, as the Working Group on the quality of public finances learned, there is also very limited comparable data on the composition of public finances.

When the Working Group started, the composition of government expenditure could only be examined with first level data from the ‘Classification of Functions of Government’ (COFOG), i.e., in no more than ten different categories.

To overcome this knowledge gap, the Working Group outlined ‘possible ways to implement a dataset to analyze the quality of public expenditure’ and conducted a survey among its members on the feasibility of an improved dataset as outlined in the EPC not from 2004. At the center of this improved set stand expenditure data broken down at a second level (COFOG-II), i.e., differentiated into seventy different groups. Meanwhile, Eurostat and the Member States have established a specialized COFOG-task force on this matter. On the basis of voluntary submissions, this work is ongoing, COFOG-II-data for most Member States are being produced, and they are envisaged to be made publicly available soon, as the above-mentioned EPC-note of 2007 reports.

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