A 'Central Bank' for Budget Policy

Institutional or constitutional fixes for broken US fiscal policy are ever on the agenda: Gramm-Rudman-like fiscal rules, PAYGO schemes, balanced-budget amendments, and so on. In Europe "fiscal councils"--appointed, purportedly apolitical bodies to oversee budget policy--have been catching on, and they've had some success. The US has flirted with this idea too. The Bowles-Simpson commission was a kind of fiscal council, though its fast-track legislative powers were never activated. Italy, you could say, now has an unelected fiscal council in place of its entire government.

Dealing with fiscal emergencies is one thing, but should technocrats or balanced-budget rules have a more permanent role? Advocates draw a parallel with central-bank independence. Politicized monetary policy has a pro-inflation bias. Politicized fiscal policy has a pro-deficit bias. In each case, it's argued, we're better off if governments somehow bind themselves to do the right thing.

I start out skeptical. Forget simple balanced-budget rules. They're just bad economics. Sometimes, like now, countercyclical fiscal policy is a vital tool. Complex rules (eg, balance the budget over the course of the cycle) are better because they can allow more flexibility, but they're also easier to subvert.

What about "independent" fiscal councils? I've doubts about the central-banking parallel. As I've previously mentioned, the standard case for central-bank independence needs to be revisited. (Central banks have lately gone way beyond monetary policy as previously understood.) Also, there's a subtle but important difference between the two cases. Although inflation is always tempting, low inflation here and now is often good politics. Central-bank independence makes low inflation easier to deliver, so there's a quick pay-off for the government of the day in surrendering some power. In contrast, balancing the budget here and now is unavoidably painful. If the job can be passed along to the next administration, that's better for the team currently in charge. So you'd expect politicians to be much less likely to surrender fiscal powers than monetary powers.

Nonetheless they keep talking about it and now and then even do it.

In a new column I mention an approach that I think might make a lot of sense: a fiscal council equipped with (1) a narrow remit and, more adventurously, (2) a tax instrument.

Imagine an independent agency whose mandate is fiscal stability. It would be the fiscal equivalent of the central bank. Suppose that agency had one, and only one, sufficiently powerful and flexible instrument: a national sales tax, say. It could cut this tax in recessions to provide short-term stimulus, and at other times would set it at whatever rate it judged necessary to stabilize long-term debt. That would be its dual mandate: short-term stability and long-term fiscal solvency.

This Fiscal Stability Board would not be deciding which districts get bridges or defense installations, when people should retire, what medical treatments should attract public subsidy, or how mildly to tax manufacturers and private-equity partners. Above all, it would not be deciding what share of national income the government should spend. All that would fall to elected politicians.

In the U.S., Congress could carry on doing what it loves best: showering favors on its preferred constituencies. But once the legislature had made its choices, the Fiscal Stability Board would decide whether the fiscal balance looked right, short-term and long-term. Much as a central bank sets an interest rate and gives an expected path of future rates, the FSB would then set the sales tax.

Perhaps the chances of this happening are close to zero. But just suppose. Would it be a good idea?

The point to notice is that this would not be taking the politics out of fiscal policy. In emergencies, doing that (or trying to) might be the lesser evil, but as a permanent regime it stinks. If democracy isn't about taxes and government spending, what is it about? Elected politicians should set national priorities, write the budget and decide who pays. But I'm claiming that control of deficits and management of public debt--the macro rather than micro aspects of fiscal policy, where politics encounters the constraints of arithmetic and solvency--fall into a different category. Sure, polarized politics can annex almost any issue and recast it in left v. right terms, but disagreements over the pace of fiscal adjustment ought to be technical more than ideological.

I look at it this way. With its remit confined to deficits and debt, a fiscal council with a blunt tax power would ask us to yield only a little democratic control in exchange for a really big improvement in fiscal stability.

Worth thinking about.