Relevant bureaucratic units are carrying out extensive studies on fiscal rule for a certain period. The fiscal rule issue is also prone to discussions. The framework of the fiscal rule was for the first time mentioned in the Medium Term Program announced in September 2009. On Thursday, I made some evaluations on fiscal rule which was opened to discussion again in the meeting Deputy Prime Minister Ali Babacan hosted in Istanbul. But there is one more important point about fiscal rule which was not involved in my evaluations and which I forgot to mention in the said meeting.
It is also of importance how the budget adjustment in line with the fiscal rule be take place. Fiscal rule will work as follows: if public budget diverges from the level planned in the year before due to a series of reasons, how this divergence will be compensated for in the coming years should be declared in advance in the framework of the fiscal rule. If growth rate is above potential, savings are increased and budget deficit is lowered, whereas deficit is increased in years of growth below the potential.
Now, assume it became evident that budget deficit set in the context of the fiscal rule will be exceeded. What shall the government do? It can reduce expenditures or try to increase tax revenues. You can do both, too. But which particular items of budget expenditures or tax revenues will be reduced or increased?
If the easiest way to improve revenues seems to be increasing indirect tax revenues, you have to stop there. To put it differently, the first solution you come up with shall not be increasing the taxes collected from goods and services consumed by all sections of the society. Among OECD countries, ratio of indirect taxes to total tax revenues is highest in Turkey. And the difference is not inconsiderable: Turkey almost doubles the OECD average. As you rely more on indirect taxes, you collect the same amount of tax from any taxpayer regardless of his/her level of income. This is highly unfair. Apart from this, indirect taxes also have an effect of stimulating inflation. As tax rate is increased once, price of the goods and services it is imposed on also rises once. That is, inflation goes up for the month the tax is raised. This might not seem a big of a problem; but it is. After all, the Central Bank is compelled to revise the inflation estimate made a few months ago. In this sense, the risk of changing the path of the interest rate policy arises. At the same time, the problem of giving account for this change comes to fore. The tax raise also takes effect through the increases in the costs in sectors which use the relevant goods and services as inputs.
It is for sure that in an extraordinary period where budget deficit must be reduced with any method possible, such as the post-2001 crisis, it is legitimate to adopt the mentioned tax raises. Nonetheless, when designing the future (normal times) and making effort to ensure that the future will be more definite and investment-friendly, it is necessary to think through how to secure fiscal discipline.
In this context, there are several practices that first come to mind: Some constraints can be introduced within the fiscal rule framework. It can be stipulated that raises in price of and tax on goods and services which are traditionally subjected to such arrangements frequently, shall be adjusted within the borders of inflation targets. Goods using crude oil as an input can be exempted from this arrangement as well as promising that the existing price setting mechanism applicable for those goods will not be changed.
As noted before, these are the arrangements that first come to mind. I presented these to exemplify and discuss the issue. The key is the essence of the issue; which I believe is quite evident.
This commentary was published in Radikal daily on 01.02.2010
