Study: Finland’s spending limits system needs a reform, as the current rules do not function effectively in unexpected crises

The regulatory framework of Finland's fiscal policy has faced several crises that have revealed its ineffectiveness in dealing with unexpected situations. The system should be reformed and its operating model clarified, finds a recent study conducted by the Research Institute of the Finnish Economy (ETLA) for the Government. According to the researchers, the budgetary framework should distinguish between the operating procedures for normal economic cycles and exceptional crises. Independent monitoring of the regulatory framework should be intensified, while the relationship between the national and EU-level regulations should be clarified.

As a rule, the development and balance of Finland’s general government finances are guided by the objectives set in the Government Programme, as well as by EU regulations governing general government finances and the related national regulations. The central government expenditure ceiling has not been adhered to during the current government term, which has undermined the credibility of the system. Even before, keeping within the expenditure ceiling could not curb the growth of public indebtedness. The fiscal policy framework therefore requires a comprehensive review.

A key objective for reform of the system should be to clarify its operating model so that it can function better in times of exceptional crisis. The new ETLA report, entitled ‘General government fiscal frameworks and their development needs in Finland’, states that crisis response in the fiscal framework should distinguish between operating models for normal economic cycles and for exceptional crises.

Under normal conditions, the flexibility built into the framework should give sufficient room for fiscal policy. In exceptional crises, which in recent years have included the COVID-19 pandemic and Russia’s war of aggression, the framework could be suspended and derogations could be made using a well-defined and sufficiently restrictive escape clause. The escape clause should determine the preparation process for exceptional circumstances in relation to normal conditions, and its use should be accompanied by a requirement for a clear exit plan.

“Experiences from recent years show that it is essential to be better prepared for surprises, both within the central government’s spending limits and more broadly when designing the fiscal framework. Deviating from the spending limits works poorly in a system intended to guide spending decisions as jointly agreed by the parties in Government. An important starting point is to ensure that the central government expenditure ceiling is scaled correctly, meaning that it provides sufficient scope to cover the expenditure of the Government Programme,” says ETLA Research Director Tero Kuusi, who led the study.

The effectiveness of Finland’s regulatory framework can be improved in many ways

The study also proposes making long-term sustainability reviews a more integral part of the regulatory framework and increasing the role of independent scrutiny of fiscal policy. In principle, the central government spending limits system should keep the revenue and expenditure sides separate: it should not be possible to compensate for higher expenditure growth with discretionary revenue measures during parliamentary terms.

National fiscal policy regulations are needed alongside the EU regulations, as they have different goals. That said, separate national goals are only justified if they are consistent with or stricter than the EU-level requirements. For example, the goals for the position of Swedish and Danish public finances are stricter than their EU equivalents, so compliance with the national goals also guarantees compliance with the EU obligations.

“In Finland, as in the other Nordic countries, there is a political consensus on an extensive welfare state. The broad scope of the public sector means that special attention must also be paid to its financial position. A crisis in the public sector poses particularly serious problems for the national economy. Finland’s population also has a less favourable age structure than that of the other Nordic countries, so it is particularly important to ensure that Finland’s fiscal policy regulations function effectively,” says Tero Kuusi.

Inquiries: Tero Kuusi, Research Director, ETLA, tel. +358 41 444 8144, [email protected]

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