17 September 2012

Public Finance International: Debt, deficits and democracy

A recent article featured in the Economist, Democracies and debt: Voters are now facing a harsh truth, discussed the contradictions of democracy and the harsh truths faced by voters. Voters are often tempted by politicians’ promises to send money in their direction, and as a consequence they may be tempted to vote for those very candidates who are the most fiscally irresponsible.

The article identified as a possible solution to this dilemma the removal, from elected officials, of the responsibility for fiscal policy, similar to the way monetary policy has been ceded to central banks in many countries.

However, rather than excusing elected officials from responsibility, politicians should instead be forced to be more accountable and transparent, and be presented with more powerful incentives to behave in a fiscally responsible manner.

Many appear to believe that the public debt is the best, or even an adequate, measure of the obligations a government faces, hence the frequent references to debt to GDP ratios as a measure of fiscal strength. In fact, debt tells only part of the story. The fuller, and richer, story encompasses assets, liabilities, contingent liabilities and net worth.

Truth be told, the accounting of the US Federal Government is not bad at all – certainly better than many other jurisdictions.  Notwithstanding this, the set of fiscal arrangements taken as a whole do not seem to inhibit the political decisions that lead to $16 trillion in debt, and a much larger number if non-debt liabilities and obligations are included.

There is an urgent need, not just in the United States, for institutional changes that will make it more difficult for elected officials to ignore the full set of factors — liabilities, contingent liabilities, and obligations like Medicare, as well as assets and other external factors — when they make either political promises or budgetary decisions.

What is needed is significant institutional reform – reform that provides politicians with more powerful reasons to focus on long-term fiscal sustainability, and provides voters with better information about the current fiscal position and the implications of the fiscal policies the candidates are presenting.

The accrual basis for accounting, budgeting and appropriations is a necessary but not sufficient element of such reforms. Financial statements should be prepared, and audited, against independently determined accounting, and auditing, standards.

Full article

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