Amending the Constitution to ensure fiscal stability

Some did see it coming. Inside politics I would probably have been dubbed a ‘visionary a dreamer by my opponents, but ‘with foresight’ among my admirers, possibly even ‘blue skies’ by others. Apolitical as I have always been, the accolade I have lately received is ‘veteran’, dubiously complimentary.

Nobody has so far pointed even a small finger in our direction for the disarray in the single currency area- Karm Farrugia

I had better explain. Fourteen years of continuous pre-1985 Labour administrations produced no perceptible deficits in our public accounts. On the contrary, state investments which were later privatised to help reduce the national debt, as well as progressive advancement in social services, amazingly hardly impinged at all on books’ balancing. Adequate revenue seemed somehow to be always on tap from local sources and in the form of foreign-sourced grants and rentals.

Like all pre-Keynes political economists, uncharacteristically Labour in Malta (but not in the UK) treated public finances as though they were those of a pivate individual, oblivious of the fact that such a juvenile needed financing desperately in order to grow fast enough to catch up with the rest of Europe. By my reckoning most of those 14 budgets would comfortably qualify as ‘surplus’ ones by today’s benchmarks. A change at the helm in 1985, however, reversed the trend in the two remaining Labour budgets, necessitated by a strong political determination to tackle an unacceptably high unemployment level.

But even these consecutive deficits barely dented the government’s coffers: the national debt hovered only around 20 per cent of the Gross Domestic Product (GDP) – a fiscal utopia in current thinking, and undoubtedly a far cry from the magical 60 per cent capping we are today so energetically endeavouring to go down to from a forbidding 70 per cent.

Little wonder, then, that the Nationalist administration in 1987 had such a field day, and deservedly so.

That is, until eventually it went overboard. A puritanical fiscal regime had previously been choking Malta’s growth process, especially as it started aspiring to European integration. Physical, social and educational infrastructure had not been allowed to move with the times.

Thank you, Labour, for being so philistine in economic management; we can now afford to give the economy a big jolt, not just a gradual fillip. We will even outdo the Keynesians, ironically often associated (wrongly) with a centre-left political economy. On top of increasing stimulating expenditure, capital and recurring, we will also drastically cut down on direct taxation in the belief that government revenue will consequently swell so much as to more than neutralise the sacrificed intake.

An unfortunate misrepresentation of the Laffer principle which, in explaining the relationship between economic activity and the rate of taxation, endeavours to calculate the optimal rate at which tax revenue will be maximised. Even as I write, the Laffer curve, if ever there was one, on which the 35 per cent income tax rate was based, remains shrouded in secrecy. Politics over economics? Not unusual in Malta. As it turned out, not just government spokesmen but almost everyone came to believe that the resultant future increases in revenue had been totally attributable to the lowering of the tax rate, a belief which even the opposition accepted unreservedly.

An econometric analysis of the 1987-96 years, however, would show that the major contributor to the national coffers had in fact been the huge deficit budget financing at an unprecedented scale, something which even Keynesians advocate only in times of extreme underdeployment of resources or in a scenario of stark underdevelopment. The big chop in direct taxation had been a minor contributor, strange as it may seem in the eyes of most.

As often happens with politicians long outside government, and particularly in a country starved of infrastructural investment but also with a low sovereign debt-to-GDP, the new Nationalist administration tended to throw fiscal caution to the wind at times, and started to produce a series of high-deficit budgets with total revenue barely covering a ballooning recurrent expenditure, thus leaving inadequate funds for huge capital outlays (painful to the Keynesians) and, consequently, overloading the debits of the national accounts whilst also adding to future years’ interest burden.

The extent of the resultant deficits, then structural year after year, worried me as a bystander to the point of gently challenging, tete-a-tete, the then Finance Minister during a 1995 reception, suggesting that he could well, for once, produce a balanced budget if only to prove to sceptics like me that public finances had not become uncontrollable. Impossible, and even more so with a general election already on the horizon. Everybody came to know what happened, fiscally speaking, during Labour’s 1996-98 interregnum. The deficit problem not only surfaced, but morphed into a crisis.

During the 1998 election campaign I felt so badly about this matter that I published an article advising that the time had become opportune to restrict the annual deficit via an amendment/addition to our Constitution that would deter reckless overspending and consequential mortgaging of our future. A party in government would balance its budgets over the whole legislature, with a capping at three per cent of GDP for anyone year. Any temporary relaxation of these restrictions would need a two-thirds majority in the House. The proposed entrenchment in the Constitution would take effect as from the next following legislature in order to allow the incoming administration sufficient man­ouevring space also for a changeover from cash to accruals public accounting.

Not a single comment, for or against. In Malta only politicians are heeded, mostly for criticism not praise. To my surprise, soon after the election, NET TV invited me to join a discussion panel on public finances in the presence of the Finance Minister. Unexpectedly, the presenter turned to me, reminded me of what I had proposed some months earlier and invited me to amplify why legislating wasn’t enough, but a constitutional amendment was needed. “Rather drastic, don’t you think?”

I still doubt whether any political party in government would unilaterally legislate on this matter in the knowledge that the law could well be repealed or rendered ineffectual by the other party when back in power. I then warned that if the borrowing rate for the previous decade were to persist, the country’s copious reserves underpinning the Malta lira would be dissipated, and chaos would ensue in our public finances, swiftly debilitating the whole economy. Admittedly, I didn’t have Greece in mind then, but I did say that it might become too late even to amend the Constitution.

Such a Malthusian prediction was, fortunately, pre-empted by our resolve to join the European Union, and, more importantly, the eurozone. Nobody, however politically biased, can seriously criticise our comportment inside both institutions. Unlike some other eurozone members, our behaviour has been quite exemplary. Nobody has so far pointed even a small finger in our direction for the disarray in the single currency area.

However, the fact that already some countries are thinking of entrenching germane provisions in their constitution should make us start thinking on the same lines.

Germany did it in 2009. Italy and France have it in draft form. The two main parties in Spain have formally agreed terms for a constitutional insertion that would cap their long-term structural deficit to 0.4 per cent of GDP. A ‘golden rule’ as from 2012 is being drafted in order to forestall further debt crises in the eurozone. The European Commission itself has applauded such acts as building a cornerstone for a new Stability and Growth Pact

Here in Malta, what on earth are we waiting for?

The author is an economist.