Budget Surpluses: Experiences of Other Nations and Implications for the
United States (Chapter Report, 11/02/1999, GAO/AIMD-00-23).

In fiscal year 1998, the United States had a budget surplus for the
first time in nearly 30 years. Although balancing the federal budget has
been the clear and generally accepted fiscal goal for many years, there
is no consensus yet on the appropriate fiscal policy during a period of
budget surpluses. Should the surpluses be maintained? How should they be
used? This report examines the experiences of six countries that have
recently experienced budget surpluses--Australia, Canada, New Zealand,
Norway, Sweden, and the United Kingdom. GAO discusses (1) how they
achieved budget surpluses and what their fiscal policies were during
periods of surplus, (2) how they addressed long-term budgetary
pressures, and (3) how they adapted their budget process during a period
of surplus. GAO also identifies the lessons that these nations learned
that might be useful for the United States. GAO concludes that
sustaining a surplus over time to address the United States' own
long-term needs will require a framework that provides transparency
through the articulation and defense of fiscal policy goals; provides
accountability for making progress toward those goals; and balances the
need to meet selected pent-up demands with the need to address long-term
budget pressures.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD-00-23
     TITLE:  Budget Surpluses: Experiences of Other Nations and
	     Implications for the United States
      DATE:  11/02/1999
   SUBJECT:  Foreign governments
	     Budget surplus
	     Deficit reduction
	     Budget outlays
	     Budget administration
	     Fiscal policies
IDENTIFIER:  Australia
	     Canada
	     New Zealand
	     Norway
	     Sweden
	     United Kingdom

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GAO/AIMD-00-23

Report to the Chairman and Ranking Minority Member, Committee on the
Budget, U.S. Senate

November 1999

BUDGET SURPLUSES

Experiences of Other Nations and Implications for the United
States
*****************

*****************

GAO/AIMD-00-23

Letter                                                                     7

Executive Summary

                                                                          8

Chapter 1               Introduction

                                                                         23

Chapter 2               Countries Developed Strategies for Surplus

                                                                         34

Chapter 3               Countries Have Taken Actions to Address Long-Term
Pressures

                                                                         52

Chapter 4               The Role of Budget Processes and Measures of
Fiscal Position During Periods of Surplus

                                                                         61

Chapter 5               Implications

                                                                         71

Appendixes 

Appendix I:Commonwealth of Australia

                                                                         80

Appendix II:Canada

                                                                         99

Appendix III:New Zealand

                                                                        130

Appendix IV:Norway

                                                                        150

Appendix V:Sweden

                                                                        164

Appendix VI:United Kingdom

                                                                        182

Appendix VII:GAO Contacts and Staff Acknowledgements

                                                                        207

Table 1:  Characteristics of the Six Case Study Countries and 
the United States, 1997                         30

Table 2:  Projected Growth in Annual Public Pension 
Expenditures as a Percentage of GDP, 1995-2030  54

Table 3:  Fiscal Outlook for Fiscal Year 1998-99125

Figure 1:  From Deficits to Surpluses: U.S. Unified Budget 
Balance as a Percentage of GDP, 1990 to 2009    10

Figure 2:  GDP per Capita Assuming Non-Social Security 
Surpluses are Eliminated Versus Unified Budget Balance18

Figure 3:  Composition of Spending as a Share of GDP, 
Assuming On-budget Balance                      19

Figure 4:  Shifts in General Government Financial Balances28

Figure 5:  1998 General Government Gross and Net Debt as 
a Percent of GDP                                29

Figure 6:  Change in Average Annual GDP Growth During 
Economic Slowdown of Late 1980s and/or Early 1990s35

Figure 7:  1998 General Government Financial Balance38

Figure 8:  Long-term Projections for Pension Expenditures 
and Petroleum Revenues as a Percentage of GDP in Norway40

Figure 9:  Ratio of Population Aged 65 and Over to Population 
Aged 15-64, 2000 and 2030                       53

Figure 10:  Improvement in General Government Net Debt as 
a Percentage of GDP During the 1990s            59

Figure 11:  GDP per Capita Assuming Non-Social Security 
Surpluses are Eliminated vs. Unified Budget Balance75

Figure 12:  Composition of Spending as a Share of GDP, Assuming On-budget
Balance76

Figure 13:  Commonwealth of Australia Underlying Budget 
Balance, 1982-83 to 1997-98                     81

Figure 14:  GDP Growth in Australia, 1983 to 199884

Figure 15:  Receipts and Outlays in Australia, 1982-83 to 1996-9789

Figure 16:  Net Public Sector Debt in Australia, Fiscal Years 
1980-81 Through 1998-99                         91

Figure 17:  Federal Budgetary Surpluses/Deficits in Canada, 
1980-81 to 1998-99                             100

Figure 18:  Real GDP Growth in Canada, 1981 to 1998104

Figure 19:  Federal and Provincial-Territorial Net Debt in Canada, 
1980-81 to 1998-99                             111

Figure 20:  Major Federal Transfers to Other Levels of Government 
in Canada, 1980-81 to 1998-99                  114

Figure 21:  The Canada Health and Social Transfer115

Figure 22:  Deficit Targets Compared to Actual Results in Canada, 
1994-95 to 1997-98                             117

Figure 23:  Federal Government Revenues and Expenditures in 
Canada, 1993-94 to 1998-99                     120

Figure 24:  Summary of Spending and Tax Actions in the 1997-98, 
1998-99, and 1999-2000 Canadian Federal Budgets122

Figure 25:  Budgetary Balance in New Zealand, 1974-75 to 1997-98131

Figure 26:  GDP Growth in New Zealand, 1983 to 1998135

Figure 27:  Comparison Between Adjusted Cash and Operating 
Balances in New Zealand, 1994-95 to 1997-98    138

Figure 28:  Net Public Sector Debt in New Zealand, 1980 to 1998143

Figure 29:  General Government Financial Balance as a Percent 
of GDP in Norway, 1970 to 1998                 151

Figure 30:  Real GDP Growth in Norway, 1981 to 1998154

Figure 31:  Long-term Projections for Pension Expenditures and 
Petroleum Revenues as a Percentage of GDP in Norway, 1973 
to 2050                                        161

Figure 32:  General Government Financial Balance in Sweden, 
1981 to 1998                                   165

Figure 33:  Real GDP Growth in Sweden, 1982 to 1998169

Figure 34:  Expenditures and Revenues as a Percentage of GDP 
in Sweden, 1970 to 1998                        172

Figure 35:  General Government Gross Financial Liabilities in 
Sweden, 1981 to 1998                           177

Figure 36:  Surpluses/Deficits in the United Kingdom, 1980-81 to 
1998-99                                        183

Figure 37:  GDP Growth in the United Kingdom, 1980 to 1998186

Figure 38:  Receipts and Expenditures in the United Kingdom, 
1980-81 to 1995-96                             191

Figure 39:  Projected Surpluses/Deficits and Actual Results in 
the United Kingdom, 1986-87 to 1993-94         193

Figure 40:  Actual and Structural Surpluses/Deficits in the United 
Kingdom, 1986-87 to 1998-99                    198

Figure 41:  Projections of Real GDP Compared to Actual Results 
in the United Kingdom, 1988 to 1994            199

AME     annually-managed expenditure

CAP     Canada Assistance Plan

CHST    Canada Health and Social Transfer

CPP     Canada Pension Plan

DEL     departmental expenditure limits

EI      Employment Insurance

EPF     Established Programs Financing

EU      European Union

FRA     Fiscal Responsibility Act

GDP     gross domestic product

GIS     Guaranteed Income Supplement

GST     goods and services tax

MMP     mixed member proportional

NAO     National Audit Office

OAG     Office of the Auditor General

OAS     Old Age Security

OECD    Organization for Economic Cooperation and Development

PAYGO   pay-as-you-go

PSBR    public sector borrowing requirement

PSNB    public sector net borrowing

PSNCR   public sector net cash requirement

RAB     resource accounting and budgeting

TFF     Territorial Formula Financing

U.K.    United Kingdom

VAT     value added tax

B-281269

November 2, 1999

The Honorable Pete V. Domenici
Chairman
The Honorable Frank R. Lautenberg
Ranking Minority Member
Committee on the Budget
United States Senate

As you requested, this report reviews the experience of six nations with
budget surpluses-Australia, Canada, New Zealand, Norway, Sweden, and the
United Kingdom. You asked us to determine how these nations achieved
budget surpluses, used surpluses to address long-term budgetary pressures,
and adapted their budget processes once surpluses were achieved.

Like the United States, these nations achieved budget surpluses largely as
the result of improving economies and sustained deficit reduction efforts.
As they entered a period of surplus, these nations debated how surpluses
should be used and developed unique strategies for using surpluses to
address national priorities. The experiences of these nations suggest that
it is possible to sustain support for continued fiscal discipline during a
period of surpluses while also addressing selected pent-up demands. 

We are sending copies of this report to the Honorable John R. Kasich,
Chairman, and the Honorable John M. Spratt, Jr., Ranking Minority Member,
House Budget Committee and other interested parties. We will make copies
available to others upon request.

This report was prepared under the direction of Paul L. Posner, Director,
Budget Issues, who may be reached at (202) 512-9573 if there are any
questions. 

*****************

*****************

David M. Walker
Comptroller General
of the United States

EXECUTIVE SUMMARY
=================

Purpose
-------

In fiscal year 1998, the United States achieved a unified budget surplus
for the first time in nearly 30 years. Budget surpluses represent both the
success of past deficit reduction efforts and an opportunity to address
pressing needs. With the arrival of surpluses there has been much debate
about whether surpluses should be maintained and how they should be used.
While balancing the budget has been the clear and generally accepted
fiscal goal for many years in the United States, there is not yet
agreement on the appropriate fiscal policy during a period of budget
surpluses.

To help inform the current budget debate, GAO was asked to look at other
countries with recent experience with budget surpluses. During the 1980s
and 1990s, several advanced democracies achieved budget surpluses. Senate
Budget Committee Ranking Member Lautenberg, subsequently joined by
Chairman Domenici, asked that GAO examine the experiences of six nations
that have achieved budget surpluses-Australia, Canada, New Zealand,
Norway, Sweden, and the United Kingdom. Specifically, GAO was asked to
determine (1) how they achieved budget surpluses and what their fiscal
policies were during periods of surplus, (2) how they addressed long-term
budgetary pressures, and (3) how they adapted their budget process during
a period of surplus. GAO was also asked to identify lessons these nations
learned from their experiences with budget surpluses that might be
applicable to the United States. 

Background

Balancing the budget is a fiscal goal that often commands broad support-at
least in the abstract-from policymakers and the public alike. The idea of
a government spending no more than it takes in has a near universal appeal
across the political spectrum. In contrast, a government running a budget
surplus-spending less than it takes in-is a goal with less intuitive
appeal, and a policy that often lacks a natural constituency. 

Following years of sustained deficit reduction efforts and as a result of
strong economic growth, the United States achieved a budget surplus in
1998 following a prolonged period of deficits./Footnote1/ During that past
15 years, there has been a general consensus on the need to reduce budget
deficits. Surpluses are now projected to continue for at least the next 10
years./Footnote2/ (See figure 1.) With the arrival of budget surpluses, a
new political debate has emerged: Should surpluses be saved or spent? If
they are spent, what should they be spent on? How should they be allocated
among debt reduction, spending, and tax cuts? Can surpluses be used to
address long-term fiscal pressures? Should the U.S. budget process be
modified during a period of surpluses? 

Figure****Helvetica:x11****1:    From Deficits to Surpluses: U.S. Unified
                                 Budget Balance as a Percentage of GDP,
                                 1990 to 2009
*****************

*****************

Note: Figures for 1999 and beyond are estimates.

Source: Fiscal Year 2000 Budget of the United States: Historical Tables,
Office of Management and Budget and The Economic and Budget Outlook: An
Update, July 1, 1999, Congressional Budget Office.

The answers to these questions can have important consequences for the
future economic and fiscal health of the United States. On the one hand,
surpluses inspire proposals to allocate funds for current consumption on
both the spending and revenue sides of the budget. On the other hand, the
more of the budget surplus that is saved, the greater the long-term fiscal
and economic benefits. From a budgetary standpoint, surpluses reduce debt
and lead to a reduction in interest costs, freeing up budgetary resources
to be spent on other priorities. 

Running surpluses can also help to increase economic growth in the long
term. A budget surplus increases national saving and leads to an increase
in the amount of funds available to be invested elsewhere in the economy.
Lower government borrowing also puts downward pressure on interest rates,
as there is less demand for available funds. Together, lower interest
rates and higher saving and investment increase the capacity for economic
growth over the long term. 

Another benefit of reducing debt is the enhanced ability to meet future
needs. The United States faces a significant challenge associated with an
aging population that will result in significant spending pressures for
public pension and health programs. Reducing debt today can strengthen our
nation's capacity to finance the future burgeoning costs of health and
retirement programs.

Results in Brief

Like the United States, other countries achieved budget surpluses largely
as a result of improving economies and sustained deficit reduction
efforts. As they entered a period of surplus, they also debated how
surpluses should be used. The countries GAO studied have generally reached
consensus on how they plan to use surpluses, and they have developed
unique strategies that address national priorities. As part of their
strategies, they have developed explicit goals to guide fiscal policy and
have justified their goals with compelling rationales that often pointed
out the potential fiscal and economic benefits of continued fiscal
discipline. The case study countries generally chose to continue with a
fiscally cautious approach, with three countries-New Zealand, Norway, and
Sweden-aiming for sustained surpluses. New Zealand and Sweden have focused
on the need to reduce debt as a justification for sustained surpluses,
while Norway has focused on the need to save for long-term budget and
economic pressures. To maintain support for their policies, these three
countries have also devoted some portion of their surpluses to tax cuts
and/or spending increases, addressing critical needs while still aiming
for an overall general surplus. 

Each of the case study countries has taken actions to address long-term
budgetary and economic concerns. For Norway in particular, long-term
budget and economic pressures were a major factor leading the government
to decide that surpluses were needed to ensure the long-term
sustainability of its fiscal policies. For other countries, programmatic
reforms aimed at addressing long-term pressures enacted prior to the
arrival of surpluses resulted in increased fiscal flexibility during a
period of surplus. Over the last two decades, four of the case study
countries-Australia, Canada, Sweden, and the United Kingdom-have reformed
their pension systems, improving their long-term sustainability. As a
result, as these countries entered a period of surplus, their debate
focused on other needs, such as reducing debt or addressing areas affected
by past budget cuts. New Zealand, by focusing on using surpluses to reduce
debt, has also taken action to improve its long-term economic and fiscal
health. 

Budget process reforms have played a key role in both framing the debate
about surpluses and helping maintain fiscal discipline during periods of
surplus. Each case study country changed its budget process during the
1990s in an attempt to better control spending and/or to guide fiscal
policy decisionmaking. As countries entered a period of budget surpluses,
these reforms played a critical role in guiding fiscal policy and
maintaining fiscal restraint. As part of their new strategies, some
countries chose to focus on measures of fiscal position other than year-
end balance to justify continued fiscal discipline in times of surplus.
For example, New Zealand focuses on its debt to GDP ratio, and Norway uses
a structural measure that adjusts for the economy's impact on the budget. 

Despite the many differences between the case study countries and the
United States, the experiences of these nations can provide helpful ideas
to be considered in our debate on whether to sustain surpluses and/or how
to use them. GAO's study suggests that it is possible to sustain support
for continued fiscal discipline during a period of surpluses while also
addressing pent-up demands. However, a fiscal goal anchored by a rationale
that is compelling enough to make continued restraint acceptable is
critical. For each country in our study, the goal and the supporting
rationale grew out of its unique economic experience and situation. Many
in the United States have made the case for sustaining at least some
portion of surpluses to help deal with our longer-term budgetary
pressures, as reflected in the current debate over how to save the portion
of the surplus derived from the Social Security program. GAO's long-term
model simulations illustrate the need for continued fiscal restraint:
saving some of the surplus is necessary along with structural reform of
public retirement and health programs.

The United States is faced with the challenge of making the transition
from a budget regime focused on eliminating the deficit to one that deals
with allocating the surplus between long-term pressures and short-term
demands. While eliminating a deficit is arguably self-defining and
straightforward, other nations' experiences suggest that sustaining even a
portion of our surpluses calls for a different framework featuring
explicit fiscal policy goals and targets to both inform the allocation of
surpluses and to promote public acceptance of the choices. Such a
framework would include an agreement on appropriate long-term fiscal goals
to guide the more specific debate over the relative merits of different
priorities-how much of the surplus to devote to reducing debt, increasing
domestic discretionary or defense spending, securing existing unfunded
entitlement promises, and cutting taxes.

As essential as fiscal targets may be for sustaining surpluses, they are
not self-evident. Unlike budget balance where a single number may be an
appropriate goal, decisions about sustaining a surplus may call for more
complex measures. There is no single number like "0" in the surplus world.
The debate has already begun over what might replace "0" deficit as an
appropriate fiscal policy measure for the United States-and what process
might be appropriate to achieve it. The experiences of other nations
suggest that sustaining a surplus over time to address our own long-term
needs calls for a framework which:

o provides transparency through the articulation and defense of fiscal
  policy goals;

o provides accountability for making progress toward those goals; and

o balances the need to meet selected pent-up demands with the need to
  address long-term budget pressures.

GAO Analysis

A Period of Budget Surpluses Led to New Fiscal Strategies
---------------------------------------------------------

As countries have transitioned from an era of deficit reduction to a
period of surplus they have developed unique strategies for how to use
their surpluses. The countries in GAO's study found it important to set
clear fiscal goals and to articulate compelling rationales explaining the
potential 
long-term benefits of their policies in order to maintain public support
for continued fiscal discipline. 

In general, the countries decided to continue with a fiscally cautious
approach. Three countries-New Zealand, Norway, and Sweden-set a goal for
continued annual budget surpluses. The other three-Australia, Canada, and
the United Kingdom-set budget balance as their main fiscal goal, but as
part of a cautious fiscal strategy that has resulted in them achieving
small surpluses. Leaders in these countries pointed to the potential long-
term economic and fiscal benefits as a compelling rationale to justify
their policies, and there has generally been broad support for continued
fiscal discipline during a period of surplus. However, the countries have
generally made room for additional spending initiatives and/or tax cuts,
in some cases to address perceived needs following a period of deficit
reduction. Remarkably, several nations have instituted spending cuts to
sustain surpluses during this period.

Addressing Long-term Pressures 
-------------------------------

Like the United States, most countries in our study face significant
challenges arising from an aging population. While demographic trends
differ among the countries, all are projecting an increase in the ratio of
retirees to workers. If current spending patterns continue, increased
spending on public pensions and health care threatens to crowd out
spending on other important public goods and services. 

Over the past two decades, the case study countries generally have taken
actions that address long-term fiscal pressures expected to arise from an
aging population. Surpluses have helped nations enhance future fiscal and
economic capacity by reducing debt burdens. By reducing its debt burden,
each country has taken a step toward improving its long-term fiscal and
economic health and enhancing future budget flexibility. Budget surpluses
increase national saving, which can lead to increased investment and
productivity, thereby increasing potential future economic output and
living standards. Budget surpluses also reduce the government's interest
costs, freeing resources to be spent on other priorities. Furthermore,
lower levels of debt can improve a nation's capacity to borrow and meet
future budgetary needs.

Norway is explicitly attempting to use its budget surpluses to address
long-term fiscal and economic concerns. The combined effects of an aging
population and declining oil revenues are projected to result in an
unsustainable fiscal path and eventual economic decline. To address this
problem, Norwegian decisionmakers reached a broad consensus on the need to
save projected surpluses and established a Petroleum Fund where budget
surpluses are deposited and invested to pay for future budget needs. 

Four other countries-Australia, Canada, Sweden, and the United Kingdom-
enacted major pension reforms during the past two decades, which have
reduced long-term budgetary pressures and put their pension systems on a
more sustainable path. Australia and the United Kingdom carried out
pension reforms in the 1980s and 1990s; and as they have entered a period
of surpluses, long-term budgetary pressures due to increasing pension
costs have not emerged as a major focus of political debates. Canada and
Sweden have traditionally accounted for their pension systems separately
from the government budget, and their pension fund assets have been
invested outside the government. As a result, pension fund surpluses have
not been included in their surplus debates. Each country was able to
reform its pension system during the 1990s, placing its pension system on
a more sustainable path. The United States has not yet engaged in
fundmental reforms of our public pension and health systems. Such reforms
are necessary to assure the sustainability of these important national
programs and to relieve the related longer term budget pressures.

Budget Process Both Guides and Supports Fiscal Strategy for Surplus
-------------------------------------------------------------------

The framework for fiscal decisionmaking, which includes both the budget
process and the way fiscal position is measured, can play a critical role
in the ability of a government to maintain fiscal discipline. In an effort
to aid deficit reduction efforts, each country made important changes to
its budget process during the 1990s, which were continued and adapted to a
period of surplus. As these countries moved into a period of budget
surpluses, their budget processes have continued to play an important role
in maintaining fiscal discipline and/or in setting fiscal policy. 

In Norway and Sweden, expenditure limits have continued to play a critical
role as they attempt to run sustained surpluses. Bolstered by explicit
spending limits, the renewed budget framework has enabled each country to
maintain better control over spending during the current period of
surplus. As Canada has entered a period of small surpluses, the government
generally does not spend projected surpluses until they are about to
materialize. The size of Canada's available surpluses appears low because
the government's projections extend for only 2 years and are based on
conservative economic forecasts. To the extent that the economy performs
better than forecast, funds become available for new policy initiatives
during the fiscal year. 

The measure of fiscal position is important because it can be used to
define a goal and to measure "success." Zero deficit is generally accepted
as one such measure and a signal of the fiscal health of a country.
However, during periods of surplus, other measures are necessary to
sustain some degree of fiscal restraint. In New Zealand, the statutory
requirement that the government establish a "prudent" debt level as a
fiscal goal has been critical to its ability to sustain fiscal discipline
during a period of surpluses. Specifically, in 1994 the government
established a debt goal of between 
20 and 30 percent of GDP, and set as its fiscal policy to run surpluses
until that goal was achieved. In 1996, when it became apparent that the 
30 percent debt target would be achieved, the government enacted a tax cut
and reset its debt target to 20 percent of GDP. Norway focuses on a
structural measure of fiscal position, which removes the effects of the
economy and petroleum activities, when setting fiscal policy. The
government uses this measure to justify continued fiscal restraint during
periods of strong economic growth and large budget surpluses. Finally,
Canada and Sweden account for their public pension funds separately from
the general fund, and as a result, their surplus debates have focused on
other issues. 

Implications for the United States
----------------------------------

Like the nations in GAO's study, the United States has turned years of
deficits into a surplus; but unlike most of these nations, U.S.
policymakers have not yet reached agreement on goals and targets to
allocate the use of our surpluses. Over the last 15 years, fiscal policy
in the United States has focused on the need to reduce-and eventually
eliminate-the deficit. 

Furthermore, pent-up demands for federal policy actions accumulated during
years of deficits. Although the United States is still operating under the
rules established to achieve budget balance, the advent of a surplus has
led to increased pressure for spending increases and/or tax cuts. The
legitimacy of the restraints adopted to rescue the nation from deficits is
increasingly questioned as surpluses build up. The unified budget reached
balance earlier than expected, and the Congress and the President now face
the difficult situation of having to comply with tight spending caps
designed to eliminate deficits at the same time that the budget is in
surplus. 

The experiences of other nations suggest that it is possible to sustain
support for continued fiscal discipline during a period of surpluses while
also addressing pent-up demands. A fiscal goal anchored by a rationale
that is compelling enough to make continued restraint acceptable is
critical. Many in the United States have made the case for sustaining at
least the portion of surpluses resulting from annual Social Security
surpluses to help deal with our longer-term pressures. 

GAO's long-term model simulations illustrate the need for continued
restraint: saving some of the surplus is necessary along with structural
reform of retirement and health programs. GAO's simulations show that
saving a good portion of the projected surpluses would strengthen the
nation's capacity to finance the burgeoning costs of health and retirement
programs prompted by the aging of our population. For instance, GAO has
estimated that national income would be nearly $20,000 higher per person
in real terms by 2050 if the Social Security portion of the budget surplus
is saved-that is, eliminate the non-Social Security surplus-compared to a
unified budget balance position./Footnote3/ (See figure 2.) Moreover,
there is widespread recognition in the United States of the need to
address long-term budget drivers-Social Security and Medicare-because even
if surpluses are (r)saved(c) and used to pay down debt, growth in these
programs threatens to crowd out discretionary spending. (See figure 3.)

Figure****Helvetica:x11****2:    GDP per Capita Assuming Non-Social
                                 Security Surpluses are Eliminated Versus
                                 Unified Budget
                                 Balance
*****************

*****************

Note: The "eliminate non-Social Security surpluses" path assumes that
permanent unspecified policy actions (that is, spending increases and/or
tax cuts) are taken through 2009 that eliminate the on-budget surpluses.
Thereafter, these unspecified actions are projected through the end of the
simulation period. On-budget deficits emerge in 2010, followed by unified
deficits in 2019. The "eliminate unified surpluses" path assumes that
surpluses are not retained, but that the unified budget remains in balance
through 2008. 

Source: GAO analysis.

Figure****Helvetica:x11****3:    Composition of Spending as a Share of
                                 GDP, Assuming On-budget
                                 Balance
*****************

*****************

Note: Revenue as a share of GDP falls from its actual 1998 level to CBO's
2008 implied level and is held constant at this level for the remainder of
the simulation period.

*In 2030, all other spending includes offsetting interest receipts.

Source: GAO Analysis.

Therefore, a challenge for the United States is to find a way to make the
transition from a budget regime focused on eliminating the unified deficit
to one that deals with allocating the surplus between long-term pressures
and short-term demands. Agreement on appropriate long-term fiscal goals is
important to both inform the allocation of surplus and promote public
acceptance of the choices. For the United States, overall fiscal targets
could guide the more specific debate over the relative merits of different
priorities-how much of the surplus to devote to reducing debt, increasing
domestic discretionary or defense spending, securing existing unfunded
entitlement promises, and cutting taxes. These choices could be considered
within a broader context that considers tradeoffs between current
consumption and saving for the future. 

The design and use of fiscal targets requires care. U.S. experience shows
that a target cannot replace agreement on the steps necessary to achieve
it. In order for any fiscal policy goal to govern actions, it must be
grounded in a discussion of national needs and the tradeoffs associated
with reaching such a goal. In addition, selecting the appropriate measures
in a time of surplus is complicated-indeed a surplus period may call for
more complex measures. In our nation's setting, targets could provide a
renewed focus for fiscal policy geared to monitoring and enhancing long-
term U.S. economic and fiscal capacity to shoulder the increased
obligations associated with the retirement of the baby boom generation.
Although it is not easy, the countries in GAO's study sought to design a
framework strong enough to guide action but flexible enough to survive
when economic conditions or other factors change. In our setting, the
current debate over saving the Social Security surplus may ultimately
yield an agreement on both fiscal targets as well as a process for
sustaining support for these targets over time. 

Conclusions

Can the experiences of these nations be translated to the U.S.
environment? What do their experiences say about the next steps in the
U.S. debate? First, the failure to define an explicit fiscal path for the
future has serious downside risks. As GAO has discussed in this and other
reports, "doing nothing" is not really an option-long-term pressures will
overwhelm the budget absent reform of public pension and health programs.
While the debate has begun on how to save a portion of the surplus, until
the fiscal path for a period of budget surpluses is fully and clearly
articulated there is a risk of losing the opportunity to enhance our long-
term economic 
well-being. A number of the case study countries had already dealt with
reform of their pension or old-age support programs; this made their task
easier. This has not been done yet in the United States and so
policymakers must factor the pressures associated with such programs into
any new fiscal framework.

As the United States considers how to use surpluses to address our own
long-term needs, the other nations' experiences suggest a framework which:

o provides transparency through the articulation and defense of fiscal
  policy goals;

o provides accountability for making progress toward those goals; and

o balances the need to meet selected pent-up demands with the need to
  address long-term pressures.

As the United States moves from deficit to surplus, it will be important
for policymakers to reach agreement on a clearly defined and transparent
fiscal policy framework that makes sense in light of both the current
pressures and the long-term projections. In order for this framework to
succeed in setting a broad set of principles to guide fiscal policy
decisionmaking, the rationale for it must be explained and defended. 

Within this new framework, clear fiscal policy goals should be
articulated. As with the other countries in GAO's study, these goals
should not be rigid fixed targets to be achieved on an annual basis.
Rather, they should consist of broader goals defining a future fiscal
policy path for the nation. The goals can provide an accountability
framework strong enough to guide annual budget targets but flexible enough
to survive when economic conditions and other factors change. Without this
balancing of needs, the strains on the enforcement regime become too great
and the discipline to follow a glide path to achieving national goals may
be weakened. In other countries these goals included reducing the burden
of national debt, maintaining international investor confidence, and
increasing the national saving rate. Although the prospect of a loss in
international investor confidence is not as threatening to the United
States as it might be for other nations, goals and measures relevant to
our own long-term fiscal outlook need to be explored. Such goals would go
beyond "0" budget balance to focus on such issues as debt burden,
questions of intergenerational equity, and contributions of fiscal policy
to net national saving. The use of structural measures of fiscal position
might help keep fiscal policy focused on the underlying fiscal position of
the federal government, excluding temporary cyclical economic trends.

The surplus presents an opportunity to address the long-term budget
pressures presented by Social Security and Medicare. If we let the
achievement of a budget surplus lull us into complacency about the budget,
then in the middle of the 21st century, we could face daunting demographic
challenges without having built the economic capacity or program/policy
reforms to handle them. A new fiscal framework for a period of budget
surpluses would be of great value to policymakers and to the U.S. public
as the nation embarks on a period of budget surpluses. Such a framework
could go a long way towards ensuring that future debate on what to do with
surpluses is focussed on issues that are most critical to advancing the
future economic well-being of the nation. 

Developing consensus on a new fiscal goal and putting in place a framework
to support such a goal is not easy. Other nations' experiences illustrate,
however, that reaching consensus on using surpluses is possible. However,
GAO would note that our nation has made measurable sacrifices of current
needs for future goals when those goals were defined in compelling enough
terms. A surplus offers the United States a unique opportunity to revisit
the framework under which budgetary decisions are made and to address
selected critical short- and long-term needs.

--------------------------------------
/Footnote1/-^U.S. surplus figures are presented on a unified basis which
  includes both the on- and off-budget portions of the budget. The off-
  budget sector reflects the annual fiscal activities of the Social
  Security trust funds and the Postal Service.
/Footnote2/-^Assumes that surpluses are not spent and that budget caps are
  adhered to through 2002, after which time they are assumed to grow with
  inflation. 
/Footnote3/-^Assumes that permanent unspecified policy actions (that is,
  spending increases and/or tax cuts) are taken through 2009 that
  eliminate the on-budget-non-Social Security-surpluses. Thereafter, these
  unspecified actions are projected through the end of the simulation
  period. On-budget deficits emerge in 2010, followed by unified deficits
  in 2019. 

INTRODUCTION
============

During the 1980s and 1990s, several advanced democracies achieved budget
surpluses. Several of these countries have been able to sustain surpluses
over a period of several years and have set a fiscal policy goal calling
for sustained surpluses. They have been able to justify sustained
surpluses despite obvious difficulties associated with continued fiscal
restraint. A discussion of how and why these countries were able to
justify continued fiscal discipline can provide insights to U.S.
policymakers as they continue to debate fiscal policy during the current
period of projected budget surpluses. 

Senate Budget Committee Ranking Member Lautenberg, subsequently joined by
Chairman Domenici, asked that we examine the experiences of six nations
that have achieved budget surpluses in the 1980s and 1990s-Australia,
Canada, New Zealand, Norway, Sweden, and the United Kingdom-and to
identify lessons these nations learned from their experiences with budget
surpluses that might be applicable to the United States. 

The Politics of Running a Budget Surplus 
-----------------------------------------

Balancing the budget is a fiscal goal that often commands broad support-at
least in the abstract-from policymakers and the public alike. The idea of
a government spending no more than it takes in has a near universal appeal
across the political spectrum. In contrast, a government running a budget
surplus-spending less than it takes in-is a goal with less intuitive
appeal, and a policy that often lacks a natural constituency. During
periods of surplus, a government hears many calls for new spending or tax
cuts. This may reflect in part a reaction to a period of restraint and the
often difficult steps taken to eliminate deficits. In the face of these
calls to respond to deferred demands, it can be difficult for politicians
to justify running a surplus. 

The politics of surplus are very different from the politics of deficits.
During a deficit reduction period the goal is clear and political
decisions tend to focus on the mix and severity of spending cuts and tax
increases needed to bring the budget into balance. While there may be
disagreement over the detailed actions to be taken and how long it should
take to achieve balance, there is generally agreement on the goal of
balance. During a surplus period, the political debate focuses on whether
surpluses are needed at all. If consensus is reached on the need for
surpluses, then agreement can be reached on how long they are needed and
how large they should be. The answers to these questions are not obvious
as there is no single goal with the intuitive appeal of a balanced budget
or zero deficit. 

While most economists agree that there are economic and fiscal benefits of
running a surplus, these benefits are longer term and must compete with
current needs. The potential economic benefits of running a surplus
include lower real interest rates, a larger pool of domestic savings to
finance productive investment, and, ultimately, improved prospects for
higher economic growth and living standards in the future. Running
surpluses can also lead to budgetary benefits, including lower interest
payments and increased future budgetary flexibility. Consequently, it may
be politically difficult to justify sustained surpluses because the
benefits will occur in the future and/or there is not always a strong
political constituency to support these goals. Furthermore, these benefits
must be weighed against calls for spending increases or tax cuts, which
are usually supported by organized political advocates and can have more
immediate political benefits. 

Support for retaining a surplus can be further weakened by the fact that
many countries achieve surpluses after several years of painful deficit
reduction efforts. Popular programs may have already been cut and/or taxes
raised to achieve surplus. Electorates willing to accept relatively tight
fiscal discipline to achieve balance may be unwilling to continue to do so
when there is "excess" money at the end of the year. This "fiscal fatigue"
can greatly increase the pressure to "spend" the surplus. Consequently,
governments that adopt a surplus goal often allow a portion of surpluses
to be used for spending increases or tax cuts. 

The Benefits of Running a Budget Surplus
----------------------------------------

Countries with budget surpluses can expect to receive both fiscal and
economic benefits. From a budgetary standpoint, the fact that surpluses
reduce debt means that the associated interest cost falls, freeing up
resources to be spent on other priorities./Footnote1/ A high interest
burden tends to lead to even higher deficits and debt, which, in turn,
contribute to rising interest costs-creating a (r)vicious cycle(c) of
increasing deficits and debt. Replacing deficits with surpluses reduces
debt and begins a (r)virtuous cycle(c) where lower levels of debt lead to
lower interest payments-possibly at lower interest rates./Footnote2/ These
lower interest payments in turn lead to larger potential surpluses and/or
increased budget flexibility. 

Running surpluses can also help to increase economic growth in the long
term. A budget surplus increases national saving, and leads to an increase
in the amount of funds available to be invested elsewhere in the economy.
Lower government borrowing also puts downward pressure on interest rates,
as there is less demand for available funds. Together, lower interest
rates and higher saving and investment increase the capacity for economic
growth over the long term. Increased national saving results in increased
private investment and raises productivity, thereby increasing future
economic output and living standards. 

Another benefit of reducing debt is the enhanced ability to meet future
needs. Many countries face the challenge of an aging population that
brings with it significant spending pressures for pension and health
programs. As their populations age, countries face a declining number of
workers relative to retirees at the same time people will live longer in
retirement. If these countries enter the period of the baby boom
retirement with large debt loads, the relatively smaller working
generation would face a twin challenge of supporting the pension and
health care needs of retirees and paying the interest expenses on a large
debt. Reducing debt today can increase a nation's fiscal capacity to
afford future budget pressures. Thus, budget surpluses can have an
important effect on intergenerational equity by helping countries prepare
for future challenges.

Also, surpluses can have a positive impact on investor confidence because
of the long-term fiscal and economic benefits that could result and
because surpluses can be perceived as an indicator of good fiscal
management. Increased investor confidence can lead to lower interest rates
and reduce the cost of borrowing. 

Finally, using surpluses to reduce debt burden allows a country to be
better equipped to handle future economic shocks. If debt is at a
manageable level, countries have a greater ability to increase borrowing
during recessions. If debt is at a high level, there is the risk that
additional borrowing will be at higher interest rates as investors demand
a premium to cover the risk of nonpayment. 

Why the Experiences of Other Countries Are Relevant to the United States
------------------------------------------------------------------------

The United States is currently entering a period of projected budget
surpluses for the first time in many years./Footnote3/ Since the arrival
of surpluses in 1998, there has been much debate about whether surpluses
should be maintained and how they should be used. To better inform our
current debate, it is instructive to look at other countries with recent
experience with budget surpluses. How did they reach consensus on the use
of surpluses? What strategies did they employ to carry out their fiscal
policy during a period of surplus? Have they taken steps to address their 
long-term budgetary pressures? How have they used their budget process to
maintain fiscal discipline during a surplus period? The answers to these
questions offer important insights as the national debate continues.

We chose six case study countries-Australia, Canada, New Zealand, Norway,
Sweden, and the United Kingdom-because they have all recently experienced
budget surpluses. Admittedly, the six case study countries differ from the
United States in many ways. They are all smaller and more dependent on
foreign trade. The role of the central government varies from country to
country. Two countries-Australia and Canada-have a federal system similar
to ours, while the other four countries have unitary systems, with the
central government playing a key role in financing local sector
activities. When all levels of government are combined, the case study
countries generally have a larger public sector than the United States. 

Another key difference is that all six case study countries have
parliamentary systems of government. Some might express skepticism about
the transferability of experiences between different systems of
government. Parliamentary systems are thought to facilitate controversial
political action by consolidating power in the hands of the governing
party. In contrast, the U.S. system's separation of powers is thought by
some to present leaders with greater obstacles to political agreement. Yet
imposing sacrifice, even during a period of surplus, is a difficult task
for any democratically elected government. Furthermore, coalition or
minority governments can form in some case study countries resulting in
confrontation and controversy between the coalition partners. Coalition or
minority governments routinely must seek the support of other political
parties in order to enact legislation, and as result can act in a similar
fashion to our system of separate legislative and executive branches. 

Each of these differences can have an impact on the relative need for
surpluses and the ability to achieve and sustain them. However, despite
our differences, the experiences of these countries provide many important
lessons for us to consider as we continue with our current budget debate.
Like us, they achieved budget surpluses largely due to sustained deficit
reduction efforts and a period of strong economic growth. They are all
democracies with modern economies. Most face many of the same long-term
challenges associated with an aging population as we do. 

Fiscal History and Condition of the Case Study Countries 
---------------------------------------------------------

As of 1998, each of the case study countries has a budget surplus. Norway
and New Zealand have had surpluses since 1994, the longest periods of
sustained surpluses among the case study countries. The other four
countries achieved budget surpluses in either 1997 or 1998. Four of the
six case study countries achieved budget surpluses in the late eighties
and then returned to deficits in the early nineties. (See figure 4.)

Figure****Helvetica:x11****4:    Shifts in General Government Financial
                                 Balances
*****************

*****************

Note: Data for 1998 are estimates. General government financial balance
accounts for all levels of government. 

Source: OECD Economic Outlook 65, June 1999.

Debt burden varies from country to country. As of the end of 1998, general
government gross debt as a percent of gross domestic product (GDP) ranged
from a high of nearly 90 percent in Canada to less than 35 percent in
Australia and Norway. General government gross debt includes the debt of
the central government and all sub-levels of government, such as states
and provinces, counties, and cities. However, it is also instructive to
look at net debt, which accounts for government owned financial assets,
such as loans, stocks, and bonds, because it provides a better picture of
the government's net financial impact on the economy. As of 1998, general
government net debt ranged from a high of about 60 percent of GDP in
Canada to a low of about negative 47 percent in Norway-meaning that Norway
owns more than enough financial assets to completely pay off its debt. See
figure 5 for each country's most recent general government gross and net
debt figures. 

Figure****Helvetica:x11****5:    1998 General Government Gross and Net
                                 Debt as a Percent of
                                 GDP
*****************

*****************

Note: Data for Norway, Sweden, the United Kingdom, and Australia are
estimates. Net debt includes government financial assets, such as loans,
stocks, and bonds. Norway's net debt is negative because it owns more
financial assets than it has debt outstanding.

Sources: OECD Economic Outlook 65, June 1999, and New Zealand Treasury.

Economic and Fiscal Characteristics of the Case Study Countries
---------------------------------------------------------------

The case study countries are smaller, more reliant on trade, and have a
larger public sector than the United States. (See table 1.) The United
Kingdom has the largest population of the case study countries while New
Zealand has the smallest, with a population about 1/16 the size of the
United States. The economies of the case study countries are also smaller,
with the United Kingdom the largest at about 16 percent of the United
States economy and New Zealand the smallest at less than 1 percent of the
United States economy. The economies of the case study countries are more
dependent on trade than the United States with exports as a percentage of
GDP ranging from almost two times to more than four times that of the
United States. 

Table****Helvetica:x11****1:    Characteristics of the Six Case Study
                                Countries and the United States, 1997

-------------------------------------------------------------------------
|               : Population  :         GDP : Exports  :        Public  |
|               :             :   (billions :  (% GDP) : Sector Outlays |
|               :         (in :        $US) :          :       (% GDP)  |
|               :  thousands) :             :          :                |
|               :             :             :          :                |
|               :             :             :          :                |
|-----------------------------------------------------------------------|
| Australia     :      18,532 :       392.9 :     15.6 :          33.5  |
|-----------------------------------------------------------------------|
| Canada        :      30,287 :       607.7 :     35.5 :          42.3  |
|-----------------------------------------------------------------------|
| New Zealand   :       3,761 :        65.0 :     21.8 :          38.9  |
|-----------------------------------------------------------------------|
| Norway        :       4,393 :       153.4 :     31.6 :          43.6  |
|-----------------------------------------------------------------------|
| Sweden        :       8,848 :       227.8 :     36.4 :          62.3  |
|-----------------------------------------------------------------------|
| United Kingdom:      58,105 :     1,282.9 :     22.1 :          41.0  |
|-----------------------------------------------------------------------|
| United States :     266,792 :     7,824.0 :      8.8 :          33.6  |
-------------------------------------------------------------------------

Note: Outlay figures are for all levels of government.

Sources: OECD Economic Outlook 65, June 1999 and various countries' OECD
economic surveys, 1999.

Public sector spending for all levels of government as a percentage of GDP
is smaller in the United States than in any of the case study countries
except Australia, which has about the same level of public spending. This
generally reflects a larger role for the governments of the case study
countries. For example, the case study countries provide universal health
care coverage for their citizens and many provide more generous social
benefits. 

A large public sector can affect fiscal position and fiscal policy in
significant ways. Generally, a larger public sector results in wider
swings in fiscal position corresponding to swings in the economy. Programs
that are economically sensitive-such as unemployment benefits and income
taxes-add to the size of deficits during downturns and surpluses during
periods of strong growth. These economically sensitive programs act
automatically to stabilize the economy by increasing aggregate demand
during weak periods and decreasing demand during periods of strength. The
larger these 
so-called (r)automatic stabilizers(c) are relative to the economy, the
larger the swing in fiscal position can be. For example, Sweden with
public sector outlays accounting for about two-thirds of the economy, went
from a deficit of over 12 percent of GDP in 1994 to a surplus of nearly 2
percent of GDP in 1998. 

Definition of a Budget Surplus
------------------------------

In its simplest definition, a surplus is an excess of revenue over
spending in a given period. However, definitions of revenue and spending
vary among countries, and to compare across countries we used OECD data
wherever possible. OECD data are presented on a general government basis,
which includes the aggregate fiscal balances of all levels of government
in that nation. In analyzing the experiences of the individual nations we
focused on the measure of fiscal position used by the central government,
which formed the basis for policy debates. The definition of budget
balance varies significantly from country to country, and can have an
impact on the nature of the budget debate during a period of surplus. For
example, Canada excludes surpluses in its public pension system from its
primary measure of fiscal position. More detailed information on the
measure of fiscal position used by each of the six countries is provided
in appendixes I through VI, and chapter 4 contains a discussion of how the
different measures can have an impact on the budget debate. 

Objective, Scope, and Methodology
---------------------------------

Senators Domenici and Lautenberg asked us to review the experiences of six
countries that had achieved budget surpluses. Specifically, they asked us to

o determine how these countries achieved a budget surplus and developed
  fiscal policies in periods of surpluses,

o determine how other countries have addressed long-term budgetary
  pressures and adapted their budget process during a period of surplus,
  and

o identify lessons these nations learned from their experiences with
  budget surpluses that might be applicable to the United States.

To accomplish these objectives, we reviewed OECD data on the case study
countries' fiscal position, and in each country we interviewed officials
and analysts familiar with their government's actions. We also interviewed
and obtained documentation from government officials to better understand
how countries developed fiscal strategies during periods of budget
surpluses. We interviewed and obtained data and information from public
policy critics, academicians, journalists, and members of political
opposition parties to obtain their views. We reviewed a wide array of
reports and economic analysis on fiscal and economic policy in general and
on the specific case study countries. Experts from each case study country
reviewed the appendix on their country, and experts in comparative public
policy reviewed our analysis and findings. The reviewers generally agreed
with our work, and we have incorporated their comments where appropriate.

In this report, we present significant fiscal policy actions taken by the
six countries, either in terms of size, political importance, or economic
impact. While the report does not fully detail all of the economic
policies of the case study countries, we outline elements of the economic
situation and policies which best helps explain how the countries chose
their particular fiscal path. 

Our work was conducted in the six case study countries and Washington,
D.C., from March 1998 through October 1999 in accordance with generally
accepted government auditing standards.

--------------------------------------
/Footnote1/-^There is not always a one-to-one relationship between the
  size of a budget surplus and the amount of debt reduction due to
  accounting differences between the two measures. Debt is a cash measure
  of the government's borrowing needs. Measures of budget surpluses
  sometimes include non-cash items, such as the subsidy amount of
  government loans instead of the cash value of those loans.
/Footnote2/-^Just as deficits put upward pressure on interest rates, a
  period of budget surpluses should relieve this pressure. Lower interest
  rates then reduce interest costs.
/Footnote3/-^Prior to 1998, the United States has achieved budget
  surpluses in 8 years since the Great Depression. The most recent surplus
  occurred in 1969, and the longest period of surpluses lasted 3 years
  from 1947 to 1949.
In 1992, the Commonwealth government passed the Superannuation Guarantee
Act making it mandatory for employers to offer retirement benefits, in the
form of employer-funded pension programs, to their employees. Under the
Act, employers make contributions to individual pension accounts of the
employees' choosing. By 1996, approximately 

COUNTRIES DEVELOPED STRATEGIES FOR SURPLUS
==========================================

In the case study countries, the early 1990s were characterized by slow
economic growth and large budget deficits. In response, policymakers
enacted structural reforms and deficit reduction packages designed to
improve economic and fiscal performance. As each case study country
approached budget surplus in the 1990s, its government was faced with a
decision about how to approach fiscal policy. The previous period of slow
economic growth and large budget deficits continued to play a critical
role in shaping how the case study countries approached surpluses, and
they generally chose to continue on fiscally cautious paths. 

As countries have transitioned from an era of deficit reduction to a
period of surplus, they have developed unique strategies for how to use
their surpluses. Case study countries have found it important to set clear
fiscal goals and to articulate compelling rationales explaining the
potential benefits of their policies in order to maintain public support
for continued fiscal discipline. These countries have generally recognized
the importance of competing priorities and have devoted some portion of
their surpluses to tax cuts and/or spending increases rather than
attempting to reserve the entire surplus for debt reduction. Some nations
have been able to sustain surpluses for several years and have taken the
difficult step of enacting cuts to maintain surpluses. The budget process
has played a critical role guiding fiscal policy and/or supporting
continued fiscal discipline. 

Factors That Shaped the Surplus Debate During the 1990s
-------------------------------------------------------

The political debate surrounding a budget surplus was influenced greatly
by the economic slowdowns and budget deficits of the late 1980s and early
1990s. Each country we studied experienced a significant economic slowdown
during this period, generally coinciding with a broader worldwide economic
slowdown. (See figure 6.) In several countries the slowdown became severe.
Sweden, for example, experienced 
3 consecutive years of negative growth beginning in 1991. In other
countries, including New Zealand and Norway, there were prolonged periods
of below-average growth.

Figure****Helvetica:x11****6:    Change in Average Annual GDP Growth
                                 During Economic Slowdown of Late 1980s
                                 and/or Early
                                 1990s
*****************

*****************

Source: OECD Quarterly National Accounts, Number 3, 1998, and OECD
National Accounts, Main Aggregates Volume I, 1960-1996.

In several case study countries, a loss of investor confidence in fiscal
and economic health added to the economic downturn, and fiscal and
monetary policies were tightened in reaction to investors pulling money
out of the country. Policymakers were limited in their ability to respond
to an economic slowdown because they were forced to take procyclical
actions to win back investor confidence. For example, both Norway and
Sweden were pursuing a policy of fixed exchange rates when a drop in
investor confidence resulted in downward pressure on currency valuations.
To support the value of the currency, each country raised interest rates,
which had the effect of further slowing the economy. New Zealand and
Sweden received credit downgrades due to concerns over their economic and
fiscal health. Interest rates rose as a result, increasing the cost of
borrowing and causing the economies to slow further. Also, several
countries took actions to reduce budget deficits during the economic
downturn, which slowed the economies further. These events made
decisionmakers keenly aware of the need to sustain foreign investor
confidence in their economic and fiscal policies.

The economic slowdowns of the late 1980s and early 1990s were a major
factor leading to the reemergence of large budget deficits in the case
study countries. In four countries, deficits followed a period of budget
surpluses. For these countries, spending increases and/or tax cuts made
during a period of surplus also contributed to the reemergence of
deficits. The reemergence of large budget deficits was seen as a step
backward following years of progress reducing budget deficits. 

In reaction to slow economic growth, large budget deficits, and a drop in
investor confidence, leaders in the case study countries took actions to
restore fiscal and economic health. In general, the pervasive philosophy
was that in order to sustain economic growth, inflation rates had to be
kept low and stable and efforts taken to reduce budget deficits. To show
their commitment to reducing inflation rates, five case study countries
set explicit inflation targets and increased the independence of the
central bank to respond to inflationary pressures. Each country also
renewed deficit reduction efforts and implemented budget process changes
to reinforce their commitment. 

Several countries enacted large deficit reduction packages in response to
the large deficits that had built up. For example, in 1994, Sweden enacted
a deficit reduction package amounting to 7 percent of GDP over 4 years.
Similarly, in 1994, the Canadian government introduced a package reducing
the deficit by over 3 percent of GDP over 4 years, while the New Zealand
government reduced its budget deficit by more than 4 percent of GDP from
1991 through 1993. In the other countries, the deficit reduction packages
were relatively smaller and more gradual.

Leaders in each country enacted difficult spending cuts and/or tax
increases in their efforts to bring the budgets back into balance. The New
Zealand government cut fiscal year 1991-92 net spending by 10 percent from
the level projected in October 1990 and delayed implementation of a
campaign promise to eliminate an unpopular surcharge on public pensions.
Australia reduced expenditures in health, education, and employment
services. Canada cut the federal workforce by 15 percent and cut back aid
to provinces significantly, which had the effect of reducing spending on
health care. Likewise, Sweden enacted a deficit reduction package that
included reductions in subsidies for medical and dental care, indexation
of certain taxes, and increased contribution rates for the unemployment
benefit system. 

A strengthening economy combined with deficit reduction efforts
contributed to a significant improvement in fiscal position in each of the
case study countries. By 1998, all of the case study countries had
achieved a budget surplus. (See figure 7 for the fiscal position as of
1998 for each country.)

Figure****Helvetica:x11****7:    1998 General Government Financial
                                 Balance
*****************

*****************

Source: OECD Economic Outlook 65, June 1999.

Countries Developed Fiscal Strategies for a Period of Surplus
-------------------------------------------------------------

As noted in chapter 1, balancing the budget is a fiscal goal that often
commands broad support from both policymakers and the public alike. In
contrast, a government running a budget surplus-spending less than it
takes in-is a goal with less intuitive appeal, and a policy that often
lacks a natural constituency. As case study countries entered a period of
budget surpluses, decisionmakers had to decide what their fiscal policy
goals would be. The previous period of slow economic growth and poor
fiscal condition continued to influence fiscal policy. 

As each country entered its current period of surplus, it has developed
unique strategies to help ensure continued fiscal progress. Leaders in
these countries have developed fiscal goals to help guide budgetary
decisions during a period of surplus. In general, the case study countries
decided to continue with a fiscally cautious approach. Three countries-New
Zealand, Norway, and Sweden-set a goal for continued budget surpluses. The
three others-Australia, Canada, and the United Kingdom-each set balance as
its main fiscal goal, but as part of a cautious strategy that has resulted
in them achieving small surpluses. 

Leaders in these countries have pointed to the potential economic and
fiscal benefits as a compelling rationale to justify their policy, and
there has generally been broad support for continued fiscal discipline
during a period of surplus. Often, countries retained features of their
budget process designed to aid deficit reduction efforts. The case study
countries have generally made room for additional spending initiatives
and/or tax cuts, sometimes to address perceived needs following a period
of deficit reduction. Remarkably, several nations have instituted
expenditure cuts to sustain surpluses during this period.

Three Countries Aim for Budget Surpluses
----------------------------------------

New Zealand, Norway, and Sweden have each set sustained surpluses as their
primary fiscal policy goal. Following a period of economic and fiscal
crisis, broad consensus was reached on the need for sustained surpluses.
Leaders in these countries chose to pursue surpluses to address long-term
fiscal and economic concerns, reduce debt, and/or sustain investor
confidence in their fiscal management. 

Norway Aims for Surpluses to Address Long-term Fiscal and Economic Concerns

Norway has established a goal of sustained surpluses in order to build up
savings to address long-term fiscal and economic concerns resulting
primarily from an aging population and declining petroleum revenues. 
(See figure 8.) Norway projects both a near doubling of retirement
benefits from about 7 percent of GDP currently to about 15 percent of GDP
by 2030 and a parallel decline in oil revenues from about 8 percent of GDP
to less than 1 percent over the same period. Also, Norway is concerned
that economic growth could decline in the long run if a strong petroleum
industry crowds out investment in other industries. The combined effects
of an aging population and declining oil revenues are projected to result
in an unsustainable fiscal path and eventual economic decline. This long-
term problem has been clearly communicated to policymakers and the public
and has developed as a primary rationale for their current fiscal policy
of sustained surpluses.

Figure****Helvetica:x11****8:    Long-term Projections for Pension
                                 Expenditures and Petroleum Revenues as a
                                 Percentage of GDP in
                                 Norway
*****************

*****************

Source: Statistics Norway and Norwegian Ministry of Finance.

In the mid-1990s, Norwegian decisionmakers reached a broad consensus on
the need to save projected surpluses to pay for future budget needs and to
help increase long-term economic growth. Surpluses were projected to
result from increased oil revenues and a strengthening economy. To ensure
that surpluses were saved, the government created the Government Petroleum
Fund, in which surpluses were to be deposited to help pay for future
pension costs./Footnote1/ The fund's assets are invested in foreign stocks
and bonds to help reduce inflation and upward pressure on the exchange
rate. Low inflation and a stable exchange rate help to keep Norway's
exports competitive with other countries. If Norway allowed excess
petroleum revenues to remain in the domestic economy, it could result in
higher levels of inflation and an appreciation in the value of its
currency. As a result, 
non-oil industries would become less competitive over time as the price of
their goods and services would rise relative to foreign competitors. This
is a major concern to policymakers because Norway projects that petroleum
output will decline early in the 21st century, and Norway will have to
rely more on its non-oil industries to generate economic growth. If those
industries lose their competitiveness now, it could have a negative impact
on long-term economic growth when the petroleum industry declines.
Consequently, policymakers in Norway have come to view surpluses as
critical to the long-term fiscal and economic health of the country. The
Government Petroleum Fund has become a symbol of the importance of saving
for future needs. 

The ability of the government to maintain fiscal discipline during a
period of surplus has come under increasing pressure. Fiscal policy stance
remained tight through 1997, with the cyclically adjusted deficit,
excluding oil, declining from over 7 percent of GDP to less than 3 percent-
a major fiscal tightening by international standards./Footnote2/ Following
the 1997 elections, a weak minority coalition took over the government,
and proposed to use a portion of the surpluses to increase spending on
pensions and family allowances in its first budget. A sharp decline in oil
revenues in 1998 led to a sharp decline in the budget surplus, including
oil revenues, from about 
7 percent of GDP to about 4 percent of GDP. Financial markets became
concerned over the relatively easy stance of fiscal policy, resulting in
strong downward pressure on Norway's currency. Furthermore, a tight labor
market has led to increased inflationary pressures. The government remains
committed to maintaining surpluses, but it may be difficult for a weak
minority coalition government to maintain fiscal discipline in light of
the pressures that have emerged since 1997. 

New Zealand and Sweden Aim for Surpluses to Reduce Debt Burden and
Maintain Investor Confidence

Both New Zealand and Sweden have set sustained surpluses as their primary
fiscal goal in order to reduce debt burden, which increased greatly during
the previous deficit period. New Zealand's general government gross debt
reached a peak of nearly 65 percent of GDP in 1992, while Sweden's debt
climbed to over 80 percent of GDP in 1994. Surplus goals were also adopted
to regain investor confidence after a loss of confidence in the early
1990s led to a credit downgrade and/or currency devaluation.

As each country neared a budget surplus, decisionmakers decided to set
sustained surpluses as their main fiscal objective. In New Zealand, this
goal took the form of an explicit goal to reduce debt burden by running
surpluses. In 1994, New Zealand enacted the Fiscal Responsibility Act
(FRA) which put in place a framework to guide fiscal decision-making. FRA
was enacted in part to address concerns that a recently enacted electoral
reform could weaken political resolve to sustain fiscal
discipline./Footnote3/ FRA requires the government to set a prudent debt
level, and to attempt to run budget surpluses until the goal is achieved.
A debt target provides an additional measure of fiscal health and provides
justification for continued surpluses. 

FRA has played a critical role in New Zealand's ability to sustain fiscal
discipline during its current period of budget surplus. Initially, in
1994, the government set a goal to reduce net debt to between 20 and 30
percent of GDP from over 40 percent. The government committed the entire
budget surplus to debt reduction, but promised to cut taxes once the debt
target was achieved. In 1996, when it became apparent that the 30 percent
debt target would be achieved, the government enacted a tax cut and reset
its debt target to 20 percent of GDP.

FRA has continued to play a critical role following the first election
under the new electoral system. Following the 1996 election, a coalition
government formed for the first time in many years. The minority partner
in the coalition government was a strong advocate of new social spending,
while the larger National party, which had held the previous majority
government, was a major advocate of continued debt reduction and tax cuts.
Nonetheless, under their coalition agreement the new government set
continued surpluses and debt reduction as its overall fiscal policy. As a
compromise, they agreed to delay planned tax cuts 1 year and implement a
spending package while still allowing for continued surpluses. In 1998,
the minority partner left the coalition government and the National party
continued as a minority government. The government has retained the
previously agreed to debt target to justify continued fiscal discipline.
In the fall of 1998, when budget forecasts showed that the budget would go
into a deficit, largely as a result of the Asian economic crisis, the
government enacted a package of spending cuts and scaled back the
previously promised spending increases to sustain surplus. Consequently,
the government is projecting rough balance in the operating budget for
fiscal year 1999-2000 and operating surpluses starting in fiscal year 2000-
2001.

Similarly, the Swedish government has also set a goal of sustained
surpluses to reduce debt and to maintain investor confidence. Of the case
study countries, Sweden experienced the most severe economic downturn and
the largest budget deficit during the 1990s. In reaction, the government
ended its fixed exchange rate policy, enacted a large deficit reduction
package, and reformed the budget process to better support fiscal
discipline, putting in place multi-year expenditure limits for the first
time. In 1997, when it became apparent that the budget was nearing
balance, the government set a goal for surpluses of 2 percent of GDP in
order to help retain investor confidence in its policies and to ensure
continued progress toward debt reduction. 

By setting an explicit goal and keeping to expenditure limits, the Swedish
government has been able to maintain fiscal discipline during the early
stages of its current surplus period. Specifically, the government
established expenditure limits for 1998 that would allow it to gradually
achieve its surplus goal. However, due to continued strong economic growth
and other technical factors, Sweden achieved its surpluses earlier than
expected./Footnote4/ As larger than expected surpluses are projected, the
government has reiterated its commitment to the previously agreed to
expenditure limits. At the same time, the government has been able to
increase spending somewhat because of the way the expenditure ceilings
work. Under Sweden's new budget process all open-ended appropriations,
mostly to entitlement programs, were abolished, making all expenditures
subject to annual reviews. To provide a buffer against forecasting errors
in these programs, the government built a "budget margin" into the
expenditure limits. Thus, to the extent economic and budget forecasts turn
out to be accurate or better than expected, the government can increase
spending up to the amounts allowed under the expenditure
ceilings./Footnote5/ Since the expenditure ceilings have been in place,
the economy has outperformed the forecasts, freeing up additional room for
spending. 

In 1999, actual spending was projected to breach the expenditure caps. The
government reiterated its commitment to the expenditure caps and proposed
cutting spending by about 1 percent to stay within the caps, including
cuts to labor market programs, agriculture, and health care. Due to
concerns over its international competitiveness-Sweden has among the
highest overall tax levels among OECD countries-the government has also
proposed a package of tax cuts aimed mostly at low and medium income
workers. 

Three Countries Aim for Balance Upon Achieving a Budget Surplus
---------------------------------------------------------------

Upon achieving surplus, Australia, Canada, and the United Kingdom each set
a fiscal policy goal of balance. However, each country has developed a
cautious fiscal strategy, which has resulted in them achieving small
surpluses in the near term. The budget process has continued to play a key
role in each country's ability to limit spending and tax actions following
the arrival of surpluses. In general, their spending and tax actions have
been taken to address perceived needs arising from their previous deficit
reduction periods. 

Australia Aims to Maintain National Saving

Australian policymakers have focused on the need to increase national
saving and long-term economic growth to guide their fiscal policy
decisions. The government was particularly concerned that continued
deficits could act to reduce national saving, which had fallen in the
early 1990s by more than 5 percentage points below the average of the
prior three decades. This is of major concern to policymakers because
Australia has had to rely on foreign sources of capital to finance private
investment. Concerns arose about Australia's prospects for long-term
economic growth if it had to depend on foreign sources to make up the
saving-investment gap. As the fall in national saving closely tracked
increased public sector borrowing, policymakers committed to fiscal
policies aimed at restoring national saving by reducing government
borrowing. With the government running balanced budgets instead of
deficits, more resources would be available for private sector investment. 

Consequently, the current government in Australia has set a fiscal goal of
balanced budgets over the economic cycle to ensure that, overtime, the
Commonwealth general government sector "makes no call" on national saving,
and therefore does not detract from national saving./Footnote6/ For
example, one of the justifications for establishing mandatory private
pensions was to increase national saving./Footnote7/ Currently, the
government is aiming for budget surpluses for the medium term to coincide
with a strong economy.

Since 1996, the "Charter of Budget Honesty" (the Charter) has played a
critical role in framing Australia's fiscal policy stance. The Charter set
out principles for the conduct of sound fiscal policy and put in place
institutional arrangements designed to improve discipline, transparency,
and accountability in the formulation of fiscal policy. Specifically, the
Charter established the following five principles for sound fiscal
management: (1) to maintain prudent levels of debt, (2) to ensure that
fiscal policy contributes to national saving and moderates economic
fluctuations, (3) to pursue a policy of stable and predictable tax
burdens, (4) to maintain the integrity of the tax system, and (5) to
ensure that policy decisions consider impacts on future generations. The
framework of the Charter allows flexibility for the government to define
its medium-term fiscal strategy and short-term fiscal goals in such a way
as to fulfill these principles.

In fiscal year 1997-98, Australia achieved a small budget surplus, and,
with the fiscal year 1999-2000 budget, the government forecasts surpluses
for the next 4 years./Footnote8/ The government's medium-term fiscal
strategy, developed as required by the Charter, is to balance the budget
over the cycle, which means a short-term goal of running surpluses during
the projected period of expansion. Also, the government currently has a
goal to eliminate net debt by fiscal year 2002-03 from its 1998-99 level
of about 11 percent of GDP.

Within this goal of surpluses for the short term, the government has made
room for new selected spending increases and selective tax cuts. The
fiscal year 1998-99 budget proposed spending initiatives totaling nearly 
A$10 billion through fiscal year 2001-02, with a large portion dedicated
to health care. The government has also decided to use a portion of its
projected surpluses to help finance a major tax reform, which was passed
in 1999. The tax reform package included the introduction of a national
goods and services tax (GST) along with a reduction in income tax rates
for individuals. A GST has been proposed several times in Australia's
recent history but has failed to pass due to concerns over its
regressiveness. However, the government was able to pass the GST in 1999
due, at least in part, to the availability of budget surpluses that could
be used to pay for income tax rate cuts used to offset the impact of the
GST. 

Canada Aims for "Balance or Better"

Upon achieving a surplus, Canada set as its fiscal goal to achieve
"balance or better" and has kept its "prudent" budget practices in place
to better ensure that it meets its goal. These "prudent" budget practices
were put in place in support of the government's effort to eliminate
deficits and include a shortened forecast period of 2 years, the use of
conservative economic estimates, and a contingency fund to be used for
unforeseen events or debt reduction. The effect of these practices has
been that Canada has met or exceeded its fiscal goals. During a surplus
period, the effect has been to limit the ability of the government to
spend surpluses until they materialize. Thus, Canada has adopted a
cautious allocation strategy, waiting until additional resources are
nearly certain before introducing small-scale tax cuts and spending
increases.

The Finance Department uses assumptions for interest rates, and sometimes
economic growth, that are intentionally more conservative than private
sector forecasts. This cautious forecasting policy has been in place since
1994 and was based on a recommendation from a panel of economists convened
in late 1993 to advise the government on fiscal and economic issues. The
panel's recommendation was underscored by a private sector analysis that
found that the government's economic assumptions in the 1980s and early
1990s tended to be overly optimistic. Under the current government's
cautious approach, the Finance Department's economic assumptions have
often been more pessimistic than actual outcomes.

The contingency reserve is an annual amount that is built into projected
spending, but is not allocated to any specific program. It is an
accounting mechanism used to supplement the government's cautious
forecasting policy, rather than an actual cash fund. Under the current
government, this reserve is not available to fund new initiatives.
Instead, it serves solely as a buffer against unanticipated developments,
such as an adverse change in the economy. If the government's budget
projections are on target (or overly pessimistic), the reserve acts to
reduce the deficit or increase the surplus. For example, in fiscal year
1998-99, the government projected a balanced budget. This balanced budget
estimate assumed that the 
CAN$3 billion contingency reserve would need to be spent to compensate for
shortfalls in the projections. If the budget forecast is exactly on
target, the government will actually realize a CAN$3 billion surplus that
will be used to reduce debt. For example, in fiscal year 1998-99, the
actual fiscal result was close to the target, and Canada realized a
surplus of 
CAN$2.9 billion, which it used to reduce debt.

The final element in the government's cautious approach is a short
forecast horizon; it publishes detailed projections for only 2 years.
Prior to the current government, the Finance Ministry used a 5-year
budgeting time frame for setting fiscal policy and repeatedly failed to
meet its deficit targets. In contrast, since fiscal year 1994-95, the
current government has consistently bettered its 2-year fiscal targets.
While using a short forecast period is not necessarily a more prudent
approach to budgeting, the government explains that its short horizon is a
response to the inherent sensitivity of longer-term forecasts to future
economic developments. Another important reason for the shorter forecasts
is that during a period of deficit reduction, they focus attention on
making cuts today rather than delaying action until tomorrow. During a
time of surplus, shorter forecasts can reduce the temptation to spend
projected surpluses. On the other hand, a short-term budgeting time frame
does not disclose the full long-term impact of policy decisions.

As it has entered a period of budget surpluses, the government has
continued to rely on a cautious approach. Excluding the contingency
reserve, the Finance Ministry does not publicly project budget surpluses.
The government's current fiscal goal is, at a minimum, a balanced budget-a
strategy that it refers to as (r)balance or better.(c) However, the
contingency reserve implies that the actual target is a surplus of at
least CAN$3 billion, about 0.3 percent of GDP. The government has
acknowledged it anticipates budget surpluses by introducing the (r)Debt
Repayment Plan.(c) The plan is an explicit statement that the government's
cautious approach could result in budget surpluses and that the
contingency reserve would be used to reduce debt. The 1999 Budget Plan
states that (r)the level of debt in relation to the ability to service the
debt (the debt-to-GDP ratio) is still too high [at about 65 percent of
GDP]-both by historical Canadian and international standards. . . .
Reducing the debt-to-GDP ratio must remain a key objective of the
government's fiscal policy.(c)/Footnote9/

While the government is committed to using a modest amount of budget
surpluses for debt reduction through the contingency reserve, it also uses
surplus revenues for new spending and tax cut initiatives. This strategy
of dividing surpluses between debt reduction, tax cuts, and new spending
was articulated during the government's 1997 reelection campaign. At that
time, the government stated that it would devote 50 percent of budget
surpluses to new spending and the other 50 percent to a combination of tax
cuts and debt reduction. Analysts we interviewed stated that this
allocation framework applies to surpluses over the full parliamentary term
and will not necessarily be followed on a year-by-year basis. 

In both the fiscal year 1998-99 and 1999-2000 budgets, the government
introduced a number of new selected spending and tax initiatives. The
Finance Ministry estimates that these initiatives will cost the government
about CAN$50 billion cumulatively from fiscal year 1997-98 to 2001-02. On
the spending side, these initiatives have focused on health care and
education. The tax changes include an increase in the amount of income
that low-income earners can receive on a tax-free basis, the elimination
of a 
3 percent surtax, an increase in the Child Tax Benefit, and a reduction in
employment insurance rates for both employers and employees. 

In launching new policy initiatives, the government has adopted a
philosophy that generally avoids committing resources before they
materialize. Typically, the government does not introduce new spending or
tax cuts until late in the fiscal year when a surplus becomes apparent.
The fiscal year 1999-2000 budget explained this approach and its rationale
as follows: 

"Central to [the government's] planning approach is the notion that
spending initiatives and tax cuts will be introduced only when the
government is reasonably certain that it has the necessary resources to do
so. This protects against the risk of having to make hasty, and
potentially damaging, corrections to the budget plan, such as announcing
tax relief one year and then having to raise taxes the following year."

In line with this cautious approach, the government has generally shied
away from both large-scale spending commitments and major tax cuts. In
addition, the government has enacted nonpermanent spending initiatives,
showing its preference for limiting future commitments. An example is the
Canada Millennium Scholarship Fund. The full cost of the fund-a
nonrecurring CAN$2.5 billion-was booked in fiscal year 1997-98, though
scholarships will not be awarded until 2000./Footnote10/ The government
has also made many nonpermanent investments for health care, research, and
education, addressing some of the areas cut back the most during the
previous period of deficit reduction. This cautious strategy for
allocating extra resources is supported by the Finance Ministry's use of
conservative economic assumptions, which tend to understate the resources
available for spending. 

United Kingdom Aims to Increase Investment Spending

The current government has developed a new framework for fiscal policy
that reflects "lessons learned" from the United Kingdom's past
experiences. The fiscal strategy emphasizes a greater focus on the
structural budget, a more explicit distinction between current and capital
spending, and firm multi-year spending ceilings that will not be subject
to annual review. The current Labor government's fiscal strategy is guided
by two rules: (1) the "golden rule," under which borrowing will not be
used to finance current spending (that is, total spending excluding
investment), and (2) the "sustainable investment rule," which promises to
keep net public debt as a share of GDP at a "stable and prudent" level
(which the government currently defines as below 40 percent). Both rules
are to be applied over the economic cycle, allowing for fiscal
fluctuations based on current economic conditions. 

Under the "golden rule," the government is aiming for operating balance,
allowing for deficit financing of capital investment. The government
defines investment as "physical investment and grants in support of
capital spending by the private sector."/Footnote11/ Investment spending
was significantly restrained under the previous deficit reduction efforts,
and, as a result, the current government has made boosting public
investment a major priority, proposing to nearly double it as a share of
the economy-to 1.5 percent of GDP-over the course of the current
Parliament. While investment spending is a priority, the (r)sustainable
investment rule(c) is intended to ensure that financing such spending does
not result in an imprudent rise in debt. 

A sharper focus on the economic cycle is a general feature of the current
government's policy that explicitly reflects the "lessons learned" from
the past. A recent Treasury report explains the importance of taking the
cycle into account: 

"Experience has shown that serious mistakes can occur if purely cyclical
improvements in the public finances are treated as if they represented
structural improvements, or if a structural deterioration is thought to be
merely a cyclical effect. The Government therefore pays particular
attention to cyclically-adjusted indicators of the public sector
accounts."/Footnote12/

As a result of the government's rules, its fiscal policy allows for small
deficits to be used to finance investment spending, provided that overall
debt burden is kept at a stable and prudent level. Despite this allowance
for small deficits, the Treasury estimates that the budget registered a
surplus of 0.1 percent of GDP for public sector net borrowing in fiscal
year 1998-99. Using the government's "current budget" measure, which
excludes investment, the fiscal year 1999-2000 budget estimated that there
would be a surplus of 4.1 percent of GDP for fiscal year 1998-99 and
projected surpluses on the current budget every fiscal year until 2003-04.

--------------------------------------
/Footnote1/-^The government decided not to use surpluses to pay off debt.
  It wished to keep a domestic debt market active in case it needed to
  increase borrowing, and by paying off debt it would keep petroleum money
  in the domestic economy, possibly adding to inflationary pressures.
/Footnote2/-^Norway's budget is in deficit if the effects of oil revenues'
  economic growth are excluded. 
/Footnote3/-^In 1996, New Zealand's electoral system was changed from a
  first-past-the-post system, in which the candidate with the most votes
  won the seat, to a mixed member proportional (MMP) system, in which
  seats were awarded to political parties in rough proportion to their
  share of the popular vote. MMP was put in place to address concerns that
  smaller political parties were not adequately represented in Parliament.
  As a result, the likelihood for coalition and/or minority governments
  increased greatly. 
/Footnote4/-^For example, in 1998, the government incorporated the
  National Pension Fund's real estate holdings, which resulted in an
  upward adjustment of the financial balance due to government accounting
  rules.
/Footnote5/-^If budget or economic forecasts turn out to be overly
  optimistic, then the government would presumably be forced to take
  action to stay within expenditure limits by cutting spending. There is
  some additional flexibility to borrow against future year expenditures.
/Footnote6/-^The government took "balance over the cycle" to mean that it
  would run surpluses during periods of economic growth to increase
  budgetary flexibility and allow the government to better respond to
  future economic shocks.
/Footnote7/-^89 percent of public and private sector employees were
  covered by superannuation, with the remaining 11 percent of the work
  force falling below the income threshold where superannuation started to
  apply.
/Footnote8/-^Beginning in 1996 the Australian measurement of the
  surplus/deficit changed from a cash basis to an "underlying" balance
  basis, which excludes the net effects of advances, such as loans, and
  equity transactions, such as sales and purchases of capital assets, from
  the calculation of surplus/deficit. If a cash measurement is used,
  Australia achieved a small surplus in fiscal year 1996-97.
/Footnote9/-^The Budget Plan 1999, Government of Canada, Department of
  Finance, February 16, 1999, p. 52.
/Footnote10/-^It should be noted that the Office of the Auditor General
  argued that this transaction should have been booked in the year it
  occurred, and as a result the federal surplus figure for 1997-98 was
  understated by CAN$2.5 billion.
/Footnote11/-^Fiscal Policy: current and capital spending, HM Treasury
  (United Kingdom), p. 7, footnote 2.
/Footnote12/-^Stability and Investment for the Long Term: The Economic and
  Fiscal Strategy Report 1998, HM Treasury (United Kingdom), June 1998, p.
  45.

COUNTRIES HAVE TAKEN ACTIONS TO ADDRESS LONG-TERM PRESSURES
===========================================================

Over the past two decades, the case study countries have taken actions
that address long-term fiscal pressures expected to arise from aging
populations. In Norway's case, long-term pressures were a major factor
leading the government to decide that surpluses were needed to ensure the
long-term sustainability of its policies. For other countries,
programmatic reforms aimed at addressing long-term pressures enacted prior
to the arrival of surpluses resulted in increased fiscal flexibility
during a period of surplus. Over the last two decades, four countries--
Australia, Canada, Sweden, and the United Kingdom--enacted major pension
reforms that have reduced long-term budgetary pressures and put their
pension systems on a more sustainable path. Consequently, as these
countries have entered a period of surpluses, long-term budgetary
pressures due to increasing pension costs have not emerged as a major
focus of political debates. 

By achieving budget surpluses and reducing debt, these countries have
taken a step toward improving their long-term fiscal and economic health
and enhancing future budget flexibility. Budget surpluses increase
national saving, which can lead to increased investment and productivity,
thereby increasing potential future economic output and living standards.
By reducing debt, budget surpluses also reduce the government's interest
costs, freeing resources to be spent on other priorities. Furthermore,
lower levels of debt can improve a nation's capacity to borrow and meet
future budgetary needs. 

Most Countries Face Increasing Costs Due to an Aging Population
---------------------------------------------------------------

Like the United States, most countries in our study face impending
challenges arising from an aging population. While demographic trends
differ among the countries, all are projecting an increase in the ratio of
retirees to working age population. If current spending patterns continue,
increased spending on pensions and health care threatens to crowd out
spending on other important public goods and services. 

Each of the case study countries is projecting an increase in the aging
population relative to the working age population. (See figure 9.) In
about 10 years, the baby boom generation will start to retire, and the
number of retirees will rise faster than in the past. Increased life
expectancy will also contribute to the aging pressure, as the number of
years spent in retirement increases. The number of people in the working
population will also shrink as a percentage of the population, placing
increased pressure on the fiscal system. In Canada for example, the ratio
of people aged 65 and over to those in the working age population is
expected to more than double between 2000 and 2030.

Figure****Helvetica:x11****9:    Ratio of Population Aged 65 and Over to
                                 Population Aged 15-64, 2000 and
                                 2030
*****************

*****************

Source: Data from World Population Projections 1994, The World Bank, Bos
et al.

The aging population is expected to give rise to growing demand for
pension and health care services. The demand for public pensions alone can
be a substantial strain on the budgets, caused by annual public pension
costs that, absent any policy changes, are expected in some countries to
double as a percentage of GDP by 2030. (See table 2.) For example, annual
public pension costs in Norway are projected to increase from about 
7 percent in 1996 to about 15 percent in 2030. Similarly, the demand for
health care is expected to increase substantially, not only from an aging
population but also from improved technology and the resulting greater
expectations placed on the health system. Several countries have taken
steps to address these pressures, either by setting aside budget surpluses
as Norway has done or by enacting pension reforms. 

Table****Helvetica:x11****2:    Projected Growth in Annual Public Pension
                                Expenditures as a Percentage of GDP, 1995-
                                2030

-------------------------------------------------------------------------
|            : 1995 : 2030 :  : Description of public pension system    |
|-----------------------------------------------------------------------|
| Australia  :  3.2 :  4.1 :  : Flat-rate, means-tested benefits        |
|            :      :      :  : financed from general fund revenue.     |
|            :      :      :  : Also includes service pension for       |
|            :      :      :  : veterans.                               |
|-----------------------------------------------------------------------|
| Canada     :  4.4 :  7.5 :  : Near-universal, non-contributory        |
|            :      :      :  : benefits financed from general fund     |
|            :      :      :  : revenues and a compulsory earnings-     |
|            :      :      :  : related public pension.                 |
|-----------------------------------------------------------------------|
| New Zealand:  5.0 :  9.0 :  : Flat-rate benefits financed from        |
|            :      :      :  : general fund revenues.                  |
|-----------------------------------------------------------------------|
| Norway     :  7.0 : 15.0 :  : Flat-rate, universal benefits and       |
|            :      :      :  : additional benefits based on annual     |
|            :      :      :  : earnings and years at work financed     |
|            :      :      :  : by payroll taxes and general fund       |
|            :      :      :  : revenues. Includes disability pensions. |
|-----------------------------------------------------------------------|
| Sweden     : 11.8 : 15.0 :  : Flat-rate, minimum benefits for all     |
|            :      :      :  : residents meeting residency or work     |
|            :      :      :  : requirements and a supplementary        |
|            :      :      :  : pension based on income. Also           |
|            :      :      :  : includes government housing             |
|            :      :      :  : supplements and a system of partial     |
|            :      :      :  : pension for those between 61 and 64     |
|            :      :      :  : years of age.                           |
|-----------------------------------------------------------------------|
| United     :  4.2 :  4.7 :  : Flat-rate, basic benefits               |
| Kingdom    :      :      :  : supplemented by an earnings-related     |
|            :      :      :  : pension. Employees are provided tax     |
|            :      :      :  : incentives to move from the public      |
|            :      :      :  : earnings-related pension plan into      |
|            :      :      :  : private plans. Also includes means-     |
|            :      :      :  : tested assistance for low-income        |
|            :      :      :  : retirees.                               |
|-----------------------------------------------------------------------|
| United     :  4.8 :  5.9 :  : The Old-Age, Survivors and Disability   |
| States     :      :      :  : Insurance Program provides monthly      |
|            :      :      :  : payments based on annual earnings to    |
|            :      :      :  : beneficiaries. The program is           |
|            :      :      :  : financed from payroll taxes.            |
-------------------------------------------------------------------------

Note: In Australia, the public pension system is supplemented by a
mandatory private pension scheme funded from employer contributions. In
Sweden, in 1998 the Parliament passed legislation to comprehensively
reform the pension system from a pay-as-you-go, defined-benefit system to
a pay-as-you-go, defined contribution system with mandatory individual
accounts. Pension expenditure data for Sweden does not reflect the reform.

Sources: Data from case study countries; David Stanton and Peter
Whiteford, Pension Systems and Policy in the APEC Economies, 1998;
Bosworth and Burtless, Aging Societies: The Global Dimension, 1998; Social
Security Administration, Retirement Income Security in the United Kingdom,
1998; 1999 Annual Report of the Board of Trustees of the Federal Old-Age
and Survivors Insurance and Disability Insurance Trust Funds.

Countries Have Taken Action to Address Future Demographic Pressures
-------------------------------------------------------------------

Case study countries have taken actions in recognition of the fiscal and
economic pressures arising from aging populations. As discussed in chapter
2, Norway has developed a policy goal to save its current budget surpluses
to address long-term pressures. In 1991, Norway established the Government
Petroleum Fund, in which budget surpluses are invested in stocks and bonds
to be used in the future to pay for a projected increase in pension
spending./Footnote1/ Other countries have taken actions to reform their
pension systems prior to the arrival of budget surpluses, allowing them to
focus on other uses for their surplus. 

Norway Has Set Aside Surpluses to Address Long-term Issues
----------------------------------------------------------

Norway faces the situation of an aging population, a shrinking proportion
of working age population to retirees, and a projected sharp decline in
oil revenues in the future. As noted in chapter 2, pension expenditures as
a share of GDP are projected to more than double by 2050, while petroleum
revenues as a share of GDP are projected to fall drastically over the same
period. Today, revenues from petroleum activities account for a
significant share of government revenues at about 16 percent of total
revenue. Norway has responded to this future pressure by establishing the
Government Petroleum Fund, in which budget surpluses, which are generated
from petroleum revenues, are invested outside the government to pay for
future pension costs. The fund constitutes a real asset that can be drawn
upon as pension costs increase in the future. 

The Government Petroleum Fund is also designed to boost Norway's long-term
economic growth potential. The fund is invested in foreign stocks and
bonds. By purchasing foreign assets, the fund automatically reduces
Norway's large current account surpluses and reduces upward pressure on
Norway's exchange rate, thereby enhancing the cost competitiveness of non-
oil industries with other countries. The government recognizes that in the
long run, as petroleum output declines, having competitive non-oil
industries will become increasingly important to maintaining economic
growth. 

The fund could also aid long-term growth because it provides a buffer
against severe downturns. While the rationale for saving more of the
surplus has been the long-term pressure caused by an aging population,
fund assets are not explicitly reserved for future pension costs.
Consequently, fund assets may be used to cover government deficits when
necessary, eliminating the need for additional borrowing. In fact, a
portion of the fund has been used to cover non-oil budget deficits. 

Australia and the United Kingdom Reformed Pension Systems in the 1980s
----------------------------------------------------------------------

Australia and the United Kingdom enacted major pension reforms starting in
the 1980s and continuing through the 1990s. Each country enacted a tiered
pension system, with a significant portion of the pension benefits
accruing in private plans and the government providing basic pension
benefits that are either limited or have substantially eroded in value. As
more workers build up pension benefits in private plans, the government's
pension obligations are projected to decrease.

While the budgetary effects are similar, Australia and the United Kingdom
undertook their reforms for different reasons. The United Kingdom
undertook reform as part of its deficit reduction efforts and to ensure
the sustainability of its pension funds. The United Kingdom's government
significantly scaled back its commitment to future retirees by changing
the way the basic pension was indexed and by encouraging the movement of
workers into individual pensions or employer-provided pensions./Footnote2/
Australia reformed its pension system as part of a wider effort to reduce
real wage increases and thus avert short-term inflationary pressures, to
improve the living standards of retirees, and to increase national saving.
In 1986, the Australian government created a guaranteed private pension
scheme for employees involved in collective bargaining where employers
contribute a portion of the employees' wage into individual accounts
invested in the market. In 1992, this scheme was expanded to require
mandatory employer contributions to employee retirement benefits.

While these countries had different rationales for reforming their pension
systems, both approached the challenge of reducing the budgetary pressure
of an aging population by switching a portion of the costs away from the
public sector. While spending on retirement systems will increase in both
countries in the next half-century, retirement spending is projected to
take up a relatively small share of GDP. This may explain why, upon
entering a period of surpluses, these countries have focused on other
issues. 

Canada and Sweden Reform Public Pensions to Ensure Sustainability 
------------------------------------------------------------------

Sweden and Canada both account for their pension systems separately from
the rest of their budgets. Both countries have generally run annual
surpluses in their plans and have used the proceeds to build up
reserves./Footnote3/ Consequently, discussions regarding the need to
address future shortfalls in their pension systems have occurred
separately from debates about deficits or surpluses.

During the mid-1990s, both countries modified their pension systems to
improve their sustainability. These reforms occurred largely as a result
of projections showing that they would run out of money early next
century. Canada's reform calls for some benefit reductions coinciding with
a gradual buildup of reserves through increased payroll taxes and higher
returns on investments by allowing for a portion of fund assets to be
invested in stocks and bonds for the first time. Sweden changed its
benefit formula to automatically adjust for changing demographics and
economic performance and set up individual accounts in which individuals
can choose how to invest their fund balances. 

In Canada, these pension fund surpluses will continue to be excluded from
the budget surplus/deficit measure. In Sweden, due to a change in its
fiscal measure in 1995, pension fund surpluses are now counted as part of
the government's measure of surplus. However, pension fund surpluses will
continue to be accounted for separately from central government revenues,
and as a result, annual budget deliberations focus primarily on the 
non-pension fund portion of the budget.

Reduced Debt Levels Can Help Countries Better Deal With Long-term Pressures
---------------------------------------------------------------------------

By eliminating budget deficits and reducing debt, case study countries
have increased their ability to respond to future fiscal pressures. Lower
levels of debt can increase national saving, leading to increased
investment and productivity, and ultimately increasing potential economic
growth. Each case study country lowered its debt burden during the 1990s.
If these countries continue to reduce debt, as is the stated goal for
several countries, they can expect increased budgetary flexibility to
address fiscal pressures in the future. Leaders in several countries have
decided to pursue lower levels of debt to increase their ability to
respond to future fiscal pressures and to improve long-term economic
prospects. 

As a result of improving budgets and the achievement of surpluses, case
study countries have reduced their debt levels during the 1990s. (See
figure 10.) New Zealand achieved the greatest improvement in debt burden
during the 1990s, cutting its debt burden by more than half between 1992
and 1998. Norway also achieved great success, improving its debt burden by
about 
17 percent of GDP between 1994 and 1998.

Figure****Helvetica:x11****10:    Improvement in General Government Net
                                  Debt as a Percentage of GDP During the
                                  1990s
*****************

*****************

Note: 1998 data for Canada, Norway, Sweden, and the United Kingdom are
OECD estimates. Debt figures for New Zealand are for central government
only.

Sources: OECD Economic Outlook 65, June 1999, and the New Zealand Treasury.

During the 1990s, policymakers have developed fiscal policies with an eye
to the potential long-term benefits associated with lower levels of debt.
As mentioned in chapter 2, several case study countries have pursued
surpluses in an attempt to address long-term pressures, increase budgetary
flexibility, and improve long-term economic growth. Canada, New Zealand,
and Sweden are all attempting to reduce debt levels in order to enhance
future budgetary flexibility. Norway is saving its budget surpluses to
address long-term budgetary pressures. Australia views budget surpluses as
a means of increasing national saving leading to higher long-term economic
growth. The United Kingdom is attempting to increase investment spending
to enhance long-term economic growth. As these countries transition to a
period of projected surpluses, having a long-term outlook has played a
critical role in the justification of continued fiscal discipline.

--------------------------------------
/Footnote1/-^The Norwegian government receives a significant amount of
  revenue annually from its petroleum sector. To "save" these excess
  revenues and prevent them from overheating the economy, Norway
  established the Government Petroleum Fund in 1991.
/Footnote2/-^Under the revised pension indexation formula, increases were
  tied solely to prices rather than the greater of price or wage
  increases, as was done previously.
/Footnote3/-^Canada has traditionally invested its surpluses in
  provincial, territorial, and federal government securities. Its current
  reform allows for investment in stocks and bonds. In Sweden, surpluses
  are invested in a combination of stocks and bonds.

THE ROLE OF BUDGET PROCESSES AND MEASURES OF FISCAL POSITION DURING
PERIODS OF SURPLUS
===========================================================================

The framework for fiscal decision-making, which includes both the budget
process and the way fiscal position is measured, can play a critical role
in shaping fiscal policy and maintaining fiscal restraint. The budget
framework can play an especially important role during a period of budget
surplus when the goal of fiscal policy is not always clear and maintaining
fiscal discipline can be difficult. The measure of fiscal position can be
used to define a goal and to measure "success." Zero deficit is generally
accepted as one such measure and a signal of the fiscal health of a
country. However, during periods of surplus, other measures may play a
more prominent role because they shed light on long-term fiscal health
and/or the fiscal position independent of the economy's impact.

All of the countries in our study changed their budget process during the
1990s. In some cases, budget process changes were enacted to support
deficit reduction efforts, while in other cases, they were enacted to help
guide fiscal policy decisions. In Norway and Sweden, these changes focused
on setting top-down spending and revenue targets before policy initiatives
were considered, making it more difficult to increase spending and/or cut
taxes. Australia, New Zealand, and the United Kingdom focused on
increasing transparency by requiring the government to clearly state its
fiscal goals. Canada's changes centered on using conservative budget
estimates to better ensure that it would be able to meet its fiscal goals.
As these countries moved into a period of budget surpluses, their budget
processes have continued to play an important role in maintaining fiscal
discipline and/or in setting fiscal policy. 

The measures that case study countries use to assess fiscal position
influence and inform decisionmaking not only during periods of deficit,
but also during periods of surplus. These countries do not always focus on
a cash balance figure when formulating fiscal policy. For example, some
countries focus on debt burden or the structural budget position, which
factors out the economy's impact on the budget. In periods of surplus,
these measures can provide a justification for continued fiscal
discipline, whereas focusing solely on a cash balance may not. Some other
countries do not include annual surpluses from public pension funds in
their primary measure of fiscal position, removing these funds from any
debate about how to use surpluses.

Budget Process Changes Play a Critical Role During Period of Surplus
--------------------------------------------------------------------

All the case study countries changed their budget processes during the
1990s. In some cases, budget process changes were enacted to support
deficit reduction efforts, while in other cases, they were enacted to help
guide fiscal policy decisions. These reforms varied in design, but all
strove to make it more difficult to increase spending and/or to cut taxes.
In general, the reforms took an approach where (1) overall expenditure
limits were agreed upon before budget details were worked out, (2)
transparency increased because governments were required to clearly define
their fiscal goals, and (3) conservative budget estimates were used to
better ensure that fiscal goals would be met. Decisionmakers and budget
experts in each country cited budget process reforms as a critical
component of their ability to maintain fiscal discipline and/or to set
fiscal policy goals. As the case study countries have transitioned from
deficit reduction to surpluses, leaders in these countries have continued
to use budget processes to support fiscal constraint. 

Expenditure Limits Used to Control Spending
-------------------------------------------

Expenditure limits as part of a top-down approach to budgeting have played
a key role in attempts to control spending, both during periods of deficit
and surplus. Under this approach, decisionmakers agree on overall spending
limits prior to making specific decisions on policy initiatives. After
reaching an agreement on spending and/or revenue levels, any new policy
initiative must fit within these limits. 

Expenditure ceilings represented a significant change for two countries in
particular. Prior to budget process reforms in the 1990s, Norway and
Sweden had not previously set expenditure ceilings. In fact, the general
trend in each country had been for Parliament to increase spending above
the government's budget proposals, and this was perceived to be a problem
in each country.

The Norwegian Parliament reformed its budget process in 1997 to show its
continued support for fiscal discipline and in reaction to past spending
increases. For the first time, the Parliament adopted a top-down approach
to budgeting, setting aggregate revenue and expenditure ceilings. Under
the old procedure there was no agreement on an overall expenditure and
revenue limit at the beginning of the budget process, and the final budget
represented the aggregate of individual spending decisions. As a result,
the previous budget process often led to Parliament increasing spending
above the government's proposed levels. Under the new budget process,
Parliament agrees on an overall fixed budget ceiling and ceilings for 
23 spending and 2 income areas at the beginning of the budget process. All
spending and revenue proposals must fit within these ceilings.

Sweden enacted a comprehensive budget process reform in the mid-1990s in
reaction to several studies which found its budget process to be among the
weakest in Europe in its ability to control spending and react to large
budget deficits. Under this reform, Parliament is required to pass an
aggregate expenditure ceiling, and expenditure ceilings covering both
discretionary and mandatory programs for a 3-year period. Once enacted,
the expenditure ceilings are fixed and generally cannot be changed.
Parliament passes a new aggregate expenditure limit every year for the
third year only.

Sweden's budget process reform has had a significant impact on fiscal
policy during the current period of projected surpluses. As Sweden entered
the current period of projected surpluses, the government has remained
committed to the previously agreed-to expenditure ceilings. As a result of
its commitment, the government has proposed spending cuts totaling nearly
17 billion kronor in fiscal years 1999 and 2000 to remain under the
expenditure ceilings. This is much different than in the past when Sweden
found it difficult to maintain fiscal discipline. Also, the expenditure
ceilings have changed the focus of Sweden's debate. Because the government
remains committed to the expenditure ceilings, the surplus debate has so
far focused mainly on the need to reduce debt or cut taxes. As a result
the current government has proposed a broad-based income tax cut as part
of its fiscal year 2000 budget proposal. 

Countries Increased Budget Transparency by Setting Clear Fiscal Goals 
----------------------------------------------------------------------

Several governments in the case study countries have also attempted to
increase the transparency of their budget processes by requiring clearly
defined fiscal goals. These reforms require governments to set fiscal
goals not only on the bottom-line fiscal position, but also for other
important fiscal and economic indicators such as debt burden, national
saving, and investment spending. 

New Zealand was the first country to change its focus when it passed the
Fiscal Responsibility Act (FRA) in 1994. Under FRA, New Zealand's
decisionmakers must consider the impact of fiscal policy on such variables
as debt burden and national wealth. Likewise, Australia passed the Charter
of Budget Honesty Act in 1998, which requires decisionmakers to assess the
budget's impact on national saving and debt burden. In 1998, the United
Kingdom passed into law a requirement laying out the parameters within
which fiscal policy must be set. Based on this statute, the current
government has developed a Code for Fiscal Stability, in which the
government's fiscal policy stance calls for balanced budgets, on average,
while allowing for borrowing only for investment.

New Zealand's Fiscal Responsibility Act

New Zealand's Fiscal Responsibility Act (FRA) introduced a new framework
for fiscal decisionmaking. FRA was designed to lead to better fiscal
outcomes by making policymakers consider not only the short-term impacts
of decisions, but also the medium- and long-term effects. The act required
that policymakers clearly define their fiscal goals and established a set
of reporting requirements designed to increase the frequency and
transparency of the government's fiscal reporting.

In New Zealand, the requirement that the government establish a "prudent"
debt level as a fiscal goal has been critical to their ability to sustain
fiscal discipline during a period of surpluses. FRA requires the
government to establish a prudent debt goal and to run budget surpluses
until the goal is met. This has had a significant impact on fiscal policy
in New Zealand since the law was passed. In 1994, the government
established a debt goal of between 20 and 30 percent of GDP, and set as
its fiscal policy to run surpluses until that goal was achieved. In 1996,
once the 30 percent target was achieved, the government established an
even lower goal of 20 percent and passed a tax cut package. Subsequently,
the government reduced its debt target to 15 percent. In the spring,
summer, and fall of 1998 budget forecasts showed that the budget would
return to deficit largely as a result of the Asian economic crisis. The
government's reaction was to pass spending cuts to maintain surpluses and
to continue to make progress toward its debt goal. 

To increase public scrutiny and hold the government accountable for its
performance, FRA established extensive reporting requirements. In addition
to various reports, the government has to disclose all decisions that may
have a material effect on the future fiscal and economic outlook. Through
these extensive reporting requirements, the act attempts to ensure that
departures from responsible fiscal management principles will be temporary
because they will be reported to the public. Consequently, the government
will be required to explain why it has not met its fiscal goals. 

Australia's Charter of Budget Honesty 

The Charter of Budget Honesty, which formally was passed into law in 1998,
has been the framework guiding fiscal decisionmaking since the current
government in Australia came to power in 1996. The Charter was developed
over concerns that the true fiscal position was not always disclosed
adequately. 

The Charter set out principles for the conduct of sound fiscal policy and
put in place reporting requirements designed to improve discipline,
transparency, and accountability in the formulation of fiscal policy. The
Charter's five principles for sound fiscal management are to (1) maintain
prudent levels of debt, (2) ensure that fiscal policy contributes to
national saving and moderates economic fluctuations, (3) pursue a policy
of stable and predictable tax burdens, (4) maintain integrity of the tax
systems, and (5) ensure that policy decisions consider the impacts on
future generations. The Charter, however, allows flexibility for the
government to define its strategy and goals in such a way as to fulfill
these principles.

To ensure improved transparency and accountability, the Charter requires
extensive reporting on policies that would affect the fiscal position.
Prior to or at the same time the budget is released, the government is
required to issue fiscal strategy statements. An Economic and Fiscal
Outlook is to be published twice each year to provide updated information
so that an assessment of performance can be made. The Charter also
requires that the government provide cost estimates of proposals made
during the election campaign and that it publish ten days after an
election is called a 
pre-election report to provide updated information on economic and fiscal
conditions. 

The Charter has been in place for only a short time, but it has helped to
guide fiscal policy decisions during the current period of projected
surplus. For example, the Charter requires the government to assess the
impact of its fiscal policy decisions on debt level and national saving.
In particular, policymakers are concerned about Australia's low rate of
national saving. Consequently, the current government has established a
fiscal policy goal calling for balance over the cycle-implying that it
will retain surpluses during periods of strong economic growth. Under this
policy, the government's actions would not reduce national saving because
the government would not borrow, on average. As a result of this policy,
the current government has projected that debt will be eliminated by
fiscal year 2002-03, due largely to continued surpluses and proceeds from
privatization.

The United Kingdom's Code for Fiscal Stability

In 1998, the United Kingdom passed into law a requirement that the
government issue a "Code for Fiscal Stability." The law's purpose is to
increase transparency and enhance accountability by requiring the
government to present a fiscal strategy. The statute itself is general,
allowing the government wide discretion in developing a fiscal strategy.
The statute establishes five principles to guide fiscal policy:
transparency, stability, responsibility, fairness, and efficiency. The
statute also requires the issuance of several reports detailing the
government's fiscal plans.

The current government's fiscal code is guided by two rules: (1) the
"golden rule," under which borrowing will not be used to finance current
spending (that is, total spending excluding investment), and (2) the
"sustainable investment rule," which promises to keep net public debt as a
share of GDP at a "stable and prudent" level (which the government
currently defines as below 40 percent). The "golden rule" is intended to
ensure "prudent" control of public finances while allowing for deficit
financing of capital investment. The government has made boosting public
investment a major priority, proposing to double it as a share of the
economy. While investment spending is a priority, the "sustainable
investment rule" is intended to ensure that financing such spending does
not result in an imprudent rise in debt. 

Both rules are to be applied over the economic cycle, allowing for fiscal
fluctuations based on current economic conditions. Taking both fiscal
rules into account, the government's overall fiscal policy allows for
running small budget deficits. Consequently, when it achieved a surplus in
fiscal year 1998-99, the government's focus was not to sustain surpluses
but to allow increased investment spending and small deficits in future
years.

Canada Uses Conservative Budget Estimates to Better Ensure That It Meets
Its Fiscal Goals

In 1994, a newly elected government put in place a series of "prudent"
budgeting practices aimed at better ensuring that it could meet its fiscal
targets. The new government felt that it had to address Canada's history
of making 5-year budget projections that were never met. To better ensure
that it could meet its projections, the new government put in place three
main budget practices: (1) shortening budget projections from 5 years to 
2, (2) using private sector forecasts and lowering them by a "prudence
factor," and (3) establishing an annual contingency fund to be used for
unanticipated developments and/or debt reduction.

By shortening the budget cycle from 5 years to 2, the new government felt
that it could better ensure that it would meet its fiscal goals. In the
past, the government's 5-year projections had proved to be overly
optimistic, with the government repeatedly failing to meet its deficit
targets. By using forecasts that are more conservative than private sector
forecasts, the new government felt that it would eliminate criticism that
it was basing its fiscal projections on overly optimistic economic
assumptions. The government took the further step of lowering these
private sector forecasts by a "prudence factor," such as raising long-term
interest rate projections by 
****ITCCentury Book:xba**** of one percent. Finally, the government put in
place a contingency reserve that contains CAN$3 billion annually, about 2
percent of total spending, to be used for emergencies and/or debt
reduction. By putting in place a contingency reserve, the government felt
that it would be able to pay for unforeseen events, better ensuring that
it would meet its fiscal goals. 

As Canada enters a period of small surpluses, the effect of its budgeting
practices is that it generally does not spend surpluses until they are
about to materialize. The size of surpluses available to be spent appear
small because the government's budget forecasts are for only 2 years and
are based on economic forecasts that are more conservative than private
sector consensus estimates. To the extent that the economy performs better
than expected, then funds become available for new policy initiatives
during the fiscal year. This was the case in 1998 when surpluses developed
during the year. Toward the end of the fiscal year, the government enacted
several initiatives that used up those surpluses. The contingency fund, in
practice, has ensured that some moderate debt reduction also occurs during
a period of surplus. Under the current government, the contingency reserve
is not available to fund new initiatives, thereby ensuring that some debt
reduction takes place if budget forecasts are on target.

The Role of Measures of Fiscal Position During Periods of Surplus
-----------------------------------------------------------------

The measures that case study countries use to assess fiscal position
influence and inform decisionmaking not only during periods of deficit but
also during periods of surplus. These countries do not always focus on a
year-end cash balance figure when formulating fiscal policy. For example,
some countries focus on debt burden, the structural budget position which
factors out the economy's impact on the budget, or operating balance which
is an accrual-based measure. In periods of surplus, these measures can
provide a justification for continued fiscal discipline, whereas focusing
solely on a cash-based measure may not. Finally, some other countries do
not include annual surpluses from public pension funds in their primary
measure of fiscal position, removing them from any debate about how to use
surpluses.

The Use of Debt Burden as an Indicator of Fiscal Health
-------------------------------------------------------

Several case study countries use debt as an additional indicator of fiscal
health and strive to reduce debt as a share of the economy. As they have
entered a period of surplus, goals for reduced debt have provided
justification for continued attempts to maintain fiscal discipline. New
Zealand, Australia, and Sweden in particular have focused on reducing debt
burden as a fiscal policy goal and as a justification for attempting to
run continued surpluses. 

Accounting for the Economy's Effects on the Budget
--------------------------------------------------

Several case study countries have set fiscal goals that take into account
the economy's impact on the budget. For example, Norway's government
routinely uses a structural measure of fiscal position when formulating
fiscal policy. Norway's structural measure, which excludes the cyclical
effects of the economy, petroleum revenues, and interest expenditures, is
the key measure used to set fiscal policy. Norway's government uses this
measure to assess if its overall fiscal policy is contributing to or
detracting from economic growth. The government then attempts to use
fiscal policy to stabilize the economy by increasing spending or cutting
taxes during slowdowns to increase growth or doing the opposite during
periods of inflationary growth. 

Other governments have also set fiscal goals that take into account the
economy's effects on fiscal position but have chosen not to employ
structural measures of fiscal position when setting fiscal policy. For
example, Australia's current fiscal policy calls for balance, on average,
over the economic cycle. However, Australia's government does not forecast
its structural budget position. It concedes in its budgets that it is very
difficult to project structural position, so it does not make such
projections. Likewise, Sweden aims for surpluses of 2 percent of GDP, on
average over the economic cycle. However, Sweden currently does not use a
structural measure of fiscal position when setting fiscal policy. 

Accrual-based Budgeting
-----------------------

New Zealand has adopted an accrual budgeting framework, which uses an
accrual-based measure-the operating balance-as a primary measure of
deficit/surplus. In general, a cash-based system recognizes a cost when
the cash outlay occurs, while an accrual-based system recognizes a cost in
the period the resource is consumed. Consequently, the key difference
between New Zealand's operating balance and the traditional cash balance
relates to the period in which revenues and expenses are recorded. This
difference can vary in magnitude and direction. For example, under the
previous cash system, leave liability would be recognized when a staff
member left a government organization and was paid for the cost of the
leave balance. Under the accrual system, the government records an expense
as the leave is earned, and recognizes a year-end liability for leave
earned but not taken. Financing capital projects affects the budget
measure in the opposite way. Under a cash measure, capital projects were
recorded when cash was disbursed. Under accrual-based measurement, capital
items are recorded in the budget over the expected life of the project,
thus reducing the initial budgetary impact. Consequently, the net effect
of using an accrual-based measure instead of a cash-based measure depends
on the specific government activities undertaken in any given year.

In addition to the operating balance, decisionmakers focus on the balance
sheet-assets, liabilities, and net worth-when making fiscal decisions
because they feel it provides an indication of the long-term
sustainability of government programs. According to officials we met with,
the balance sheet has had an impact on fiscal decisionmaking by making
policymakers more aware of some long-term liabilities that were not
addressed previously. For example, the recognition of a large unfunded
liability in the accident insurance program was cited as a key factor in
the decision to increase insurance premiums to fully fund the program.
While these decisions may not have had a large immediate impact on the
current fiscal balance, they contributed to programmatic changes, which
have improved New Zealand's long-term fiscal health. However, it is
important to note that New Zealand does not include the commitments of its
social security system in its accrual-based measures./Footnote1/ 

Excluding Pension Fund Surpluses From Budget Debates
----------------------------------------------------

Two case study countries do not include the annual balances of their
public pension funds in the central government's measure of fiscal
position. Both Canada and Sweden account for their public pension funds
separately from the general fund. The funds' assets are invested in stocks
and bonds and are not available to the general fund. As a result, pension
fund surpluses are not part of budget debates in Canada or Sweden. Debates
regarding the need to increase pension fund assets to meet future
obligations have generally occurred apart from budget debates. Both
countries enacted pension reforms during the 1990s aimed at increasing the
sustainability of the system as it became clear that their funds would run
out of money early in the next century.

--------------------------------------
/Footnote1/-^The social security commitment is not considered to be a
  liability under New Zealand's accounting standards. 

IMPLICATIONS
============

Budget surpluses reflect both the success of past deficit reduction
efforts and an opportunity to address pressing needs. As a country
transitions from a period of deficit reduction into a period of surpluses,
it is a good time to revisit fiscal goals to determine how best to use
surpluses. While balancing the budget has been the clear and generally
accepted fiscal goal for many years in the United States, the appropriate
fiscal policy for an extended period of budget surpluses does not seem so
obvious. As discussed in chapter 1, a balanced budget is a fiscal goal
that often commands broad support, while running a budget surplus is a
goal with less intuitive appeal. While economists generally agree that
there are benefits to running a surplus-lower real interest rates,
increased national saving, and lower levels of debt-these benefits must
compete with other pressing needs. It may seem difficult to justify
sustained surpluses since the benefits are diffuse and occur in the future
whereas new spending and/or tax cuts have more immediate and politically
compelling effects. Accordingly, there may not always be a political
constituency to support sustained surpluses.

The experiences of other countries suggest it is important to develop a
strategy for fiscal policy specifically tailored to a period of surplus in
order to guide budgetary decisions. Several countries are seeking to
sustain fiscal progress during a period of budget surpluses and have
developed fiscal strategies that (1) have specific goals and targets that
are justified by compelling rationales, (2) responds to long-term budget
pressures, (3) is flexible enough to address pent-up demands, and (4) is
supported by a strong budget process. In this chapter, we highlight some
of the most promising practices and approaches of the case study countries
and suggest how these could assist deliberations in the United States.

Other Countries Have Developed a Surplus Strategy
-------------------------------------------------

Surpluses offered the case study countries an opportunity to address
fiscal and economic pressures. Surpluses can be used to address any number
of national priorities with long-range benefits, such as reducing debt or
reforming rapidly growing entitlement programs. However, these long-range
goals must compete with calls for increased spending and/or tax cuts to
address more immediate demands, which can be especially strong following a
period of deficit reduction. 

The experiences of the nations in our study suggest that it is possible to
develop a strategy to use surpluses to address national priorities. The
case study countries developed fiscal strategies for a period of surplus
that addressed their own unique and compelling concerns. Fiscal caution
was the watchword in most of these nations, with three countries setting
the goal of sustained surplus. Others have set a goal for balance, but
with the caveat that surpluses be used to address some specific need, such
as increased investment spending in the United Kingdom. 

Continued fiscal restraint was reflected in specific fiscal goals that
guided the use of surpluses and helped crystallize political agreement.
Such goals, however, had to be justified to publics that had already
experienced several years of deficit reduction-a challenge that was met by
pointing to the broad and compelling national economic and fiscal
challenges that needed to be addressed. The fiscal goals articulated by
the nations in our study were, accordingly, justified as ways to improve
their long-term fiscal and economic outlook, reduce debt burdens, maintain
investor confidence, and increase the national saving rate. 

While these countries have taken steps to use surpluses to address long-
term national priorities, they have also allowed for a portion of their
surpluses to be used for more immediate needs. As part of their strategy
to maintain continued support for surpluses, the case study countries also
enacted spending increases or tax cuts, which were sometimes used as a
reward for continued fiscal progress. For example, New Zealand promised
tax cuts once debt was reduced to 30 percent of GDP. The government
devoted the entire surplus to debt reduction until it reached this target
and then cut taxes as promised.

A period of surpluses also illustrates the advantages of addressing budget
"drivers," such as public pension programs, that threaten long-term budget
sustainability. For example, to ensure that surpluses were saved to pay
for future pension commitments, Norway established a Petroleum Fund in
which budget surpluses are invested to be used in the future. The case
study countries that had taken actions to address budget "drivers" years
before the arrival of surplus have been able to use surpluses to address
other national priorities. For example, Australia and the United Kingdom
reformed their pension systems during the 1980s, placing them on a
sustainable long-term path, and Canada and Sweden have taken more recent
actions to reform their pension systems. As each of these countries
entered a period of surplus their budget debate has focused on other
national priorities. The United States has not yet engaged in fundamental
reforms of our public pension and health systems. Such reforms are
necessary to assure the sustainability of these important nationl programs
and to relieve the related longer term budget pressures.

In the case study countries, the budget process has played a critical role
in framing budgetary decisions and maintaining fiscal discipline during a
period of surplus. For example, three countries-New Zealand, Australia,
and the United Kingdom-recently enacted fiscal codes that have played a
critical role in shaping fiscal policy decisions during a period of
surplus. These codes require policymakers to consider the overall impact
of fiscal policy on such factors as debt burden, national saving, the long-
term fiscal outlook, and investment spending as part of their budget
deliberation policies. In the case of New Zealand, focusing on such broad
indicators has allowed it to develop a compelling rationale supporting a
period of sustained surplus. 

Spending targets and other budget constraints have played a critical role
in supporting the surplus policies of Canada, Norway, and Sweden. In
Norway, the Parliament imposed overall spending caps-something they had
not used before-to control spending, which had tended to increase during
previous periods of surplus. In Sweden, the government has decided to
maintain expenditure limits-including limits for mandatory spending on
social safety net and health programs-to show its commitment to
maintaining surpluses even though surpluses have materialized sooner than
forecast. Finally, Canada has decided to continue using cautious budget
assumptions and a short-term forecast horizon to ensure that surpluses
materialize before they can be spent.

Implications for the United States
----------------------------------

Like the nations in our study, the United States has turned years of
deficits into a surplus, but unlike most of these nations, we have not yet
reached agreement on goals and targets to allocate the use of our
surpluses. Over the last 15 years, fiscal policy in the United States has
focused on the need to reduce-and eventually eliminate-the deficit. Fiscal
constraint reinforced by budget process rules and strong economic growth
have been the primary reasons for our budgetary improvement./Footnote1/ In
1997, the Congress enacted a comprehensive extension and revision of
expenditure caps with the goal of balancing the budget in 2002. However,
the unified budget reached balance earlier than planned, and the Congress
and the President now face the difficult situation of having to comply
with tight spending caps at the same time that the budget is in surplus. 

As with the nations in our study, the years of deficits have led to the
accumulation of pent-up demands for federal policy actions. Although the
United States is still operating under the rules established to achieve
budget balance, the advent of a surplus has led to increased pressure for
spending increases and/or tax cuts. The legitimacy of the restraints
adopted to rescue the nation from deficits is increasingly questioned as
surpluses build up.

The experiences of other nations suggest that it is possible to sustain
support for continued fiscal discipline during a period of surpluses while
also addressing pent-up demands. A fiscal goal anchored by a rationale
that is compelling enough to make continued restraint acceptable is
critical. For each country in our study the goal and the supporting
rationale grew out of a unique economic experience and situation. Many in
the United States have made the case for sustaining at least some portion
of surpluses to help deal with our longer-term pressures. GAO's long-term
model simulations illustrate the need for continued restraint: saving some
of the surplus is necessary along with structural reform of retirement and
health programs. Our simulations show that saving a good portion of the
projected surpluses would strengthen the nation's capacity to finance the
burgeoning costs of health and retirement programs prompted by the aging
of our population. For instance, we have estimated that national income
would be nearly $20,000 higher per person in real terms by 2050 if the
Social Security portion of the budget surplus is saved-that is, eliminate
the non-Social Security surplus/Footnote2/-compared to a unified budget
balance position. (See figure 11.) Moreover, in the United States there is
widespread recognition of the need to address long-term budget drivers-
Social Security and Medicare-because even if surpluses are (r)saved(c) and
used to pay down debt, growth in these programs threatens to crowd out
other discretionary spending. (See figure 12.)

Figure****Helvetica:x11****11:    GDP per Capita Assuming Non-Social
                                  Security Surpluses are Eliminated vs.
                                  Unified Budget
                                  Balance
*****************

*****************

Note: The "eliminate non-Social Security surpluses" path assumes that
permanent unspecified policy actions (i.e., spending increases and/or tax
cuts) are taken through 2009 that eliminate the on-budget surpluses.
Thereafter, these unspecified actions are projected through the end of the
simulation period. On-budget deficits emerge in 2010, followed by unified
deficits in 2019. The "eliminate unified surpluses" path assumes that
surpluses are not retained, but that the unified budget remains in balance
through 2007. 

Source: GAO analysis.

Figure****Helvetica:x11****12:    Composition of Spending as a Share of
                                  GDP, Assuming On-budget
                                  Balance
*****************

*****************

Note: Revenue as a share of GDP falls from its actual 1998 level to CBO's
2008 implied level and is held constant at this level for the remainder of
the simulation period.

*In 2030, all other spending includes offsetting interest receipts.

Source: GAO Analysis.

Moreover, there is widespread recognition in the United States of the need
to address long-term budget drivers-Social Security and Medicare-because
even if surpluses are (r)saved(c) and used to pay down debt, the U.S.'
fiscal path is still unsustainable over the long run. Unless policy
changes are made, we could again find ourselves in a (r)vicious cycle(c)
of increasing deficits and debt. Growth in Social Security and Medicare
spending threatens to crowd out discretionary spending in the long run,
assuming a constant tax burden. However, our budget process does not
incorporate a long-term perspective, and therefore, it is not designed to
address the increasing pressures in Social Security and Medicare that
result from an aging population and will eventually turn budget surpluses
into deficits. 

Therefore, a challenge for the United States is to find a way to make the
transition from a budget regime focused on eliminating the unified deficit
to one that deals with allocating the surplus between long-term pressures
and short-term demands. Other nations' experiences suggest that the
framework for sustaining a portion of the surplus may be different than
the framework for reaching budget balance. Agreement on appropriate 
long-term fiscal goals is important to both inform the allocation of
surplus and to promote public acceptance of the choices. Overall fiscal
targets could guide the more specific debate over the relative merits of
different priorities-how much of the surplus to devote to reducing debt,
increasing domestic discretionary or defense spending, securing existing
unfunded entitlement promises, and cutting taxes. These choices could be
considered within a broader context that considers tradeoffs between
current consumption and saving for the future. 

The design and use of fiscal targets requires care, however. U.S.
experience shows that a target cannot replace agreement on the steps
necessary to achieve it. In order for any fiscal policy goal to govern
actions, it must be grounded in a discussion of national needs and the
tradeoffs associated with reaching such a goal. In addition, selecting the
appropriate measures in a time of surplus is complicated-indeed a surplus
period may call for more complex measures. There is no single number like
(r)0(c) in the surplus world. The debate has already begun over what might
replace (r)0(c) deficit as an appropriate fiscal policy measure for the
United States-and what process might be appropriate to achieve it. Several
nations, for instance, have selected debt to GDP targets, with a goal of
reducing debt burden over time by saving a portion of the surpluses. In
our nation's setting, such targets could provide a renewed focus for
fiscal policy geared to monitoring and enhancing our long-term economic
and fiscal capacity to shoulder the retirement of the baby boom
generation. Although it is not easy, the countries in our study sought to
design a framework strong enough to guide action but flexible enough to
survive when economic conditions or other factors change. In our setting,
the current debate over saving the Social Security surplus may ultimately
yield an agreement on both fiscal targets as well as a process for
sustaining support for these targets over time. 

Conclusions
-----------

Can the experiences of these nations be translated to the U.S.
environment? What do their experiences say about the next steps in the
U.S. debate? First, the failure to define an explicit fiscal path for the
future has serious downside risks. As we have discussed in this and other
reports, "doing nothing" is not really an option-long-term pressures
associated with public pension and health programs will overwhelm the
budget. While the debate has begun on how to save a portion of the
surplus, until the fiscal path for a period of budget surpluses is fully
and clearly articulated there is a risk of losing the opportunity to
enhance our long-term economic 
well-being. A number of the case study countries had already dealt with
reform of their pension or old-age support programs; this made their task
easier. This has not been done yet in the United States and so
policymakers must factor the pressures associated with such programs into
any new fiscal framework.

As the United States considers how to use surpluses to address our own
long-term needs, the other nations' experiences suggest a framework which:

o   provides transparency through the articulation and defense of fiscal
  policy goals;

o provides accountability for making progress toward those goals; and

o balances the need to meet selected pent-up demands with the need to
  address long-term budget pressures.

As the United States moves from deficit to surplus, it will be important
for policymakers to reach agreement on a clearly defined and transparent
fiscal policy framework that makes sense in light of both the current
pressures and the long-term projections. In order for this framework to
succeed in setting a broad set of principles to guide fiscal policy
decisionmaking, the rationale for it must be explained and defended. 

Within this new framework, clear fiscal policy goals should be
articulated. As with the other countries in our study, these goals should
not be rigid fixed targets to be achieved on an annual basis. Rather, they
should consist of broader goals defining a future fiscal policy path for
the nation. The goals can provide an accountability framework strong
enough to guide annual budget targets but flexible enough to survive when
economic conditions and other factors change. Without this balancing of
needs, the strains on the enforcement regime become too great and the
discipline to follow a glide path to achieving national goals may be
weakened. In other countries these goals included reducing the burden of
national debt, maintaining international investor confidence, and
increasing the national saving rate. Although the prospect of a loss in
international investor confidence is not as threatening to the United
States as it might be for other nations, goals and measures relevant to
our own long-term fiscal outlook need to be explored. Such goals would go
beyond "0" budget balance to focus on such issues as debt burden,
questions of intergenerational equity, and contributions of fiscal policy
to net national saving. The use of structural measures of fiscal position
might help keep fiscal policy focussed on the underlying fiscal position
of the federal government, excluding temporary cyclical economic trends.

The surplus presents an opportunity to address the long-term budget
pressures presented by Social Security and Medicare. If we let the
achievement of a budget surplus lull us into complacency about the budget,
then in the middle of the 21st century, we could face daunting demographic
challenges without having built the economic capacity or program/policy
reforms to handle them. A new fiscal framework for a period of budget
surpluses would be of great value to policymakers and to the U.S. public
as the nation embarks on a period of budget surpluses. Such a framework
could go a long way towards ensuring that future debate on what to do with
surpluses is focussed on issues that are most critical to advancing the
future economic well-being of the nation. 

Developing consensus on new fiscal goals and putting in place a framework
to support those goals is not easy. Other nations illustrate, however,
that reaching consensus on using surpluses is possible. Our nation has
made measurable sacrifices of current needs for future goals when those
goals were defined in compelling enough terms. A surplus offers us with a
unique opportunity to revisit the framework under which budgetary
decisions are made and to address selected critical short-term needs and
known long-term obligations.

--------------------------------------
/Footnote1/-^The United States has achieved balance using the budgetary
  control regime established by the Budget Enforcement Act of 1990 (BEA).
  Under BEA the budget is divided into two parts: (1) discretionary
  spending, defined as spending that stems from annual appropriations
  acts, and (2) direct spending, or spending that flows directly from
  authorizing legislation; often referred to as mandatory spending.
  Discretionary spending is subject to annual dollar limits, or spending
  caps. Mandatory spending and receipts legislation are subject to a pay-
  as-you-go (PAYGO) requirement that legislation enacted during a session
  of Congress be deficit neutral (i.e., that any mandatory spending
  increase or tax cut be offset).
/Footnote2/-^Assumes that permanent unspecified policy actions (i.e.,
  spending increases and/or tax cuts) are taken through 2009 that
  eliminate the on-budget-non-Social Security-surpluses. Thereafter, these
  unspecified actions are projected through the end of the simulation
  period. On-budget deficits emerge in 2010, followed by unified deficits
  in 2019. 
Gross saving is the measure of saving used here and is defined as income
minus consumption. Gross saving does not subtract depreciation-the
consumption of capital. Net saving, which is gross saving minus
depreciation, is a better estimate of the amount of domestic resources
available for increasing a nation's capital stock. However, depreciation
is difficult to measure and is measured differently across countries. To
facilitate 

COMMONWEALTH OF AUSTRALIA
=========================

The Commonwealth of Australia has experienced two periods of budget
surpluses since the mid-1980s, preceded by periods of deficits and deficit
reduction./Footnote1/ Beginning in fiscal year 1987-88 Australia entered a
4-year period of surpluses that marked its first surpluses in more than
three decades./Footnote2/ The surpluses were achieved through a
combination of strong economic growth and deficit reduction efforts begun
in 1984./Footnote3/ Australia's main fiscal objective during this period
of surpluses was to run balanced budgets. In accordance with this policy
and the additional goal of the government to reduce outlays as a
percentage of gross domestic product (GDP), the government continued to
cut aggregate spending while also implementing a tax reform, which
included tax cuts. Deficits reemerged in fiscal year 1991-92 primarily as
a result of the 1991 recession. 

In 1996, a newly elected government embarked on a renewed deficit
reduction effort and achieved a small budget surplus in fiscal year 1997-
98. This government advanced a new framework for developing fiscal policy
called the "Charter of Budget Honesty." The Charter laid out a set of
guiding principles and reporting requirements aimed at improving fiscal
performance while increasing transparency and accountability. Under this
framework, the new government also established a fiscal policy aimed at
achieving underlying budget balance over the economic cycle so as not to
reduce national savings. In contrast to the previous surplus period when
budget balance was the goal, the current government explicitly calls for
running surpluses during periods of economic strength. The fiscal year
1998-99 budget forecasted surpluses totaling more than A$23 billion for
fiscal years 2000-01 and 2001-02, which were used in part to fund a tax
reform package, passed in June 1999, containing tax cuts totaling 
A$12 billion. Figure 13 shows the Commonwealth budget balance between
fiscal years 1982-83 and 1997-98.

Figure****Helvetica:x11****13:    Commonwealth of Australia Underlying
                                  Budget Balance, 1982-83 to 1997-
                                  98
*****************

*****************

Note: The underlying balance is derived by excluding, from a cash measure
of surplus/deficit, the net effects of advances, such as loans, and of
equity transactions, such as sales and purchases of capital assets. If a
cash measurement is used, Australia achieved a small surplus of about 0.5
percent of gross domestic product in fiscal year 1996-97.

Source: 1998-99 Budget Strategy and Outlook, Budget Paper No. 1.

Background

The Commonwealth of Australia is a federation composed of the national
government, 6 state governments, a number of territories, and about 
900 local government bodies. The legislative power at the national level
is vested in the Commonwealth Parliament, made up of the House of
Representatives (148 members) and the Senate (76 members-12 from each
state and 2 from each of the 2 most populous territories). The party or
coalition of parties with a majority in the House of Representatives forms
the government and provides the Prime Minister. Cabinet Members are
generally selected from either the House or the Senate.

The two largest political parties in the Commonwealth Parliament are the
Australian Labor Party and the Liberal Party of Australia. The Labor Party
has traditionally represented worker and union interests while the Liberal
Party has represented business and conservative constituencies. The other
parties are the Australian Democrats, the National Party of Australia, and
independents. The Labor Party was in office from 1983 until 1996, after
which it was replaced by a Liberal-National Coalition. In the Senate, no
party or coalition of parties currently has a majority. 

The Commonwealth government collects more than 70 percent of the public
sector revenue, but it is responsible for just over half of public sector
expenditures-the remainder being transferred to state and local
governments to fund additional public sector spending./Footnote4/ However,
this imbalance is being addressed by the tax reform measures to take
effect in 2000-01. (See section below on tax reform.) Commonwealth budget
responsibilities include national defense, immigration, postal and
telecommunications services, outpatient services and pharmaceuticals, and
social security./Footnote5/ State responsibilities include most public
sector spending on education, hospitals, public safety, and
infrastructure. Local responsibilities include local roads and parks,
libraries, and land use planning. The Commonwealth raises revenue
primarily from income taxes, sales taxes, and custom and excise duties.
States receive their revenue mainly from payroll, business franchise, and
stamp taxes, as well as Commonwealth transfers in the form of general and
specific purpose grants. Local government revenue is derived from property
taxes, charges, fines, and a portion of the Commonwealth grants to the
states.

The Australian Economy
----------------------

Australia is a small economy that is relatively dependent on trade-its GDP
is about 5 percent the size of the United States economy and exports
account for 15.6 percent of GDP, compared to about 9 percent for the
United States in 1997.

Recent Economic History

Australia's economy grew quickly in the late 1980s, spurred by strong
exports, consumption, and high business investment. However, in 1991
Australia entered a short but severe recession. The economy began to
recover in late 1992 and since then Australia has experienced a period of
sustained growth averaging about 4 percent per year, compared to an
average slightly higher than 3 percent in the 1970s and 1980s. In the 
12 months ending March 1999, GDP growth remained strong at nearly 
5 percent, despite an economic crisis in much of Asia. See figure 14 for
Australia's GDP growth since 1983.

Figure****Helvetica:x11****14:    GDP Growth in Australia, 1983 to
                                  1998
*****************

*****************

Source: OECD Economic Outlook 64, January 1999.

Australia's growth in the 1990s has been accompanied by a lower rate of
inflation than in the 1970s and 1980s. Despite a drop in the unemployment
rate, from a peak of almost 11 percent in 1993 to 7.4 percent in May 1999,
inflation has averaged an annual rate of about 2 percent since 1993. The
low inflation has occurred in part due to an increased focus on sustaining
a low inflation rate, with the Reserve Bank of Australia pursuing an
inflation target of 2 to 3 percent over the economic cycle since fiscal
year 1992-93.

However, the Australian government remains concerned about its low
national saving rate and its high net foreign debt./Footnote6/ With
exports accounting for about 16 percent of GDP, the Australian economy is
highly dependent on international trade for growth. Also, a large
proportion of capital investment comes from abroad. National saving is
crucial to economic growth because it can be used to finance domestic
investment. If national saving is insufficient to fund investment,
borrowing from foreign sources must finance the shortfall. The drop in
national saving from an average rate of more than 22 percent of GDP the
previous three decades to about 
17 percent of GDP in the 1990s led to a gap between saving and demand for
investment./Footnote7/ This gap has been financed by increased borrowing
from foreign sources. The outcome of this reliance on foreign capital is a
high net foreign debt totaling more than 40 percent of GDP in fiscal year 
1996-97-more than two-thirds of which is private sector debt. 

Budget Process
--------------

The government is responsible for developing the budget and presenting it
to Parliament. The preparation of the budget documents is the
responsibility of both the Department of the Treasury and the Department
of Finance and Administration. At the beginning of the budget process, the
Cabinet formulates and communicates the government's overall policy goals
to the spending ministries. The Cabinet relies heavily on a subgroup known
as the Expenditure Review Committee (ERC) to make decisions on which
programs to fund. In general, government budgets that fund "ordinary"
services are passed largely intact by the Parliament, while requests for
capital and new programs are subject to Senate amendments. If the
Parliament cannot pass the government's budget, it is viewed as a vote of
no confidence and a new government must be formed./Footnote8/ 

Under this process the bulk of budget deliberations takes place before the
budget is presented publicly. The ERC defines the broad budgetary policy
and sets a global budget ceiling, including budgetary savings targets and
outlay targets based on a system of forward estimates./Footnote9/ The ERC
also resolves budget conflicts and decides on reductions after consulting
with the appropriate Ministers. Cabinet Ministers appear before the ERC to
advocate new programs or increased funding. New programs that promise to
fulfill priorities set by the Cabinet are recommended to the Cabinet for
new funding. Proposed spending outside of priority areas must be funded
from savings in other areas. 

Measuring Fiscal Position 
--------------------------

Prior to fiscal year 1996-97, Australia's measure of federal
surplus/deficit encompassed all receipts and expenditures, including
privatization proceeds, other equity transactions, and net advances to
other governments as well as private trading enterprises. Basically a cash
measure, it captured the impact of government borrowing on credit markets
and was similar to the unified budget measure in the United States.

In 1996, the new Coalition government changed the primary measure of
budget position to an "underlying balance" measure. The underlying balance
excludes the effects of advances, such as loans, and equity transactions,
such as privatization proceeds. The new government felt that by excluding
transactions involving the transfer or exchange of a financial asset
between the public and private sectors, the measure more accurately
reflects the contribution of the Commonwealth budget sector to national
saving. Also, the new measure better ensures that privatization proceeds
will be used for debt reduction because they do not appear as funds
available for spending. 

Fiscal Policy of the Mid-1980s to the 1990s Driven by the Desire to
Increase National Saving and Reduce Debt

The Australian government's continued efforts-through successive
administrations-to reduce its deficits and its subsequent surplus strategy
have been developed largely in response to concerns over low national
saving and high national debt and their impact on Australia's
international competitiveness. While Australia's fall in national saving
was in some part due to a decrease in private saving, it more closely
tracked changes in public saving, i.e., budget balances. As a result of
low national saving, investment had to be financed from foreign sources,
resulting in an external debt level that was seen as too high. Low
national saving and reliance on foreign capital have led to concern over
Australia's ability to compete in the future. 

These concerns have motivated governments to attempt to search for a
solution in the public sector. Government officials felt that their
ability to influence declining private saving was limited, so they
concentrated on increasing public saving-i.e., reducing budget deficits.
Consequently, both Labor and Coalition governments have developed fiscal
policies aimed at reducing deficits in the belief that improving the
government's own fiscal performance could contribute to improved national
saving. 

Mid-1980s: First Period of Deficit Reduction
--------------------------------------------

The Labor government that came into power in 1983 did not initially focus
on reducing the budget deficit. The government's goals were to reduce
unemployment, control inflation, and stimulate the economy. This changed
in late 1984 when the Labor government turned its attention to budget
deficits. The government was concerned that borrowing in the public sector
was crowding out funds available for investment and detracting from
Australia's international competitiveness. Specifically, Australia's debt
and trade positions were worsening, and in 1986 the Australian dollar
suffered a sharp depreciation. These factors combined to create a sense of
crisis. The government decided to reduce its budget deficits to reassure
foreign capital markets that something was being done to address fiscal
and economic problems. 

In 1985, the government first articulated the need for fiscal restraint in
terms of the interest burden, arguing that a public debt interest bill of
nearly 10 percent of total outlays reduces the flexibility of the
government to direct spending in other areas. In 1986, the government
argued that further fiscal consolidation would improve the current account
deficit and reduce external indebtedness./Footnote10/ As the government
championed its fiscal goal to reduce deficits as a percentage of GDP,
expenditure restraint became the primary means of correcting fiscal
imbalances. (See figure 15.) Deficit reduction efforts were aided
initially by larger than anticipated increases in revenues resulting from
a strengthening economy.

Figure****Helvetica:x11****15:    Receipts and Outlays in Australia, 1982-
                                  83 to 1996-97
*****************

*****************

Source: Budget Statements 1995-96 and 1996-97, Budget Strategy and
Outlook, 1998-99.

In fiscal year 1985-86, social security and welfare and transfers to
states accounted for 47 percent of total Commonwealth government outlays,
and were the 2 areas most affected by deficit reduction efforts. In social
programs, the government implemented means-testing and narrowed
eligibility requirements. Also, the Commonwealth government greatly
reduced general-purpose grants to states. While some general-purpose
grants were replaced by specific-purpose grants, the latter only partially
offset the reduction in the former. As a percentage of outlays, 
general-purpose grants decreased from almost 20 percent of total outlays
in fiscal year 1985-86 to about 15 percent in fiscal year 1990-91.

In 1985, the Commonwealth government also instituted a major tax reform
package. The reform was not aimed at deficit reduction, but it was instead
designed to improve the tax structure, broaden the tax base, reduce tax
avoidance and evasion, while not increasing the overall tax burden. The
reform eliminated several tax expenditures, introduced new taxes on
capital gains and employer-paid fringe benefits, and reduced personal tax
rates./Footnote11/

The First Surplus Period: Fiscal Years 1987-88 Through 1990-1991
----------------------------------------------------------------

As a result of strong economic growth and spending restraints, the
government achieved surpluses for 4 consecutive years from fiscal years
1987-88 through 1990-91. These surpluses and proceeds from asset sales
were used to substantially reduce the Commonwealth government's debt both
in nominal terms and as a share of GDP. From fiscal year 1987-88 to fiscal
year 1990-91, public net debt declined from an estimated A$27.4 billion to
A$16.9 billion, and the debt to GDP ratio dropped from an estimated 9.1 to
4.4 percent. Figure 16 shows that the public net debt to GDP ratio
decreased during the surplus period in the late 1980s, increased after the
recession in 1991, and started to decrease again in fiscal year 
1996-97.

Figure****Helvetica:x11****16:    Net Public Sector Debt in Australia,
                                  Fiscal Years 1980-81 Through 1998-
                                  99
*****************

*****************

Note: Fiscal years 1997-98 and 1998-99 data are estimated.

Source: Budget Strategy and Outlook, 1998-99.

The government's primary fiscal objective during its surplus period was to
ensure that fiscal policy made no overall "call" on national saving-i.e.,
that the government would, on average, run balanced budgets, and thereby
not absorb resources available for private capital formation through its
borrowing actions. In accordance with this policy, and with the additional
goal of reducing outlays as a percentage of GDP, the government continued
to cut aggregate spending. At the same time, the government cut income
taxes in the 4 years of surpluses. Overall, the government did not pursue
an active policy aimed at maintaining surpluses. 

Consistent with a goal of reduced expenditures, the government continued
to reduce spending even after surpluses were achieved. Nearly all areas of
spending declined as a percentage of GDP, although some received small
increases. Overall, outlays dropped from nearly 27 to less than 24 percent
of GDP from fiscal years 1987-88 to 1989-90. Transfers to states were the
focus of spending cuts. For example, from fiscal years 1987-88 to 1991-92,
policy actions reduced outlays to states by a total of A$9.5 billion, an
average of 0.5 percent of GDP per year. Consequently, grants to states as
a percent of outlays dropped from about 19 to about 13 percent in this 5-
year period. These reductions were a major contributor to the government's
ability to sustain the surplus. 

During the surplus period Australia cut taxes several times./Footnote12/
As the result of promises made when revenue raising measures were
introduced in the 1985 tax reform package, the government enacted
substantial cuts to personal income taxes, with the first cut occurring in
December 1986 and affecting tax receipts in 1987-the first year of
surpluses. The drop in the top marginal tax rate from 60 to 49 percent
would have decreased tax revenues by 2 percent had it not been offset by
new taxes on capital gains and employer benefits and base broadening
measures. After a surplus was forecast for fiscal year 1989-90, the
government made further cuts to income tax rates, and increased tax
rebates for families with dependents and for single parents. The new round
of cuts reduced the top marginal rate further to 47 percent, for a total
reduction of 13 percentage points from the 1986 level. This policy
decision reduced revenues by more than 1.5 percent of GDP annually
beginning in fiscal year 1989-90. In fiscal year 1990-91, the last year of
surpluses, the Labor government made further cuts in personal income taxes
for low and middle-income taxpayers. In fiscal year 1990-91, revenues were
25.5 percent of GDP, down from 27.3 percent of GDP in fiscal year 1987-88. 

Fiscal Years 1991-92 Through 1996-97: A Second Period of Deficits
-----------------------------------------------------------------

In 1991, Australia experienced a short but severe recession. The recession
reduced revenue, already at a 12-year low as a result of several rounds of
tax cuts, to only 23.5 percent of GDP by fiscal year 1992-93. At the same
time, the recession led to increased spending in economically sensitive
programs such as unemployment and social welfare. In 1992, the government
implemented a major employment initiative and increased assistance to
industry in an effort to address the unemployment problem and stimulate
the economy. The decrease in revenue-from the recession-and increase in
spending resulted in deficits beginning in fiscal year 
1991-92, which peaked at 3.6 percent of GDP in fiscal year 1992-93.
Deficits remained until after the end of the Labor government's term in
1996.

Beginning in fiscal year 1996-97, the newly elected government made
numerous cuts in spending in an attempt to eliminate budget deficits. They
also made selected tax cuts, but these were mostly offset by cuts to some
tax expenditures and new tax surcharges on high-income earners. The
combined effects of policy decisions made in fiscal years 1996-97 and 
1997-98 budgets improved the budget balance by a total of 1.8 percent of
GDP. These spending and tax actions and a strong economy led to a surplus
at the end of fiscal year 1997-98. 

In addition, a large privatization effort by the new government helped
greatly to reduce Australia's debt level. Privatization proceeds totaled
more than A$23 billion in fiscal year 1996-97 and the first half of fiscal
year 
1997-98. The underlying balance-Australia's new primary measure of fiscal
position-does not include proceeds from asset sales. Consequently, while
privatization proceeds did not contribute to Australia's fiscal
improvement as measured, they did directly go to reducing public debt,
which decreased from 19.5 percent of GDP in fiscal year 1995-96 to an
estimated 15.3 percent in fiscal year 1997-98. 

A New Framework for Fiscal Decision-Making
------------------------------------------

When the new government came to power in 1996, it introduced a new
framework for fiscal decision-making called the "Charter of Budget
Honesty" (the Charter). The Charter set out principles for the conduct of
sound fiscal policy and put in place institutional arrangements designed
to improve discipline, transparency, and accountability in the formulation
of fiscal policy. The Charter was introduced in part to address the
perceived lack of transparency in the reporting of a government's
financial position, especially during election time. Specifically, the new
government pointed to its discovery upon assuming office that the
Commonwealth was in actual deficit of about 2.1 percent of GDP, as
compared to a forecast of a balanced budget. 

The Charter established the following five principles for sound fiscal
management: (1) to maintain prudent levels of debt, (2) to ensure that
fiscal policy contributes to national saving and moderates economic
fluctuations, (3) to pursue a policy of stable and predictable tax
burdens, (4) to maintain the integrity of the tax system, and (5) to
ensure that policy decisions consider impacts on future generations. The
framework of the Charter allows flexibility for the government to define
its medium-term fiscal strategy and short-term fiscal goals in such a way
as to fulfill these principles. 

To improve discipline, accountability, and transparency, the Charter also
requires frequent reporting on fiscal policies. The Charter requires the
issuance of fiscal strategy statements at or before the time the budget is
presented. Subsequent reports, such as the "Budget and Fiscal Outlook" and
the "Mid-Year Economic and Fiscal Outlook," are to contain, respectively,
information on how the government intends to implement its strategy and
updated information for an assessment of actual fiscal performance
compared to the government's plans. The Charter also requires that during
an election, cost estimates be prepared by the Department of Finance and
Administration and the Department of Treasury for election commitments
made by both the government and, if requested, the opposition. The Charter
also calls for intergenerational reports every 
5 years and for the publication of updated information on the status of
economic and fiscal policies 10 days after an election is called. 

A Second Period of Surpluses
----------------------------

In fiscal year 1997-98, Australia achieved a budget surplus, and with the
fiscal year 1999-2000 budget, the government forecasts surpluses for the
next 4 years. The government's medium-term fiscal strategy, developed as
required by the Charter, is to balance the budget over the cycle. As a
result, the Government's current fiscal policy has a short-term goal of
running surpluses during the current period of expansion that is forecast.
Also, the government is projecting that debt will be eliminated by 2002-
03./Footnote13/

Within this goal of surpluses for the short-term, the government has made
room for new spending increases and selective tax cuts. The fiscal year
1998-99 budget proposed spending initiatives totaling nearly A$10 billion
through fiscal year 2001-02, with a large portion dedicated to health
care. The government also proposed to cut personal income tax rates and
introduced a taxation rebate for savings.

The main difference between the first and the second surplus period is
that the new government's policy explicitly calls for surpluses over the 
short-term, concurrent with economic expansion. This is due in part to the
new requirements under the Charter of Budget Honesty that governments
spell out the medium-term fiscal policy and assess its impact on national
saving. The fiscal year 1996-97 budget set out to achieve balance within 
3 years, before the end of the government's first term in Parliament. The
medium-term strategy was that the underlying budget should be in balance
on average over the course of the economic cycle. After it became apparent
that the surplus would materialize before the end of the 3-year cycle, the
government reaffirmed its commitment to balance over the cycle. For this
government, achieving balance over the cycle meant that it had to achieve
surpluses during the remaining years of the present economic expansion.

Such cyclical balance has not always been achieved. As far back as fiscal
year 1996-97, the government warned that the deterioration in fiscal
position that occurred during economic slowdowns in the previous 
20 years was only partly, and sometimes not at all, offset by surpluses
during periods of strong growth. Consequently, the government is now
aiming for surpluses while the economy is growing, reducing debt, and
providing extra capacity for the government to use fiscal policy to run
deficits when the economy is weak. According to current projections, and
due to continued expansion in the Australian economy, the government
appears poised to eliminate net debt by fiscal year 2002-03.

Tax Reform
----------

Fiscal arrangements in Australia are characterized by a significant
difference between the relative revenue and expenditure responsibility of
the Commonwealth and the states-referred to as vertical fiscal imbalance.
States are unable to raise revenues sufficient to cover their obligations
and must rely on the federal government to make up the difference. For
example, the federal government in fiscal year 1997-98 raised 72 percent
of total government revenue but was responsible for only about 57 percent
of total government spending, the states accounting for most of the
remainder. As a result, states are heavily reliant on the Commonwealth for
a significant share of their revenue. 

The states' ability to raise revenues is limited by several factors.
First, the Australian Constitution denies states the power to levy certain
taxes, including retail and wholesale taxes on goods and services. Also,
the states relinquished the power to tax income to the Commonwealth in
World War II. As a result, states rely on many land, payroll, and
miscellaneous taxes for their revenue. Recently, the states' ability to
raise revenues was further limited by a Supreme Court decision in 1997
that ruled that state tobacco franchise fees were unconstitutional.

Against this backdrop, and with a forecast of budget surpluses, the
Coalition government campaigned in the 1998 election on a tax reform
platform to introduce the Goods and Services Tax (GST). As conceived, the
GST would be a broad-based sales tax levied on all goods and services. The
GST revenues would go to state governments, thereby greatly reducing the
reliance of states on the Commonwealth. To offset this, general-purpose
assistance to state governments would no longer be available while the
wholesale sales tax and nine other state taxes would be eliminated. The
GST proposal is mostly revenue neutral. However, due to concerns that a
GST would be regressive-i.e., that it would fall most heavily on low-wage
earners-the government also proposed to use budget surpluses to finance a
reduction in personal income tax rates and an increased threshold for
family benefits. 

The Coalition government was reelected in 1998. After extensive
negotiation and compromises-including major new anti-tax avoidance
measures, reduced income tax cuts, and the elimination of food from the
GST-the Parliament finally passed a tax package in June 1999, with the GST
expected to go into effect starting July 1, 2000. The new compromise tax
package includes tax cut provisions totaling A$12 billion, funded in part
from the underlying surpluses forecasted in the 1998-99 budget.
Nevertheless, the government projects continued underlying surpluses
through at least fiscal year 2002-03. 

Long-term Pressures and Reforms

Australia has a relatively younger age profile than most developed
countries. However, the proportion of the population aged 65 and over is
projected to grow from about 11 to over 19 percent between 1991 and 2030.
During the same period, the ratio of working age population to retirees is
projected to decrease from 6 to 3.3. However, many officials we talked
with remained optimistic that the budget impact of an aging population
would not be too severe. 

Australia's pension system is made up of a flat rate, means-tested public
pension program, and a mandatory superannuation program funded from
employers' contributions. Public pensions are financed from general
government revenue and account for less than 3 percent of GDP. Pension
benefits are not related to an individual's prior earnings, but they are
subject to means testing based on income and assets. Benefits are
legislated so as not to fall below 25 percent of annualized male total
average weekly earnings. 

The superannuation portion of the pension system is a mandatory, employer-
funded program. This program started in 1986 when, in an effort to rein in
inflation pressures, the Labor government put in place a program whereby
employers contributed to individual pension accounts-superannuation-in
exchange for real wage reductions. While superannuation benefits had
always been available to selected employees in professional occupations,
the 1986 program extended coverage so that by 1991 more than 72 percent of
employees were covered, up from 
42 percent in 1982. In 1992, the Commonwealth passed the Superannuation
Guarantee Act to extend employer-based retirement benefits to almost all
employees./Footnote14/ The act required the employers to make pension
contributions to individual pension accounts of the employees' choosing.
By 1996, approximately 89 percent of both public and private sector
employees were covered by superannuation, with the remaining 11 percent of
the work force falling below the income threshold where superannuation
started to apply. 

According to officials we interviewed, the 1992 reform was not undertaken
to reduce pressure on the budget. Estimates show that in the absence of
superannuation, public pensions would only have grown to 5 percent of GDP
in 2050, compared to 4.7 percent with superannuation. Rather, the reforms
were undertaken primarily to ensure that the elderly population could
retire comfortably by extending superannuation to the entire workforce.

While a growth in the elderly population is predicted to have little
effect on pension spending, officials we interviewed cited concerns about
the pressure of an elderly population on health care cost and quality.
Officials in the Department of Health and Family Services further added
that the pressure would not come from aging per se, but from improved
technology and public expectations. For example, officials informed us
that health care costs had increased recently by more than 3.5 percent
annually. Of this, only about 0.6 percent was due to the aging of the
population, with the remainder attributable to increased expectations and
technological development. However, long-term fiscal pressures have
generally not been a part of any debate about what to do with budget
surpluses. 

Conclusion

Australia experienced a period of budget surpluses in the late 1980s and
early 1990s that was largely the result of its deficit reduction efforts
of the early 1980s and a strong economy. During this period, Australia's
main fiscal policy goal was to balance the budget. However, governments
continued to cut spending throughout this period while giving fairly large
tax cuts. As the economy slipped into a short but severe recession in the
early 1990s, Australia again ran deficits. In 1996, a newly elected
government initiated a deficit reduction program and put in place a new
framework for setting fiscal policy, which called for the government in
power to consider certain factors, such as national saving and the public
debt level, when setting fiscal policy. As a result of the deficit
reduction program and increased economic growth, budget surpluses
reoccurred in fiscal year 1997-98. Under the new framework, the government
is calling for surpluses over the immediate period of economic expansion.
In 1999, the government passed a tax reform package containing tax cut
provisions totaling about A$12 billion. Nevertheless, the government
continues to project underlying budget surpluses for fiscal year 1999-2000
and the following 3 fiscal years.

--------------------------------------
/Footnote1/-^Prior to 1996 the term surplus/deficit referred to the cash
  balance, measured as the difference between revenue and outlays.
  Beginning in 1996, the measurement of the surplus/deficit changed from a
  cash basis to an "underlying" balance basis, which excludes the net
  effects of advances, such as loans, and of equity transactions, such as
  sales and purchases of capital assets. If a cash measurement is used,
  Australia achieved a small surplus of about 0.5 percent of gross
  domestic product in fiscal year 1996-97.
/Footnote2/-^Australia's fiscal year runs from July 1 through June 30.
/Footnote3/-^Deficit Reduction: Experiences of Other Nations (GAO/AIMD-95-
  30, December 13, 1994).
/Footnote4/-^States are limited by the Constitution in the type of tax
  that they can collect. In World War II, states also relinquished the
  power to tax income to the Commonwealth.
/Footnote5/-^The term "social security" refers to old-age pensions,
  unemployment benefits, and welfare. Old-age pension payments are funded
  out of the general fund, and neither employers nor employees make
  contributory payments. Unemployment benefits are also funded out of the
  general fund, and there is no separate unemployment insurance fund.
/Footnote6/-^National saving consists of the private saving of households
  and businesses and the saving or dissaving of all levels of government.
  Net foreign debt measures total indebtedness of the Australian public
  and private sectors to foreign investors, less any investment made by
  the Australian public and private sectors. 
/Footnote7/-^cross-country comparisons, the gross saving measure is used.
  Using the same concept, the gross saving of the United States has
  fluctuated between 14 and 17 percent in recent years, down from around
  20 percent in the late 1970s. 
/Footnote8/-^This occurred in 1975 when a refusal by the Senate to pass
  the funding bills for government operations resulted in a "double
  dissolution" of the Labor government under Prime Minister Whitlam and
  the sitting Parliament.
/Footnote9/-^Forward estimates are outlay estimates based on decisions
  made in the previous budget year with no future policy changes-similar
  to the (r)budget baseline(c) in the United States. Forward estimates are
  generated by the Department of Finance and Administration rather than by
  each individual department, as was the practice prior to fiscal year
  1983-84.
/Footnote10/-^The current account balance is the difference between goods
  and services bought and sold abroad.
/Footnote11/-^The capital gains tax did not take effect until 1986-87, and
  therefore was not payable until the 1987-88 budget year. Tax
  expenditures are reductions in tax liabilities that result from
  preferential provisions in the tax code, such as exemptions and
  exclusions from taxation, deductions, credits, deferrals, and
  preferential tax rates. 
/Footnote12/-^Since the Australian income tax system is not indexed for
  inflation, some of these cuts were to offset the effects of "bracket
  creep." Bracket creep occurs when taxpayers move into higher tax
  brackets as their incomes grow due to the effects of inflation. 
/Footnote13/-^In mid-1998, the government proposed reducing debt to about
  1****ITCCentury Book:xba**** percent of GDP by fiscal year 2001-2002 by
  selling its remaining equity in Telstra-the government's telephone
  monopoly. While the Senate has rejected the government's proposal, it
  recently approved the sale of an additional 16 percent of Telstra. 
/Footnote14/-^The Superannuation Guarantee Act established an income
  threshold-less than A$450 per month-under which employers do not have to
  pay superannuation benefits.

CANADA
======

After struggling with large deficits for over two decades, Canada achieved
federal budget surpluses in fiscal years 1997-98 and 1998-99./Footnote1/
(See figure 17.) These results reflect several years of significant fiscal
restraint, particularly on the spending side of the budget, as well as a
large surplus in the Employment Insurance Account. Fiscal restraint was
prompted by concerns that a high and rising debt burden was a major
obstacle to the nation's economic future. In response, the federal
government's strategy since 1994 has been to reduce the deficit and
achieve a balanced budget. To support this strategy the government put in
place a cautious approach to budget planning designed to increase the
government's chances of exceeding its fiscal goals. The government has set
as its official fiscal policy a goal of "balance or better," which implies
a policy of at least modest surpluses given its cautious approach to
budget planning.

Figure****Helvetica:x11****17:    Federal Budgetary Surpluses/Deficits in
                                  Canada, 1980-81 to 1998-
                                  99
*****************

*****************

Source: Fiscal Reference Tables, Department of Finance of Canada,
September 1999.

The government's cautious planning strategy is based on three elements:
(1) economic assumptions that are more conservative than those of private
forecasters, (2) a CAN$3 billion contingency reserve that applies to debt
reduction if it is not needed to cover unexpected shortfalls, and (3) a 2-
year short forecast horizon that focuses attention on achieving goals in
the 
near-term. As the federal budget has come into surplus, the central
government has adopted a similarly cautious approach to allocating
additional resources. This allocation strategy is based on an approach
where the government waits until surpluses are apparent before introducing
new spending and tax cut initiatives. 

During the period of deficit reduction, the government's fiscal policy
received widespread support. Since Canada has achieved budget surpluses,
consensus for the government's fiscal strategy has eroded. Critics have
argued that the government's careful planning approach amounts to a policy
of "stealth surpluses" that makes it difficult to conduct a full-scale
public debate over how to use current and future surpluses. 

There has been much debate over how to allocate budget surpluses. This
debate has been heavily influenced by pent-up demand following years of
fiscal restraint. For example, since the mid-1990s, the federal government
has substantially cut aid to the provinces for health care and other
social programs. Given the current fiscal climate, the provinces have
pushed for additional grants for health spending to address public
concerns that the system has been deteriorating. In another example, the
business community and others have used the improved fiscal situation to
argue for substantial tax cuts. They point out that Canada has one of the
highest personal income tax burdens among major industrial countries.
Finally, some fiscal analysts continue to express concern that Canada's
high debt burden warrants a more aggressive approach to debt reduction. 

Background

Canada is a federal system composed of a central government, 10 provincial
governments, and 3 territories./Footnote2/ It has a parliamentary form of
government, which is composed of a Senate and a House of Commons. Members
of the House of Commons are elected by popular vote, at least every 5
years, while Senators are chosen by the Prime Minister. The House of
Commons is the main law-making body. In general, the political party with
the majority of seats in the House of Commons forms the government and the
leader of this party becomes the Prime Minister./Footnote3/

Prime Minister Jean Chretien is leader of the current Liberal government.
He became Prime Minister in 1993 when the Liberals regained a majority in
the House after 9 years of Progressive Conservative Party rule. In June
1997, the Liberal government was reelected, winning 155 seats in the
House. Throughout most of this century, the left-of-center Liberal Party
and the right-of-center Progressive Conservative Party have dominated
Canadian federal politics. As of September 1999, however, the Reform Party
had the second largest number of seats in the House at 58. The remaining
seats are divided among the Bloc Quebecois (44), the New Democratic Party
(20), the Progressive Conservatives (18), and independent members (3).

Executive authority at the federal level resides in the Prime Minister's
Cabinet. The Prime Minister chooses Cabinet ministers from members of
Parliament in the governing party. The Cabinet is responsible for most
legislation; it develops government policy and is responsible to the House
of Commons. The Cabinet has the sole power to prepare and introduce budget-
related bills. In general, neither the House nor the Senate may increase
taxes or expenditures./Footnote4/

The federal government has explicit responsibility over national defense,
interprovincial and international trade and commerce, immigration, the
banking and monetary system, criminal law, and fisheries. Provincial
governments are responsible for education, property and civil rights, the
administration of justice, the hospital system, natural resources within
their borders, social security, health, and municipal institutions. All
powers not specifically conferred upon the provinces are assigned to the
federal government.

The majority of provincial spending is directed toward health, education,
and social service programs. For many years, the federal government has
contributed to the funding of these and other provincial and territorial
programs and services through a system of transfer payments. Overall, in
fiscal year 1997-98, federal cash transfers to provinces accounted for
nearly 15 percent of total provincial revenues.

The three main transfer programs are the Canada Health and Social Transfer
(CHST), the Equalization Program, and Territorial Formula Financing (TFF).
These three programs account for more than 90 percent of all federal
transfers to the provinces and territories, with CHST representing the
largest portion. CHST is a block grant that helps finance health care,
post-secondary education, social assistance, and social services provided
by the provinces. The Equalization Program ensures that provincial
governments can provide similar levels of public services at reasonably
comparable levels of taxation. The program subsidizes provinces whose
revenue-raising capacities are below a national standard. TTF, the main
source of revenue for territorial governments, was designed to reflect the
higher costs of providing services in the territories and to compensate
for their lower revenue-generating capacity, which results from a less
developed economic base. Territories also receive funds via CHST. 

The Canadian Economy
--------------------

The Canadian economy is about one-tenth the size of the United States'
economy and heavily dependent on trade. In 1997, exports accounted for
about 40 percent of gross domestic product (GDP). Exports to the United
States are particularly important to Canada's economy as they constitute
nearly 30 percent of Canada's GDP. Therefore, the United States' economy
has a large effect on overall economic activity in Canada. 

Recent Economic History

During the last two decades, Canada experienced two short but severe
recessions and two lengthy periods of growth. As a result of the first
recession in 1981 and 1982, unemployment soared from less than 8 percent
in 1981 to nearly 12 percent in 1983. The economy rebounded strongly from
the recession, with real economic growth above 5 percent in both 1984 and
1985. The strong recovery, however, eventually led to inflationary
pressures and the Bank of Canada responded by tightening monetary policy
in late 1987. When economic activity slowed in late 1990, the Bank began
to gradually lower interest rates.

By 1991, the Canadian economy was again in recession. The unemployment
rate rose from about 8 percent in 1990 to over 10 percent in 1991, and
remained above 10 percent until 1995. The recovery from this recession was
unusually slow. Growth finally began picking up in mid-1993, increasing
from 0.9 percent in 1992 to 2.3 percent in 1994. Growth was even stronger
in 1994 at 4.7 percent, but began to slow again in 1995. During the last 2
years, however, growth has again picked up. (See figure 18.)

Figure****Helvetica:x11****18:    Real GDP Growth in Canada, 1981 to
                                  1998
*****************

*****************

Source: Canadian Embassy, Washington, D.C.

Since 1993, inflation has remained relatively low and stable, allowing for
an overall easing of monetary policy and historically low interest rates.
Although the Bank of Canada controls monetary policy, the government does
influence the direction of monetary policy, at least in part, because the
Bank of Canada Act stipulates that "[t]he Minister and the Governor shall
consult regularly on monetary policy and on its relation to general
economic policy."/Footnote5/ Since 1991, the Bank of Canada and the
government have jointly set specific inflation-reduction
targets./Footnote6/ Inflation has remained in or below the target range
since the targets were established. In 1990, the last full year before the
targets were introduced, the inflation rate was 
4.8 percent. The first targets were established for a 5-year period with
the goal of reducing inflation to 3 percent by the end of 1992 and to 2
percent by 1995. By 1993, inflation was down to 2 percent and the Bank and
the government extended the targets until 1998 with a new target range of
1 to 3 percent. In 1998, the existing target range was extended through
2001.

Budget Process
--------------

The Canadian federal budget process is relatively closed to the public as
well as to Members of Parliament. The government, led by the Finance
Department, prepares the budget, and until the budget is presented to
Parliament only the Prime Minister and the Finance Minister know the exact
details. Having received some criticism for the closed nature of the
budget process, the government began to open up the process somewhat in
1994. In the fall of 1994, the government began releasing mid-year fiscal
updates that include any deficit/surplus targets and an economic update.
At the same time, the Finance Minister presents to Parliament plans for
the upcoming budget. Subsequently, the House of Commons Standing Committee
on Finance holds a series of prebudget consultations with the public and
presents its recommendations to the Minister of Finance. It is important
to note, however, that the budget is still formulated by the Finance
Department and it is almost never changed in Parliament. 

Measuring Fiscal Position
-------------------------

Canada's main measure of the federal surplus/deficit-called the budgetary
balance-is calculated on a modified accrual basis./Footnote7/ Canada also
reports a cash-based measure called (r)financial requirements/surplus.(c)
The main difference between these two measures is the treatment of federal
employee pensions./Footnote8/ Under the (r)budgetary(c) measure, employee
pension costs are accrued as they are earned by current workers, not when
cash payments are made to retirees. In contrast, the (r)financial(c)
measure reflects only the cash paid to cover current retiree benefits less
employee premiums paid. In recent years, the financial measure has
recorded significantly lower deficits or higher surpluses than the
budgetary measure. For example, in fiscal year 1997-98, the budgetary
surplus was nearly CAN$3.5 billion-about 0.4 percent of GDP-while the
financial surplus came in at about CAN$12.7 billion. Given this pattern,
Canada achieved a financial surplus in fiscal year 1996-97-1 year earlier
than it reached a budgetary surplus, its primary measure of fiscal position.

Canada's main budget measure-the budgetary balance-does not include the
finances of the Canadian Pension Plan (CPP)./Footnote9/ The CPP is an
earnings-related pension program that is broadly similar to the United
States' Social Security system. The CPP was established in 1965 as a joint
federal-provincial program, and it has been separate from both federal and
provincial budgets since its origin. Until recently, any surpluses
generated by the CPP were, by law, invested in provincial, territorial,
and federal government securities./Footnote10/ In addition to the CPP,
Canada does provide some retirement income support through the federal
budget, which is financed by general revenues. This support includes an
Old Age Security (OAS) pension received by all retirees and a Guaranteed
Income Supplement (GIS) benefit for low-income retirees.

While Canada's budget excludes the CPP's finances, it includes a fund for
unemployment benefits-the Employment Insurance (EI) fund-that has been
running large surpluses in recent years. This fund, similar to trust funds
in the United States' federal budget, is a budget account with an
earmarked revenue source./Footnote11/ Fiscal analysts we interviewed noted
that without the surpluses in the EI fund, Canada's budget would still be
in deficit.

In addition to its measures of annual fiscal position, Canada also
emphasizes the debt to GDP ratio as a useful indicator of the government's
fiscal health. Net debt, which is total debt minus financial assets, such
as assets held in the employee retirement system, is the debt measure most
frequently used for computing this ratio-and this measure corresponds to
the budgetary balance indicator./Footnote12/ The debt to GDP ratio is
particularly important given Canada's high debt burden and its
implications for the budget and the economy. To underscore how a high debt
level restricts budgetary flexibility, the government also reports an
interest burden measure in which interest spending is expressed as a share
of budgetary revenues./Footnote13/

Due to the prominence of the provincial governments in Canada's federal
system, it is important to consider their fiscal situation in any
assessment of Canadian government finances. Provincial-territorial program
spending accounts for a greater percentage of GDP than federal program
spending. For this reason, Canada's federal budget documents regularly
include fiscal data on provinces. For example, a combined federal-
provincial debt measure is used show the total burden of government debt
on the economy. 

Canadian Fiscal Policy in the 1980s and 1990s

Before the substantial fiscal progress of the mid- to late 1990s, Canada
had struggled with large federal deficits for two decades./Footnote14/
(See figure 17.) These sizable and persistent deficits emerged in the mid-
1970s in response to several factors, including a slowdown in economic
growth, increased program spending, and the indexation of both social
programs and the tax system to inflation. In the 1980s, the Canadian
government began attempting to eliminate budget deficits. While these
efforts did reduce the size of deficits, they did not eliminate them. In
the early 1990s an economic slowdown hampered the government's deficit
reduction efforts. Beginning in 1994, a newly elected government initiated
a new deficit reduction program and put in place a set of cautious
budgeting practices to better ensure that deficit targets would be met.
Canada achieved a budget surplus in fiscal year 1997-98 as a result of
these efforts and an improving economy. 

Deficit Reduction in the 1980s
------------------------------

In 1984, a Progressive Conservative government came into power with a
fiscal strategy that emphasized deficit reduction. Their objective was to
reduce the growing debt burden and to bolster both domestic and
international investor confidence in the economy. Maintaining investor
confidence has been an important concern during recent decades. While
Canada has never experienced an economic crisis in which the government
was unable to sell its bonds, it has experienced currency depreciations,
high interest rates, and lowered credit ratings by external bond rating
agencies at both the federal and provincial levels. 

The government's deficit reduction efforts in the mid-1980s produced
noticeable progress. Between fiscal years 1984-85 and 1989-90, the deficit
fell by nearly half as a percentage of GDP due to robust economic growth
and a combination of tax increases and spending cuts. Among these policy
actions were the introduction of a tax on OAS pension benefits and the
partial de-indexation of the tax system. The OAS change, referred to as a
"claw-back" tax, requires higher income seniors to repay part or all of
their benefits depending on their income level. Under the indexation
change, Canada's taxes are only adjusted for annual inflation that exceeds
3 percent./Footnote15/ Both of these actions, which are still in force,
have continued to contribute to fiscal improvement in the 1990s. For
example, an analysis by a public policy research group found that for 1998
alone, the tax indexation change resulted in more than CAN$10 billion in
additional revenue-over 
1 percent of GDP./Footnote16/ And this amount grows every year due to the
cumulative effect of partial indexation on the tax base. 

Despite the successful initiatives of the mid-1980s, the government had
some difficulty in sustaining these efforts and the deficit remained
relatively high at over 4 percent of GDP in fiscal year 1989-90. One
reason for the intractable nature of these large deficits was the debt
burden that had accumulated since the mid-1970s. Between the mid-1970s and
the late 1980s, the federal debt nearly tripled as a share of the economy-
rising from less than 20 percent of GDP to over 50 percent. Rising debt
was accompanied by growing interest costs. From fiscal years 1974-75
through 1987-88, interest spending increased from just over 11 percent of
total federal revenues to nearly 30 percent, significantly reducing the
government's budgetary flexibility. Excluding these interest costs, the
government's finances actually reached a surplus in the late 1980s. 

Deteriorating Economy Prompts Rising Deficits 

The strong economic growth in the mid- to late 1980s eventually created
upward pressure on inflation. In response, the Bank of Canada
significantly tightened monetary policy beginning in 1987. In the early
1990s, Canada experienced a recession that was influenced by high interest
rates and the economic difficulties of its trading partners-particularly
the United States. As a result of the recession, the deficit began rising
again despite renewed efforts by the government to restrain spending. By
fiscal year 1992-93, the deficit had risen to nearly 6 percent of GDP.
Consequently, the debt burden, which had stabilized in the late 1980s,
began rising rapidly again, going from 57.6 percent of GDP in fiscal year
1990-91 to 71.1 percent of GDP in 1994-95.

New Government Confronts Growing Fiscal Crisis
----------------------------------------------

A newly elected Liberal government came to power in 1993 pledging to
reduce the deficit to 3 percent of GDP over 3 years./Footnote17/ Both this
target and the government's initial budget were criticized by some as too
modest. However, a fiscal crisis beginning in 1994 led the government to
take more radical steps to reduce the deficit.

During 1994 and early 1995, Canada's fiscal outlook deteriorated quickly.
The situation worsened due to a sharp rise in interest rates, which rose
in response to interest rate hikes in the United States and partly due to
concerns in the international investment community about Canada's large
debt burden. Long-term interest rates in 1994 turned out to be 2
percentage points higher than the Finance Department's original
projections, even though these projections had been intended to reflect
conservative assumptions. Canada's large federal debt burden and its
associated interest payments made federal finances particularly vulnerable
to higher interest rates. For example, in 1994, the Finance Department
estimated that a 
1 percentage point increase in interest rates would raise interest
expenditures by CAN$1.7 billion in the first year-0.23 percent of GDP.
Growing interest expenses threatened the government's ability to achieve
its 3 percent deficit to GDP target in fiscal year 1996-97. 

Adding to the sense of fiscal crisis in 1994 was the decline in provincial
finances that occurred in the early 1990s. The aggregate provincial
deficit rose from 0.7 percent of GDP in fiscal year 1989-90 to 3.6 percent
of GDP in 1992-93. As at the federal level, these deficits resulted in a
rapidly rising debt burden. Together, the federal and provincial debt
approached 
100 percent of GDP during the mid-1990s. (See figure 19.) According to an
analyst we interviewed, the 100 percent level had an unsettling
psychological effect.

Figure****Helvetica:x11****19:    Federal and Provincial-Territorial Net
                                  Debt in Canada, 1980-81 to 1998-
                                  99
*****************

*****************

Note: 1998-99 data for provincial-territorial net debt is an estimate.

Sources: Fiscal Reference Tables, Department of Finance of Canada,
September 1999, and The Budget Plan 1999, Department of Finance of Canada,
February 1999.

Canada's declining fiscal fortunes and its vulnerability to future
economic shocks convinced the federal government of the need for
comprehensive structural changes in the fiscal year 1995-96 budget. These
changes were considered necessary to ensure that the 3 percent deficit to
GDP target would be met. In the fall of 1994, the government laid the
groundwork for its 1995-96 budget with the publication of two reports. The
first report-known as the Purple book after the color of its cover-
outlined in detail the origins and implications of the nation's current
economic and fiscal difficulties. The second report-called the Grey book-
was a fiscal update that was intended to encourage a public dialogue by
discussing the scope of the budget challenge. 

The Purple book emphasized Canada's spiraling debt burden and how it posed
a major threat to the government's economic agenda:

"Returning Canada to fiscal health is a prerequisite to achieving all of
the other elements of the [government's] economic
strategy.****Symbol:xbc****Increasing productivity and sustained job
growth are the results of investment, of entrepreneurial vigour, and of
consumer confidence. All are being undermined by a growing public debt
that has led to higher taxes, higher real interest rates, and a diminished
capacity of the Government of Canada to address the other vital issues of
an economic strategy for the future.(c)/Footnote18/

Since the fundamental problem outlined in the government's analysis was
the debt burden, the solution was to break the vicious circle of high
deficits, a growing debt burden, and rising interest costs. The government
concluded that achieving this goal would require a major effort to reduce,
and eventually eliminate, the deficit and to set the debt to GDP ratio on
a declining path. The deficit reduction efforts were to be based heavily
on spending restraint because the government concluded that the revenue
burden was already very high and, over the long term, should be reduced.
The government reinforced its commitment to solving the fiscal problem
with a promise by Finance Minister Paul Martin to reach the 3 percent
deficit to GDP target "come hell or high water." 

In assembling the fiscal year 1995-96 budget, the government relied on
comprehensive reviews of government programs to generate the savings
needed for the deficit reduction package. An assessment called "Program
Review" covered most components of direct program spending (which excludes
major transfer payments to individuals and other levels of government).
Under this review, the Finance Department determined spending cut targets
for each ministry, and the ministries were responsible for assembling a
detailed plan to meet these targets. A governmentwide Committee of
Ministers was charged with overseeing the budget plans proposed by the
ministries under the Program Review process. In addition to the Program
Review, the government conducted assessments of major transfer programs to
the provinces and territories and employment insurance benefits. 

As the budget was prepared, the fiscal outlook continued to deteriorate.
The economic crisis experienced by Mexico in late 1994 raised concerns in
the international investment community about the potential for similar
problems in Canada. Investors responded by shifting some of their assets
out of Canada. This asset shift further pushed up Canadian interest rates,
pushed down the Canadian dollar, and added a clear element of crisis to
federal budget preparations. The government was very concerned about
Canada's vulnerability to foreign investors. The Grey book emphasized that
Canada's deficits and debt were among the highest of major industrial
countries. Likewise, the nation's foreign debt-public and private combined-
was also high, reaching 44 percent of GDP by the end of 1993. The result
was that foreign investors demanded higher interest rates on Canadian debt
to compensate for its perceived riskiness compared to the debt risk posed
by other major industrial countries.

According to an account of the period, to help ensure that the budget
would be well received by financial markets, the Finance Department
increased the amount of deficit reduction planned for the fiscal year 
1995-96 budget. Finance Minister Martin was concerned that if the
financial markets judged the fiscal restraint in Canada's budget to be
insufficient, the government might be forced into revising its plans. A
negative reaction from the financial community could result in a downgrade
to Canada's bond rating, and further declines in the currency, which had
already reached an 8****ITCCentury Book:xba****-year low against the U.S.
dollar. This posed a significant risk as a decline in the value of the
Canadian dollar would make 
foreign-denominated debt more expensive to repay.

The final fiscal year 1995-96 budget included CAN$5 billion in deficit
reduction measures in the first year, and CAN$29 billion over 3 years. In
the budget, these measures were described as "by far the largest set of
actions in any Canadian budget since post-war demobilization." For every
dollar of revenue increases there were nearly 7 dollars of spending cuts.
The reductions affected nearly every government department. Major cuts
included the extension of a pay freeze on public employee salaries, the
elimination of 15 percent of the federal workforce, and a large reduction
in subsidies to businesses, such as railways, agricultural industries, and
cultural industries. In addition, a major restructuring of provincial aid
was announced that would take effect in the following fiscal year. The two
major social services grants to the provinces covering health care,
education, and welfare were combined into one block grant and funding was
cut substantially. (See figure 20.) For more information on this change in
provincial aid, see figure 21 on The Canada Health and Social Transfer.

Figure****Helvetica:x11****20:    Major Federal Transfers to Other Levels
                                  of Government in Canada, 1980-81 to 1998-
                                  99
*****************

*****************

Note: Includes the Canada Health and Social Transfer, fiscal transfers,
insurance and medical care, Canada Assistance Plan, and education support.

Source: Fiscal Reference Tables, Department of Finance of Canada,
September 1999.

Figure****Helvetica:x11****21:    The Canada Health and Social
                                  Transfer
*****************

*****************

Canada Achieves Rapid Fiscal Progress In Mid- to Late 1990s
-----------------------------------------------------------

The deficit reduction packages in the 1994-95 and 1995-96 budgets, along
with an improving economy, provided the main impetus for Canada's rapid
fiscal progress in the late 1990s. Subsequent budgets have held to the
course of fiscal restraint without introducing any major new deficit
reduction initiatives./Footnote19/ The current government has consistently
bettered its fiscal targets, often by a wide margin. For example, the
government had promised a deficit of no more than 3 percent of GDP in 1996-
97, and the actual result was a deficit of about 1 percent of GDP. (See
figure 22.)

Figure****Helvetica:x11****22:    Deficit Targets Compared to Actual
                                  Results in Canada, 1994-95 to 1997-
                                  98
*****************

*****************

Note: Negative number indicates a surplus.

Source: Various Canadian budgets, fiscal years 1994-95 through 1998-99.

To ensure that its targets are met, the government has relied on cautious
planning techniques that have become a defining characteristic of its
approach to budgeting. These techniques provide a buffer against
forecasting errors and unpredictable events. The government's cautious
strategy is composed of three main elements: (1) conservative economic
assumptions and forecasting methods, (2) a sizable contingency reserve
that cannot be tapped for new initiatives, and (3) a 2-year planning
period. 

Canada's Cautious Budgeting Techniques 
---------------------------------------

The federal government relies on a cautious approach to budget planning
that is based on conservative economic and technical assumptions, a
contingency reserve, and a short forecast horizon.

The Finance Department uses assumptions for interest rates, and sometimes
economic growth, that are intentionally more conservative than private
sector forecasts. In developing these assumptions, the department first
surveys private forecasters. Then, using the average of these forecasts as
a base, it adjusts interest rate projections upward. For example, the
adjustment factor for long-term interest rates is typically ****ITCCentury
Book:xba**** of 1 percent 
(50 basis points). This cautious forecasting policy was based on a
recommendation from a panel of economists convened in late 1993 to advise
the government on fiscal and economic issues. The panel's recommendation
was underscored by a private sector analysis that found that the
government's economic assumptions in the 1980s and early 1990s tended to
be overly optimistic. Under the current government's cautious approach,
the Finance Department's economic assumptions have often been more
pessimistic than actual outcomes.

The contingency reserve is an annual amount that is built into projected
spending, but it is not allocated to any specific program. It is an
accounting mechanism used to supplement the government's cautious
forecasting policy, rather than an actual cash fund. Under the current
government, this reserve is not available to fund new initiatives.
Instead, it serves solely as a buffer against unanticipated developments,
such as an adverse change in the economy. If the government's budget
projections are on target (or overly pessimistic), the reserve acts to
reduce the deficit or increase the surplus. For example, in fiscal year
1998-99, the government projected a balanced budget. This balanced budget
estimate assumed that the 
CAN$3 billion contingency reserve would need to be spent to compensate for
shortfalls in the projections. If the budget forecast is exactly on
target, the government will actually realize a CAN$3 billion surplus that
will be used to reduce debt./Footnote20/ 

The final element in the government's cautious approach is a short
forecast horizon; it publishes detailed projections for only 2 years. A
short forecast period is not necessarily a more prudent approach to
budgeting, but the government explains that its short horizon is a
response to the inherent sensitivity of longer-term forecasts to future
economic developments. Another important reason for the shorter forecasts
is that during a period of deficit reduction they focus attention on
making cuts today rather than delaying action until tomorrow. For example,
prior to the current government, the Finance Department used a 5-year
budgeting time frame for setting fiscal policy and repeatedly failed to
meet its deficit targets. In contrast, since fiscal year 1994-95, the
current government has consistently bettered its 2-year fiscal targets.
The effect of this policy during a time of surplus is to reduce the
ability to spend projected surpluses. On the other hand, a short-term
budgeting time frame does not disclose the full 
long-term impact of policy decisions.

Aided by these cautious planning techniques, the government progressively
lowered its deficit target to zero-i.e., a balanced budget. In fiscal year 
1997-98, the federal budget registered a small surplus, its first in nearly 
30 years. The elimination of the deficit has begun to ease Canada's high
federal debt burden. After peaking in fiscal year 1995-96 at just over 
70 percent of the economy, it has fallen modestly. The interest burden
declined more dramatically, from 36 percent of revenues to just under 
27 percent, between fiscal years 1995-96 and 1997-98./Footnote21/ By
running balanced budgets and not using the contingency reserve, the
government intends to reduce debt as a share of GDP.

The government and the Organization for Economic Cooperation and
Development (OECD) attribute the majority of this substantial fiscal
improvement to spending restraint rather than increased revenue. (See
figure 23.) The 1999-2000 budget estimated that program spending (which
excludes interest) will have fallen from 16.6 percent of GDP in 1993-94 to
12.6 percent of GDP in 1998-99. In comparison, the budget estimates that
revenues will have risen from 16 to 17.6 percent of GDP over the same
period./Footnote22/

Figure****Helvetica:x11****23:    Federal Government Revenues and
                                  Expenditures in Canada, 1993-94 to 1998-
                                  99
*****************

*****************

Sources: Fiscal Reference Tables, Department of Finance of Canada,
September 1999.

The Debate Over Fiscal Choices During a Period of Surplus
---------------------------------------------------------

As it has entered a period of budget surpluses, the government has
continued to rely on a cautious approach. Excluding the contingency
reserve, the Finance Department does not publicly project budget
surpluses. The government's current fiscal goal is, at a minimum, a
balanced budget-a strategy that it refers to as (r)balance or better.(c)
However, the contingency reserve implies that the actual target is a
surplus of at least CAN$3 billion, about 0.3 percent of GDP. The
government has acknowledged that it anticipates budget surpluses by
introducing the Debt Repayment Plan. The plan is an explicit statement
that the government's cautious approach could result in budget surpluses
and that the contingency reserve would be used to reduce debt. The 1999
Budget Plan states that (r)the level of debt in relation to the ability to
service the debt (the debt-to-GDP ratio) is still too high-both by
historical Canadian and international standards. . . Reducing the debt-to-
GDP ratio must remain a key objective of the government's fiscal
policy.(c)/Footnote23/

While the government is committed to using a modest amount of budget
surpluses for debt reduction through the contingency reserve, it also uses
surplus revenues for new spending and tax cut initiatives. (See figure
24.) This strategy of dividing surpluses between debt reduction, tax cuts,
and new spending was articulated during the government's 1997 reelection
campaign. At that time, the government stated that it would devote 
50 percent of budget surpluses to new spending and the other 50 percent to
a combination of tax cuts and debt reduction. Analysts we interviewed
stated that this allocation framework applies to surpluses over the full
Parliamentary term and will not necessarily be followed on a year-by-year
basis.

Figure****Helvetica:x11****24:    Summary of Spending and Tax Actions in
                                  the 1997-98, 1998-99, and 1999-2000
                                  Canadian Federal
                                  Budgets
*****************

*****************

Source: The Budget Plan 1999, Department of Finance of Canada, February
1999. 

In both the fiscal year 1998-99 and 1999-2000 budgets, the government
introduced a number of new spending and tax initiatives. The Finance
Department estimates that these initiatives will cost the government about
CAN$50 billion cumulatively from fiscal years 1997-98 through 2001-02. On
the spending side, these initiatives have focused on health care and
education. The tax changes include an increase in the amount of income
that low-income earners can receive tax-free, the elimination of a 3
percent surtax, an increase in the Child Tax Benefit, and a reduction in
employment insurance rates for both employers and employees. 

In launching new policy initiatives, the government has adopted a
philosophy that generally avoids committing resources before they
materialize. Typically, the government does not introduce new spending or
tax cuts until late in the fiscal year when a surplus becomes apparent.
The 1999-2000 budget explained this approach and its rationale as follows: 

"Central to [the government's] planning approach is the notion that
spending initiatives and tax cuts will be introduced only when the
government is reasonably certain that it has the necessary resources to do
so. This protects against the risk of having to make hasty, and
potentially damaging, corrections to the budget plan, such as announcing
tax relief one year and then having to raise taxes the following year."

In line with this cautious approach, the government has generally shied
away from both large-scale spending commitments and major tax cuts. In
addition, the government has enacted nonpermanent spending initiatives,
showing its preference for limiting future commitments. An example is the
Canada Millennium Scholarship Fund. The full cost of the fund-a
nonrecurring CAN$2.5 billion-was booked in fiscal year 1997-98, though
scholarships will not be awarded until 2000. The government has also made
many nonpermanent investments for health care, research, and education.
This careful strategy for allocating extra resources is supported by the
Finance Department's use of conservative economic assumptions, which tend
to understate the resources available for spending. 

Recent Critiques of Cautious Budgeting During a Period of Surplus

While the government's deficit reduction strategy received widespread
support, as Canada entered a period of surplus many fiscal analysts have
criticized some of the government's techniques. Although many of these
critics support the general notion of cautious planning, they suggest that
the degree of caution used by the government is excessive. A pervasive
concern is that, while the government officially targets a balanced
budget, its cautious techniques result in "stealth surpluses." According
to a number of analysts and social advocates from both sides of the
political spectrum we interviewed, understating the size and duration of
expected surpluses precludes a full-scale public debate over how to
allocate these additional resources. 

Several different techniques may contribute to understating budget
surpluses. These techniques fall in two distinct groups: (1) the planning
assumptions that were developed during the period of deficit reduction and
(2) the practices adopted by the government for allocating surplus
revenues. 

Planning Assumptions

Some analysts have criticized the government's continued use of a 2-year
time frame for budget planning. They assert that this short horizon makes
it harder to argue either for permanent spending or tax changes or for
initiatives with benefits realized over a longer period, such as
substantial debt reduction. A 1998 report from a public policy research
group argued that the government's 2-year horizon "may have helped rein in
the federal deficit, but it is not so well suited to the task of framing
priorities for the post-deficit era, since it by definition neglects the
longer-term implications of decisions made today." 

Another practice that has received some criticism is the use of
conservative economic assumptions. Analysts told us that they routinely
discount the Finance Department's forecasts as overly pessimistic. Due to
this tendency, some groups have argued that the government should adopt
more realistic assumptions for its budget projections. However, other
analysts continue to support the use of conservative assumptions as an
acceptable way of ensuring that Canada's finances remain under control. In
addition, a recent Finance Committee report suggested that recent economic
developments, such as declining commodity prices and a projected slowing
of economic growth, have validated the government's cautious approach. The
government has recently responded to these criticisms and plans to
explicitly show the impact of its "prudent" economic assumptions on its
budget totals. By fully disclosing the impact of its assumptions, the
government feels that there will be less debate surrounding the likely
size of the surplus.

Allocation Techniques

Several analysts have criticized the way in which the government allocates
surplus resources, charging that its methods obscure how much money is
really available. Some cite the government's recent pattern of introducing
new initiatives near the end of a fiscal year that have the effect of
reducing the surplus realized in that year. For example, the government
estimated that new spending and tax cuts introduced in the fiscal year
1999-2000 budget would cost CAN$5.7 billion in fiscal year 1998-99. Along
with economic and technical adjustments, these new initiatives reduced a
potential fiscal year 1998-99 surplus from an estimated CAN$11.7 billion
to zero, excluding the contingency reserve. (See table 3.)

Table****Helvetica:x11****3:    Fiscal Outlook for Fiscal Year 1998-99

-----------------------------------------------------------------------
| Billions of Canadian dollars                :                       |
|---------------------------------------------------------------------|
| Budgetary surplus from April 1, 1998        :                $11.7  |
| through December 1998                       :                       |
|---------------------------------------------------------------------|
| Economic and technical adjustments          :                 -3.2  |
|---------------------------------------------------------------------|
| Impact of new initiatives announced during  :                 -5.5  |
| fiscal year 1998-99                         :                       |
|---------------------------------------------------------------------|
| Remaining surplus                           :                  3.0  |
|---------------------------------------------------------------------|
| Less contingency reserve                    :                 -3.0  |
|---------------------------------------------------------------------|
| Planning outcome                            :                    0  |
-----------------------------------------------------------------------

Source: The Budget Plan 1999, Department of Finance of Canada, February
1999.

Several analysts are also critical of the accounting methods that the
government uses for some of its new initiatives. They argue that the
methods overstate deficits or understate surpluses. For example, during
fiscal year 1997-98, the government announced the Millennium Scholarship
Fund and booked the cost of the fund in the current year even though the
fund and the expenditure were not yet authorized. This action was
criticized by Canada's Auditor General,/Footnote24/ among others. The
government responded that the disputed amounts were authorized before the
financial statements for the fiscal year in question were
finalized./Footnote25/

Alternative Views on Allocating Budget Surpluses

The debate over the size and duration of budget surpluses is closely tied
to the debate over how to allocate them. For example, the government's
position is that since the size of the surplus is uncertain, it is safer
to assume that it will be small. And, since the government's budgeting
horizon is limited to 2 years, it tends to avoid allocation decisions that
would have a major impact on the long term. Therefore, the government
prefers modest tax cuts and nonpermanent spending initiatives over more
costly and longer-term commitments. In contrast, various analysts and
advocates prefer spending cuts or tax increases that are both more
substantial and more permanent.

In addition to differences over the size of surpluses, the allocation
debate is about differing preferences for debt reduction, spending
increases, and tax cuts. The government emphasizes a balanced approach,
dividing money between the three priorities with more emphasis on
spending. (See figure 24.) Others have argued for a greater focus on one
or more of these priorities. To some extent, public and interest group
opinion on the surplus reflects pent-up demands from the years of
budgetary restraint. 

Advocates of greater spending point to the large cutbacks in health care,
unemployment benefits, and other social assistance programs enacted
earlier in the decade. Boosting health care spending, in particular, has
commanded widespread public support and has been a top priority for
provincial governments and interest groups. Many have expressed concern
that the cuts in federal aid to the provinces have caused substantial
erosion in Canada's national health insurance program. Health Canada (the
federal department of health) estimates that from 1992 through 1996 public
sector spending on health dropped from 7.5 percent to 6.6 percent of GDP.
In response to these concerns, the government announced in the fiscal year
1999-2000 budget that it was increasing provincial aid for health care by
CAN$11.5 billion over the next 5 years. However, critics have stated that
this amount is still insufficient to cover the system's growing funding
needs. 

Similarly, tax cut supporters, including the business community and a
number of economic analysts, have characterized the government's tax
relief initiatives as inadequate. They point out that Canada has a high
tax burden, which makes it difficult for its businesses to compete. More
specifically, they note that Canada's taxes are significantly higher than
taxes in the United States, which poses a potential problem for Canada's
economic competitiveness. 

Several of those who support tax cuts also favor a more aggressive
approach to debt reduction. According to the Finance Department, the
government's current fiscal plans would reduce the debt to GDP ratio from
about 68 percent at the end of fiscal year 1997-98 to about 55.5 percent
in fiscal year 2002-03, assuming nominal economic growth averages 3.5
percent annually and the contingency reserve is available to pay down the
debt. Several analysts and organizations that we spoke with would like
debt reduction to occur at a faster pace. Some cited the lack of budgetary
flexibility caused by the federal government's large interest burden and
vulnerability to higher interest rates. 

To help support a policy of debt reduction, several analysts suggest that
the government adopt debt to GDP targets to replace or complement the
fiscal targets that have been used successfully since the mid-1990s.
Suggested targets vary from 40 to 60 percent of GDP. Five provinces and
one territory have fiscal rules concerning debt. While some of these
fiscal rules are more stringent than others, they reveal a focus on debt
and the need to reduce or at least stabilize it.

Canada Faces Long-term Demographic Pressures

Like many other industrial nations, Canada faces an aging population due
to a baby boom generation and increasing longevity. According to
Statistics Canada, the agency that collects statistics on Canada's society
and economy, the ratio of the population that is 65 and over to those aged 
20 through 64 will nearly double from 20 percent in 1998 to over 38
percent by 2031. 

Long-term fiscal analysis does not have any formal role in Canada's budget
process as the Finance Department does not publish detailed budget
projections beyond 2 years. However, federal officials and analysts are
concerned about longer-term issues. For example, regular long-term
projections are prepared for the Canadian Pension Plan (CPP), and these
projections were used to help support a recent reform of the
system./Footnote26/ 

Going beyond an analysis of particular programs, Canada's Office of the
Auditor General (OAG) has looked at the broader fiscal implications of
long-term spending trends. As part of its annual report to Parliament in
1998, OAG looked out three decades into the future to assess the fiscal
implications of demographic pressures using illustrative simulations for
spending and revenues./Footnote27/ OAG found that, absent any policy
changes, spending on retirement income programs and health care is
expected to grow much faster than the economy in coming decades-rising
from around 12 percent of GDP in 1996 to about 17 percent of GDP in 2031
using the mid-range assumption for growth in health spending./Footnote28/
Such dramatic growth would cause significant pressure to reduce all other
spending, assuming that the government chose to keep the debt burden
stable. OAG's simulations showed that devoting at least a portion of
budget surpluses to debt reduction over the next decade could help
alleviate some of this pressure by shrinking the burden of interest
spending.

Reforming Canada's Retirement Income and Health Care Programs
-------------------------------------------------------------

In 1997, Canada announced a major reform of CPP that is designed to build
up a substantial reserve in what had been a largely pay-as-you-go system.
The changes include a substantial increase in payroll tax rates, benefit
reductions, and a plan for investing some of CPP's reserves in higher
yielding assets, such as equities. Several analysts we interviewed were
largely supportive of the CPP reform and some noted that the government
effectively built support for this reform through a period of public
consultations and education. Since CPP is separate from the rest of the
federal budget, debates over reforming the program generally do not become
entangled in other budgetary issues as they often do in the United States. 

While the CPP reform has been successful, a recent government proposal for
reforming the government's existing retirement income programs, the OAS
and GIS programs, was dropped last year in response to opposition from
fiscal analysts and interest groups. Analysts we interviewed said that
critics of the proposal expressed concern that it would have created
significant disincentives for middle income people to save for retirement
by requiring beneficiaries to give back a substantial portion of future
benefits as their income levels increased. 

In the OAG's 1998 report, two of three health cost projections showed
health spending rising considerably faster than GDP in the coming decades.
The third projection-a cost-containment scenario-shows health spending
rising in absolute terms and growing at about the same rate as projected
GDP. However, recent debate about healthcare has focused on restoring
health care funding following the years of spending cuts that were part of
the government's deficit reduction efforts. 

Conclusion

To support a successful policy of fiscal restraint begun in the mid-1990s,
the Canadian government has relied on cautious budgeting practices that
have allowed it to regularly exceed its fiscal goals. Having succeeded in
eliminating the deficit, the government's current goal is "balance or
better." As the budget has come into surplus, the government has
maintained its cautious planning practices and has adopted a similarly
cautious approach to allocating budget surpluses. This allocation
strategy, which reserves a portion of surpluses for debt reduction, is
based on a philosophy under which the government waits until surpluses are
apparent before introducing new initiatives. Critics have argued that the
government's careful planning approach amounts to a policy of "stealth
surpluses" that makes it difficult to conduct a full-scale public debate
over how to use surpluses. Despite the criticisms, the federal
government's cautious approach has been adopted by many of the provinces,
whose combined deficits decreased from 2.8 percent of GDP in 1993-94 to
only 0.4 percent of GDP in 1997-98.

--------------------------------------
/Footnote1/-^Canada's fiscal year runs from April 1 to March 31.
/Footnote2/-^In addition, provincial legislatures may set up municipal
  governments, giving municipal governments powers as the legislatures see
  fit.
/Footnote3/-^Each provincial legislature is composed of a single house
  that is elected by popular vote. 
/Footnote4/-^Members are allowed to propose a decrease in a tax or
  expenditure, but such actions are rare. If a budget, or any other
  legislation, is not passed-meaning the government does not have the
  support of a majority in the House-a new election must be held or the
  opposition party forms a new government.
/Footnote5/-^Consolidated Statutes, Chapter B-2, Bank of Canada Act,
  Department of Justice of Canada.
/Footnote6/-^The target rate is actually the midpoint of a target range
  that extends 1 percentage point on either side.
/Footnote7/-^Unless otherwise noted, any reference to Canada's
  surplus/deficit throughout this appendix refers to the budgetary balance
  measure.
/Footnote8/-^In addition to the treatment of employee retirement costs,
  the budgetary measure includes other obligations incurred during a year,
  while "financial requirements" reflects only actual cash outlays.
/Footnote9/-^Quebec has a separate, but similar, plan called the Quebec
  Pension Plan.
/Footnote10/-^In the United States, analysts have expressed concern that
  Social Security's finances--which are invested in United States Treasury
  securities and included in the unified budget--mask the actual fiscal
  position of the government. However, this concern is not an issue for
  Canada's provinces because CPP is a separate entity--not an account
  within provincial government budgets. 
/Footnote11/-^Trust funds in the United States' federal budget are budget
  accounts that are designated as "trust funds" by law. The largest trust
  fund accounts, like Social Security, typically have earmarked sources of
  revenue. Trust fund expenditures and receipts are included in the
  unified budget surplus/deficit.
/Footnote12/-^Market debt is the measure that corresponds to the financial
  requirements indicator. Throughout this report the term debt refers to
  the net debt measure.
/Footnote13/-^Interest spending on net debt includes the interest paid to
  employee retirement accounts.
/Footnote14/-^For a detailed discussion of this period, see Deficit
  Reduction: Experiences of Other Nations (GAO/AIMD-95-30, December 13,
  1994), pp. 95-117.
/Footnote15/-^Since 1992, Canada's inflation rate has not exceeded 3
  percent, meaning that there has been no automatic inflation adjustment.
/Footnote16/-^Finn Poschmann. "How Do I Tax Thee? Choices Made on Federal
  Income Taxes," C.D. Howe Institute, February 25, 1998, p. 4.
/Footnote17/-^This target consciously echoed the deficit ceiling set for
  countries participating in the European Monetary Union.
/Footnote18/-^A New Framework for Economic Policy, Government of Canada,
  Department of Finance, 1994, p. 71.
/Footnote19/-^The 1996 budget did include a proposal for reforming the
  basic pension and income support benefits provided to Canada's seniors.
  The proposed Seniors' Benefit was expected to provide cost savings over
  the long term. However, the government later decided to drop this
  proposal. In 1997, the federal government and the provinces agreed to a
  major reform in the earnings-related Canadian Pension Plan. But, since
  CPP is a separate financial entity, these changes had no impact on the
  budget.
/Footnote20/-^The realized surplus was actually CAN$2.9 billion in fiscal
  year 1998-99, which was used to reduce debt.
/Footnote21/-^These figures include interest on internally held government
  debt, for instance interest on the federal government's employee pension
  plan. 
/Footnote22/-^A portion of this revenue increase is due to the partial
  deindexation of the tax system that was enacted in the 1980s.
/Footnote23/-^The Budget Plan 1999, Government of Canada, Department of
  Finance, February 16, 1999, p. 52.
/Footnote24/-^1998 Public Accounts of Canada, Office of the Auditor General.
/Footnote25/-^The books on each fiscal year are not closed until 6 to 7
  months after the fiscal year ends.
/Footnote26/-^The Canada Pension Plan law requires that an actuarial
  report be prepared every 3 years to allow for a review of CPP's
  contribution rates. The most recent report was issued in December 1998
  and includes projections of CPP revenue and spending up to the year 2100.
/Footnote27/-^Report of the Auditor General of Canada, (April 1998),
  Chapter 6, "Population Aging and Information for Parliament:
  Understanding the Choices." 
/Footnote28/-^Health care spending in the OAG study includes all levels of
  government in Canada. The OAG produced three different simulations for
  growth in health care spending: low cost, medium cost, and high cost. 

NEW ZEALAND
===========

After almost two decades of deficits, New Zealand has experienced 6 years
of surpluses since fiscal year 1993-94./Footnote1/ The initial drive
toward surplus began in 1984 when the newly elected Labor government
faced, upon election, an impending economic crisis marked by heavy capital
outflows, which precipitated a large exchange rate devaluation, a credit
downgrade, high inflation, and high debt. In response, the government
implemented a series of sweeping economic reforms. In addition, the
government undertook comprehensive public sector reforms that reduced the
role of the government in the economy. During this period, fiscal
restraint played an important role and was supported across the political
spectrum. The Labor government attempted to address a deficit of 6.5
percent of gross domestic product (GDP) by increasing taxes and cutting
expenditures in some areas, such as assistance to industries, while
increasing expenditures in social programs, such as housing and education
assistance to 
low-income earners. However, in 1990, when Labor left office, the budget
was still in deficit, and net debt had grown to 50 percent of
GDP./Footnote2/

In 1990, a newly elected National government embarked on a program of
increased fiscal restraint, targeting mainly social expenditures. However,
a recession in the early 1990s led to large budget deficits that increased
net debt to 52 percent of GDP in 1992. The continuation of the
government's deficit reduction program, combined with a strengthening
economy, led to surpluses beginning in fiscal year 1993-94. (See figure 25.)

Figure****Helvetica:x11****25:    Budgetary Balance in New Zealand, 1974-
                                  75 to 1997-98
*****************

*****************

Note: In 1994, the New Zealand government changed its definition of
surpluses/deficits from a adjusted financial balance (cash) basis to an
operating balance basis, and no longer reported its operations on an
adjusted financial balance basis. The budgetary balances from fiscal years
1994-95 through 1997-98 are derived by making adjustments to cash flows
from operations to approximate the cash basis. 

Source: New Zealand Treasury.

As surpluses materialized, the government introduced a new framework for
developing fiscal policy called the Fiscal Responsibility Act (FRA) of
1994. FRA has played a critical role in guiding fiscal policy in times of
surplus. Specifically, FRA laid out a set of guiding principles for fiscal
decision-making. FRA also set out reporting requirements aimed at
improving fiscal performance while increasing transparency and
accountability. Using this framework, the National government established
a fiscal policy aimed at reducing debt by running surpluses. Specifically,
the government promised to defer tax cuts until net debt was reduced to
between 20 and 30 percent of GDP. In 1996, once the 30 percent target was
achieved, the government reduced the debt target to 20 percent of GDP,
while still allowing for some spending increases and tax cuts. Setting a
debt target played a critical role in the government's ability to maintain
fiscal discipline. In May 1998, the government articulated a new fiscal
goal of running surpluses to reduce net debt below 15 percent of GDP. 

Background

New Zealand has a unicameral parliamentary system with 120 members elected
for 3-year terms through general elections. The executive government of
New Zealand is composed of the Governor General and the
Cabinet./Footnote3/ The Cabinet consists of the Prime Minister, the Deputy
Prime Minister, and other Ministers chosen from elected members of
Parliament. The Cabinet has the power to make administrative or regulatory
changes without further public input or legislative approval where this
power has been delegated by Parliament. These changes are simply announced
before implementation.

During the 1990s, New Zealand's electoral system underwent significant
reform. Prior to the 1996 election, New Zealand had a "first-past-the-
post" system, in which the political party that won the most votes in an
electoral region won the electoral seat. Parties that gained a majority of
the electoral seats formed the government and provided the Prime Minister.
Under a "first-past-the-post" system two major parties controlled the
government while smaller parties found it difficult to obtain
representation. From 1984 through 1990, the Labor Party was in power. From
late 1990 through 1996, the New Zealand National Party, representing more
conservative constituencies, controlled the government. 

The electoral system changed significantly in 1993 when New Zealand voted
for a "mixed member proportional" (MMP) system of representation. The MMP
system was put in place in part to address concerns that minority views
were underrepresented in a "first-past-the-post" system. Under MMP, voters
cast two ballots: one for members of Parliament and one for the party.
Around half of the 120 members of Parliament are elected directly as
representatives of their district, while the remaining members are chosen
by the parties in proportion to the percentage of the overall party vote
received in the election. The outcome of the new system is that smaller
parties are now able to gain more seats. In 1996, the first year under the
new MMP system, the National Party won 44 out of 120 seats and entered
into an agreement with the New Zealand First Party (17 seats) to form a
coalition government. In August 1998, the coalition dissolved and was
replaced by a minority government led by the National Party./Footnote4/ 

The New Zealand Economy
-----------------------

New Zealand is a small economy that is dependent on trade-its GDP is less
than 1 percent the size of the U.S. economy and exports account for nearly
22 percent of GDP, compared to about 9 percent for the U.S. in 1997.

Recent Economic History

Until the early 1980s, New Zealand was one of the most regulated of the
developed economies. New Zealand heavily subsidized its industries, with
the agricultural sector receiving price supports and tax concessions, and
the manufacturing sector benefiting from import licensing and tariffs. The
government provided a fairly comprehensive and generous package of social
programs, including pensions for the elderly, benefits for single parents
and mothers, universal health care, and policies that ensured full
employment. The government also played a large, direct role in the
economy, with a major presence in industries such as telecommunications,
banking, energy, forestry, transport, and broadcasting services that
together produced more than 12 percent of GDP. 

New Zealand has traditionally been heavily dependent on trade for economic
growth. In 1997, exports of goods and services totaled 22 percent of GDP.
Until the mid-1980s, New Zealand relied heavily on the United Kingdom as a
market for its exports, which were mostly agricultural products. The
United Kindgom's entrance into the European Common Market in 1973 opened
the British market up to goods from European Union countries but denied
New Zealand easy access to its traditional major export market. 

In addition to losing the United Kingdom as a protected market for
agricultural exports, New Zealand was also affected by two world oil price
shocks in the 1970s. The government responded by increasing taxes,
devaluing the currency, and implementing programs such as state-funded
investments aimed at cushioning the economy from these international
shocks. One such response was "Think Big," a program designed to improve
New Zealand's production of energy, thereby reducing its reliance on
external energy sources. Contrary to the government's expectations, these
initiatives led to increased debt, fiscal constraints, and higher interest
rates. Economic growth remained low: from 1975 through 1982 there was
virtually no growth, while inflation averaged about 15 percent per year.
During this period, unemployment emerged as a serious problem, rising from
less than 1 percent to more than 5 percent in 1983. Furthermore, large
fiscal deficits emerged in the late 1970s, and foreign debt rose rapidly
as a result of large external deficits. By the early 1980s, economic
performance as measured by a wide range of indicators-growth,
unemployment, inflation, and the external deficit-had deteriorated
substantially. 

In response to the deteriorating economic and fiscal conditions, the new
Labor government in July 1984 began to institute a series of sweeping
reforms that by the end of its term in 1990 had transformed the country
from one of the most to one of the least regulated economies. However,
economic benefits did not materialize until the 1990s. In 1991, after 7
years of reform, real GDP was only 2.8 percent higher than in 1984
compared to an average of 24 percent for Organization for Economic
Cooperation and Development (OECD) member countries in the same period.
Unemployment also grew during this period, peaking at almost 11 percent in
September 1991, up from less than 5 percent in the early 1980s.

Strong export-driven growth began in 1991, and the economy grew at an
annual average rate of 3.5 percent from 1991 through 1997. From June 1995
through December 1996, unemployment dropped to a low of around 
6 percent. Since 1996, growth has slowed, as shown in figure 26, and
unemployment increased to 7.7 percent in December 1998. More recently, the
Asian economic downturn and drought conditions have negatively affected
the country's growth rate.

Figure****Helvetica:x11****26:    GDP Growth in New Zealand, 1983 to
                                  1998
*****************

*****************

Source: OECD Economic Outlook 63, June 1998.

Economic changes in the 1990s can be linked, in part, to a change in
monetary policy. In 1989, New Zealand passed the Reserve Bank of New
Zealand Act that assigns a single role for monetary policy: to achieve and
maintain price stability. Prior to the act, monetary policy focused on
ensuring the stability of the economy, maintaining full employment, and
increasing economic growth. The act requires a written agreement between
the Treasurer and the Governor of the Reserve Bank that defines and makes
public the specific targets for price stability. 

The Governor of the Reserve Bank believes that the stable inflation policy
has contributed to the strong fiscal performance by offsetting, or
threatening to offset, expansionary fiscal policies. For example, in
response to an expansionary budget introduced during the 1990 election
year, the bank tightened monetary policy. In 1996, the government reduced
income tax rates only after it was satisfied that such tax cuts would not
result in a significant tightening of monetary policy.

Budget Process
--------------

The government, through the Treasury, is responsible for developing the
budget and presenting it to Parliament. The process starts with the
government releasing its policy statement setting forth its vision and the
strategic objectives for the fiscal year and the coming 3 years. After the
release of the policy statement, departments submit bids for new program
initiatives. Bids are reviewed by the Cabinet on advice from Treasury, and
those that fit with strategic objectives can receive new funding. In May
or June, the government submits a budget that has to fulfill the strategic
objectives announced in the policy statement or provides explanations or
justifications for inconsistencies. By that time, the government has
decided which new programs and policy actions to fund. 

Under this process, most budget deliberations and the approval of new
policy actions take place prior to the public presentation of the budget.
After the budget is presented to Parliament, select committees examine the
budget, question ministers and departments about their budget requests,
and may propose changes to appropriations. However, in general, government
budgets are passed without many changes. Failure to pass a budget would
result in the dissolution of the government and probably a new election. 

Measuring Fiscal Position 
--------------------------

Prior to 1994, New Zealand's surplus/deficit was a cash number, similar to
the unified budget figure used in the United States. Revenue and
expenditures, including capital expenditures, were recorded when cash was
actually received or spent. Consequently, the surplus/deficit measure
encompassed all receipts and expenditures.

In 1994, New Zealand became the first OECD country to use an accrual-based
measure of fiscal position./Footnote5/ The measure, called the operating
balance, is designed to match more closely the cost of resources consumed
in the production of goods and services with the revenues. As part of this
change, departments no longer record an expenditure when an asset is
purchased. Rather, a depreciation expense is recorded when the asset is
used. Another important change is that the government records the cost of
liabilities when the events that give rise to these liabilities occur. For
example, the cost of providing public employee pensions is recorded at the
time the employee works, rather than when the employee has claim on the
cash. This method of recognizing liabilities differs from the approach
taken under the cash basis, under which the cost is recognized only when a
cash outlay occurs. The net effect of the differences between the
operating balance-the primary measure of fiscal position-and the cash
balance is shown in figure 27.

Figure****Helvetica:x11****27:    Comparison Between Adjusted Cash and
                                  Operating Balances in New Zealand, 1994-
                                  95 to 1997-98
*****************

*****************

Note: In 1994, the New Zealand government changed its definition of
surpluses/deficits from an adjusted financial balance (cash) basis to an
operating balance basis and no longer reported its deficit/surplus on a
cash basis. The adjusted cash balances from fiscal years 1994-95 through 
1997-98 are GAO calculations. They reflect adjustments made to the cash
flows from operations, which approximate the adjusted financial balance
used to measure surpluses/deficits prior to 1994. However, some additional
adjustments are necessary to arrive at an exact measure of the adjusted
financial balance as reported prior to 1994.

Source: New Zealand Treasury.

Government officials and experts we met with felt that accrual measures of
deficits/surpluses better reflect the ongoing health of the government
than pure cash measures. They stated that by recognizing employee pension
costs, accrual data give a better picture of the cost and obligations of
government policies. Also, by excluding privatization proceeds that are
one-time-only transactions that cannot be expected to occur again in the
future, the new measure better reflects the ongoing performance of
government. Finally, by requiring recognition of the long-term cost of
decisions, accrual measures make clear the full cost of spending decisions
that have minimal effects today but greatly affect future budgets. For
example, in the 1970s, the government did not recognize the cost of
establishing guarantee programs for energy projects. In the late 1980s,
the guarantee costs totaled more than NZ$6 billion, or more than 10
percent of GDP. According to an ex-finance official, under accrual such
costs would have been recognized over the years and such a large delayed
charge to the budget would not have occurred. Had the full cost of such
decisions been made available, commitments with large deferred costs may
not have been made. However, New Zealand does not include the commitment
of its social security system in its accrual-based measures because these
commitments (1) can be changed by acts of Parliament, and (2) cannot be
reliably estimated and, therefore, do not meet the criteria, as defined by
generally accepted accounting practice, for recognition as a liability. 

In addition to the operating balance, New Zealand also emphasizes the debt
to GDP ratio as a key indicator to track the government's performance in
the economy. The government articulated the need for New Zealand, as a
nation with a small and open economy, to maintain a low debt to GDP ratio
in order to be better able to respond to economic shocks. Officials and
experts we interviewed explained that setting debt targets was a necessary
first step in determining the operating balance and articulating the
necessity for operating surpluses. These officials felt that the use of
the debt to GDP ratio was a critical factor in keeping the government on
track towards surpluses in order to pay down debt.

Fiscal Policy of the Mid-1980s Driven by the Desire to Reduce the
Government's Role in the Economy

As shown earlier in figure 25, New Zealand had large deficits extending
back to the late 1970s. The deficits were large, exceeding 2 percent of
GDP in all years before 1984. The deficits were caused in part by
government actions taken to implement fiscal policies that sought to
counter the effects of a weak economy through expansionary policies. These
policies, which were financed largely through additional borrowing from
abroad, led to a sharp deterioration in the fiscal position. By 1984, the
ratio of government expenditure to GDP was more than 38 percent, and the
deficit was 
6.5 percent of GDP. Thus, deficit reduction efforts in New Zealand
beginning in 1984 were aimed at reforming the economy and reducing the
size of the public sector.

Economic and Public Sector Reform
---------------------------------

The New Zealand economy in the late 1970s and early 1980s was marked by a
major government presence in many sectors of the economy and extensive
government intervention in the economy. However, from 1975 through 1982,
the New Zealand economy experienced virtually no growth, while inflation
averaged about 15 percent per year and unemployment, which had never risen
beyond 1 percent, reached a peak of over 
5 percent in 1983. A loss of investor confidence led to heavy capital
outflows, which precipitated a large currency crisis. Thus, in the early
1980s, the New Zealand economy was marked by serious problems.

The impending economic crisis prompted the Labor government that came to
power in 1984 to take decisive actions. The primary goal of the new
government was to introduce more openness and competition-which the
reformers saw as the primary engines for economic growth-into the highly
controlled economy. From 1984 through 1990, the government focused its
efforts primarily on reforming the economy to improve its performance and
restore investor confidence, while deficit reduction played a supporting
role. Specifically, in 1984 the new government devalued the currency by 
20 percent and then allowed its value to float on the open market, opened
up the financial markets to international competition and investment, and
deregulated major sectors of the economy. The government also removed wage
and price controls and reduced or eliminated subsidies for many industries. 

Along with economic reforms, the government implemented many reforms that
resulted in a smaller public sector. It began by corporatizing government
departments engaged in commercial activities into state-owned enterprises
and putting them on a commercial basis. In many instances, these
enterprises had to adopt business practices and compete with private
sector enterprises. From 1986 through 1990, many of these state-owned
enterprises were privatized. By 1994, privatization and other initiatives
aimed at improving economic and government performance had reduced the
number of public sector employees to less than half the 1984 level. 

In addition, the government passed several laws changing the focus of
government management and budgeting. The Public Finance Act of 1989
required the use of accrual budgeting while the State Sector Act of 1988
shifted responsibility for managing inputs, such as the number of
employees, from central control to department managers. The acts gave
these managers more latitude in purchasing and hiring decisions in
exchange for the delivery of outputs such as serving a specific number of
welfare recipients. 

Deficit Reduction Efforts
-------------------------

From 1984 through 1990, deficit reduction was achieved mainly through
increases in revenues. In October 1986, the government introduced a broad-
based 10 percent Goods and Services Tax (GST), part of a general effort to
move the tax burden from direct taxes such as income taxes to indirect
taxes such as GST./Footnote6/ Although there were significant cuts in the
marginal personal income tax rates, these were offset somewhat by the
elimination of tax loopholes and a general broadening of the tax base. As
the tax brackets were not indexed for inflation and the economy grew, tax
revenues increased as a share of GDP. In addition, government-owned
enterprises were generating healthy surpluses, which were counted as
government revenue. Taken together, the result was an increase in revenue
from about 32 percent of GDP in fiscal year 1984-85 to almost 40 percent
of GDP in fiscal year 1989-90. 

Despite efforts to cut government spending, government expenditures as a
percentage of GDP increased from less than 37 to more than 41 percent from
fiscal year 1984-85 to fiscal year 1989-90. Although the government moved
initially to reduce or abolish subsidies and restrain spending in most
program areas, these cuts were more than offset by growth in expenditures
in social welfare, health, and education that together made up more than 
55 percent of the budget in 1984. Increases in social expenditures were
driven by increased demand for education and health programs. In addition,
the turbulence in the economy and slow economic growth led to large
increases in cyclically-sensitive claims such as unemployment. By fiscal
year 1990-91, social programs had grown to about 62 percent of the budget,
representing more than 25 percent of GDP and a level that was 
5 percentage points higher than in fiscal year 1984-85.

Although privatization was undertaken mainly to improve economic
performance, proceeds from these efforts led to a decrease in debt during
the 1980s. From 1988 through the end of 1990, 15 of the largest state-
owned enterprises were privatized. Privatization proceeds totaled more
than NZ$9.4 billion as of December 1990. Proceeds contributed to reduction
of the gross public debt from almost 78 percent of GDP in 1987 to about 
62 percent of GDP in 1990.

Fiscal Policy of the Early 1990s Focused on Eliminating the Deficit and
Then Reducing the Debt 

Beginning in late 1990, the newly elected government focused on deficit
reduction. The government was unaware that it would face, upon election, a
large deficit instead of a balanced budget. Furthermore, upon taking
office, it became apparent that deficits would persist due to an economy
that was entering a deep recession, unless policy actions were taken. In
addition, New Zealand was faced with the prospect of a credit downgrade
due to concerns about the state of the economy, which would cause its
borrowing costs to increase. Decisionmakers became keenly aware of the
need to sustain foreign investor confidence in their economic and fiscal
policies.

Shortly after the election, the government presented an economic package
that focused primarily on spending cuts to restore fiscal health. The
package reflected the keen awareness among decisionmakers of the need to
sustain foreign investor confidence in their economic and fiscal policies.
Among other things, the budget retained the surcharge on superannuation
(New Zealand's public pension program) that the new government had
promised to abolish during the 1990 campaign. The fiscal year 1990-91
budget enacted severe cuts to social welfare benefits totaling 
NZ$245 million while the fiscal year 1991-92 budget cut another 
NZ$1.25 billion. The government also held spending increases to a minimum
on other expenditure categories. Officials believed that such difficult
decisions were necessary to turn the economy and the fiscal position
around. 

The deficit reduction program, along with an improving economy led by
growth in exports, provided the impetus for New Zealand's improving fiscal
position. By fiscal year 1993-94, the first year of surplus, the
government had succeeded in reducing expenditures from more than 42
percent of GDP in fiscal year 1990-91 to less than 35 percent./Footnote7/
Strong progress on constraining expenditure, together with proceeds from
privatization totaling nearly NZ$3.2 billion from 1991 through 1993,
allowed the government to reduce debt. 

In 1994, when it became apparent that surpluses would continue, the
government articulated the need for continued surpluses in order to reduce
debt. New Zealand is a small, open economy that is highly susceptible to
international shocks. The government believed that a lower debt level
would improve fiscal flexibility and better prepare New Zealand for the
next economic shock. Furthermore, policymakers thought that reducing debt
would serve to increase the confidence of international investors in the
New Zealand economy. The government's efforts have largely been
successful, with public sector debt falling from over 50 percent of GDP in
1990 to a 1998 level of under 25 percent. (See figure 28.) While this is
generally viewed as a significant achievement, some believe that further
debt reduction will be necessary if the country is to successfully address
long-term fiscal and economic issues. Currently, the government has a
public sector debt goal of less than 15 percent of GDP.

Figure****Helvetica:x11****28:    Net Public Sector Debt in New Zealand,
                                  1980 to 1998
*****************

*****************

Source: New Zealand Treasury.

New Zealand finance officials we interviewed credited at least part of the
ability to maintain fiscal discipline to budget and accounting reforms.
They stated that the government maintained departmental budgets at the
same level from 1991 through 1998 unless departments could present a
compelling case for increased spending. As a result, it became difficult
to introduce new programs or undertake additional activities under this
new approach, and most departments experienced a budget reduction in real
terms, which they were expected to absorb through increased efficiency.
Officials we spoke with felt that the budget and accounting reforms
improved their ability to price governmental goods and services (outputs)
and have helped New Zealand to make efficiency gains without a drop in the
level and quality of service. For example, by requiring that departments
absorb a capital charge, the government reduced the desire to acquire new
capital assets and provided an incentive for selling non-performing assets. 

A New Framework for Fiscal Decision-making
------------------------------------------

As noted earlier, in 1994 the government passed the FRA, which established
a new framework for fiscal decision-making. FRA was developed to lead to
better fiscal outcomes by making policymakers consider not only the 
short-term impacts of decisions but also the medium- and long-term
impacts. FRA was also put in place, in part, in anticipation of the new
MMP electoral system. The change to MMP was likely to lead to coalition
governments. Officials feared that the compromises resulting from
coalition governments would result in a deterioration of fiscal
discipline. FRA was designed to make this more difficult. 

FRA established five main principles for sound fiscal management. The
government is required to (1) establish a prudent level for debt necessary
to provide a buffer against future adverse events, then work to reduce
debt to that level by achieving operating surpluses every year that the
debt is above a targeted level, (2) maintain this prudent debt level once
achieved by running a balanced budget on average over the economic cycle, 
(3) achieve a level of national net worth that would provide a buffer
against adverse economic shocks, (4) pursue a policy of stable and
predictable tax rates, and (5) manage the risks facing the government. The
framework does not dictate specific targets for debt, surpluses, or risks,
but allows the government to define its own medium-term strategies and
short-term fiscal goals in such a way as to fulfill these principles. 

FRA also put in place institutional arrangements designed to improve
transparency in the formulation of and accountability in the performance
of fiscal policies by requiring extensive reporting on these policies.
Before the budget is presented, a Budget Policy Statement must be
presented that sets forth the broad strategic goals of the government. The
Fiscal Strategy Report that accompanies the budget has to specify that the
budget is consistent with the Budget Policy Statement or justify any
departure. This report must provide fiscal scenarios covering at least the
next 10 years. Other reporting requirements include the Economic and
Fiscal Update at the time of the budget, a half-year Economic and Fiscal
Update in December, an update with supplementary appropriations, as well
as a 
pre-election economic and fiscal update at least 14 days before a general
election. FRA also requires the government to use accrual concepts for
budgeting and reporting. Finally, FRA requires the government to disclose
all decisions that may have a material effect on the future fiscal and
economic outlook. The government hoped that these extensive reporting
requirements would ensure that departures from what are deemed the
principles of responsible fiscal management would only be temporary since
they would have to be reported and justified to the public.

New Zealand Aims for Sustained Surpluses

Since 1994, New Zealand's fiscal policy has been to run sustained
surpluses until a desired debt level is achieved./Footnote8/ The
government cites three main reasons for running sustained surpluses and
reducing debt: (1) to provide a buffer against economic shocks, (2) to
deal with the significant pressures that demographic trends will place on
the fiscal position in the future, and (3) to allow for lower taxes in
order to increase international competitiveness and economic growth. 

Most officials and experts we talked with agreed that the New Zealand
economy is extremely susceptible to external economic shocks. A fallback
into budget deficit is seen as undesirable because it would likely result
in an adverse response by international markets. The resulting increase in
interest rates would be harmful to the business sector and, ultimately,
would be detrimental to the health of the economy as a whole. A budget
deficit is not acceptable because concern still exists over the debt level
and because future demographic pressures are becoming more apparent. 

Interviewees added that the New Zealand political landscape has undergone
substantial changes, to the point that running sustained surpluses is now
the accepted norm of most political parties. While some interviewees,
concerned about the deterioration in the national infrastructure, argued
that New Zealand could assume additional debt for investment purposes,
most agreed on a policy of continued surpluses. An ex-finance official
argued that some consensus existed for maintaining surpluses in time of
economic growth so the government could better address long-term pressure
such as the aging population. According to this ex-official, the relevant
question in New Zealand is not whether to maintain surpluses but rather
how rigidly the policy needs to be carried out. Some opposition parties
are committed to achieving surpluses over the business cycle, allowing for
deficits during periods of economic weakness. However, the current
government has said it is imperative to maintain surpluses until the
desirable level of debt is achieved.

The fiscal year 1994-95 budget was the first in a series of budgets to
operationalize the principles of FRA. A main objective of the budget was
to reduce net debt to between 20 and 30 percent of GDP and achieve a debt
to GDP ratio of 20 percent by 2003-04. In fiscal years 1994-95 and 1995-96-
2 years after the first budget surplus was achieved-the government
continued to maintain fiscally conservative policies. In 1995, the
government reaffirmed its commitment to running short-term surpluses and
promised to consider tax cuts only after net debt fell below 30 percent of
GDP. Pointing to experience that showed that the fiscal balance could
shift up or down by more than 3 percent of GDP over the cycle, the
government committed itself to running surpluses of at least 3 percent of
GDP in an environment of strong economic growth. In addition, the
government continued its privatization programs. Proceeds from
privatization, as well as cash made available from operating surpluses,
were dedicated to debt reduction, resulting in substantial progress
towards achieving the 30 percent debt goal./Footnote9/

As a result of the increasing revenues and decreasing expenditures, New
Zealand ran operating surpluses averaging almost 3 percent of GDP from
fiscal years 1994-95 through 1997-98. Despite the fact that the government
did not actively increase taxes during the mid-1990s, revenues increased
as a percent of GDP during this period for several non-policy related
reasons. Tax receipts increased because New Zealand's taxes are not
indexed to inflation and corporate profits grew with the improving
economy. In fiscal year 1995-96, taxes and other revenues accounted for
more than 38 percent of GDP, an increase from 36.6 percent in fiscal year
1993-94. On the expenditure side, the government held the line on nominal
increases, so that by fiscal year 1995-96, expenditures as a share of GDP
decreased to approximately 34.5 percent, from 36 percent in fiscal year
1993-94. 

Once the government's debt level goals were reached, the government both
lowered the targets and passed budgets with tax cuts and increased
expenditures. In 1996, as the debt level was estimated to reach the
initial target of 30 percent of GDP, the government enacted a new budget
that aimed to reduce debt to below 20 percent of GDP while making room for
reduction in taxes. The 1996 tax cut package consisted of a two-stage
reduction in the income tax rate planned for 1996 and 1997. The package,
which went into effect July 1, 1996, totaled more than NZ$7 billion over 
3 years and, along with smaller measures, reduced revenues from more than
38 percent of GDP in fiscal year 1995-96 to a fiscal year 1998-99
estimated level of less than 35 percent. While the budget also targeted
specific areas such as health and education for spending increases, the
growth in expenditures was relatively small. 

As mentioned previously, the 1996 election resulted in the formation of a
coalition government in New Zealand. The coalition government supported
spending initiatives that were not included in the fiscal year 1996-97
budget. In response to these pressures, the government passed a 
NZ$5 billion spending package to be phased in over 3 fiscal years starting
with fiscal year 1997-98. The spending package allocated additional
funding to health and education and abolished the superannuation surcharge
to fulfill a 1990 campaign promise. To mitigate the fiscal pressure and
reaffirm its commitment towards surpluses, the government postponed the
second round of tax cuts until July 1, 1998, citing as reasons slowing
economic conditions and reduced projected surpluses. 

Despite actions taken to reduce taxes and increase expenditures, reducing
net debt is still the overriding objective of fiscal policy. In 1998, the
government once again changed its target for debt to less than 15 percent
of GDP and planned to run surpluses until this level of debt was achieved.
In response to the Asian downturn and a forecasted fallback into deficit,
the government agreed in May 1998 to set aside NZ$300 million of the 
NZ$5 billion spending package to bolster operating surpluses, thus
effectively reducing spending by NZ$150 million in fiscal years 1998-99
and 1999-2000. In July 1998, the government once again reduced NZ$300
million from the spending package, thus lowering funding for policy
initiatives to NZ$4.4 billion over the next 3 years. In September 1998,
the government launched yet another program to cut NZ$150 million in
expenditure that contained, among other provisions, a continuation of
government policy to index old-age pension benefits to prices instead of
wages until benefits reach 60 percent of average wage. According to an ex-
official we interviewed, this was a difficult and controversial decision
because it reduced the potential increases in benefits, but it was
necessary if the government wanted to adhere to its debt reduction policy.
Most recently, the government forecast that its budget would be in balance
for fiscal year 1999-2000, before achieving surpluses again starting with
fiscal year 
2000-01. 

Long-term Pressures and Reforms

Like many other industrial nations, New Zealand faces the fiscal pressures
associated with an aging population. The proportion of the population aged
65 and over is projected to increase by more than 75 percent between 1996
and 2031, from about 12 percent to 21 percent of the population. About the
same time, the ratio of workers to retirees is projected to decrease from 
5.8 to 3.4 workers per retiree. The growth in the elderly population is
forecast to impose extensive pressure on New Zealand's fiscal position.
Because the benefits are fairly generous and because beneficiaries are not
subject to either asset or explicit income tests to qualify for benefits, 
old-age pensions are forecast to almost double as a share of GDP from a
current level of more than 5 percent of GDP. 

The government has made temporary changes to pension provisions, such as
imposing a surcharge on high-income earners (subsequently repealed) and
indexing old-age pension to prices rather than wages. In 1991, the
government raised the eligibility age for pensions from 60 to 65 over a 
10-year period from 1991 through 2001. However, these changes have not
fully addressed the large projected increases in pension expenditures. In
an attempt to improve the long-term fiscal balance, the government in 1997
designed a compulsory savings scheme that was submitted to a public
referendum, but it was overwhelmingly rejected. Officials that we spoke
with said they thought this outcome had deferred pension reform
discussions for the time being. 

According to officials, the health system also presents numerous
challenges to reformers. The system is primarily a public system,
supplemented by private insurance and out-of-pocket copayments for general
practitioners and pharmaceuticals and for surgical procedures that would
otherwise not be available immediately. Since the 1980s, health care
expenditures have shifted to the private sector, with their share of total
health expenditures increasing from 12 percent in fiscal year 1979-80 to
almost 23 percent in fiscal year 1996-97. Despite the expenditure shift
and other government actions to reform this area, government health
expenditure continued to average around 5 to 6 percent of GDP, below the
average of other developed nations. The growth in the elderly population
is forecast to almost double health care costs from fiscal year 1997-98
through the year 2050. 

Conclusion

New Zealand began on the road to surpluses and lower debt by first
addressing economic fundamentals and undertaking reforms of the public
sector that included substantial privatization of government enterprises.
In the 1980s, proceeds from privatization and increased tax revenues
allowed the government to pay down debt and support large increases in
social expenditures. In the 1990s, the government began a deficit
reduction period that was marked by a focus on holding the line on
expenditures. The government further enforced fiscal discipline by putting
in place a new framework that focused fiscal policies on achieving prudent
debt levels. By focusing on the debt to GDP ratio, the government was able
to justify the need to run surpluses for several years. Upon achieving its
initial goal of a net debt level from 20 to 30 percent of GDP, the
government enacted a package of tax cuts. Subsequently, the government has
set even lower levels of debt and confirmed surpluses as its primary goal,
while allowing for increased spending in priority areas.

--------------------------------------
/Footnote1/-^New Zealand's fiscal year runs from July 1 through June 30.
/Footnote2/-^Net debt is defined as gross debt owed to the public offset
  by similar financial assets of the New Zealand government. 
/Footnote3/-^The Governor General is the Queen's representative. He/she
  does not actively participate in government, but acts on the
  recommendation of the government. 
/Footnote4/-^A minority government can remain in power so long as it can
  survive a vote of no confidence, or until another coalition with more
  votes is formed. If a majority of the members of Parliament vote no
  confidence in the government, then an election must be held. 
/Footnote5/-^The Public Finance Act of 1989 first required the use of
  accrual budgeting at the department level. In 1994, the government
  enacted FRA, which reaffirmed its commitment to greater accountability
  and transparency in government through improved financial management and
  devolution of responsibilities. FRA endorses the move to accrual as
  necessary to the new fiscal environment and requires that the government
  as a whole budget on an accrual basis. 
/Footnote6/-^The GST rate was subsequently increased to 12.5 percent in
  March 1989.
/Footnote7/-^In 1993-94, New Zealand achieved surplus in both cash and
  operating bases. 
/Footnote8/-^The targeted net debt level was originally set at between 20
  and 30 percent of GDP in the 1994 budget. The target was decreased to 20
  percent of GDP in the 1995 budget and further decreased to less than 15
  percent of GDP in May 1998. 
/Footnote9/-^The full cash value of privatization proceeds is not included
  in the operating balance. Under an accrual basis, only gains or losses
  are recorded in the operating balance. A gain would occur if the sale
  price was above the net asset value, and a loss would occur if the sale
  price was below the net asset value. However, all of the cash from the
  asset sale is available for debt reduction. 

NORWAY
======

Norway has achieved budget surpluses on a general government basis in all
but two-1992 and 1993-of the last 50 years./Footnote1/ Generally
throughout the 
post-war period, running budget surpluses was the aim of the government in
power. Since the early 1970s, surpluses have increasingly been the result
of a rapid increase in revenues from the oil industry. A large and growing
oil industry has had a dramatic impact not only on the budget but also on
the Norwegian economy. Norway has generally enjoyed strong economic growth
during the past 25 years as a result of its petroleum industry. However,
beginning with an oil price collapse in late 1985, Norway experienced a
prolonged economic slowdown, which by the early 1990s resulted in record
high unemployment and a return of budget deficits for the first time in
nearly 50 years. 

Decisionmakers responded with a series of reforms aimed to improve the
long-term fiscal and economic health of the country. In 1993, the
government entered into an agreement with labor and business leaders with
the stated goal of achieving long-term economic growth, high employment,
low inflation, and a stable exchange rate. The government agreed to focus
fiscal policy on stabilizing the economy, while monetary policy would
focus on stabilizing the currency. Labor and business leaders agreed to
hold down wage increases, reducing inflationary pressures in the economy.
Officials we spoke with felt that these reforms have played a critical
role in the turnaround of the economy and the return to surpluses. Figure
29 shows Norway's general government financial balance as a percentage of
GDP from 1970 to 1998.

Figure****Helvetica:x11****29:    General Government Financial Balance as
                                  a Percent of GDP in Norway, 1970 to
                                  1998
*****************

*****************

Source: OECD Economic Outlook 65, June 1999.

Upon achieving surpluses, the government has adopted a long-term focus for
fiscal policy-attempting to save surpluses to deal with future budget
pressures. Specifically, Norway projects a sharp rise in public pension
expenditures and a corresponding decrease in petroleum revenues. The
government has decided that it needs to accumulate financial wealth to
help pay for these pressures, and since 1996 has deposited budget
surpluses in the Government Petroleum Fund. To further support continued
fiscal discipline, the Parliament reformed its budget process in 1997,
putting in place expenditure and revenue ceilings for the first time.
However, the ability of the government to maintain fiscal discipline
during a period of surplus came under increasing pressure. A minority
coalition government was formed in 1997, and it increased spending above
the previous government's proposals. A tight labor market, a sharp drop in
oil prices, and turbulence in currency markets have, together, placed
increasing strain on the government's ability to maintain fiscal
discipline. 

Background

Norway is a constitutional monarchy with a parliamentary system of
government./Footnote2/ The Parliament, called the Storting, is composed of
two chambers with a total of 165 members. The government is headed by the
Prime Minister and a Cabinet of 19 ministers. The governing party or
coalition of parties must be backed by a majority of Parliament but need
not constitute a majority of Parliament. The government is responsible for
most legislation, but individual members of Parliament may introduce
bills. Each year, the government prepares and introduces the budget to
Parliament. Parliament has final authority over all budget matters and in
practice often changes the government's proposals.

Elections are held every 4 years, and a new election may not be called
outside this cycle. If the government receives a no confidence vote or
resigns, then a new government must form from the current Parliament.
Norway has a system of proportional representation with the number of
representatives of each party determined roughly in proportion to the
votes the party receives in the election./Footnote3/

Since 1945, the left-of-center Labor party has dominated Norwegian
politics, holding government for all but 16 years. From 1945 until 1961,
the Labor party held a majority of seats. Since 1961, power has alternated
between coalition governments and minority Labor governments, with the
Conservative party holding power from 1981 to 1983. 

Currently, Prime Minister Kjell Magne Bondevik is leader of a minority
coalition government. He became Prime Minister following the 1997 election
when a centrist coalition made up of the Christian Democrats 
(Mr. Bondevik's party), the Centre party, and the Liberal party formed the
government. The coalition government took over after the Labor party
stepped down following a poorer than expected showing in the 1997
election, despite the fact that Labor holds a higher percentage of seats
with 35 percent than the coalition with 26 percent./Footnote4/

Economy
-------

The Norwegian economy is about 2 percent the size of the U.S. economy and
heavily dependent on foreign trade. In 1997, exports accounted for about
41 percent of GDP. Norwegian industry has traditionally been raw-material
based. The discovery of oil in the late 1960s has had a profound effect on
the Norwegian economy, and the petroleum sector has grown rapidly to
account for about 20 percent of the economy and about one half of total
merchandise exports.

Recent Economic History

Since the 1970s, Norway's economic performance has been heavily influenced
by its rapidly growing oil industry. However, as a result, the Norwegian
economy has become subject to increasingly volatile swings in oil prices
and production. For example, Norway experienced a period of strong
economic growth in the mid-1970s as a result of high oil prices and
increased oil production, which was followed by a period of slow growth in
the early 1980s. Then, in the mid-1980s, Norway experienced a short but
strong economic boom, which was brought on by expansionary fiscal and
monetary policies and a sharp increase in the availability of consumer
credit. From 1986 to 1992, Norway experienced its longest economic
downturn since World War II, which was precipitated by a sharp drop in
world oil prices. The slowdown continued through the late 1980s as the
government maintained its tight fiscal policy stance in an attempt to
reduce inflationary pressures and because consumer spending slowed in
reaction to the sharp run-up in borrowing during the mid-1980s and the
increased cost of borrowing. 

In reaction to rising unemployment, the government adopted an expansionary
fiscal stance beginning in 1989, but the economy did not begin its
turnaround until 1992. The expansion has been broadly based, with strong
growth in investments, exports, and private consumption. See figure 30 for
Norway's annual GDP growth since 1981.

Figure****Helvetica:x11****30:    Real GDP Growth in Norway, 1981 to
                                  1998
*****************

*****************

Sources: OECD Economic Outlook 65, June 1999 and OECD Economic Outlook 63,
June 1998.

Key Structural Factors of the Norwegian Economy That Affect Fiscal Policy

As a small, trade dependent nation, Norway is sensitive to external
factors that affect its economy. Particularly important to Norway's
economic performance is its currency exchange rate and inflation rate.
Appreciation in the value of its currency makes Norway's exports
relatively more expensive, reducing the competitiveness of its export
industries. It is also important for Norway that inflation remains at or
below the rate of key trading partners. If inflation is higher, then
Norwegian goods become more expensive relative to competitors. The period
from the late 1970s to the late 1980s was marked by high inflation and
deteriorating cost competitiveness, and on occasion the government
devalued the currency to maintain cost competitiveness. 

The ability to maintain competitiveness is particularly critical in Norway
because a strong petroleum sector could lead to a weaker economy in the
long run. Strong petroleum exports put upward pressure on exchange rates,
can lead to increased public and private spending, and high inflation.
This effect, known as "Dutch Disease," results in a loss of
competitiveness to traditional industries exposed to international
competition./Footnote5/ Over the long run, as petroleum revenues decline,
this could have a negative impact on economic growth when Norway becomes
more dependent on other sectors to generate economic growth.

Budget Process
--------------

The Norwegian budget process occurs in two distinct steps. First, the
government prepares its budget proposal with the Finance Ministry taking
the lead. At the beginning of this phase, the Minister of Finance proposes
expenditure and revenue ceilings based on economic projections from the
Ministry of Finance. Then, the entire cabinet meets to decide spending
limits and debate how to allocate the budget. Most of this debate takes
place away from public view.

During the second phase of the budget process, the Parliament debates the
government's proposal and passes a budget bill. The Finance Committee sets
an aggregate ceiling and ceilings for 23 expenditure areas and 
2 revenue areas, which must be approved by Parliament./Footnote6/
Parliamentary committees then must develop their budget proposals within
the expenditure limits. It is not unusual for Parliament to change the
government's budget proposal.

Measuring Fiscal Position
-------------------------

Norway's main measure of fiscal position is the fiscal budget
surplus/deficit, which includes all the activities of the central
government and is similar to the United States' unified budget measure.
Because of the significance of petroleum revenues in Norway's budget, it
also reports a non-oil budget figure, which separates the oil-related
revenues and expenditures from the fiscal budget. The difference can be
quite large. For example, in 1998 the government recorded a fiscal budget
surplus of more than 27 billion krone, while the non-oil budget deficit
was about 17 billion krone.

Also, Norway's government uses the non-oil cyclically adjusted balance net
of interest payments as a key measure for setting fiscal policy. The
government uses fiscal policy in an active manner in an attempt to smooth
economic fluctuations and stabilize inflation. Consequently, this measure
is important because it shows the impact of the government's core fiscal
actions on the economy by removing the effects of oil activities, the
economy, and fixed interest expenses. Officials we met with pointed out,
however, that it can be difficult to correctly forecast economic
performance, and in the past their estimates have varied significantly
from actual outcomes. 

Norway Adopts Fiscal Policy to Address Long-term Fiscal and Economic
Pressures

Over the last 30 years Norway's economy has undergone truly profound
changes due to a rapid increase in the size of its petroleum industry. The
petroleum industry has grown to account for a large share of both the
economy and government revenues. Prior to the arrival of petroleum
revenues, Norwegian governments had a history of achieving budget
surpluses. While Norway has generally continued to achieve surpluses, they
have become increasingly due to petroleum revenues. 

Following a prolonged period of slow growth in the late 1980s and early
1990s, Norway developed a new framework to support sustained economic
growth. This framework, the so called "Solidarity Alternative," was
adopted in 1993 and called for low nominal price inflation, sound public
finances, and a stable exchange rate in order to maintain stable economic
growth and high levels of employment. This framework was viewed as playing
a key role in the fiscal and economic improvement that occurred during the
mid-1990s. As a result of fiscal tightening measures and strong growth in
petroleum revenues the budget has improved significantly, with surpluses
growing to over 7 percent of GDP in 1997. 

As surpluses have developed, the government has adopted a long-term
budgetary focus and has called for setting aside budget surpluses to help
pay for future expenses. Norway faces the prospect of increasing public
pension expenditures at the same time that petroleum revenues are forecast
to decline. In order to help pay for these future expenses, the government
began depositing budget surpluses in the Government Petroleum Fund in
1996./Footnote7/ Also, the Parliament reformed its budget process,
adopting top-down spending and revenue targets in order to help maintain
fiscal discipline. However, as called for by the Solidarity Alternative,
it became increasingly difficult to maintain fiscal discipline during the
current period of strong economic growth. A minority coalition government
was elected in 1997 and increased spending above the previous government's
proposals. A tight labor market, a sharp drop in oil prices, and
turbulence in currency markets have, together, placed increasing strain on
the government's ability to maintain fiscal discipline. 

1970s and 1980s: A Transition to a Petroleum Based Economy 
-----------------------------------------------------------

The Norwegian economy underwent truly profound changes with the discovery
of oil in the late 1960s. Oil production began in 1971 and increased
rapidly after 1975. From 1975 to 1985, the petroleum sector grew from
about 2.5 percent of GDP to nearly 20 percent, oil and gas exports grew
from 9 percent to nearly one half of all exports, and oil tax revenues
increased from 2 percent to about 19 percent of total government income. 

The impact on the broader economy was no less dramatic. During a period of
generally slow worldwide growth, Norway's average annual real GDP growth
was 3.8 percent from 1975 to 1983, compared to 1.8 percent for other OECD
countries. From 1975 to 1983, unemployment averaged about 
2 percent, nearly 5 percent below the OECD average. The government ran
budget surpluses from 1975 to 1983 averaging about 3 percent of GDP,
compared to an average deficit of 3.5 percent for other European OECD
countries. However, budget surpluses were increasingly due to petroleum
revenues-the non-oil budget showed a deficit of about 7 percent of GDP in
1983 compared to a surplus of about 4 percent 10 years earlier. 

Almost from the beginning, there was debate about how to manage the
petroleum wealth. There were concerns that a strong petroleum sector could
crowd out investment in the rest of the economy, leading to a weaker
economy in the long run when petroleum revenues declined. Initially,
during the early 1970s, it was decided to develop and spend oil revenues
cautiously to minimize the impacts on other sectors of the economy.
However, attempts to limit the impact of oil on Norway's economy proved
unsuccessful as Norway's oil revenues increased more rapidly than planned
as a result of a rise in the price of oil and the dollar exchange rate. 

Concerns over a dominant petroleum sector crowding out other sectors of
the economy proved well founded. Growth in the manufacturing sector
stagnated from 1975 to 1985 and employment in that sector dropped by over
13 percent. In response, the government increased subsidies to domestic
industries, including shipbuilding, farming, and fisheries. By the mid-
1980s, Norway's corporate subsidies were among the highest of OECD
nations. The strong petroleum sector and the strong overall economy also
had other costs. A tight labor market contributed to persistently high
inflation and a decrease in the cost competitiveness of exports, which
Norway compensated for by devaluing its currency several times. 

1983 Through 1986: An Overheating Economy 
------------------------------------------

Beginning in 1983 and lasting until 1986, Norway experienced a period of
strong economic growth. Although, initially the upturn was led by an
increase in exports, it was sustained by increasing domestic demand led by
expansionary fiscal and monetary policies. Also, the expansion was aided
by a steep rise in private consumption caused, in part, by the increased
availability of private credit following financial market
deregulation./Footnote8/

By 1985, the Norwegian economy had become overheated, led by a surge in
private consumption of more than 8 percent, and unemployment fell to about
2 percent. Also, inflation rates remained high and above those of other
industrial countries, resulting in a loss of competitiveness, a drop in
exports, and a widening trade gap. Largely as a result of the strong
economy and strong petroleum revenues, budget surpluses grew to a peak of
about 10 percent of GDP in 1985. 

1986 Through 1992: Norway Experiences the Longest Economic Downturn in Its
Post-war History
---------------------------------------------------------------------------

From 1986 to 1992, Norway experienced the longest economic downturn in its
post-war history. A sharp drop in oil prices, from about $30 a barrel in
late 1985 to about $10 a barrel in 1986, precipitated the downturn. The
economic and fiscal effects were severe. Norway experienced a 1-year 
10 percent decline in real national income, a 15 percent decline in total
export earnings, and a decline in the budget surplus of about 4 percent of
GDP. In 1986, the Norwegian currency came under increasing pressure, as
investors became concerned over the impact of a fall in oil prices on
Norway's economy, and the central bank intervened to defend the currency. 

Against this backdrop, a newly elected minority government came to power
in 1986 and implemented a strategy to restore economic stability and
international competitiveness. The new government devalued the currency by
10 percent, improving the cost competitiveness of its export sector. The
government also tightened monetary and fiscal policy to slow down the
economy and reduce inflationary pressures. Finally, the new government
took several steps to improve Norway's centralized wage negotiation
process and to reform its system of industrial subsidies. These measures
were intended to improve international competitiveness by reducing wage
inflation pressures and improving economic efficiency. 

The economic slowdown was also prolonged due to a drop in consumption as
consumers attempted to reduce the indebtedness they had built up during
the mid-1980s borrowing surge. This retraction was exacerbated by a tax
reform package enacted in 1987, which reduced marginal tax rates and the
tax deductibility of interest payments, increasing the cost of debt. 

The government continued to maintain a tight fiscal policy until 1989 when
it changed to a stimulative fiscal policy in reaction to rising
unemployment rates. Specifically, the government increased spending on
labor market programs, housing loans, and public construction while
reducing employer social security contributions in an attempt to stimulate
the economy and increase employment. However, just as the economy showed
signs of picking up due to increased private consumption in 1990, a
general worldwide economic slowdown acted to prolong Norway's slowdown. 

Prolonged Economic Downturn Leads to Consensus on the Need for Fiscal
Discipline
---------------------------------------------------------------------------

The prolonged economic downturn led Norwegian policymakers to take actions
to improve economic performance. As a result, the budget had moved into
deficit in 1992 and 1993 for the first time in many years. Unemployment
peaked at about 6 percent in 1992-a very high level by Norwegian
standards. Following turmoil in European exchange markets in 1992, Norway
was forced to give up its fixed exchange rate policy. 

Against this backdrop, the government appointed a commission in 1991 to
study the causes of the rapid rise in unemployment. The Commission
consisted of representatives from all political parties in Parliament,
labor and business groups, economic experts, and government officials. In
the summer of 1992, the Commission, with broad support from the major
political parties, issued its report recommending a new approach for
economic policy-a so called (r)Solidarity Alternative.(c) 

The Solidarity Alternative established clear roles for fiscal and monetary
policy. The government was to use fiscal policy in a counter-cyclical
fashion-increasing demand during economic slowdowns and decreasing demand
during periods of overly strong economic growth. Monetary policy was to be
used primarily to maintain stable exchange rates. In addition, as part of
the Solidarity Alternative labor and business leaders agreed to cooperate
to mitigate wage inflation pressures. Officials and experts we spoke with
felt that the Solidarity Alternative played a key role in the turnaround
of the economy. 

Norway Sets Goal for Surpluses to Address Long-term Fiscal and Economic
Concerns

Once the fiscal budget was projected to return to surplus in 1996, the
government added a long-term focus to its fiscal policy goals. A major
reason for the return to surplus was a surge in petroleum revenues, which
more than doubled between 1994 and 1996, and an overall improvement in the
economy and in non-oil exports. Also, the government's attempt to limit
the growth of "underlying" expenditures (excluding unemployment benefits
and one-time items) contributed to fiscal improvement. 

With the advent of surpluses, Norway established a goal of sustained
surpluses in order to build up savings to address long-term fiscal and
economic concerns resulting primarily from an aging population and
declining petroleum revenues. (See figure 31.) The goal to save surpluses
was based, in large part, on a study of the long-term outlook for
government finances./Footnote9/ Specifically, the study projected that
petroleum revenues would peak in 2001 at about 8 percent of GDP and
decline thereafter to about 1 percent of GDP in 2030. At the same time,
public pension expenditures were projected to grow from about 7 percent of
GDP to nearly 15 percent. Figure 31 shows the most recent long-term
forecast extended out to 2050. This long-term problem has been presented
as the primary rationale for the current fiscal policy of sustained
surpluses.

Figure****Helvetica:x11****31:    Long-term Projections for Pension
                                  Expenditures and Petroleum Revenues as a
                                  Percentage of GDP in Norway, 1973 to
                                  2050
*****************

*****************

Source: Statistics Norway and Norwegian Ministry of Finance.

The government's projections showed that it was necessary to accumulate
financial reserves to help pay for increasing public expenditures. As a
vehicle for accumulating assets, the government created the Government
Petroleum Fund in 1991 to help manage Norway's petroleum wealth over the
long term. The Government Petroleum Fund serves several important fiscal
and economic functions. By investing surpluses, the Fund is an instrument
for saving part of Norway's petroleum revenues for the next generation.
Also, the Fund's assets are invested in foreign stocks and bonds to help
reduce inflation and upward pressure on the exchange rate. Low inflation
and a stable exchange rate help to keep Norway's exports competitive with
other countries. If Norway allowed excess petroleum revenues to remain in
the domestic economy it could result in higher levels of inflation and a
real appreciation of its currency. As a result, non-oil industries would
become less competitive over time as the price of their goods and services
would rise relative to foreign competitors. This is a major concern to
policymakers because petroleum output is projected to decline early in the
21st century, and Norway will have to rely more on its non-oil industries
to generate economic growth. If those industries lose their
competitiveness now, it could have a negative impact on long-term economic
growth when the petroleum industry declines. Consequently, policymakers in
Norway have come to view surpluses as critical to the long-term fiscal and
economic health of the country, and the Fund has become a symbol of the
importance of saving for future needs. 

Budget Process Reformed to Sustain Fiscal Discipline
----------------------------------------------------

The Norwegian Parliament reformed its budget process in 1997 to show its
continued support for fiscal discipline and in reaction to past spending
increases. For the first time, the Parliament adopted a top-down approach
to budgeting, setting aggregate revenue and expenditure ceilings. Under
the old procedure there was no agreement on an overall expenditure and
revenue limit at the beginning of the budget process, and the final budget
represented the aggregate of individual spending decisions. As a result,
the previous budget process often led to Parliament increasing spending
above the government's proposed levels. Under the new budget process,
Parliament agrees on an overall fixed budget ceiling and ceilings for 
23 spending and 2 income areas at the beginning of the budget process. All
spending and revenue proposals must fit within these ceilings. 

Surplus Policy Comes Under Pressure
-----------------------------------

During the 1997 elections, the then governing Labor party promoted
continued austerity in order to avoid making the mistakes that occurred
during the 1980s, while several smaller opposition parties called for
increased spending on various social programs. In order to ensure support
for continued fiscal discipline, the Labor party vowed to step down unless
it received an equal percentage of the popular vote in the election as in
the previous election. The Labor party failed to garner an equal
percentage of votes and stepped down as promised, despite holding the
largest number of seats in Parliament. A minority coalition took over, and
its first budget proposed to increase spending on pensions and family
allowances. 

In 1998, a sharp decline in oil revenues led to a sharp decline in the
budget surplus, including oil revenues, from about 7 percent of GDP to
about 
4 percent of GDP. Financial markets became concerned over the relatively
easy stance of fiscal policy, resulting in strong downward pressure on
Norway's currency. In late 1998, the Central Bank was forced to step in
and defend the currency. Furthermore, a tight labor market has led to
increased inflationary pressures. Consequently, it may be difficult for a
weak minority coalition government to maintain fiscal discipline in light
of the pressures that have emerged since 1997. Nonetheless, the government
remains committed to the Solidarity Alternative and maintaining surpluses
to be invested for the future.

Conclusion

Norway has had a long history of budget surpluses and fiscal discipline.
With the discovery of oil in the late 1960s, the Norwegian economy and
fiscal position have come to be increasingly influenced by oil activities.
Following a prolonged period of slow economic growth in the late 1980s and
early 1990s, the government reached a broad consensus on the need to take
actions to sustain economic growth and maintain full employment over the
long term. Part of this agreement called for fiscal policy to be used in a
counter-cyclical fashion and has been a major reason why Norway has been
able to maintain fiscal discipline throughout the latter half of the
1990s. With the arrival surpluses in 1996, the government has added a 
long-term focus to its fiscal goals and now calls for surpluses to be
saved to help pay for future budgetary pressures. However, this framework
has come under increasing pressure due to a weak minority government, a
strong domestic economy, and turbulence in international currency markets.
Nevertheless, the current government remains committed to the Solidarity
Alternative and maintaining surpluses to be invested for the future.

--------------------------------------
/Footnote1/-^A general government basis includes the fiscal position of
  subnational levels of government and public pension funds.
/Footnote2/-^In practice, the King accepts the will of Parliament and
  functions in a largely ceremonial role. 
/Footnote3/-^There is some discrepancy between the popular vote and the
  makeup of Parliament. Norway's electoral system is weighted to give more
  sparsely populated areas more representation. Also, seats for Parliament
  are allocated by electoral district, and as a result some smaller
  parties may not get enough votes to receive a seat. To compensate for
  this, Norway added eight nationwide seats to Parliament in 1989, to be
  awarded to parties so that the makeup of Parliament more closely
  approximates the election results. 
/Footnote4/-^The Labor government stepped down because it failed to
  receive a larger percentage of the vote in the 1997 elections than in
  the 1993 elections.
/Footnote5/-^Dutch Disease refers to the experience of the Netherlands in
  the 1970s. During this period the Netherlands received large revenues
  from gas exploration which led to strong economic growth and growth in
  public expenditures. However, there were unwanted side effects. The
  exchange rate appreciated resulting in reduced competitiveness. Also,
  there was a strong rise in real wages, an expansion in services-both
  public and private-and a contraction in manufacturing. The economy
  slowed, unemployment increased significantly, and large budget deficits
  developed in the early 1980s. The government reacted with a large
  deficit reduction effort. The restructuring of the Dutch economy has
  taken a long time and the country still suffers from the after-effects
  of the strong expansion of the 1970s. 
/Footnote6/-^This new process was adopted in 1997. Prior to the
  implementation of expenditure ceilings, spending increases and tax cuts
  could be passed without any offsets. This was often the case with the
  budget passed by Parliament usually exceeding the spending proposed by
  the government. 
/Footnote7/-^Petroleum fund assets are not specifically earmarked to cover
  public pension obligations. Therefore, the Fund's assets could be used
  to cover any government expense.
/Footnote8/-^Traditionally, Norway had maintained extensive controls over
  its financial markets, which included controls over the supply of credit
  available to the private sector. Starting in the late 1970s, Norway
  began to deregulate its controls over financial markets which had the
  effect of making credit more available.
/Footnote9/-^Long-term Program for 1994-1997, Norwegian Ministry of
  Finance. 

SWEDEN
======

Since the early 1980s, Sweden has experienced 2 periods of budget
surpluses: 1987 through 1990 and again beginning in 1998./Footnote1/
Surpluses achieved in the late 1980s were largely the result of the
deficit reduction program begun in 1982 and a strong economy. During this
period, the government did not have an explicit policy to sustain
surpluses and generally attempted to use fiscal policy to stabilize the
economy and control inflation. Deficits reemerged in 1991 as the economy
slipped into its worst recession since the 1930s. The budget swung from a
surplus of about 4 percent of GDP on a general government basis in 1990 to
a deficit of more than 12 percent of GDP 3 years later. Unemployment
increased sharply, several large banks nearly failed, and the currency was
devalued.

In response to the economic crisis of the early 1990s the government
undertook a series of major reforms. In 1992, Sweden ended its policy of
maintaining a fixed exchange rate by changing the focus of monetary policy
to controlling inflation. As a result, the use of fiscal policy to
stabilize the economy and control inflation was reduced. The government
focused its fiscal policies on deficit reduction and, in 1994, introduced
a package that attempted to reduce the deficit by about 7 percent of GDP
over 4 years. To support the deficit reduction program, the government
reformed its budget process to include, for the first time, the use of
spending caps. Finally, Sweden overhauled its pension system with the goal
of making it permanently sustainable. By 1998, Sweden returned to a budget
surplus and had set as its fiscal objective running surpluses averaging 2
percent of GDP. Figure 32 shows Sweden's general government financial
balance as a percentage of GDP from 1981 to 1998./Footnote2/ 

Figure****Helvetica:x11****32:    General Government Financial Balance in
                                  Sweden, 1981 to
                                  1998
*****************

*****************

Sources: OECD Economic Outlook 63, June 1998 and OECD Economic Outlook 65,
June 1999. 

Background

Sweden is a constitutional monarchy with a parliamentary form of
government. The Swedish Parliament, the Riksdag, is unicameral with 
349 members. Sweden has a proportional electoral system, with 
310 members elected from districts, while the remainder are nominated by
their parties in order to achieve a nationally proportional
result./Footnote3/ 

General elections for Parliament are held in Sweden every 4
years./Footnote4/ A government forms from the political party, or
coalition of parties, that can garner the majority support of Parliament.
However, the governing party or parties do not need a majority of seats in
Parliament. Governments have no specific term limit and can remain in
office for as long as they maintain majority support of Parliament. A
change in government can occur after an election when a governing party or
coalition loses its majority or when a sitting government resigns. If at
least half the members of Parliament support a vote of no confidence, the
government is forced to resign. No government has actually been overthrown
by a formal vote of no confidence. Occasionally, however, governments have
resigned after losing important votes in Parliament, in effect an informal
vote of no confidence. Governments have also resigned as a result of
internal disagreements; this occurs most often with coalition governments.

For most of the last 60 years, Sweden has had minority or coalition
governments. The Social Democratic Party, a left-of-center party generally
representing the interests of labor, has held power for approximately 58
of the last 67 years. After losing the 1991 election, the Social Democrats
returned to power in 1994 with 46 percent of the vote. After the election
in 1994, the Social Democratic minority government was first supported by
the Left Party, then by the Center Party. In the September 1998 elections,
the Social Democrats' share of the vote dipped to 36.4 percent. However,
they were able to remain in power with the support of the more politically
left-of-center Green and Left parties. G****ITCCentury Book:x9a****ran
Persson is the current Prime Minister./Footnote5/ 

The cabinet, headed by the Prime Minister, is the decision-making body for
the government. It is composed of the Prime Minister, a Deputy Prime
Minister, 13 Heads of Ministry, and 7 Ministers without portfolio. Cabinet
Ministers are appointed by the Prime Minister and are generally
representatives of the political party or parties in power. They are
often, but not always, members of the Parliament. The government is
responsible for preparing the budget, which is submitted to Parliament in
September.

The Swedish Economy
-------------------

Sweden has a small economy that is dependent on trade-its GDP is less than
3 percent the size of the U.S. economy and exports accounted for over 35
percent of GDP in 1997, compared to about 9 percent for the United States.

Recent Economic History

During the 1970s, Sweden's economy experienced an extended period of slow
growth similar to that of other developed economies. Between 1974 and
1984, average annual growth was 1.3 percent, about 2 percentage points
lower than the previous 10 years. During this period of slow growth,
Sweden continued to pursue a policy of full employment, financed largely
by increased public sector borrowing. As a result, Sweden's public
expenditures grew at a fast rate during the 1970s, reaching a peak of
nearly two-thirds of GDP in 1982. Under this fiscal policy, Sweden
maintained a low unemployment rate-but at the cost of high inflation and
large budget deficits. 

By the early 1980s, Sweden was experiencing slow economic growth, high
inflation, and growing budget deficits. Beginning in 1982, Sweden enacted
an economic and fiscal reform package designed to help revive the economy
and reduce budget deficits. During the early and mid-1980s, Sweden's
government also deregulated its financial markets, which included the
removal of governmentally-imposed limits on the amount of credit that
banks could issue in a given year./Footnote6/ The increased availability
of credit led to a surge in borrowing and a large increase in consumer
spending and real estate investment./Footnote7/ These reforms contributed
to a sustained period of growth beginning in 1982 and ending in 1990. 

In 1990, the Swedish economy entered its worst recession since the 1930s,
due largely to a slowdown in consumer spending and a slowing world
economy. Consumer spending slowed as borrowing costs increased due in part
to a government tax reform package which decreased marginal tax rates on
capital income and reduced the deductibility of interest costs. A loss in
confidence by investors in the underlying strength of the economy led to
strong downward pressure on the value of Sweden's currency. The
government's attempts to maintain the fixed exchange rate exacerbated the
economic slowdown; interest rates for loans in the central bank were
increased to 500 percent in the fall of 1992 in an attempt to defend the
currency. Economic growth was negative from 1991 to 1993, and registered
unemployment increased dramatically from about 2 percent in 1990 to over 8
percent in 1993. The slowing economy also precipitated a banking crisis
requiring the government to bail out several banks. The economic slowdown
and banking bailout had dramatic fiscal effects leading to a sharp
increase in budget deficits, which peaked at over 12 percent of GDP in
1993. 

In reaction to the economic and fiscal crisis, the government took a
number of steps to revive the economy and bring the fiscal situation under
control. First, Sweden ended its fixed exchange rate policy in 1992 and
reoriented monetary policy toward a focus on controlling inflation. In
late 1994, a newly elected Social Democratic government put in place a
deficit reduction package totaling over 7 percent of GDP over 4 years.
Sweden also reformed its budget process to include expenditure caps and
reformed its pension system. By 1994, the economy had begun to turn around. 
(See figure 33.) In the later half of the 1990s, inflation has remained
low and stable, unemployment rates have begun to come down, and the budget
moved into surplus in 1998.

Figure****Helvetica:x11****33:    Real GDP Growth in Sweden, 1982 to
                                  1998
*****************

*****************

Source: OECD Economic Outlook 65, June 1999.

Key Structural Factors of the Swedish Economy That Affect Fiscal Policy

As a country with a small, open economy, Sweden is sensitive to external
factors that affect its economy. Particularly important to Sweden's
economic performance is its exchange rate, as appreciation in its currency
makes Sweden's exports more expensive and reduces its competitiveness.
Prior to 1992, Sweden generally pursued a fixed exchange rate policy.
Since 1992, it has allowed its currency to float on the open market.

Prior to 1992, Sweden's primary tool to regulate exchange rates was
monetary policy. However, as a result, monetary policy was limited in its
ability to control inflation. Containing inflation at the rate that
prevails abroad is important to maintaining a fixed exchange rate. Through
the early 1990s, Sweden attempted to control inflation primarily through
the use of fiscal policy. However, fiscal policy was often expansionary,
even during economic booms, generally adding pressure to an overheating
economy and higher rates of inflation. Consequently, Sweden's fixed
exchange rate policy was ultimately unsuccessful, and the central bank was
unable to defend the value of the currency. 

Budget Process
--------------

Sweden began its budget process reforms in 1994 based, in large part, on
several studies showing its process was weak in its ability to control
overall spending. The reforms put in place a top-down budget process
intended to facilitate spending constraint and lead to better budget
outcomes. The new budget process was fully implemented in 1997. These
reforms are now viewed as a major factor contributing to Sweden's recent
fiscal improvement.

Sweden's budget reforms focused on achieving better fiscal outcomes,
mainly by placing controls on spending. For example, the new process
requires the adoption of fiscal policy targets for a 3-year period,
including expenditure ceilings. Operating under a 3-year time horizon,
each year the government adds the overall expenditure ceiling for the
third year, keeping in place previously agreed to expenditure ceilings.
Expenditure ceilings may be changed in exceptional cases, but since they
were introduced, there have been no increases of previously agreed to
ceilings./Footnote8/ 

The adoption of a top-down approach to budgeting represents a significant
change for Sweden. Prior to the reforms, top-down targets were generally
not used by the government or by Parliament. In fact, the general trend
was that Parliament would increase spending above the government's budget
proposal. Under the new process Parliament passes a bill establishing the
aggregate spending level 3 months prior to the government's final budget
proposal. The government's budget proposal must conform with these limits
established by Parliament. Parliament, upon receiving the government's
budget proposal, then prepares its own budget bill allocating expenditures
among 27 expenditure areas. By passing expenditure ceilings at the
beginning of the parliamentary budget process, the new process limits the
ability of Parliament to increase spending once overall targets are agreed
upon.

Measuring Fiscal Position
-------------------------

Sweden's main measure of fiscal position is the general government
financial balance, which includes the central government budget, the local
government sector, and Sweden's public pension system. Prior to 1995, the
government focused primarily on the central government budget, also known
as the state budget. After joining the European Union (EU) in 1995,
Sweden's primary measure of fiscal position became the general government
financial balance. EU member countries must comply with the Growth and
Stability Pact. Under the Pact, countries agree to support the economic
growth and stability of the Union, by, among other things, keeping
government budgets close to balance and maintaining low levels of debt.
The EU assesses compliance with the balanced budget requirement using a
general government financial balance measure because it includes all
levels of government activity allowing for better comparisons across
countries. Consequently, Sweden chose this measure as its primary measure
of fiscal position.

However, when planning the budget the government also focuses on the
expenditure ceiling. The overall expenditure ceiling includes central
government spending as well as the public pension system. Until the recent
focus on the general government financial balance, Sweden's pension system
was considered separately from the rest of the central government budget.
The pension system funds are still accounted for separately from central
government revenues, and surpluses accumulating in the pension system are
invested in marketable securities, i.e., they are not used to reduce the
government's public borrowing needs. 

Sweden's Fiscal Policy in the 1970s, 1980s, and 1990s 

Sweden's public expenditures, taxes, and deficits all increased at a
significant rate throughout the 1970s as the government reacted to an
economic slowdown by attempting to use fiscal policy to stimulate the
economy and reduce unemployment. By 1982, public expenditures totaled
about two-thirds of the economy, up dramatically from less than 45 percent
in 1970. Revenues also grew at a rapid rate during this period-increasing
from about 48 percent of GDP in 1970 to about 58 percent of GDP in 1982.
(See figure 34 for expenditures and revenues as a percent of GDP from 1970
to 1998.) As rapidly as revenues grew, they did not grow fast enough to
offset rapidly increasing expenditures, and very large deficits emerged by
the early 1980s. In 1982, the central government's deficit stood at nearly 
10 percent of GDP.

Figure****Helvetica:x11****34:    Expenditures and Revenues as a
                                  Percentage of GDP in Sweden, 1970 to
                                  1998
*****************

*****************

Sources: OECD Economic Outlook 42, December 1987 and OECD Economic Outlook
65, June 1999.

Beginning in 1982, a newly elected government enacted an economic and
fiscal reform package aimed at improving economic performance and reducing
the budget deficit. The government's efforts were largely successful
leading to an economic recovery, which lasted until 1990. As a result, the
budget reached surplus from 1987 until 1990. During this surplus period,
the government's fiscal policy was generally neutral as attempts to
tighten fiscal policy to slowdown an overheating economy failed to garner
support in Parliament. Beginning in 1990, the Swedish economy entered its
worst economic slowdown since the 1930s, with economic growth falling by
about 5 percentage points from 1991 to 1993 and the unemployment rate
reaching record levels. The economic slowdown was a major factor
contributing to a substantial deterioration in public finances during this
period. From 1990 to 1993, Sweden's budget went from a surplus of about 
4 percent of GDP to a deficit of more than 12 percent. The large deficits
resulted in an explosion of government debt, with general government gross
debt nearly doubling as a percentage of GDP from 1990 to 1994. 

In reaction to the crisis, Sweden's main fiscal objective changed during
the mid-1990s from a focus on maintaining full employment to a focus on
reducing budget deficits and stabilizing debt as a share of GDP. Sweden
put in place an austere deficit reduction program in fiscal year 1994-95
with spending reductions and revenue increases totaling about 7 percent of
GDP through 1998. Sweden also overhauled its budget process with the aim
of constraining spending. These efforts played a critical role in Sweden's
ability to eliminate budget deficits. In 1998, Sweden ran a small surplus
and now projects surpluses for the next 3 years. Sweden's current stated
fiscal goal is to run surpluses of 2 percent of GDP, on average, over the
economic cycle. 

The government has also made reforms aimed at improving its long-term
fiscal health. During the mid-1990s, Sweden overhauled its public pension
system when it became apparent that the system was unsustainable and would
run out of money early next century. Sweden's pension system is run
separately from central government finances-tax revenues go directly to
the pension system and excess monies are invested in stocks and bonds
through one of several government-managed funds. Consequently, the pension
reform debate occurred separately from the general budget debate, and
prior to any debate about the need for surpluses.

1982 Through 1987: A Period of Deficit Reduction 
-------------------------------------------------

Sweden began the early 1980s in the midst of fiscal and economic crisis.
Sweden's public sector had grown throughout the 1970s to account for about
two-thirds of the economy in 1982, the largest proportion among developed
economies at that time. However, the increase in expenditures throughout
the late 1970s was not matched by an increase in revenues, and large
budget deficits developed, peaking at about 7 percent of GDP in 1982.
Government debt also grew rapidly during the late 1970s and early 1980s,
reaching its peak of about 67 percent of GDP in 1984. By the early 1980s,
Sweden was experiencing slow growth, high inflation, and rising
unemployment.

Against this backdrop, a newly elected Social Democratic government came
to power in 1982 and enacted a comprehensive economic stabilization
program in an attempt to address concerns over economic underperformance
and persistent budget deficits. The first step in the stabilization
program was a devaluation of the currency to make Swedish exports more
cost competitive and boost economic growth by increasing exports.
Secondly, the government attempted to reduce the budget deficit by
reducing expenditures gradually as the economy recovered. The economy did
pick up beginning in 1982, but the deficit initially worsened as the
devaluation increased the interest costs of the government because a large
portion of its debt was denominated in foreign currencies./Footnote9/
Also, the government initially increased spending in an attempt to limit
the negative economic effects of the devaluation and to fulfill campaign
promises. Finally in 1983, the government proposed a deficit reduction
program containing both spending cuts and tax increases. 

Over the next 3 years, the government continued to focus fiscal policy on
reducing the size of public expenditure and debt. From 1982 to 1986, the
general government financial deficit was reduced from 7 percent of GDP to
about 1 percent of GDP, primarily due to spending restraint and aided by
an improving economy. For example, interest payments were reduced in 1985
due to a depreciation in the U.S. dollar-nearly one half of Swedish public
debt at that time was denominated in U.S. dollars. 

The government's economic stabilization package led to a rapidly improving
economy, which also contributed to improving budget figures. For example,
the 1982 currency devaluation increased the price competitiveness of
Swedish exports and led to a temporary increase in exports. Also, the
government's deregulation of the credit markets made credit more readily
available to consumers and businesses. As a result, consumers increased
their borrowing leading to increased growth as borrowed money was used for
consumption and investment spending, especially in real
estate./Footnote10/ The growing economy, coupled with the cuts in
spending, greatly improved Sweden's fiscal position, and it achieved a
budget surplus in 1987 and in the next 3 years.

1987 Through 1990: A Period of Surpluses
----------------------------------------

Sweden achieved budget surpluses for 4 years beginning in 1987 largely as
a result of the booming economy and deficit reduction efforts. During this
period, Sweden did not have an explicit policy for sustaining surpluses,
as fiscal policy was focused on maintaining full employment and
controlling inflation. Under such a regime, fiscal policy would be
tightened-i.e., taxes raised or spending cut-during periods of
inflationary growth.

However, during the surplus period, the government's fiscal policy varied
from year to year as a lack of political consensus halted most attempts to
tighten fiscal policy. With the arrival of surpluses in 1987, the
government continued with its attempts to tighten fiscal policy, and in
1988 the government's fiscal policy was broadly neutral. In an attempt to
tighten fiscal policy in its fiscal year 1989-90 budget, the government
proposed an increase of 2 percent in the value-added tax (VAT). However,
the minority government was unable to develop enough support for its
passage. Instead, Parliament passed a temporary compulsory savings scheme
as part of a more limited attempt to tighten fiscal policy. By 1990, the
economy was beginning to weaken, and in 1991 the budget went back into
deficit where it remained for 7 years. 

1991 Through 1998: A New Focus for Fiscal Policy
------------------------------------------------

In the early 1990s, Sweden experienced its worst recession since the
1930s. In 1991, the government enacted a tax reform package that lowered
marginal rates and eliminated certain deductions, including the consumer
interest deduction. As a result, consumer spending slowed dramatically as
the cost of borrowing became more expensive despite the income tax cuts.
Also, a loss of confidence in the Swedish currency led to downward
pressure on its value, which the government initially tried to defend. The
central bank raised overnight interest rates to over 500 percent, a record
high for any country at that time. However, the high interest rates
further slowed the economy, and consumer confidence declined as the
efforts to defend the currency were unsuccessful. GDP growth turned
negative from 1991 through 1993 and unemployment jumped from 2 percent in
1990 to 
7.5 percent in 1993. These economic events had a significant impact on the
fiscal policy of the 1990s and reinforced the need to maintain fiscal
discipline.

During the initial stages of the economic crisis, the government focused
its fiscal policy on reviving the economy by increasing spending and
addressing specific crises such as the near failure of several large
banks. Because monetary policy was focused on defending the currency,
interest rates were raised significantly, acting to slow the economy and
working against the government's attempts to stimulate the economy through
fiscal policy. The economic slowdown and large jump in unemployment had a
severe impact on the budget, mostly due to the large size of the
government as a share of the economy. Sweden has a generous social welfare
system and spending increases rapidly when the economy slows. During the
early 1990s, outlays increased rapidly, from about 59 percent of GDP in
1990 to over 70 percent in 1993. Also, tax receipts fell from over 63
percent of GDP in 1990 to about 59 percent in 1993 due primarily to lower
than expected receipts from the 1991 tax reform and a change in the
composition of GDP toward areas with lower tax rates./Footnote11/ As a
result of increasing expenditures and falling revenues, Sweden's budget
deficit peaked at over 12 percent of GDP in 1993. Debt also increased
during this period with gross debt nearly doubling from 1990 to 1994,
where it peaked at over 80 percent of GDP. (See figure 35 for Sweden's
debt level from 1981 to 1998.)

By 1993, the focus of fiscal policy had changed from stimulating the
economy and maintaining full employment to bringing the budget back under
control by lowering deficits and stabilizing debt. In April of 1993, the
government announced a deficit reduction package which amounted to about 5
percent of GDP and included reductions in subsidies for medical and dental
care, indexation of certain taxes, and increased contribution rates for
the unemployment benefit system.

Figure****Helvetica:x11****35:    General Government Gross Financial
                                  Liabilities in Sweden, 1981 to
                                  1998
*****************

*****************

Note: Number for 1998 is an estimate. 

Sources: OECD Economic Outlook 63, June 1998 and OECD Economic Outlook 65,
June 1999.

With a stagnant economy and a deteriorating fiscal position, a real sense
of crisis permeated the 1994 elections. Nearly all political parties put
forth plans to bring deficits under control and revive the economy. This
was a major change in focus from past elections where parties generally
focused on proposing new initiatives that would lead to spending
increases. The Social Democrats were returned to power after 3 years out
of office and immediately began to implement a deficit reduction program.
Their stated fiscal policy was to balance the budget by 1998 and to
stabilize debt as a percentage of GDP. To accomplish this goal, the
government presented a series of deficit reduction packages, with
expenditure reductions accounting for about 60 percent of the improvement
and revenue increases accounting for the other 40 percent. These measures
were projected to total about 7.5 percent of GDP by 1998.

New Budget Process Designed to Control Spending
-----------------------------------------------

To support its deficit reduction effort, the new government overhauled the
budget process. Under the new process, the government established a 
top-down approach whereby it set aggregate spending levels before any
programmatic initiatives were proposed. Under the new process, Parliament
enacted an aggregate expenditure ceiling and ceilings for 
27 spending categories for the current budget year and the next 2 years.
The expenditure ceilings were set on a rolling basis, with a new ceiling
set for the third year only. Sweden's expenditure ceilings are noteworthy
because they cover entitlement programs, such as social
security./Footnote12/ 

Several experts we spoke with felt the new budget process was a critical
factor in Sweden's fiscal improvement. The multi-year expenditure limits
have been particularly important because they make it difficult to
increase spending if the budget improves more than forecast. This is
especially important as Sweden enters a new period of budget surpluses. 

Government Sets Goal for Surpluses to Reduce Debt and Maintain Investor
Confidence
---------------------------------------------------------------------------

The government has surpassed its fiscal goals due in large part to a
stronger than expected economy. In 1996, when it became apparent that
Sweden would achieve balance sooner than expected, the government
established a new fiscal policy goal to run surpluses after 1998. In 1997,
the government defined its long-term goal as running surpluses of 2
percent of GDP, on average, over the business cycle-surpluses would
gradually increase after 1999, reaching 2 percent of GDP in 2001. The
government's primary reason for wanting to run surpluses was to reduce the
debt level which shot up dramatically in the early 1990s. Also, the
government wishes to maintain investor confidence in its fiscal and
economic policies. By running surpluses, the government hopes to increase
its future fiscal flexibility should another crisis materialize. The
economic and fiscal crisis of the early 1990s has continued to
significantly affect policymakers, resulting in a general consensus on the
need for continued surpluses. Nonetheless, there has been some
disagreement over how big surpluses should be and how extra surpluses
should be used. Several political parties have called for smaller
surpluses and have proposed using them for tax cuts or spending increases. 

The budget process reforms enacted to support deficit reduction efforts
have continued to play an important role in shaping fiscal policy
decisions as Sweden has entered a period of surplus. The government
established expenditure ceilings for 1998 that would enable it to achieve
the goal of a surplus of 2 percent of GDP by 2001. However, due to
continued strong economic growth, and other technical factors, they have
achieved their surpluses sooner./Footnote13/ As larger than expected
surpluses have developed, the government has reiterated its commitment to
the previously enacted expenditure ceilings. At the same time it has been
able to increase spending somewhat because of the way the expenditure
ceilings work. Under Sweden's new budget process, all open-ended
appropriations-mostly to entitlement programs-were abolished, making all
expenditures subject to annual reviews. To provide a buffer against
forecasting errors in these programs, the government built a (r)budget
margin(c) into the expenditure limits. Thus, to the extent economic and
budget forecasts turn out to be accurate or better than expected, the
government can increase spending up to the amounts allowed under the
expenditure ceilings./Footnote14/ Since the expenditure ceilings have been
in place, the economy has outperformed the forecasts, freeing up
additional room for spending. 

More recently, the government has proposed spending cuts to remain beneath
the expenditure ceiling. In April 1999, the government proposed spending
cuts for savings of about 7.7 billion kronor in 1999 and nearly 
9 billion kronor in 2000.

By remaining committed to the expenditure ceilings, the current debate
over surpluses has been limited to debt reduction and/or tax cuts. The
fiscal year 2000 budget projects that surpluses will exceed 2 percent of
GDP in the year 2000, 1 year prior to the original plan. As a result, the
government has proposed tax cuts as part of its fiscal year 2000 budget.
Specifically, the government has proposed income tax cuts worth about 
10 billion kronor in fiscal year 2000 as well as reductions in some
property taxes. 

Sweden Has Acted to Address Long-term Fiscal Pressures

Like many other western economies, Sweden faces fiscal pressures
associated with an aging population. However, Sweden has taken steps to
address some of these pressures by redesigning the state pension system
from a pay-as-you-go defined benefit system, to a partially funded,
defined contribution system./Footnote15/ Further, the new system is
designed to allow for changes in longevity and economic performance by
adjusting benefits accordingly-making it essentially a self-sustaining
system. Sweden also provides comprehensive health coverage for its
citizens, but the impact of an aging population is unclear. 

Sweden's pension reform occurred in large part due to perceptions that the
system was unsustainable in the long run and was forecast to run out of
money early next century. Debates about Sweden's pension system have
traditionally been separate from budget debates because the system has
been "off-budget." This has been the case even though the pension system
has run annual surpluses since its inception. These funds have been
invested in several bond and stock funds and as a result have not been
available to offset other government spending.

Conclusion

Over the past two decades, Sweden has experienced two periods of budget
surpluses, coinciding with its two periods of strong economic growth.
During its first period of surplus, Sweden had no clear policy related to
sustaining the surplus. Attempts were made to tighten fiscal policy during
this period, but political consensus was difficult to reach. 

Sweden experienced a severe economic downturn in the early 1990s and as a
result has implemented a number of economic, fiscal, and institutional
reforms. Sweden enacted a large deficit reduction program, changed the
role of the central bank and monetary policy, redesigned its budget
process, and reformed its pension system. As a result of these changes,
and an improving economy, the budget has moved back into surplus, debt has
been reduced, and the government has established a goal for surpluses
equal to 2 percent of GDP.

--------------------------------------
/Footnote1/-^In 1995, Sweden changed its measure of fiscal position to a
  general government measure, which includes not only the central
  government's fiscal position, but also the fiscal position of local
  governments and its public pension funds. Prior to 1995, budget figures
  refer primarily to the central government budget. The fiscal surplus was
  positive for both the central and general government in 1987-1990.
  Sweden has also changed its fiscal year from July 1 to January 1; 1997
  was the first budget year to coincide with the calendar year. 
/Footnote2/-^General government financial balance includes the financial
  balance of the federal government, the public pension system, and local
  government. 
/Footnote3/-^A party must gain at least 4 percent of the national vote to
  qualify for representation.
/Footnote4/-^Governments may call for an election between regularly
  scheduled elections, with the results of a mid-term election remaining
  in effect only until the next scheduled election.
/Footnote5/-^G****ITCCentury Book:x9a****ran Persson was appointed Prime
  Minister in March 1996 after Prime Minister Ingvar Carlsson resigned as
  leader of the Social Democrats.
/Footnote6/-^Sweden's government set borrowing and lending ceilings in an
  attempt to control credit growth.
/Footnote7/-^Interest payments were deductible from income taxes, which,
  combined with high marginal tax rates and a relatively high inflation
  rate, led to a negative real rate of interest for many borrowers.
/Footnote8/-^However, the ceilings have been adjusted for technical
  reasons. For example, with the introduction of the new pension system,
  ceilings were adjusted since pension fees were to be paid on transfers.
  The fiscal balance for the general government was not affected by this
  change. The ceilings have not been changed due to inability to contain
  spending.
/Footnote9/-^Interest payments on foreign denominated debt must be made in
  that currency. Consequently, a devaluation in the Swedish krona made
  these payments more expensive.
/Footnote10/-^Interest on consumer loans was tax deductible in Sweden at
  the time. With high marginal tax rates and a high rate of inflation,
  many borrowers were able to borrow at a negative real interest rate.
/Footnote11/-^Tax receipts also dropped for technical reasons. For
  example, employers' social security contributions for sickness benefits
  were reduced.
/Footnote12/-^If the expenditure ceiling for an entitlement program is
  exceeded in any year, it will not necessarily result in benefits being
  cut off. Rather, the spending ceiling for entitlement programs, in
  effect, acts as an early warning system. The government closely monitors
  spending in these areas throughout the year, and when cost overruns
  become apparent, a decision must be made to find extra funds from other
  categories, cut benefits, or raise the ceiling. 
/Footnote13/-^For example, in 1998, the government incorporated the
  National Pension Fund's real estate holdings, which resulted in an
  upward adjustment of the financial balance due to government accounting
  rules.
/Footnote14/-^If budget or economic forecasts turn out to be overly
  optimistic, then the government would presumably be forced to take
  action to stay within expenditure limits by cutting spending. There is
  some additional flexibility to borrow against future year expenditures.
/Footnote15/-^Sweden also provides a basic pension, available to all
  eligible citizens regardless of earnings, financed out of general
  revenues.
During the late 1980s, the forecast period was 4 years--the budget year
plus 3 years. In the fiscal year 1992-93 budget, the Conservative
government extended its forecast period to 

UNITED KINGDOM
==============

The United Kingdom experienced a 4-year period of budget surpluses from
fiscal years 1987-88 through 1990-91./Footnote1/ The government's fiscal
strategy never called for running surpluses, and the arrival of surpluses
was unexpected. Once surpluses materialized, the government planned to
gradually bring the budget back into balance. In accordance with this
policy of phasing out surpluses and given the economic forecasts at the
time, the government cut taxes substantially and increased spending. These
forecasts proved to be overly optimistic and, in the early 1990s, the
economy slipped into recession. This combination of tax cuts, additional
spending, and slower growth led to a deterioration in the United Kingdom's
fiscal position. Deficits reemerged in fiscal year 1991-92 and grew
rapidly over the next 2 years, hitting a peak of over 7 percent of GDP in
fiscal year 1993-94. Consistent with the goal of a balanced budget, the
Conservative government adopted major tax and spending measures to reduce
the deficit. The combination of these policies-which have been continued
under the current Labor government-with a strong economy has brought the
United Kingdom's budget back into a small surplus position in fiscal year
1998-99. (See figure 36.)

Figure****Helvetica:x11****36:    Surpluses/Deficits in the United
                                  Kingdom, 1980-81 to 1998-
                                  99
*****************

*****************

Note: The surplus/deficit measure is the Public Sector Net Cash
Requirement (PSNCR).

Source: The United Kingdom Treasury Department.

The Labor government that took office in 1997 developed a new framework
for fiscal policy intended to prevent a return to the kind of severe "boom
and bust" fiscal cycle that occurred in the late 1980s and early 1990s.
The government enacted a statute requiring a Code for Fiscal Stability,
which sets out the framework for developing fiscal strategy. As required
by the Code, the current government has stated that its fiscal policy will
be guided by two rules: (1) the "golden rule," under which borrowing will
not be used to finance current spending (i.e., total spending excluding
investment); and (2) the "sustainable investment rule," which promises to
keep net public debt as a share of GDP at a "stable and prudent" level.
Both rules are to be applied over the economic cycle, allowing for fiscal
fluctuations based on current economic conditions. Under these rules, the
government's fiscal policy allows for deficits to be used to finance
investment spending, provided that the debt burden is maintained at a
sustainable level.

Background

The United Kingdom is a unitary state composed of England, Scotland,
Wales, and Northern Ireland. The United Kingdom has two main levels of
government: the central government and local authorities. The central
government is the dominant fiscal decision-maker with direct or indirect
control over most government revenue and spending, while local authorities
are primarily responsible for service delivery in education, housing, and
social services./Footnote2/

The government is a parliamentary system, with a Parliament composed of
two chambers-the House of Lords and the House of Commons. The House of
Lords (approximately 1,300 members) has limited powers in the legislative
process and virtually no power on budget matters. The House of Commons
(659 members) is elected and is responsible for the passage of legislation
and scrutiny of public administration. The government is headed by a Prime
Minister, who is the leader of the majority party in the House of Commons,
and an appointed Cabinet of about 20 members, who are also Members of
Parliament.

A general election is held at least once every 5 years. Two parties have
long dominated British politics: the Labor Party and the Conservative
Party. The current Labor government, headed by Prime Minister Tony Blair,
was elected in 1997. Labor has a large legislative majority with 415 seats
to the Conservatives' 162 seats./Footnote3/ Prior to Labor's electoral
victory in 1997, the Conservatives had held power since 1979. The
Conservative governments were led by Prime Minister Margaret Thatcher from
1979 to 1990 and Prime Minister John Major from 1990 to 1997.

The United Kingdom's Economy
----------------------------

The United Kingdom's economy is less than 16 percent of the size of the
United States' economy. The United Kingdom is more dependent on trade than
the United States, with exports accounting for over 22 percent of GDP in
1996-compared to about 8.5 percent for the United States.

Recent Economic History

Over the past two decades, the United Kingdom has experienced periods of
both deep recession and robust growth. After recovering from a major
recession between 1979 and 1981, the economy grew at an annual average
rate of more than 3 percent in real terms for nearly a decade. Growth was
especially robust in the late 1980s. However, inflation, which had fallen
significantly from double-digit levels in the early 1980s, began to show
signs of rising. During 1988 and 1989, the government responded to the
growing inflationary pressure by imposing a series of interest rate hikes.
In 1990, the economy went into a recession that lasted until 1992. The
economy began to recover in the second half of 1992 and has continued to
expand since then. (See figure 37.)

Figure****Helvetica:x11****37:    GDP Growth in the United Kingdom, 1980
                                  to 1998
*****************

*****************

Source: The United Kingdom Office of National Statistics.

The economy often has a powerful impact on a government's finances. For
example, recessions typically reduce a government's tax revenues while
increasing spending on programs like unemployment insurance. During the
past two decades, changes in the United Kingdom's fiscal position have
closely followed the economic cycle. Deficits gave way to surpluses during
the 1980s expansion. Then, with the onset of the recession in the early
1990s, deficits reemerged before steadily declining in tandem with the
sustained economic growth of the mid- to late 1990s.

Controlling inflation has been the chief goal of monetary policy over the
past two decades. Until 1997, monetary policy was under the control of the
government. When the Labor Party assumed power in 1997, it delegated the
power to set interest rates to the Bank of England-the United Kingdom's
central bank. Under this system, the Government sets an inflation target
that the Bank has to achieve and the Bank's Monetary Policy Committee
decides how to meet the target. 

The Budget Process 
-------------------

The governing political party effectively controls the entire budget
process. Spending and tax decisions are made primarily within the Treasury.

Under the previous Conservative government, the Treasury controlled budget
resources by setting targets for total spending and establishing cash
limits for specific programs. The broad spending target, known as the
Control Total, covered about 85 percent of the budget. It excluded
interest, privatization proceeds, and the portion of social security
directly affected by the economic cycle (e.g., spending for unemployment
compensation). Within the Control Total, specific cash limits were set for
individual programs. Spending plans were made for a 3-year period but were
reviewed annually. A reserve fund controlled by the Treasury was included
in the spending total and departments were allowed to request funds from
the reserve to cover program spending in excess of the cash limits.

The current Labor government has modified the budget planning process.
Under the new system, spending is split into two categories with separate
control mechanisms. Each category covers about 50 percent of total
spending. The first category is subject to Departmental Expenditure Limits
(DELs), which are set for 3 years and, unlike in the previous process,
will generally not be reviewed annually. The second category of spending
is referred to as Annually-Managed Expenditure (AME) and covers spending
that is more difficult to control. Its largest components are social
security benefits, interest, and local government expenditure. Spending
covered by AME will be subject to annual review and considered as part of
total spending for purposes of meeting the government's fiscal goals. The
budget still has an annual reserve, but it is significantly smaller than
in the past. This reserve is intended more for emergency spending than as
a source of supplemental funds for agencies. 

Another process change under the Labor government is the greater emphasis
given to distinguishing between current and capital spending. For spending
that is subject to DELs, there are separate current and capital limits.
The government also plans to adopt a form of accrual budgeting, called
Resource Accounting and Budgeting (RAB), that the previous government
originally proposed in the mid-1990s. RAB is being adopted to improve the
measurement of the costs of government activities and to clarify the
distinction between current and capital spending.

Measuring Fiscal Position
-------------------------

Prior to 1998, the main measure of the surplus/deficit was the public
sector net cash requirement (PSNCR), referred to at the time as the public
sector borrowing requirement (PSBR). The PSNCR includes receipts and
expenditures at all levels of government, including privatization
proceeds, and is similar to the United States' unified budget.
Privatization proceeds provided an additional source of revenue during the
1980s and part of the 1990s. The Conservative governments often presented
their fiscal projections with and without privatization proceeds. 

Under the Labor government, the Treasury has switched to public sector net
borrowing (PSNB) as the main overall budget measure./Footnote4/ PSNB
differs from the PSNCR by excluding privatization proceeds and other
financial transactions./Footnote5/ While these measures have varied
substantially in the past, Treasury projects that they will be very
similar over the next several years, with differences ranging from 0.1 to
0.4 percent of GDP. The PSNB measure is a comprehensive measure of revenue
and spending. It includes, for example, local government and capital
spending budgets. In 1998, the government changed its budget measurement
to conform to the 1995 European System of Accounts in order to facilitate
comparisons with other European Union countries. The effect of this change
was to slightly raise projected PSNB over the 5-year forecast period.

In addition to the PSNB measure, the Treasury also emphasizes the
"current" surplus/deficit and the public sector net debt to GDP ratio,
which are used to assess performance against the golden rule and the
sustainable investment rule respectively./Footnote6/ PSNB is equal to the
current surplus/deficit minus net investment spending./Footnote7/ The
public sector net debt to GDP ratio is used to monitor the government's
progress at keeping the debt burden under control. 

Fiscal History of the United Kingdom, 1980s and 1990s

The United Kingdom experienced persistent budget deficits from the mid-
1970s to the mid-1980s. Beginning in 1979 when a new government came to
power, deficit reduction efforts combined with several years of strong
economic growth led to a 4-year period of surpluses beginning in fiscal
year 1987-88. The government's fiscal policy during its surplus period was
a gradual return to balance. A recession beginning in 1990 led to a return
to budget deficits, which grew quickly, peaking at 7 percent of GDP in
fiscal year 1993-94. The government responded with renewed efforts to
reduce budget deficits. A new government came to power in 1997 and
continued the previous government's deficit reduction efforts, leading to
a small surplus in fiscal year 1998-99. This government has put in place a
new framework to guide fiscal decision-making. Under this framework, the
government has set as its fiscal policy to increase investment spending
without increasing the debt burden. 

Deficit Reduction Efforts Plus Strong Economic Growth Led to Budget
Surpluses in the Late 1980s and Early 1990s
---------------------------------------------------------------------------

From the mid-1970s to the mid-1980s, the United Kingdom experienced a
period of persistent budget deficits. When Margaret Thatcher's
Conservative government came to power in 1979, it emphasized a commitment
to lower deficits, spending restraint, and a reduced tax burden. After
substantial deficit reduction efforts and several years of solid economic
growth, the United Kingdom reached surplus in fiscal year 
1987-88.

The success of deficit reduction was due primarily to spending restraint,
although increased revenue also contributed. (See figure 38.) During the
decade, annual real growth in total spending averaged 1.3 percent-a
significant drop from the average 1970s level of 3.3 percent. Program
spending was cut in the areas of transportation, trade and industry, and
housing. Investment spending was scaled back significantly, as was the
public sector workforce. The government also reduced its current and
future pension expenditures by changing the indexing of the basic benefit
from wages to prices and cutting future benefits in the earnings-related
pension program. While revenue declined as a share of GDP during the
1980s, increased revenue from tax changes, economic growth,
privatizations, and oil revenue all contributed to the success of deficit
reduction./Footnote8/

Figure****Helvetica:x11****38:    Receipts and Expenditures in the United
                                  Kingdom, 1980-81 to 1995-
                                  96
*****************

*****************

Source: United Kingdom Treasury Department.

The economy was growing rapidly when the budget entered surplus-over 
4 percent per year from 1986 through 1988. According to recent estimates,
this growth caused the United Kingdom's economy to exceed the level of
output estimated to be consistent with stable inflation. The United
Kingdom was experiencing an economic boom. Wages and salaries were growing
rapidly, housing prices were soaring, and personal savings were declining.
These factors helped drive substantial growth in consumption. Imports also
increased at a fast pace, propelling the trade balance into
deficit./Footnote9/

Government Aimed to Gradually Phase Out Budget Surpluses
--------------------------------------------------------

When the first surplus materialized, the government adjusted its fiscal
strategy from a focus on deficit reduction to attempting to gradually
phase out surpluses. For example, in the 1988-89 budget, the first budget
prepared during the surplus period, the government adopted a goal of
balancing the budget over the medium term, which meant phasing out the
surplus. The government explained its goal as follows: "[A balanced
budget] is a prudent and cautious level and can be maintained over the
medium term. It also provides a clear and simple rule, with a good
historical pedigree."

The fiscal year 1988-89 budget projected that after a small surplus in
1988-89, the medium-term goal of balance would be reached in the following
year and maintained over the rest of the forecast horizon./Footnote10/
However, the 1988-89 surplus turned out to be much larger than expected,
and in the fiscal year 1989-90 budget the government anticipated a more
gradual elimination of surpluses over several years. However, as the
economy slowed and slipped into recession, the surplus decreased more
rapidly than expected. Beginning with the 1989-90 budget, the Treasury's
estimates were consistently too optimistic. (See figure 39.) By fiscal
year 1990-91, the budget had returned to approximate balance, and deficits
reemerged the following year.

Figure****Helvetica:x11****39:    Projected Surpluses/Deficits and Actual
                                  Results in the United Kingdom, 1986-87
                                  to 1993-94
*****************

*****************

Note: Surplus/deficit measure is the public sector net cash requirement.

Source: United Kingdom Treasury Department.

Because of the government's policy to return to balance, the political
debate during the surplus period focused not on whether to run surpluses
but on how to use extra resources for new policy initiatives. The
opposition Labor Party favored more spending on health and social
services. However, the government chose to cut taxes significantly while
also allowing for some increased spending. The government's spending
increases were allocated for priority areas such as health, law and order,
defense, education, roads, and the disabled. In general, however, spending
was decreasing as a percent of GDP-from about 41 percent in fiscal year 
1987-88 to about 39 percent in 1990-91. These policy changes in the late
1980s supported the government's goal of phasing out budget surpluses, but
they also contributed to the large deficits that unexpectedly emerged in
the early 1990s. The following is a year-by-year summary of the major
budget actions during the United Kingdom's surplus era. 

Fiscal Year 1988-89 Budget

Tax-cutting was an important priority for Prime Minister Thatcher's
government, and it continued to dominate the fiscal agenda during the
surplus period of the late 1980s. The fiscal year 1988-89 budget
introduced tax cuts with a first-year impact of about ****Char Pound****4
billion, around 1 percent of GDP./Footnote11/ The tax cut package mainly
consisted of reductions in personal income taxes with a cut in the lowest
marginal rate from 27 percent to 
25 percent and in the top rates to a maximum of 40 percent. 

The budget clearly spelled out the expected impact of tax cuts on the
government's fiscal position. The budget estimated that the surplus would
be about ****Char Pound****7 billion for fiscal year 1988-89 without the
tax cuts and about 
****Char Pound****3 billion in 1988-89 with them. The government explained
the remaining surplus by saying it could have chosen to cut taxes by a
larger amount, but that because of its gradualist approach to fiscal
policy, "only part of [the] room for tax reductions has been
used."/Footnote12/ 

On the spending side of the budget, the government's main goal throughout
the 1980s and 1990s was to reduce total spending as a share of GDP. Since
the early 1980s, spending as a share of GDP had fallen substantially and
the 1988-89 budget supported a continuation of this trend, referring to
continued spending restraint as "a vital element of the government's
economic strategy." Real (inflation-adjusted) spending-excluding
privatization proceeds-was projected to grow by less than 1 percent per
year from fiscal years 1986-87 through 1990-91./Footnote13/ At the same
time, the budget provided some increased spending for priority services
such as health, law and order, defense, education, and capital investment.
These increases could be made while meeting the government's objective of
reducing spending as a share of GDP in part because, as GDP expanded
rapidly, reduced interest payments on the debt helped restrain spending
growth. 

Fiscal Year 1989-90 Budget

The fiscal year 1989-90 budget was prepared during what, in retrospect,
turned out to be the high water mark of the surplus period. The 1988-89
surplus came in at about 3 percent of GDP-compared to a projected
borrowing requirement of 1 percent of GDP. This surprising fiscal
performance can be explained by 3 main factors: (1) a strong economy that
resulted in rapid revenue growth and lower spending for income support
programs, (2) higher-than-expected inflation, which also boosted
revenues,/Footnote14/ and (3) a high volume of privatization proceeds.
This favorable position suggested to policymakers that surpluses were more
persistent than earlier anticipated, and they budgeted accordingly. While
the overall goal of phasing out the surplus and balancing the budget
remained the same, the 1989-90 budget projected a surplus of similar size
to the previous year-about 3 percent of GDP-with smaller surpluses through
the 1992-93 fiscal year.

Budget plans for the 1989-90 fiscal year were consistent with the
government's goals of cutting taxes and reducing spending as a share of
GDP. The main tax changes were cuts in National Insurance Contributions
and, for that year, non-indexation of most excise taxes./Footnote15/ The
total tax package was estimated to cost about ****Char Pound****2 billion
in the first year, about 
0.5 percentage points of GDP. Spending plans again called for restraint,
with the budget projecting a continuing decline in spending as a
percentage of the economy.

Fiscal Year 1990-91 Budget

The actual fiscal year 1989-90 surplus was only 1.4 percent of GDP-roughly
half as large as anticipated. While the economy had already begun to slow
in 1989, this was not a major driver of the smaller surplus since revenue
collections, particularly for corporate taxes, are subject to a time lag.
Rather, the shrinking surplus stemmed from lower privatization proceeds,
higher capital spending by local authorities, and a greater number of
people switching to private pensions than expected, which reduced National
Insurance Contributions./Footnote16/ 

The fiscal year 1990-91 surplus was projected to be about 1.3 percent of
GDP, approximately the same size as the fiscal year 1989-90 surplus.
Compared to the prior two budgets, tax initiatives were relatively modest
and were projected to result in a net increase in revenues. Spending was
expected to grow at the same rate as the economy, with additional
resources for priority areas such as health, transportation, the disabled,
and lower income families. For fiscal year 1991-92, a smaller surplus was
projected followed by balanced budgets in the last 2 years of the forecast
horizon. However, with the slower growth of 1989 turning into a recession
in 1990, the actual result for fiscal year 1990-91 was a small surplus,
marking the end of the surplus period. 

The United Kingdom's period of surpluses substantially reduced the
nation's debt both in nominal terms and as a share of GDP. Over the 3
years from fiscal years 1986-87 through 1989-90, the debt declined from 
****Char Pound****172 billion to ****Char Pound****150 billion, and the
debt to GDP ratio dropped from over 
40 percent to less than 30 percent. Along with the declining debt burden,
the government's interest expenditures as a share of total spending fell
from 11 percent to 9 percent.

Large Deficits Appear in Early 1990s
------------------------------------

By the time the fiscal year 1991-92 budget was released, the economy was
clearly in recession, and it was apparent that deficits were back on the
horizon. The government retained its goal of a balanced budget over the
medium term, but now it estimated that this goal would not be reached
again until fiscal year 1994-95, the last year of the projection period.
Actual deficits over the next several years were much higher than the
Treasury's estimates, peaking at more than 7 percent of GDP in fiscal year
1993-94, and the budget did not return to balance until near the end of
the decade. In the 1993-94 budget, the government acknowledged the
worsening situation by projecting that it would not reach a balanced
budget within the forecast period.

Policy decisions interacted with the recession to fuel rising deficits. A
Treasury analysis of spending from fiscal year 1988-89 to 1992-93 found
that policy initiatives were a significant factor in explaining a
substantial increase in real program spending over the period. For
example, the 
1991-92 budget contained cuts in corporate taxes and the 1992-93 budget
cut the basic rate of income tax on a portion of taxable income. On the
spending side, the 1991-92 budget increased the child benefit, which had
been frozen for 4 years, and reestablished a policy of indexing the
benefit to inflation. The fiscal year 1992-93 budget provided increased
spending for health care and transportation. A number of officials and
experts that we interviewed attributed the loosening in fiscal policy in
1991 and early 1992 at least in part to the upcoming general
election./Footnote17/ A statistical analysis conducted by a British think
tank on spending during the period is consistent with this interpretation.

Economic Estimates Presented a Misleading Picture of Fiscal Strength

To explain the deteriorating situation in the early 1990s, it is useful to
start with the perceptions of fiscal strength in the late 1980s. The
surpluses of the late 1980s provided a misleading picture of the United
Kingdom's fiscal condition. With the benefit of hindsight, fiscal analysts
and policymakers with whom we spoke in the United Kingdom generally agree
that the budget surpluses were largely due to the strength of the economy
during what turned out to be the peak period of the business cycle. The
Treasury now estimates that when the United Kingdom realized a surplus of 
3 percent of GDP in fiscal year 1988-89-its largest of the period-the
structural budget was only modestly in surplus. (See figure 40.)

Figure****Helvetica:x11****40:    Actual and Structural Surpluses/Deficits
                                  in the United Kingdom, 1986-87 to 1998-
                                  99
*****************

*****************

Note: Surplus/deficit measure is the public sector net cash requirement.

Source: The United Kingdom Treasury Department.

While the Treasury did produce structural budget estimates in the late
1980s, these estimates were not a major focus of fiscal policy 
decision-making. Officials told us that policymakers did not really
distinguish between cyclical and structural results; instead, they tended
to believe that "a surplus is a surplus." However, even if structural
estimates had been taken more seriously, they might not have helped much
because the estimates made at that time were off the mark. The Treasury,
along with some independent analysts at the time, underestimated the
extent to which the economy was growing above its trend level. So,
according to the projections of the time, it was believed that the United
Kingdom's economy could continue growing steadily without generating an
increase in inflation. This forecasting error was a major reason why,
beginning in the late 1980s, the Treasury's budget forecasts proved overly
optimistic. For example, the Treasury's estimates of real economic growth
were consistently too high during the late 1980s and early 1990s. (See
figure 41.)

Figure****Helvetica:x11****41:    Projections of Real GDP Compared to
                                  Actual Results in the United Kingdom,
                                  1988 to 1994
*****************

*****************

Source: The United Kingdom Treasury Department.

Policy Choices Contributed to Renewed Deficits

In general, policymakers overestimated the strength of the government's
finances. The Conservative government assumed that the surpluses in the
late 1980s largely reflected a structural improvement driven by
sustainable economic growth. This assumption may have contributed to the
decision to enact significant tax cuts. With hindsight, analysts contend
that this decision turned out to be an inappropriate loosening of fiscal
policy. Treasury now estimates that the fiscal year 1988-89 budget with
its substantial tax cuts contributed to a significant increase in the
structural deficit. 

In the early 1990s, increased spending also contributed to a rising
structural deficit. In an analysis conducted at that time, the Treasury
concluded that, from fiscal years 1988-89 through 1992-93, spending growth
rose substantially for most programs. Total program spending grew at an
annual average rate of 3.8 percent during this period compared to less
than 1 percent for the previous 6 years. The analysis concluded that
policy choices contributed to this growth over and above the impact of the
recession. For example, average real growth in health spending of 
4.3 percent during this period reflected policymakers' response to rising
public demand for services. In addition, the government increased
transportation spending by nearly 10 percent per year in real terms,
partly to alleviate road congestion and finance other major investment
projects. 

The Economy's Impact on Fiscal Position

While policy decisions clearly contributed to the growing deficits, the
recession was also a major factor. Estimates of its impact vary. Data from
a recent Treasury analysis suggest that the economic cycle was responsible
for a little more than 50 percent of the deterioration, with policy
choices accounting for the rest. Two earlier studies by other analysts
reached similar conclusions. However, in its 1994 survey of the United
Kingdom, the Organization for Economic Cooperation and Development (OECD)
estimated that the economy was responsible for about two-thirds of the
weakening in the fiscal position.

Privatization Proceeds Also Affected Fiscal Position 

Privatization proceeds also had a noticeable effect on the United
Kingdom's fiscal position during the late 1980s and early 1990s. Revenue
from privatization (which was counted in the budget as negative spending)
peaked as a share of the economy in fiscal year 1988-89 at about 
1.5 percent, dipped in fiscal years 1989-90 and 1990-91, rose
substantially in fiscal year 1991-92 and then began to decline. Given this
path, privatization proceeds did contribute significantly to the period of
surpluses but were only a minor factor in explaining the rising deficits
of the early to mid-1990s. Although the government recognized the one-time
nature of privatization by showing its expenditure projections with and
without privatization proceeds, its fiscal target of a balanced budget
included such proceeds. 

Deficit Reduction in the Mid- to Late 1990s
-------------------------------------------

The government responded to the rising deficits of the early 1990s by
increasing taxes and restraining spending growth. This policy of fiscal
restraint was continued by the Labor government elected in April 1997.
These efforts have succeeded-the deficit has fallen in every fiscal year
since 1993-94-and the budget is now approximately in balance. During this
period, revenue as a share of GDP rose by over 3 percentage points while
spending declined by over 4 percentage points./Footnote18/ An OECD
analysis concluded that the United Kingdom's fiscal progress between 1993
and 1997 is (r)among the most impressive(c) of the OECD's member
countries./Footnote19/ 

The major deficit reduction efforts began with the fiscal year 1993-94 and
1994-95 budgets. Both budgets included significant revenue raising
actions, including a freeze on income tax allowances, increased excise
taxes, and restrictions on mortgage interest relief. These actions are
estimated to have raised revenues by more than 2 percent of GDP. Since
taking power in 1997, the current government has also raised taxes. 

Along with tax increases, the budgets of the mid-1990s contained
substantial spending restraint. Major reductions initiated in these
budgets included a freeze on departmental operating costs (including
salaries) and cutbacks in defense and housing programs. Capital investment
and health care have also been subject to significant spending restraint.
While continuing this policy of keeping total spending in check, the Labor
government has pledged to significantly increase spending on capital
investment and health care. 

The Current Government's Fiscal Policy Is Based on Lessons From Past
Experiences
---------------------------------------------------------------------------

The current government has developed a new framework for fiscal policy
that reflects "lessons learned" from the United Kingdom's past
experiences./Footnote20/ The fiscal strategy emphasizes a greater focus on
the structural budget, a more explicit distinction between current and
capital spending, and firm multi-year spending ceilings that will not be
subject to annual review. The Labor government has also stressed
transparency and openness so that the public can easily evaluate the
government's goals and its progress in meeting them. During the 1997
election, Labor emphasized its commitment to a prudent fiscal policy by
adopting the Conservatives' spending targets for the first 2 years of the
new Parliament and pledging not to raise either the basic or top income
tax rate throughout the full Parliamentary term. However, the Labor
government does not currently call for surpluses as part of its fiscal
policy.

Labor's Code for Fiscal Stability

Labor has established a statutory basis for its fiscal policy approach
with a new law requiring the government to issue a Code for Fiscal
Stability. The law's purpose is to make fiscal decision-making more
transparent and enhance accountability by requiring the government to
present a fiscal strategy and meet certain reporting requirements. The
statute itself is very general, allowing the incumbent government wide
discretion in developing a specific fiscal strategy. The statute lays out
5 principles to guide fiscal policy: transparency, stability,
responsibility, fairness, and efficiency. The statute also requires the
issuance of several reports with details of the government's fiscal plans.

The current Labor government's fiscal strategy is guided by two rules: 
(1) the "golden rule," under which borrowing will not be used to finance
current spending (i.e., total spending excluding investment); and (2) the
"sustainable investment rule," which promises to keep net public debt as a
share of GDP at a "stable and prudent" level. Both rules are to be applied
over the economic cycle, allowing for fiscal fluctuations based on current
economic conditions.

The golden rule is intended to ensure control of public finances while
allowing for deficit financing of capital investment, net of depreciation
and asset sales. The government defines investment as "physical investment
and grants in support of capital spending by the private
sector."/Footnote21/ Investment spending was significantly restrained
under the Conservative government's deficit reduction efforts, and several
people that we interviewed agree that investment needs to be increased.
The Labor government has made boosting public investment a major priority,
proposing to nearly double it as a share of the economy-to 1.5 percent of
GDP-over the course of the current Parliament. A Treasury official told us
that this increase has been viewed as roughly the amount needed to cover
the underfunding of capital over the past several years. 

While investment spending is a priority, the sustainable investment rule
is intended to ensure that financing such spending does not result in an
imprudent rise in debt. According to a Treasury official, the government's
debt to GDP target of less than 40 percent was chosen based on analysis
showing that a net debt to GDP ratio of around 40 percent is sustainable
in the long term. The government has indicated that, other things being
equal, it is desirable to reduce public sector net debt to below 40 percent.

Taking both fiscal rules into account, the Labor government's overall
fiscal policy allows for running small budget deficits. In its fiscal year
1999-2000 budget, the Treasury estimated that the United Kingdom would
register a small surplus for public sector borrowing in fiscal year 1998-
99, and it projected small deficits for the next 5 years.

To help meet its fiscal objectives, the Labor government has completed a
comprehensive assessment of existing programs with plans to conduct
similar reviews every 3 years. This review process is designed to align
existing programs with the government's priorities and generate ways to
improve efficiency. Results of the first review were published in the
summer of 1998. Based on the results, the government has targeted real
growth in current spending at 2.25 percent per year over the remainder of
Parliament's term; the review also called for net investment to double as
a share of GDP. Within the spending total, the government has set 3-year
ceilings for each department with separate ceilings for capital and
current spending./Footnote22/

The current government's fiscal policies have been popular but not without
controversy. For example, Conservative Party officials we met with worried
that under the golden rule it would be easy for the government to redefine
capital spending in order to meet the rule. In addition, they believe that
allowing for borrowing for capital investment is not always prudent
because the financial return on government investments is questionable.
The Conservative Party officials also said the current government ought to
aim to repay or reduce the debt as a percentage of GDP. The officials then
added that the Conservatives' objective would be to balance the budget
over the cycle and bring down the debt as a percentage of GDP.

Incorporating the Economic Cycle Into Fiscal Planning

A sharper focus on the economic cycle is a general feature of the Labor
government's policy that explicitly reflects the lessons learned from the
past. A recent Treasury report explains the importance of taking the cycle
into account. 

"Experience has shown that serious mistakes can occur if purely cyclical
improvements in the public finances are treated as if they represented
structural improvements, or if a structural deterioration is thought to be
merely a cyclical effect. The Government therefore pays particular
attention to cyclically-adjusted indicators of the public sector
accounts."/Footnote23/

Incorporating the effects of the economic cycle into policy planning
requires an estimate of several key variables, including the actual and
trend levels of GDP and the trend rate of GDP growth. Trend growth is an
estimate of the maximum rate at which an economy can grow over the long
term without causing inflationary pressure. Actual and trend growth
estimates are used to prepare an estimate of the structural budget
deficit/surplus, i.e., the underlying condition of the budget adjusting
for the effects of the economic cycle. In the past, the Treasury did
prepare estimates of the structural budget position, but it did not
publish this information. As part of the Labor government's commitment to
greater openness, the Treasury now publishes structural estimates. The
Treasury cautions that while all economic and budget projections are
subject to large errors, estimates of the structural position are even
more tenuous. 

The government states that it uses a cautious assumption for trend
economic growth of 2.25 percent in its budget formulation. To obtain an
independent review, the government asked the National Audit Office (NAO)
to evaluate the trend growth assumption./Footnote24/ The NAO concluded
that the Treasury's assumption for trend growth was reasonable. For an
additional degree of caution in its structural estimates, the Treasury
also presents a more pessimistic projection. This projection assumes that
the economy is further above trend output than in the main estimate,
meaning that future growth will likely be lower as the economy returns to
the underlying trend. 

The United Kingdom's Long-term Outlook
--------------------------------------

The population of the United Kingdom is aging, although at a slower rate
than other major industrial countries. Due to the post-World War II baby
boom and increases in life expectancy, the ratio of workers to retirees in
the United Kingdom is projected to drop from over 3 to closer to 2 between
1998 and 2040. While several analysts that we interviewed expressed some
concern about population aging, they were fairly sanguine about its likely
impact on the government's fiscal situation, especially when compared to
the outlook for other nations. While one factor in the United Kingdom's
comparatively better outlook is slower population aging, another important
reason is the major pension reforms enacted over the past two decades.
These reforms have significantly reduced the government's future
commitments. 

While pension spending appears to be under control, population aging is
expected to increase pressure on health care spending in the future.
According to a Treasury analysis, demographic factors could add about 
0.7 percentage points to the annual growth rate of public health spending,
which accounted for about 5.7 percent of GDP in 1997, over the next three
decades. However, analysts we interviewed from the United Kingdom's
National Health Service told us that they consider population aging to be
a less significant source of future cost pressure than improved technology
and public expectations.

The current Labor government has acknowledged the need to use a 
long-term fiscal outlook to evaluate the sustainability of future policy
and consider intergenerational equity. Specifically, the Code for Fiscal
Stability requires the government to publish budget projections for a
period of at least 10 years. In the March 1999 budget, the Treasury
published 30-year projections that show that current policy is sustainable
under their main assumptions. It is important to note, however, that the
government has recently announced several policies-such as welfare,
pension, and labor market reforms-to help ensure the sustainability of
public finances in the long term. In addition to its own long-term
analysis, the Treasury is supporting research on generational accounts
that is being conducted by the independent National Institute of Social
and Economic Research.

Conclusion

The United Kingdom experienced a period of budget surpluses in the late
1980s and early 1990s that was largely the product of a booming economy.
Upon achieving surplus, the United Kingdom's fiscal strategy was to return
to a balanced budget over the medium term. Influenced by overly optimistic
budget projections, the Conservative government in power at that time
chose to cut taxes substantially and increase spending as part of a
strategy of phasing out budget surpluses. As the British economy slipped
into recession in the early 1990s, the fiscal situation deteriorated
rapidly and large deficits emerged. These deficits resulted from both the
recession and policy choices made during the period. With the benefit of
hindsight, the current Labor government focuses more on the budget's
structural position to adjust for the impact of the economic cycle. The
Treasury now publishes estimates of the budget's structural position and
includes a pessimistic projection along with its baseline forecast to help
convey a sense of the risks involved if budget forecasts prove overly
optimistic. The United Kingdom achieved a small budget surplus in fiscal
year 1998-99 due to deficit reduction efforts and a strong economy. The
government's main fiscal policy is to maintain its net debt to GDP ratio
at a "stable and prudent" level, allowing for some borrowing to finance
capital investments.

--------------------------------------
/Footnote1/-^Unless otherwise noted, the term surpluses/deficits refers to
  the Public Sector Net Cash Requirement (PSNCR), formerly known as the
  Public Sector Borrowing Requirement (PSBR). The United Kingdom's fiscal
  year runs from April 1 to March 31.
/Footnote2/-^The Government is in the process of devolving power to
  Scotland, Wales, and Northern Ireland. Powers were officially
  transferred to the Scottish Parliament and the National Assembly for
  Wales on July 1, 1999. The Northern Ireland Assembly met for the first
  time on July 1, 1998, but the United Kingdom Parliament has not yet
  transferred power to the Assembly.
/Footnote3/-^The number of seats is as of April 1, 1999.
/Footnote4/-^Although it is given less emphasis, the PSNCR is still
  reported. 
/Footnote5/-^Other financial transactions include loans made by the public
  sector and accruals adjustments, which reflect the precise timing of
  payments. 
/Footnote6/-^The net debt measure is net of certain liquid assets.
/Footnote7/-^Net investment excludes depreciation and asset sales.
/Footnote8/-^For further details on the United Kingdom's deficit reduction
  efforts, see Deficit Reduction: Experiences of Other Nations (GAO/AIMD-
  95-30, December 13, 1994), pp. 191-215.
/Footnote9/-^The trade balance is a measure of the difference between a
  nation's exports and imports.
/Footnote10/-^5 years--the budget year plus 4 years. The Labor government
  uses this same forecast period.
/Footnote11/-^The data on tax changes presented in this appendix are
  measured against an indexed tax base. The tax system in the United
  Kingdom is automatically indexed for inflation each year unless
  Parliament decides differently.
/Footnote12/-^Financial Statement and Budget Report 1988-89, HM Treasury
  (United Kingdom), p. 11.
/Footnote13/-^Privatization proceeds are treated as negative spending;
  therefore, these proceeds reduce total spending.
/Footnote14/-^Even in indexed tax systems, higher inflation produces more
  tax revenue because it increases the size of taxable incomes.
/Footnote15/-^The National Insurance Contribution is a payroll tax that
  covers a variety of social programs, including public pensions.
/Footnote16/-^Under the government's 1986 pension reform, workers who
  switch from the public pension system to a private plan receive a rebate
  of part of their National Insurance Contribution. 
/Footnote17/-^The Conservative government under Prime Minister John Major
  was reelected in April 1992.
/Footnote18/-^These changes are based on data that exclude financial
  transactions.
/Footnote19/-^OECD Economic Surveys: United Kingdom, 1998, p. 49.
/Footnote20/-^The new monetary policy framework is also an important part
  of the Labor government's overall economic strategy. Giving control of
  interest rates to the Bank of England is expected to improve the
  prospects for keeping inflation in check and preventing sudden and rapid
  adjustments in interest rates.
/Footnote21/-^Fiscal Policy: current and capital spending, HM Treasury
  (United Kingdom), 1998, p. 7, footnote 2.
/Footnote22/-^As noted earlier, the 3-year limits apply to about half of
  total spending. The other half of spending is reviewed annually.
/Footnote23/-^Stability and Investment for the Long Term: The Economic and
  Fiscal Strategy Report 1998, HM Treasury (United Kingdom), June 1998, p.
  45.
/Footnote24/-^The government also asked the NAO to review several other
  assumptions, including the unemployment rate and the proportion of
  national income generated by capital and labor.

GAO CONTACTS AND STAFF ACKNOWLEDGEMENTS
=======================================

GAO Contacts

Thomas M. James, (202) 512-2996
Bryon Gordon, (202) 512-9207

Acknowledgments

In addition to those named above, Andrew Eschtruth, Mindy Frankfurter,
Richard Krashevski, and Tuyet Quan Thai made key contributions to this
report.

(935264)

Figure 1:  From Deficits to Surpluses: U.S. Unified Budget 
Balance as a Percentage of GDP, 1990 to 2009    10

Figure 2:  GDP per Capita Assuming Non-Social Security 
Surpluses are Eliminated Versus Unified Budget Balance18

Figure 3:  Composition of Spending as a Share of GDP, 
Assuming On-budget Balance                      19

Figure 4:  Shifts in General Government Financial Balances28

Figure 5:  1998 General Government Gross and Net Debt as 
a Percent of GDP                                29

Figure 6:  Change in Average Annual GDP Growth During 
Economic Slowdown of Late 1980s and/or Early 1990s35

Figure 7:  1998 General Government Financial Balance38

Figure 8:  Long-term Projections for Pension Expenditures 
and Petroleum Revenues as a Percentage of GDP in Norway40

Figure 9:  Ratio of Population Aged 65 and Over to Population 
Aged 15-64, 2000 and 2030                       53

Figure 10:  Improvement in General Government Net Debt as 
a Percentage of GDP During the 1990s            59

Figure 11:  GDP per Capita Assuming Non-Social Security 
Surpluses are Eliminated vs. Unified Budget Balance75

Figure 12:  Composition of Spending as a Share of GDP, Assuming On-budget
Balance76

Figure 13:  Commonwealth of Australia Underlying Budget 
Balance, 1982-83 to 1997-98                     81

Figure 14:  GDP Growth in Australia, 1983 to 199884

Figure 15:  Receipts and Outlays in Australia, 1982-83 to 1996-9789

Figure 16:  Net Public Sector Debt in Australia, Fiscal Years 
1980-81 Through 1998-99                         91

Figure 17:  Federal Budgetary Surpluses/Deficits in Canada, 
1980-81 to 1998-99                             100

Figure 18:  Real GDP Growth in Canada, 1981 to 1998104

Figure 19:  Federal and Provincial-Territorial Net Debt in Canada, 
1980-81 to 1998-99                             111

Figure 20:  Major Federal Transfers to Other Levels of Government 
in Canada, 1980-81 to 1998-99                  114

Figure 21:  The Canada Health and Social Transfer115

Figure 22:  Deficit Targets Compared to Actual Results in Canada, 
1994-95 to 1997-98                             117

Figure 23:  Federal Government Revenues and Expenditures in 
Canada, 1993-94 to 1998-99                     120

Figure 24:  Summary of Spending and Tax Actions in the 1997-98, 
1998-99, and 1999-2000 Canadian Federal Budgets122

Figure 25:  Budgetary Balance in New Zealand, 1974-75 to 1997-98131

Figure 26:  GDP Growth in New Zealand, 1983 to 1998135

Figure 27:  Comparison Between Adjusted Cash and Operating 
Balances in New Zealand, 1994-95 to 1997-98    138

Figure 28:  Net Public Sector Debt in New Zealand, 1980 to 1998143

Figure 29:  General Government Financial Balance as a Percent 
of GDP in Norway, 1970 to 1998                 151

Figure 30:  Real GDP Growth in Norway, 1981 to 1998154

Figure 31:  Long-term Projections for Pension Expenditures and 
Petroleum Revenues as a Percentage of GDP in Norway, 1973 
to 2050                                        161

Figure 32:  General Government Financial Balance in Sweden, 
1981 to 1998                                   165

Figure 33:  Real GDP Growth in Sweden, 1982 to 1998169

Figure 34:  Expenditures and Revenues as a Percentage of GDP 
in Sweden, 1970 to 1998                        172

Figure 35:  General Government Gross Financial Liabilities in 
Sweden, 1981 to 1998                           177

Figure 36:  Surpluses/Deficits in the United Kingdom, 1980-81 to 
1998-99                                        183

Figure 37:  GDP Growth in the United Kingdom, 1980 to 1998186

Figure 38:  Receipts and Expenditures in the United Kingdom, 
1980-81 to 1995-96                             191

Figure 39:  Projected Surpluses/Deficits and Actual Results in 
the United Kingdom, 1986-87 to 1993-94         193

Figure 40:  Actual and Structural Surpluses/Deficits in the United 
Kingdom, 1986-87 to 1998-99                    198

Figure 41:  Projections of Real GDP Compared to Actual Results 
in the United Kingdom, 1988 to 1994            199

Table 1:  Characteristics of the Six Case Study Countries and 
the United States, 1997                         30

Table 2:  Projected Growth in Annual Public Pension 
Expenditures as a Percentage of GDP, 1995-2030  54

Table 3:  Fiscal Outlook for Fiscal Year 1998-99125

*** End of document. ***