1. Regulatory or discretionary fiscal policy
The economics of fiscal deficits and public debt and their effects is a contentious area in economic theory, as Samuelson and Nordhaus explain.[1]
The effects are different in the short run and in the long run.
In the short run, higher public spending stimulates output and reduces unemployment so that discretionary fiscal policy can reduce the effects of the economic crisis and promote economic growth. However, according to economic theories, this can only last in the short term (a few years), as rising inflation causes monetary policy to interfere with economic processes and raise interest rates. The rise in interest rates puts a brake on economic growth due to a fall in investment, output and consumption.
In the long run, however, government debt reduces economic growth. Public debt diverts resources away from investment, leads to tax increases and causes inefficiencies in the economy. External debt also diverts economic resources away from the country. It can also put a country in a vicious circle, increasing public debt - increasing interest burden - even higher public debt. Hence, in the longer term, a fiscal policy based on rules that curb the growth of public debt or impose a continuous reduction of public debt is beneficial.
A rule-based fiscal policy constrains the economic policy of the country concerned, which is also facilitated by EU regulation. This type of constitutional and EU rule is also strongly reflected in Hungarian legislation and prevents discretionary fiscal policy from being applied for an unduly long period of time in view of emergency situations.
2. Challenges for Hungarian fiscal policy
The economic crisis has created a double challenge for fiscal policy on both the revenue and expenditure side, and the tools to address this challenge will be presented by examining both segments. On the revenue side, the crisis has led to declining tax revenues, rising unemployment, and falling consumption due to underinvestment, among other factors. On the expenditure side, there will be an increase in expenditure as a result of increased subsidies. At the same time, transfers and structural changes will restructure the budget, which will be reflected in the amendment of the budget law.
Both a significant fall in GDP and the rebalancing of the economy will increase public debt, as the public debt ratio is linked to GDP, and a fall in GDP alone will increase the public debt ratio without changing the public debt or deficit in nominal terms. The budget may, therefore, be affected by the crisis on the revenue side due to revenue shortfalls and on the expenditure side due to an increase in central budget support.
3. Regulating Hungarian discretionary fiscal policy
At present, however, public debt is well above the constitutionally prescribed level, and until the optimal debt level is reached, the Parliament has to adopt a budget aimed at reducing public debt. However, factors affecting the management of public finances may be subject to exceptional situations, serious problems arising from unavoidable external causes, the remedy for which is allowed by the Constitution to derogate from the strict rules (persistent downturn of the national economy, restoration of the balance of the national economy.)
The rule referring to the economic crisis is interpreted in an expansive way by the Stability Law, which states that any case of a decline in the real value of the annual gross domestic product in real terms shall be interpreted as a lasting and significant downturn in the national economy. In this case, the Stability Law allows the government sector deficit to exceed 3% of GDP and the public debt ratio to fall.
Therefore, the economic crisis resulting from the epidemic justifies a derogation from the public debt rule. The increase in public debt is a natural process in the event of an economic crisis, as government overspending and budget support increase the budget deficit. The size of the deficit depends on how the extra resources are used since if budget money is spent efficiently, it not only lays the foundations for recovery from the crisis but also for future economic growth.
The Public Finance Law provides a solution to the adverse developments in the central budget through extraordinary measures aimed at implementing government tasks taken during the year and maintaining balanced fiscal management. The legislator supplements the previous legislation with temporary measures related to the emergency situation. The legislator gives the government broad powers to make budgetary expenditures not provided for in the Budget Law and to impose extraordinary payments.
The special legal order provision provides for a relaxation of the public expenditure rules, i.e. a derogation from the strict procedural and substantive rules establishing the payment obligations, the extent of which is determined by law to the extent necessary to restore the economic downturn and equilibrium. The assessment of the necessary level has been a matter of debate, given the unprecedented nature of the health emergency affecting the whole country. However, excessive legal limits on economic instruments may hinder the government's ability to effectively manage the crisis. This is illustrated by the law adopted to combat the coronavirus epidemic, which strengthened and temporarily extended the government's emergency powers.
4. Areas of discretionary fiscal policy
Fiscal instruments can be divided into fiscal instruments affecting the revenue side of the budget and subsidy instruments affecting the expenditure side. Some of these instruments have already been introduced in 2020, while others will only come into force from 2021 onwards and will only start to have an impact from then on. In terms of the mechanism of impact, support instruments have a faster impact on the economy, while tax instruments have a longer-term impact on economic agents, with some exceptions, such as the introduction of a new tax.
The economic problems caused by the crisis have made it necessary to amend the 2020 budget. In the framework of the economic protection measures, the legislator reallocated several thousand billion forints of budgetary appropriations, creating two separate funds in the budget for epidemiological expenditure and economic protection.
In addition to the transfers affecting the central budget sub-system, legislative amendments were also made to the local government sub-system. The purpose of the amendment was twofold: on the one hand, to transfer resources to the central budget as revenue from the motor vehicle tax and, on the other hand, to reduce the municipal fees and taxes that the government indirectly subsidises for entrepreneurs and individuals.
Economic autonomy is a sine qua non for local government autonomy and is underpinned by constitutional provisions. And resource regulation is closely linked to the provision of public services. Although the state has gradually taken over tasks from the municipalities, centralisation has taken place in this area. However, the municipalities still have to provide basic public services, which require their own revenues to finance them.
However, the emergency situation overrode these principles, and the state sought to centralise resources and reallocate them to emergency defence and economic protection. This, in turn, put local authorities in a difficult budgetary situation. The government has tried to remedy this by making up the shortfall automatically in the case of smaller municipalities and discretionally in the case of large cities by examining the shortfall on an individual basis. In doing so, the government has imposed a kind of equalisation mechanism, taking resources away from better-off municipalities and giving resources to worse-off ones.
5. Instruments of discretionary fiscal policy
The rules and measures taken to tackle the economic crisis in the context of the COVID epidemic can be broken down into several areas, such as job preservation and creation, support for priority sectors and domestic businesses, support for families, maintaining security of supply, the application of official prices, and extra profit taxes.
Job preservation and job creation are a priority in the government programme. The fall in demand has forced employers to lay off workers and reduce working hours. The government has introduced subsidies for reduced working hours, which are up to 70% of the net wage, for the time lost.
Furthermore, in priority sectors, no employer's contributions were payable, employee contributions were reduced so that no pension contributions were payable, and health insurance premiums were reduced to the statutory minimum. The 2% reduction in social contribution tax also helped employment, as did the tax cuts. Special payment relief and tax mitigation options were available to employers, such as the temporary abolition of the labour market contribution.
For entrepreneurs in certain priority sectors (tourism and hospitality, health, food, etc.), the government has applied tax reductions and tax holidays (for small taxpayers and small business taxpayers). Support for investment and technological development has been prioritised to create jobs.
In addition to the environment, priority is given to industries with promising futures, such as artificial intelligence and quantum technologies, among others, and to sectors that have been particularly affected by the economic crisis. In order to ensure human resources, support for retraining and further training has been provided under each programme. For families, a moratorium on loan repayments has been introduced to support investment in housing, and social benefits that are due to expire have been extended during the emergency.
In the aftermath of the pandemic, strong inflation, both on the demand and supply side, emerged as the main economic policy challenge. The Ukrainian-Russian war further increased inflation in the world economy. In 2021, a fuel price freeze was introduced, with a gradual change in staffing to avoid abuses and to preserve stocks and the security of supply. However, the intervention in the market price led to a fall in supply as distributors were not compensated. Before the market collapsed and supply problems increased, the government withdrew price fixing.
A different regime was introduced for energy prices. An energy crisis sent market prices out of control, and in order to keep prices low for the public, it introduced official prices for electricity and gas. The eligibility for the reduced residential tariff is linked to the level of consumption, above which the market price is payable. In this case, the government compensated the supplier for its losses. However, inflationary pressures have not only affected prices for energy and fuel but also on basic foodstuffs. For basic foodstuffs, price controls were introduced, with the prices of some foodstuffs having to be set and fixed by retail suppliers at the lower price level of a previous period, which became the prevailing gross retail price.
An interest rate freeze on variable-rate loans was introduced partly to safeguard the economic situation of households and partly to safeguard the economic situation of small and medium-sized enterprises. The fixed interest rate prevented the enforcement of loan contracts of interest rates that had risen significantly as a result of inflation.
In addition to all these measures, the budget has sought to find resources to finance the official price of energy and to reduce the budget deficit by introducing special taxes and increasing their rates. The surcharges and tax increases have affected several sectors, such as banks, oil producers, power plants, retailers, insurance companies, telecoms, and airlines. The tax policy objective of taxation is to divert the excess profits generated by inflationary price rises into public spending.
6. Conclusion
Fiscal developments in 2023 were not favourable, and we were not in line with EU requirements. This is likely to result in an excessive deficit procedure for Hungary in the EU. Under the procedure, EU rules set out a timetable for deficit and debt reduction. The Hungarian government also seems committed to complying with the rules but has taken slower steps to improve the balance indicators in order to preserve economic balance and ensure economic growth. A further problem is the deficit-increasing impact of monetary policy. The MNB has incurred a loss of 402 billion forints in 2022, which will be further increased by a loss of around 1500-2000 billion forints in 2023. The question is what fiscal policy rules will be imposed by EU rules and whether the rules-based budget, the foundations of which are laid in Hungarian law, will be fully implemented. The economic crisis has not fully passed, and inflation has been brought down to 6-7% by 2024[2], a significant improvement compared to the 18.4% average inflation in 2023.[3] If economic growth picks up next year as expected, fiscal policy could also return to a more regulated framework, ensuring compliance with EU requirements.
Reference
[1] Paul A. Samuelson-William D. Nordhaus : Economics, Academic Publishing House, Budapest, 2012. pp. 582-589.
[3] https://kormany.hu/hirek/2024-a-gazdasagi-novekedes-erositesenek-eve
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