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Fiscal Councils (FCs) are offices of budget specialists tasked with producing independent analysis to policymakers on matters relevant to the fiscal situation of a jurisdiction. Examples of this include the  Parliamentary Budget Office (PBO) of Australia, which provides Commonwealth parliamentarians with independent costings of policies, and the Office of Budget Responsibility (OBR) in the United Kingdom. Subnational-level fiscal councils also exist in jurisdictions such as New South Wales and Victoria.

In situating the relationship of Fiscal Councils to the governments that they are attached to, there are still many open questions and therefore a variety of models to consider. This piece considers the introduction of Comply or Explain (CoE) model in a Fiscal Council context as posited by a supranational Fiscal Council, the European Fiscal Board (EFB).

There is an argument in the field of corporate governance that corporate supervision is improved not through binding laws, but through looser arrangements of compliance. These arrangements have a given code and deviations from this code must be explained by the private actor. This form of regulation is commonly referred to as Comply or Explain (CoE), and it has grown in popularity since its introduction in the early 1990’s in the United Kingdom and consequent spread into Western Europe.

The CoE model is derived from neoliberal thought, placing the emphasis on market forces to make decisions. This leaves the initiative for regulation to those agents that themselves are being regulated. For such a system to work, there is a high degree of responsibility imposed on private actors to willingly comply with codes. Egregious deviations from the regulatory code will jeopardize the system itself.

While much debate has surrounded the application of Comply or Explain in the private sector, what is of increasing theoretical interest is whether such a model could be applied to governments themselves. It was suggested in the European Fiscal Board’s annual report that Fiscal Councils (alternatively known as Independent Fiscal Institutions or IFIs) might benefit from a CoE relationship with governments. The European Fiscal Board’s annual report argues:

“One way to enhance the advisory role of national IFIs while preserving governments’ prerogative to take fiscal policy decisions is through the comply-or-explain principle, i.e. an obligation for a government to publicly explain the reasons for deviating from an advice issued by an IFI.”

But it is important to pose the question: could Comply or Explain really be transposed onto the relationship between fiscal councils and governments?

The fiscal governance framework of the euro area already includes elements of the Comply-or-Explain principle, even though its legal underpinnings are relatively weak. For example, it is part of the European Fiscal Compact (2012), but only in the following specific cases: (i) the activation of the correction mechanism in the compact; (ii) the process for monitoring the correction process; and (iii) escape clauses in relation to the budget-balance rule within the compact.

So to bring it into fuller form, the annual report advocates the principle on the following basis:

“The most powerful influence of the comply-or-explain principle is via the public debate it triggers. In particular, the activation of the explain part puts pressure on decision-makers to act transparently and responsibly in fiscal matters. This ultimately helps operationalise the enhanced transparency and accountability that comes with the scrutiny from IFIs. Once established and accepted, the comply-or-explain principle ideally plays a pre-emptive role, as decision-makers internalize the potential confrontation with the IFIs in their proposals. Such scrutiny has the advantage of transforming itself into a routine that is anticipated by the media and the public.”

Governments would therefore seem to be in a beholden state known as ex-ante oversight. They would adhere to established codes for fiscal responsibility, and deviations would then need to be explained.

But this is where the questions really begin. Explain to whom? If the government owes an explanation to the people, then this assumes the public is both sufficiently informed about fiscal policy and have a means of proving their explanation. It is also likely that in the case of greater pro-cyclical spending, the people would be inclined to accept an explanation which justifies more generous fiscal programs.

If the purpose of Comply or Explain is for a government to explain deviations to its fiscal council, there must be some ‘teeth’ to that system, as they are in the corporate world, where governance is ensured through the regulatory authority to sanction corporations. So, is it possible for a fiscal council to have that sort of authority to impose sanctions? One such theoretical model was advanced as an ‘Independent Fiscal Agency’; an institution with authoritative fiscal powers.

However, as I have argued, there are problems with putting this into practice, since politicians would be hard pressed to surrender authority in a democratic dispensation to such an institution. If a fiscal council does not wield any teeth, how can it demand an explanation from the government? If a fiscal council does not have some form of political influence, the Comply-or-Explain model would not be particularly effective in terms of enforcement.

It ultimately boils down to the roles that we expect to assign to our fiscal councils. The Comply-or-Explain model has worked to a degree in the corporate world because of the authoritative powers that regulators have, even when corporations are the ones who take the initiative in compliance. By contrast, the suggestion of a CoE arrangement for governments ends up reverting to historical problems of both a political and economic nature. This is why fiscal councils must be strengthened in a variety of ways in order for them to play a role in the budget process and create value for the public, all the while balancing both efficiency and democracy.

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