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PSE – Public Finance – Sandrine Duchêne1
Public financeCourse 1
Framework and tools
PSE – Public Finance – Sandrine Duchêne2
Introduction
What is public finance ?
Study of the taxing and spending activities of a government Something misleading: because not financial (= not related to money) Economics of the public sector, public economics
“micro” functions : allocation of resources, distribution of income
“macro” functions : use of taxing, spending and monetary policies to affect overall level or GDP or unemployment => usually taught in separates courses (A. Epaulard). Here special look : linkages between public finances and the business cycles (European framework for public finance analysis)
PSE – Public Finance – Sandrine Duchêne3
Introduction
Not in our field, but quite important => regulatory policies, which have important effects on resource allocation
Sometimes, goals can be achieved by regulation or by tax and spending instruments.
3 examples:
i. Environmental considerations : caps, permits, market instruments, taxation
ii. Labor market : economists admit that regulation/institutions can have a great influence on employment : labor contract, labor duration/ tax cuts diminishing labor costs
iii. Purchasing power : direct subsidies (especially to the poor)/ stimulating concurrence on the goods markets.
PSE – Public Finance – Sandrine Duchêne4
Introduction
Program
I The « macro » framework : why monitoring public finance ?
1. Data, facts and concepts2. Public finance and the business cycle3. Do we care about long term ?4. Are budgetary rules useful ?
II The « micro » tools and main issues for reforms
1. Tax policy: some theoretical concepts2. Reforming our tax system: some issues3. Public expenditure: public goods, education, social insurance
PSE – Public Finance – Sandrine Duchêne5
Introduction
Chapter I-1 Data, facts, and concepts
1. The role of the public sector: current issues2. Public finance in EMU: an overview3. Example: the French situation (what is the problem ?)4. To practice: some calculation5. Concepts and data; procedures.
1- Role of the public sector/current issues
What is public finance ? By tradition (Musgrave), three roles devoted to the public sector :
Allocation : Public good provision Redistribution : social transfers, progressivity in the tax system Stabilization : “automatic stabilizers”
Do these 3 objectives conflict ? The answer is yes. Trade-off efficiency/equity Room for macroeconomic stabilization when there are pressures
for a fiscal adjustment ?
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PSE – Public Finance – Sandrine Duchêne7
1- Role of the public sector/current issues
Illustration: Public expenditure breakdown
France UE-25 Germany Spain Italy Poland UK Sweden
1 General public services 7,4 6,7 6,3 5,1 8,8 5,9 4,7 8,2
2 Defence 1,9 1,7 1,2 1,1 1,5 1,2 2,7 2,1
3 Public order and safety 1,3 1,7 1,6 1,8 2,0 1,7 2,5 1,4
4 Economic affairs 3,2 4,0 3,9 4,3 4,1 3,3 2,9 4,9
5 Environmental protection 0,8 0,7 0,5 0,9 0,8 0,6 0,7 0,3
6 Housing and community amenities 1,8 1,0 1,1 1,1 0,7 1,5 0,6 0,9
7 Health 7,2 6,7 6,3 5,1 8,8 5,9 4,7 8,2
8 Recreation, culture and religion 1,4 1,0 0,7 1,4 0,9 0,9 0,6 1,1
9 Education 6,4 5,4 4,2 4,4 5,1 6,1 5,7 7,3
10 Social protection 22,0 19,1 22,5 13,0 17,9 19,0 16,1 24,7
11 total expenditure 53,4 47,6 48,4 38,3 48,1 44,5 43,2 58,2Source INSEE, 2003
1- Role of the public sector/current issues
Allocation
Justifications for the State intervention in the provision of public goods are well known: the very nature of public goods, externalities, endogenous growth … justice, defense, security, education, health…but also direct interventions to corporations and individuals.
Questions : Cost/effectiveness of public policies? Efficiency of public spending? What is the good production model? Distinguishing between financing and
producing (delegation, agencies models): education, health, defense are concerned.
Public intervention proper area? Public coverage for expenditure (education, health).
Quality of public finance, allowing better growth in the long term? Public policy evaluation
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1- Role of the public sector/current issues
Distribution
Social insurance, horizontal and vertical distribution.
Difficult to disentangle from the third function (stabilization): insurance aims at avoiding hysteresis effects in bad times (unemployment insurance, on-the-job training, minimum benefits)
Current re-visited (old) questions : Justification for the public action? “Minimalist” State avoiding economic
distorsions, flat tax in Eastern European countries… Rooms for manoeuvre: how to deal with the increase in the age-related
expenditures? Acceptable inequities in a society? Efficiency/equity dilemma. Fiscal
competition issues. “New” social contract: “rights and duties” issues
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1- Role of the public sector/current issues
Stabilization
Size and effectiveness of automatic stabilizers
Justifications for discretionary action along the business cycle
Questions Effectiveness of automatic stabilizers revisited in the context of fiscal
retrenchments (keynesian/non-keynesian effects). Effectiveness of discretionary policies has been questioned
At the European level, leave enough margins to let automatic stabilizers play (“mimimum benchmark”)
Fiscal policy in the current crisis and discretionary policy: framework has to be adapted
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2- Public finance in Europe : an overview
The budgetary framework: initial framework (up to 2005)
Treaty (Maastricht 1992, then Amsterdam 1997)
•Member states have to avoid excessive deficits, with respect to deficit and debt reference values
•These references are defined in an annexed protocol (n°20): 3% of GDP and 60%.
Stability and Growth Pact endorsed in 1997:
•Two regulations: preventive arm, corrective arm
•Stability programs
•Definition of medium term objectives (MTO): “close to balance or in surplus”
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2- Public finance in Europe : an overview
Main Issues for the conduct of fiscal policies in Europe
One common fiscal framework = common rulesTreaty and the reference valuesStability and Growth Pact (amended in 2005)
Addressing heterogeneous situations (as concerns deficit levels, cyclical conditions or sustainability conditions)
In the short run, enforce the whole play of automatic stabilizers (preventive arm of the Pact), better interpret the cyclical conditions (preventive and offensive arm), prevent “pro-cyclical biais”. This view is currently challenged by the huge economic downturn (Pact is suspended)
In the long run, address the problem of an increasing age-burden : achieving budgetary consolidation (stability programs)
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2- Public finance in Europe : an overview
The initial budgetary framework: strongly critized
From a theoretical point of view: lack of economic bases. Nominal
targets independent on cyclical conditions, and on specificities of the countries (“one size fits all”)
From a practical point of view (crisis in 2003)
Economic reflexion had already started in 2001-2002, continued till 2005.
Reformed SGP in 2005 Better attention paid to cyclical evolutions (course 2) Better attention paid to the long term and sustainabitity questions, with
linkage to the MTO (course 3)
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2- Public finance in Europe : an overview
Fiscal heterogeneity in Europe: crossing data on the level of public deficit and debt :
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2- Public finance in Europe : an overview
Consolidation efforts in 2007: dispersion
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2- Public finance in Europe : an overview
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2- Public finance in Europe : an overview
Long term sustainability conditions
3- The French situation : what is the problem ?
France: the pathologic case? A brief look at some facts
Public deficit: still high, around 3% Public debt: increasing Public expenditure: high compared to other countries (reflects social
choices) Tax ratio: high level in the context of fiscal competition
All these elements are linked together Expenditure monitoring is not stringent enough (compared to GDP
evolutions) No room for fiscal adjustments No room for significant tax cuts
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3- The French situation : what is the problem ?
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3- The French situation : what is the problem ?
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3- The French situation : what is the problem ?
Public expenditure: long term trend and composition
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3- The French situation : what is the problem ?
Expenditure level : a French exception ? High level, compared to other countries Stability since 10 years
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3- The French situation : what is the problem ?
Since 20 years, public expenditure in line with GDP growth => no room for budgetary adjustment
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3- The French situation : what is the problem ?(iii) Public receipts
Tax ratio
Source : OCDE
10
15
20
25
30
35
40
45
50
55
1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006
Allemagne Italie
Espagne Royaume-Uni
10
15
20
25
30
35
40
45
50
55
1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006
Etats-Unis France
Suède UE à 15
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4- Some calculation
Question 1You just have been elected at the Presidency. You are discovering the budgetary situation. What is the current deficit ? The primary balance ?
Assumptions
GDP = 2000 Md€ Expenditure level = 50% of GDP Receipts level = 48% of GDP Debt level = 60% of GDP Nominal interest rate : 5%
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4- Some calculation
srb
% of GDP Md€Spending 50 1000including interest payments 3 60Public receipts 48 960Balance -2 -40primary balance 1 20debt 60 1200
déficitb
surplusb
0
0
dri
ibalanceprimaryb
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4- Some calculation
Question 2
You are building the budget law for 2008.You forecast : GDP growth : 2,5% Inflation rate : 1,5%
Suppose the public receipts are in line with GDP growth.
Just after your election, you meet your “peers” at the Ecofin Council. You claim that you will respect the Pact. So you announce that you intend to reduce public deficit by ½ percentage point of GDP next year.
What must be the for the growth rate of public expenditure ? What will be the deficit and debt ratio next year ? What is the stabilizing deficit ?
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4- Some calculation
Notations
B: general government balance (Md€)b: general government balance (% of GDP)[Public deficit = - b]
R: public receipts (Md€)r: public receipts (% of GDP)
S: public spending or public expenditure (Md€)s: public spending or public expenditure (% of GDP)
g: GDP growth in real termsπ: inflation of GDPg+ π: GDP growth in nominal termsgs: spending growth in real terms
t
tt
t
tt
t
tt
GDP
Ss
GDP
Rr
GDP
Bb
ttt
ttt
srb
SRB
tt
tt
SgsS
RgR
)1(
)1(
1
1
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4- Some calculation
Equation for deficit variation :
GDPS
GDPR
GDPB
t
t
t
t
t
t
1
1
1
1
1
1
GDPS
GDPRb
t
t
t
tt g
gs
g
g
)1(
)1(
)1(
)1(1
srb tttggs
))()(1(
1
sbbb ttttgsg
)(11
srb tttggs
))1)(1(
1
First order approx
ssrb ttttggs
)(
1
0,5 in Europe, 0,35 in the US
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4- Some calculation
)(5,01
gsgbt
GDP growth in real terms
Expenditure growth in real terms
= MARGIN for deficit reduction
Here :0,5=(2,5-gs)*0,5Gs=2,5-1=1,5
If gs<g : deficit reduces If gs>g : deficit increases
Very practical« back on the envelop »
formula
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4- Some calculation
Equation for debt accumulation :
GDPB
GDPD
GDPD
t
t
t
t
t
t
gg
)1()1(1
1
1
)1()1(11
gg bdd ttt
bdd tttg
11)(
deficitgstabilizindeficitdt 1
Stab def = 60%*0.04=2,4Def =1,5Debt variation = -0,9
bddd ttttg
11)(
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4- Some calculation
Question 3
Your administration presents you the “technical” forecasts.
Clearly the claimed evolution of expenditure is not realistic : medium term trend is rather 2% in volume per year.
What will the “true” deficit be ? What can you do (to make the public finance forecast more presentable) ?
To help you, you use the “elasticity” of the receipts with respect to GDP
tt
t
tt
t
tt
RgR
GDPGDPGDP
RRR
))(1(1
1
1
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4- Some calculation
technical forecastsgeneral government balance -2,0general government balance t+1 -1,75deficit variation 0,25spending growth (in real terms) 2receipts elascticity 1public debt variation -0,65
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4- Some calculation
Equation for deficit variation :
srb ttt g
gs
g
g
)1(
)1(
)1(
))(1(1
srb tttggsgg ))()(1())()(1(
1
)()()1(5,01
gsggbt
srbb ttttgsgg )()))(1((
1
5.0 sr tt
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4- Some calculation
technical forecasts elasticity>1general government balance -2,0 -2,0general government balance t+1 -1,75 -1,50deficit variation 0,25 0,50spending growth (in real terms) 2 2receipts elascticity 1 1,125public debt variation -0,65 -0,90
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4- Some calculation
Question 4
In addition you are fulfilling you campaign engagements.
You decide tax cuts to support activity and employment : “paquet fiscal” amount = 1 point of GDP%.
What do you do ??? Describe several options : “technical” “fulfilling European commitment”
(expenditure/elasticity options)
pb ttgsgg
11)()()1(5,0
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4- Some calculation
technical forecasts (1) spending growth (2) elasticity>1
general government balance -2,0 -2,0 -2,0general government balance t+1 -2,75 -1,50 -1,50deficit variation -0,75 0,50 0,50
tax cuts (% of gdp) 1 1 1spending growth (in real terms) 2 -0,5 2receipts elascticity 1 1 1,625
public debt variation 0,35 -0,90 -0,90
Scenarios fulifilling european comitments
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4- Some calculation
Question 5
Finally you decide announce a stabilization of the deficit next year, at its current level.
You choose 1,2 for the elasticity of receipts with respect to GDP.
Describe the key figures of the forecasts Prepare your arguments for the journalists !
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4- Some calculation
technical forecasts official forecasts
general government balance -2,0 -2,0general government balance t+1 -2,75 -2,0deficit variation -0,75 0
tax cuts (% of gdp) 1 1spending growth (in real terms) 2 1,3receipts elascticity 1 1,2
public debt variation 0,35 -0,40
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4- Some calculation
Question 6
Bad luck, GDP growth collapses during 2008.
Finally : GDP growth is 1%. Elasticity (which is a bit cyclical) is 0,8. Expenditure rate is 2% in real terms.
What is deficit and debt ratio ?
You decide privatizations during the year (1% of GDP) : what are the final deficit and debt ratio ?
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4- Some calculation
technical forecasts Final results
general government balance -2,0 -2,0general government balance t+1 -3,50 -3,75deficit variation -1,50 -1,75
tax cuts (% of gdp) 1 1spending growth (in real terms) 2 2receipts elascticity 1 0,8
public debt variation 2,00 2,25
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4- Some calculation
Conclusion
In April 2009, you notify the 2008 results to the European Commission
Observing that you are above 3%, the Commission launches the excessive deficit procedure against your country.
Well done !!
5- Concepts, data, and procedures
What is a budget?
Distinguishing budget preparation (ex ante), vote, and execution (ex post)
Juridical dimensions: authorization, vote by the Parliament. Strictly defined and bounded. Main issues: to allow information and control from the Parliament.
Procedure dimensions: elaboration of the budget law, voting rules and procedures. Technical questions: bottom-up or top-down procedures? How to better involve the Parliament?
Questions about accounting systems: reliability of the figures, accrued/cash presentations. Defining principles inspired by the rules applied to the private sector (if possible?)
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5- Concepts, data, and procedures
Two Finance laws voted each year (october-december)budget law for the stateSocial Security budget law3 types: LFI, LFR (“collectif budgétaire”) , loi de règlement
Two organic laws establishing the budgeting rules, recently revisedLOLF (2001), “ordonnance de 1959”Organic law for the Social Security (2005)
Local budget are adopted by the local executives. Financial autonomy delivered by our constitution, but limitedVote of tax rates (but not tax bases), expenditure, debt
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5- Concepts, data, and procedures
Principles for budgeting: the four “classic” principals
1- “Annualité”
• authorization is given for one year.
• Strongly criticized for a form of short sight (at the broad level, in the global monitoring of public finance/ at the “micro” level, for the managers who are in charge of structural reforms)
• Current issues: pluriannuality. In september 2008 vote of a multi-annual budget for the state, covering a 3-year period (2009-2011)
2- “Unité”
• One document for one procedure.
• To ensure transparency and coherence of the budgeting elements. To make the political choices or trade-offs more explicit. (exceptions: comptes spéciaux du trésor, budgets annexes).
• Current issues: “débudgétisations”.PSE – Public Finance – Sandrine Duchêne45
5- Concepts, data, and procedures
Principles for budgeting (continued)
3- “Universalité”
• Double design Avoiding contraction between receipts and expenditures, describing all the
flows in the budget law No receipt affected to some identified expenditure
• Current issues: affectation of receipts can be justified : environmental taxes ; willingness to pay (health care)
4- “Spécialité”
• Budgetary credits have to be affected to a precise expenditure
• Specialisation by nature or objective of the public expenditure
• Current issues: adoption of the new budget constitution (LOLF) in 2001, fully applied in 2006
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5- Concepts, data, and procedures
Emergence of new budgetary guidelines
1- “Sincérité”
• Ex ante: growth forecasts, receipts forecasts, realist evaluations for expenditures. Respecting budgeting rules (“charte de budgetisation”)
• Ex post: accounts (LOLF)
• Guidelines for budgetary transparency (IMF, OECD)
2- Equilibrium
• 1959: an abstract reference (“equilibre économique et financier”).
• Golden rule for the local governments
• Since Maastricht: a juridical constraint, enshrined by the SGP=> margins for interpretation. A target for the medium term.
• Currently debated: reforming the budget constitution and introducing an equilibrium constraint (for the State or the Social Security)
3- Performance/efficiency of public expenditure
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5- Concepts, data, and procedures
The LOLF innovation
A new architecture for the budget Missions (34)/programmes/actions, reflecting economic
concernsBetter reflecting the government priorities of public policies,
and have a complete view of the amounts devoted to certain objectives Role of the Parliament enforced: examines the whole budget, and not
only additional measures. Better reporting of the government to the Parliament
Introduction of performance indicators for each program Better implication of the public managers Reform of the public accounts, certification process by the Cour des
Comptes
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5- Concepts, data, and procedures
Budget law is composed of two parts
• First part: « conditions générales de l’équilibre financier »
– authorization to perceive taxes
– debt authorization
– fiscal measures applying to the year
– spending ceilings
– Equilibrium article
• 2d part:
– vote on the different expenditures (vote unity=mission)
Evaluative/limitative expenditures or receipts
Joined documents: text in itself+ “bleus” (“voies et moyens”, missions, RESF)+ “jaunes”, report on expenditure evolutions, report on taxes
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5- Concepts, data, and procedures
Elaboration of the budget laws
ActorsDirection du Budget/Direction de la sécurité sociale: central roleMatignon: coordination between the Ministry of Finance and the
ministries, crucial arbitration roleDGTPE (macro and public finance forecasts)Direction de la législation fiscale: fiscal measuresThe « spending » ministries/ Social security agencies
Main issues:Ensure coherence between both processes (PLF and PLFSS) =>
creation of the Ministry of Public Accounts steps up in this direction.Allow discussions at the technical level between administrations
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5- Concepts, data, and procedures
Elaboration of the budget laws (continued) Schedule
In January, « lettre de cadrage » send by the Prime Minister to the Ministers
Feb/march: « conférences d’économies structurelles »April/may: « conférences de budgétisation »June/July: expenditure ceilings decided, « lettres-plafond »June: « Débat d’orientation budgétaire » at the ParliamentJuly/August: macro forecasts and receipts forecasts. Public Finance
forecasts covering the whole general government (Maastricht form), final decisions concerning State and Social security
September: Conseil des Ministres
Main issues: improve articulation with the European commitments, with a better linkage between national targets and the stability program.
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5- Concepts, data, and procedures
Accounting notions
Several accounting systems: public accounting systems/national accounts
Each sector has its own accounting system and rules
State Budgetary accounts, budget execution
oOutcome: “solde budgétaire”= solde du budget général+ solde des comptes spéciaux du trésor (CAS privatisations, CAS
pensions, compte de dette)+ solde des budgets annexesoLimits: neither an operating result or gross saving, nor a net
lending or borrowing result. Consolidation? State guarantees?General public accounting (LOLF)
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5- Concepts, data, and procedures
Accounting notions
Social securityHarmonization started in the 90’s, now certified by the CdCSocial accounts on an accrued base“Commission des Comptes” in June (N-1) and September (N, N+1)Mostly reported: “solde du régime général”
Local governments“M14” accounting systemSpecific presentation in two parts:
oThe operating section: current charges and receipts (including taxes and transfers from the State)
oThe investment sectionMain limit: no consolidation
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5- Concepts, data, and procedures
State budget balance
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5- Concepts, data, and procedures
Social Security balance (Régime général)
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5- Concepts, data, and procedures
Social Security balance (social risks)- Social Budget Law
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5- Concepts, data, and procedures
National accounts
ESA95: harmonized system of accounts in Europe, allows comparability between countries (Maastricht criteria, annexed protocol)
Strict definition for public entities: combines control and activity (excludes public corporations like EDF or SNCF, public financial corporation like BDF or CDC)
4 sub-sectors; State, Other central government (900 entities: CNRS, CEA, FRR, CADES, universities…), Local government, Social security (larger than the PLFSS field, unemployment insurance and hospitals)=> large coverage
Consolidation between all sectors Accrued basis approach Economic approach: see Musgrave approach Non financial (B9)/financial accounts Usual aggregates: value added, EBE, gross savings, net lending/borrowing
balance (B9). For analysis expenditure/receipts approach is convenient
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5- Concepts, data, and procedures
Elaboration of public finance national accounts
Responsibility = INSEE (annual, quaterly accounts) Notification to Eurostat: twice a year (1st April N, 1st October N),
INSEE for the past data (until N-1) Government for forecasts (year N)
march N= “Compte provisoire” for the year N-1 First outcome for the year N-1 Involves 3 actors: DGCP (treatment of public accounts for a lot of entities),
DGTPE (because missing elements have to be evaluated), and INSEE (validation, decisions about treatments, coherence)
Links between usual agregates (“solde budgétaire”, “solde du Régime général”, and the “B9”)
Data are revised the years after (“compte semi definitif”, “compte definitif”)
Final judge=Eurostat
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5- Concepts, data, and procedures
Non Financial Accounts
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2003 2004 2005 2006 2007public deficit 4,1 3,6 2,9 2,4 2,7public debt 62,9 64,9 66,4 63,6 64,2expenditure ratio 53,3 53,2 53,4 52,7 52,6tax ratio 42,9 43,2 43,6 43,9 43,5Source INSEE
Public finance ratios
2003 2004 2005 2006 2007State -62,0 -52,8 -52,2 -47,4 -39,2Other central entities 4,8 9,5 7,1 10,5 -2,6Local govenrment 0,5 -2,4 -3,3 -3,2 -7,2Social Security -9,0 -14,6 -2,8 -3,3 -1,6General governement -65,7 -60,2 -51,1 -43,4 -50,6Source INSEE
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5- Concepts, data, and procedures
Structure of expenditure and receipts
Total, of which 956,9 Total, of which 910,5
Intermediate consumption (P2) 94,0 taxes on production and imports (D2) 275,9Wages (D1) 234,7 taxes on income and wealth (D5) 211,8Interest payments (D41) 46 social contributions (D6) 328,1Social transfers 420,1 property income (D4) 12,2Gross fixed capital formation (P51) 60,1 production receipts (P11) 59,5
Source INSEE, 2006
Expenditure Receipts
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5- Concepts, data, and procedures
Public expenditure at different levels (2006)
Comptabilité nationale
Md€ en %
Dépenses APU 956,9
ÉTAT 380,6 39,8%
ODAC 62,2 6,5%
APUL 199,3 20,8%
ASSO 437,0 45,7%
Total sous-secteurs 1079,1 112,8%
5- Concepts, data, and procedures
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5- Concepts, data, and procedures
Financial/Patrimonial accounts (2007)
• Register all public assets and liabilities.
• Public debt= sum of financial liabilities
• Maastricht debt=financial debt in nominal value, gross debt, and consolidated between all sub-sectors
• Net public debt
• Net value
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total of assets (1) 2104,1
Non financial assets (3) 1462
Financial assets (4) 742,1Currency and deposits (AF2) 73,6Securities other than shares (AF3) 40,9Loans (AF4) 49,9Shares and other equity (AF5) 392,4other accounts receivable/payable (AF7) 185,3
Financial liabilities (2) 1427,5Currency and deposits (AF2) 68,5Securities other than shares (AF3) 1028,2Loans (AF4) 182,2other accounts receivable/payable (AF7)+AF6148,6
Net financial debt (2)-(4) 685,4
Net value (1)-(2) 676,6Source INSEE
5- Concepts, data, and procedures
Advantages Provides a complete view on public accounts (consolidation), on an accrued
basis No “free lunch”: some measures improving the situation of certain sub-
sectors deteriorate the situation of another one Financial links between State and local governments, State and social
securityMeasures to respect the State expenditure target
In theory clear distinction between operations “above the line” and “under the line”
Limits Limits of accounting systems used as inputs “grey zones”, especially concerning the relationships between State and
Public corporations: dividends/patrimonial operations, injections of capital, State guarantees. Or securitization operations.
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