(Originally published 2 May 2016)
Aggregate expenditure ceilings are today a feature of budgeting in many OECD countries. An article of mine just published in the OECD Journal on Budgeting addresses a key design issue of the coverage of aggregate expenditure ceilings – should they cover the totality of government expenditure, or is it legitimate to exclude certain categories of expenditure?
There is a school of thought which holds that aggregate ceilings should be as comprehensive as possible and that, in particular, they should include (as in Sweden) most social security expenditure. My article takes a different view, arguing that expenditure ceilings are entirely unsuitable as an instrument for limiting social security benefit spending and other unpredictable spending during budget execution. It is not possible to apply such an expenditure ceiling to social security expenditure because the amount of spending is determined primarily by entitlements set out in legislation. Even if, at the time the budget is prepared, unbiased expenditure forecasts indicate that social security expenditure should remain within any given planning limit, circumstances can and often do change during the year in such a manner that actual benefits expenditure, even without any policy changes, exceeds the forecast level. The same is true for some other types of mandatory expenditure (including interest expenditure), because mandatory expenditure is by definition determined by either legislative or contractual rights, and not by quantitative budget appropriations.
As explained in my article, Swedish experience shows that if such unpredictable expenditure is included in the aggregate expenditure ceiling applied during budget execution, then either the budgetary contingency reserve has to be very large (which has major downsides) or there will need from time to time to be destabilising within-year cuts to discretionary spending if mandatory spending significantly exceeds forecast.
While it is true that government should prepare the budget with a ceiling for comprehensive aggregate expenditure in mind, it is unrealistic to assume that a rigid ceiling covering all spending can be applied during budget execution.
The most sensible approach to handling social security and similar expenditure is that which has been taken in the UK. In the UK, such expenditure is not covered by the aggregate expenditure ceiling (the so-called Departmental Expenditure Limits). Instead, since 2014 it has been disciplined by a “welfare cap” which is strictly a planning limit and which does not function as a ceiling during budget execution. An explanation of this system may be found in my article.