Treasurer Joe Hockey and Finance Minister Senator Mathias Cormann.

Treasurer Joe Hockey and Finance Minister Senator Mathias Cormann. Photo: Alex Ellinghausen

The Howard government's 1996 Commission of Audit recommended the adoption of fiscal responsibility legislation. The resulting Charter of Budget Honesty was an important reform that improved the transparency and accountability of fiscal policy and was associated with a significant turnaround in budget outcomes before the onset of the terms-of-trade boom around 2003. The Abbott government's Commission of Audit should aim to build on the charter by recommending the adoption of new fiscal responsibility legislation and the formation of an independent statutory fiscal commission.

There is a growing international trend towards the adoption of fiscal rules coupled with independent fiscal authorities. Whereas in 1990 only seven countries were found by the International Monetary Fund to use fiscal rules, by 2009, this had increased to 80 countries, including 21 advanced economies. The IMF has also identified 29 independent fiscal councils operating internationally, including Australia's new Parliamentary Budget Office.

Most of these independent fiscal authorities have responsibility for monitoring and enforcing compliance with fiscal policy rules. Both individually and in combination, independent fiscal councils and fiscal policy rules have been associated with improvements in fiscal outcomes at the national and sub-national level.

Independent fiscal authorities have been shown to produce more-accurate and less-biased forecasts than official government forecasts. In some countries, such as Sweden and Canada, these bodies have led to an improvement in the government's official forecasts because of increased competitive pressure.

In Britain, Treasury must use the Office of Budget Responsibility's forecasts subject to a ''comply and explain'' provision to publicly explain any departure from the independently prepared forecasts. In the Netherlands, the Bureau for Economic Policy Analysis also independently prepares the forecasts on which the government's budget is based.

In Australia, the economic parameters and fiscal projections contained in the budget have been the subject of pointless partisan debate because they are seen to lack independence from the government of the day. This has come at the expense of debating the substance of the tax and expenditure measures in the budget. While the degree of politicisation is frequently overstated, the perception is difficult to remedy without fundamental institutional change.

The Commission of Audit should recommend the formation of an independent statutory fiscal commission. The role of the fiscal commission would include defining the parameters for the annual budget and other fiscal policy statements, including the economic forecasts and fiscal projections, as well as producing analytical reports such as estimates of the structural budget balance, intergenerational reports and policy costings.

A significant shortcoming of the Charter of Budget Honesty was its reliance on a non-enforceable set of fiscal principles and discretionary fiscal targets rather than legislated fiscal rules.

The Commission of Audit should recommend the adoption of legislated limits on the budget balance, net debt and federal taxation and expenditure as a share of GDP. The federal government would then formulate its budget based on forecasts prepared by the commission and subject to legislated fiscal rules which the commission would monitor and enforce.

The federal government would still enjoy substantial discretion to make tax and spending decisions within this overall framework. The fiscal rules would serve to tie down expectations in relation to long-run fiscal outcomes in much the same way that the Reserve Bank ties down long-run inflation expectations.

The traditional objection to legislated fiscal rules is that they prevent counter-cyclical fiscal policy. But with an inflation targeting central bank and a floating exchange rate carrying the burden of adjustment to aggregate demand shocks, there is no reason to expect a positive fiscal policy multiplier. This allows fiscal policy to focus on long-run budget sustainability and the supply-side of the economy, without being distracted by demand management.

The commission should be authorised to impose pecuniary penalties on all members of Federal Parliament for breaches of the fiscal rules to underscore Parliament's collective responsibility for fiscal outcomes. The financial penalty is less important than the resulting loss of reputation that would accompany their imposition by an independent authority. Unlike the Charter of Budget Honesty, the new fiscal responsibility legislation should be made subject to administrative and judicial review.

By strengthening Australia's fiscal institutions, politicians will have the institutional technology they need to make stronger commitments to disciplined fiscal policies that better address Australia's long-term fiscal and economic challenges.

Dr Stephen Kirchner is a research fellow at the Centre for Independent Studies and author of Strengthening Australia's Fiscal Institutions.