The future of Swiss federalism: the challenge of fiscal stabilization policy in the absence of coordination

This chapter presents the way the Swiss cantons were impacted by the 2008–9 financial crisis and its aftermath, and the way the cantons reacted. The Federal Constitution of the Swiss Confederation provides that ‘the Confederation [central government], the Cantons [subcentral governments] and the Communes [local governments] shall take account of the economic situation in their revenue and expenditure policies (Art.100, al.4)’. Simultaneously, it stipulates that the ‘Cantons are sovereign except to the extent that their sovereignty is limited by the Federal Constitution’ (Art.3). Thus the cantons benefit from far-reaching political, financial and fiscal autonomy. In the past and despite the provision of Art.100, most of them have made use of this autonomy to engage in pro-cyclical fiscal policies. The pro-cyclical behaviour stems from a culture of rather conservative fiscal policy. This culture has indeed been transposed by individual cantons into their own legislation governing their public finance. Most have chosen to legally cap the deficit or even ban that possibility – often referred to as budget constraints – regardless of the macroeconomic conditions. This particular institutional setting points towards the difficulty to conduct a consistent macroeconomic policy not only between the different tiers of government, but also between the fiscal and the monetary policies. The financial crisis hit Switzerland in a rather indirect way. The negative performance of the banking sector affected the corporate tax paid by the banks. However, the economic crisis that followed was limited to a downturn in 2009 caused by a fall in the aggregate demand originated from the European Union (EU) and also by a fall in investments. With a low level of unemployment, Switzerland was in a relatively favourable position. Further, during the years prior to the crisis and thanks to the noticeable economic expansion, the cantons (and the central government) massively improved their financial position compared to the situation that had prevailed in the 1990s. The level of debt was strongly reduced. Despite the rather satisfactory internal macroeconomic circumstances, the alarming European and international situation elicited lively reactions and concerns among journalists, politicians, firms and the population. This added to the prevailing uncertainty regarding future development and prompted the federal (central) government to take discretionary fiscal measures. The effort was, however, rather moderate. Like in other small and open economies, the internal benefit of the measures (that is, the stimulus that does not dissipate in imports) was considered to be rather small compared to the fiscal cost of the measures (debt increase). Thus, most small countries, including Switzerland, relied instead on the economic recovery plans of their trading partners. Given the poor historical records of the cantons regarding vertical (with the Confederation) and horizontal (with other cantons) coordination, one could doubt that the cantons would contribute to the central government’s effort. To avoid this situation, the federal government relied on financial stimulus channelled through cantonal budgets. These federal transfers helped the cantons to finance mainly infrastructure maintenance and building works. The additional public expenditure of the three layers of government are estimated to total 0.7 per cent of 2009 and 2010 gross domestic product (GDP), among which more than 50 per cent came from subnational and local budgets. In this sense the effort was modest. The vertical coordination somehow worked and prevented cantons from excessive free riding. However, the horizontal coordination was less successful. The cantons failed to deploy such a collaborative solution. Only the French- and Italian-speaking cantons engaged in a dialogue; the German speaking cantons did not really. Additionally, no true vertical coordination took place within individual cantons between the canton and the municipalities. The favourable fiscal position situation allowed the cantons to participate in the counter-cyclical stance without breaking their own budget constraint. Actually some cantons even strengthened the constraint in the meantime. Simultaneously, the tax competition spread between cantons fuelled by the previous cyclical fiscal surpluses. This competition has weakened the fiscal structural balance of the cantons. A weakened fiscal structural balance, together with more stringent budget constraint, will increase the difficulties of coordinating the fiscal policy during any future recession. Unlike the central government’s budget constraint, none of the cantonal budget constraint includes a mechanism that mechanically allows some deficit in case of a negative output gap while requiring a surplus in case of a positive output gap. Given the cantonal autonomy provided by the Swiss Constitution and the lack of coordination, some degree of conditionality of the budget constraint with regards to macroeconomic conditions would be a necessary condition if cantons want to avoid appearing as free riders during the next economic downturn.