POLICY STRATEGIES FOR GROWTH- AND EQUITY-FRIENDLY FISCAL CONSOLIDATIONJan StráskýWith input from Boris Cournède, André Goujard and Álvaro Pina

Prague, 20 April 2015

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Remarks

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• Cournède, Goujard and Pina (2013): How to achieve growth- and equity-friendly fiscal consolidation? A proposed methodology for instrument choice with an illustrative application to OECD countries, OECD ECO Working Paper 1088. Available at http://www.oecd-ilibrary.org/economics/how-to-achieve-growth-and-equity-friendly-fiscal-consolidation_5k407lwvzkkh-en

Source

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Outline

1. Consolidation needs2. Ranking consolidation instruments3. How much consolidation can rely on

benign instruments?

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CONSOLIDATION NEEDS

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• Consolidation needs (short and long term):– Bring gross debt to 60% of GDP and

keep it there

• Choice of instruments driven by other objectives: – Output – Equity– Global rebalancing

Fiscal consolidation and other objectives

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Defining short- to medium-term and long-term consolidation needs

Further consolidation is needed over the outcomes achieved as of end-2012

Difference between debt-control and baseline underlying primary surplus

% o

f pot

entia

l GD

P

JPN

GBRGRC

USAPRT

IRL

ESPFRA

SVKPOL

FIN ISL

NLDCAN

SVNAUS

HUN

ISR

NZLCZE

BELSW

EIT

ALUX

AUTCHE

DEUDNK

ESTKOR

0

5

10

15

20

0

5

10

15

20

In the year when initial consolidation ends (short to medium term)In 2060 (long term)

8Source: Cournède, Goujard and Pina (2013).

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RANKING CONSOLIDATION INSTRUMENTS

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The instruments of fiscal consolidation: spending side

• Public consumption: Education

• Public consumption: Health

• Public consumption: Other (except family policy)

• Cash transfers: Pensions

• Cash transfers: Unemployment benefits

• Cash transfers: Sickness and disability

• Public consumption and cash transfers: Family policy

• Subsidies

• Public investment

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The instruments of fiscal consolidation: revenue side

• Personal income taxes

• Social security contributions

• Corporate income taxes

• Environmental taxes

• Consumption taxes (non-environmental)

• Recurrent taxes on immovable property

• Other property taxes

• Sales of goods and services

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• Rough assessment (--, -, +, ++) is given to the effects of each instrument on:– Short- and long-term growth– Short- and long-term equity– Global rebalancing

• This is based on the following sources:– Previous work of WP1 on the sources of growth– OECD Going for Growth– Wider literature– New econometric estimates

Growth and equity effects of fiscal consolidation instruments

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• Consolidation instruments harmful for growth

• Public investment and consumption vs. transfers and taxes (direct vs. indirect effect on AD)

• ALSO: Scope for monetary policy response to offset fiscal consolidation is important

Short-term growth effects

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• Smaller government and better allocation– Distortions through subsidies– Better pricing (also of environmental services)

• Cuts in public spending– pensions labour utilisation – unemployment benefits employment

Positive long-term growth effects

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• Tax burden on mobile and adjustable factors of production (ALL in the long run)– Personal income taxes, social security contributions

and corporate income taxes particularly harmful– Value-added and consumption taxes less bad

• Lower spending on public goods– Cuts in education and health care labour supply

and productivity – Cuts in childcare labour force participation – Cuts in family benefits ambiguous ( labour market

participation, child poverty, fertility rates)

Negative long-term growth effects

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• Many instruments aggravate income inequality– cuts in benefits, cuts in public services – Many taxes fall disproportionately more on

lower-income households

• BUT: some taxes can reduce inequality– Inheritance and capital gain taxes (here as

“other property taxes”)– Personal income tax (i.e. progressive)– Corporate income tax (i.e. on capital income)

Effects on equity

Assessing the instruments

Notes: (a) current account effects refer to a deficit country and would switch signs for a surplus country(b) this + sign relates to welfare effects as the GDP impact may be ambiguous.

Growth EquityCurrent

account(a)

ST LT ST LT STSpending cutsEducation -- -- - -- +Health services provided in kind -- - - - ++

Other government consumption -- + - +Pensions ++ ++Sickness and disability payments - + -- - ++Unemployment insurance - + - ++Family - - -- -- +Subsidies - ++ + + +Public investment -- -- ++

Revenue increasesPersonal income taxes - -- + + +Social security contributions - -- - -Corporate income taxes - -- + + ++Environmental taxes - +(b) - +Consumption taxes - - - ++

Recurrent taxes on immovable property - +Other property taxes - ++ + +Sales of goods and services - + - - + 17

Source: Cournède, Goujard and Pina (2013).

A possible generic hierarchy of consolidation instruments

Note: The rankings are based on the assessment in Table 2. Scores of +1 and -1 are given to each + and- signs respectively, each objective is given a weight, and the resulting indicator is used to rank instruments. Each individual instrument score based on the assessment in Table 2 is kept with a probability of ¾ or increased by +1 with a probability of 1/8 or reduced by -1 with a probability of 1/8. Weights ranging each from 0.15 to 0.55 and summing to unity have been given to each objective. Weights have been restricted to no smaller than 0.15 because each objective is considered important. A total of 40,000 random draws have been made.

Ranking from most (highest score) to least (lowest score) desirable instrument of consolidation

EducationChildcare and family

Social security contributionsHealth services in kind

Public investmentConsumption taxes Sickness payments

Sales of goods and servicesOther gov. consumption

Rec. taxes on imm. propertyEnvironmental taxes

Corporate income taxesPersonal income taxes

Unemployment insuranceOther property taxes

PensionsSubsidies

0 2 4 6 8 10 12 14 16 18Instrument rank

Equal weights

Simulated interdec i le range

18Source: Cournède, Goujard and Pina (2013).

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1. Consolidation needs

2. Hierarchy of instruments- Instruments used one by one until consolidation needs are met

3. Room for manoeuvre in each instrument– Move until reaching the median (OECD benchmark)– No more than one st.dev. (national preferences)– Reduced margins for pensions (esp. in the short

term)– Adjustment for pensions and education and for

unemployment benefits

The optimal use of instruments depends on:

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HOW MUCH CONSOLIDATION CAN RELY ON BENIGN INSTRUMENTS?

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• Short- to medium-term simulations– Short- to medium-term consolidation needs

• Long-term simulations– Long-term consolidation needs– Considering only long-term growth and equity

effects

Two sets of simulations for each country

Results from short- to medium-term simulations

Consolidating more in general implies using more unfavourable marginal instruments (but there are exceptions)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 160

2

4

6

8

10

12

14

16

18

20

1

12

3

3

4

5

5

6 66

7

9 9 9

9

10

11 1111

12 12

14 1417

Achieved consolidation (percent of potential GDP)

Marginal instrument rank

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Source: Cournède, Goujard and Pina (2013).

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Simulated short- to medium-term consolidation packages:• Top-half instruments only in 16 countries (e.g.

AUS, CAN, NLD)

• Top-half instruments mainly in 6 countries (e.g. FIN, FRA)

• Bottom-half instruments mainly: JAP, the UK, and the US

How far down the hierarchy of instruments do countries need to go?

Results from long-term simulations

Consolidating more in general implies using more unfavourable marginal instruments (but there are exceptions)

0 1 2 3 4 5 6 7 8 9 10 110

2

4

6

8

10

12

14

16

2 22 2

3

3

4

3

5

3

3

3

6

5

3

6

9

8

7

7

12

10 10

10

10

14 14

13

15

Achieved consolidation (percentage point of potential GDP)

Marginal instrument rank

24Source: Cournède, Goujard and Pina (2013).

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Simulated long-term consolidation packages:• Top-half instruments only in 20 countries

• Top-half instruments mainly in 6 countries

• Bottom-half instruments mainly: AUS, NZL, and the US

How far down the hierarchy of instruments do countries need to go?

On average across countries, spending reductions account for:

• 41% of short- to medium-term simulated packages

• 65% of long-term simulated packages

with considerable variation across countries.

Examples:

• In JPN and USA, the simulations give a large role to tax increases (70% of consolidation over the medium term).

• FRA has a very strong potential for spending cuts which make up 73% of the simulated medium-term package.

Spending vs. taxes in simulated packages

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A medium-term increase in the tax share

FR

A

FIN

BE

L

SW

E

AU

T

ITA

SV

N

GR

C

HU

N

NLD

LUX

ISL

PR

T

CZ

E

GB

R

ISR

NZ

L

PO

L

CA

N

ES

P

IRL

JPN

SV

K

AU

S

US

A

30

35

40

45

50

55

Cyclically-adjusted primary government revenue, % of potential GDP

Estimated in 2012 Simulated in 2020

Source: Economics Department Policy Note No. 20.

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• No room for complacency• CZE situation good in the short-/medium term, less so in the long term• Structural reforms to ease trade-offs between fiscal consolidation and other objectives

Conclusions

• OECD Economic Policy Papers No. 07, “Choosing Fiscal Consolidation Instruments Compatible With Growth and Equity”, A Going for Growth Report, July 2013.

• Cournède, B., A. Pina and A. Goujard (2013), “How to Achieve Growth- and Equity-Friendly Fiscal Consolidation? A Proposed Methodology for Instrument Choice With an Illustrative Application to OECD Countries”, OECD Economics Department Working Papers, No. 1088.

• Barbiero, O. and Cournède (2013), “New Econometric Estimates of Long-Term Growth Effects of Different Areas of Public Spending”, OECD Economics Department Working Papers, forthcoming.

• Goujard, A. (2013), “Cross-Country Spillovers from Fiscal Consolidation”, OECD Economics Department Working Papers, forthcoming.

The full results are available in:

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