Fiscal Policy in a Period of Crisis* by Vito Tanzi *To be presentedd at the Seminario Internacional Las Administraciones Tributarias Frente a la Crisis Internacional, SUNAT, Lima (Perú), November 9-11, 2009
Period before current crisis was exceptionally good for Latin America: (a) World economy had boomed; (b) Commodity prices were very high (c) Latin American exports had grown spectacularly; (d) Foreign remittances had reached records; (e) Growth rates for LA countries were generally 4% to 7 %; (f) Foreign exchange holdings at record levels.
Impact of boom on fiscal accounts (averages): (a) Increase in public sector revenue; (b) Fiscal disequilibria much reduced; (c) Primary balances raised to about 3% of GDP; (d) Share of public debt into GDP much reduced; (e) Share of foreign debt into total debt also reduced.
But some concerns remained: (a) The good times were not likely to continue forever; (b) Public expenditure was allowed to grow as a share of GDP, in spite of the high growth rates; (c) Fiscal accounts should have been in surplus (as they were in Chile, Peru and a couple other countries); (d) Public debt should have fallen more; (e) Fiscal policy should have been more countercyclical; (f) The good weather was largely imported, thus it could change.
The current crisis was not domestically made: (a) It started as a financial crisis in the USA; (b) It spread (as a financial crisis) to other industrial countries; (c) Soon the financial crisis became a crisis of the real economy; (d) Spending fell; output fell; and unemployment increased in many of Latin America s best customers (USA, Japan, Europe); (e) Imports from Latin America and commodity prices (and (f) remittances to L.A.) fell dramatically; Latin America had escaped the financial crisis but could not avoid the crisis in the real economy.
Because Latin American banks were less exposed, and large foreign reserves had been accumulated, the initial reaction was that the region could ride the storm. However, concerns have increased in more recent months. Some of these concerns have spread to the fiscal accounts that were not as strong as believed.
Causes for growing concerns: (a)growth forecasts for 2009 and 2010 for Latin America have been reduced. For 2009 from 2.5% (made in October 2008) to 2% (made in July 2009). In its May 2009 forecast, the IMF expects growth in Latin America to resume to 1-1/2% in 2010.
The growth rate was 4.2% in 2008 and 5.7% in both 2006 and 2007; (b) The world economy is expected to remain depressed for years to come; (c) Latin American countries could experience several years of low growth and fiscal difficulties.
Other concerns: (a) The spread on foreign loans for Latin American countries has increased to about 650 basis points; (b) The maturity structure on the loans is sharply down. The share of short debt in total debt had already increased from 29% in 2007 to 63% by 2008. More recent data?; (c) Both the higher spread and the reduction in maturity could continue making the financing of the Latin American public debt more difficult, at the same time when public revenue is falling.
The impact of the economic crisis on the fiscal accounts is a consequence of both automatic and discretionary changes.
Automatic impact of crisis on fiscal accounts: (a) The falls in output, in trade flows and in commodity prices have led to an automatic and growing reduction in public revenue. The drop started in third quarter of 2008 and accelerated in 2009. Revenue from VATs and from income taxes are sharply down. Effect of collection lags.
(b) The drop in public revenue is very large in Central American countries and in Chile, Mexico, Bolivia, and, to a lesser extent, in Peru. Over the years the public revenue of some countries (Chile, Ecuador, Peru and Venezuela) had become more sensitive to commodity price changes.
(c) Some public spending has also increased automatically with the fall in income. In some countries (Argentina, Ecuador, Venezuela) public spending has become more linked with commodity price changes.
Discretionary impact of crisis on fiscal accounts. Guided by Keynesian demand-management principles, some countries governments have attempted to reduce the negative effect of the economic downturn through the pursuit of countercyclical discretionary policies. Among these, two groups can be distinguished:
(a)those who had pursued a prudent countercyclical policy during the good years, by accumulating assets for the rainy days (the hormigas ). (b)those who had spent much of the windfalls, by pursuing a procyclical policy, during the good years (the cigarras ).
During the rainy days of the crisis, the hormigas can afford to pursue some countercyclical policies by using the saved resources. In Latin America some countries (Chile and Mexico) had accumulate assets in stabilization funds. Some (Perú) had accumulated assets without stabilization funds. However, if the crisis continues for a while, all countries will become vulnerable and will need to make adjustments to maintain fiscal sustainability.
Countercyclical policy can only alleviate the impact of the crisis, not neutralize it. Thus countercyclical policies used should be focused on the most vulnerable sectors. They cannot hope to maintain economic activity. The multipliers are too low and the countries are too open.
(a) Several Latin American governments have attempted to follow expansionary fiscal policies that will add to the automatic impact of the crisis on the fiscal accounts. (b) In all countries recent estimates for the overall fiscal balances indicate that, in 2009, they will have deficits ranging from 1% of GDP to as high as 6% (Jamaica) or even 9% of GDP (Venezuela). The final deficits could be even higher. (c) The deterioration in the fiscal accounts of Latin American countries,between 2008 and 2009, is expected to exceed 4% of GDP for the region.
In decreasing order, the fiscal deteriorations (estimated by the IMF) between the 2008 expected outcome and the 2009 expected outcome are: Jamaica Venezuela Chile Bolivia Dominican Republic 12.0% of GDP 9.9% of GDP 8.2% of GDP 7.5% of GDP 7.3% of GDP
Chile and Bolivia had significant fiscal surpluses in 2008. Chile had had very large surpluses for several years before 2009 so that it could afford some years of deficits. Jamaica, Venezuela, and the Dominican Republic had been already running large deficits. Peru is also in a relatively good fiscal situation because of earlier surpluses.
As mentioned, several Latin American countries have introduced fiscal stimulus packages. The packages range from an estimated 0.6% of GDP in Brazil to 2.9% of GDP in Chile. See Table 1 for details. Support provided through public banks is not included. In Brazil that support is estimated to be 3.5% of GDP. These packages compare with 2.5% of GDP in OECD countries and 5.5% of GDP in USA. Table 1 indicates that countercyclical policy actions are, perhaps, more pronounced than in past crises, because of the better initial fiscal conditions of the countries. Also, a lesson learned, is that most of the discretionary fiscal measures taken have a temporary character. They have sunset provisions.
Table 1 Fiscal Stimulus Measures in Latin America in 2009 Actions Argentina Brazil Chile Mexico Peru Expenditure Infrastructure Inv. T T T S T Support to SMF and farmers T T T S T Safety Nets T T T Housing/Const. T T T S Increase in public sector wages Other Revenue Corp. Income Tax T T T Personal Income Tax P T Indirect Taxes T T T T Estimated Budgetary Cost For2009 in % of GDP 1.5 0.6 2.9 1.5 2.0 T = temporary measures; S = self reversing measures; P= permanent measure. Source: National authorities and IMF calculations.
Arguments against discretionary fiscal actions. (a) The crisis is too large and imported. (b) Latin American countries are too open. (c) The impact of discretionary fiscal changes may be felt at the wrong time because of lags. (d) Larger fiscal deficits can have a negative impact on expectations and on borrowing cost. (e) Ricardian reactions may neutralize the impact of fiscal stimuli. (f) Multipliers are likely to be low. (g) Concern about fiscal sustainability.see Argentine experience in 2001-2002.
Arguments in favor of some discretionary actions. (a) If countries have accumulated large assets(chile?), and the crisis is expected to be short, it could make sense to use the assets. World growth is predicted to rise from 1.2% in 2009 to 2.9% in 2010 and 4.2% in 2011. But prudence is necessary in case the crisis continues. (b) The fiscal actions aim at being countercyclical, but at providing essential safety nets for vulnerable people. (c) The discretionary action can come through structural policies that reduce inefficiency and make fiscal policy more pro poor. Reduction in some regulations can be expansionary.
It would seem, at this time, that the polices followed are on the right track: some increases in unemployment insurance (Brazil and Antigua and Barbuda), health benefits for the unemployed (Mexico), subsidies for youth employment, (Chile), increases in targeted cash programs (in many countries). Thus they follow the logic of providing some safety nets for the more vulnerable groups for a limited period.
What should be the role of the tax administrations? Mostly to minimize revenue losses by reducing tax evasion and making administrative changes that can improve their inefficiency over the medium run. If there were pressure to reduce tax revenue for countercyclical reasons, the best alternative would be to reduce temporarily (say for one years) the basic rate of the VAT.
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