POLICY STRATEGIES FOR GROWTH- AND EQUITY- FRIENDLY FISCAL CONSOLIDATION Jan Stráský With input from Boris Cournède, André Goujard and Álvaro Pina Prague, 19 October 2015
Remarks The opinions expressed and arguments employed in this document are the authors and do not necessarily reflect the official views of the Organisation or of the governments of its member countries. This document and any map included therein are without prejudice to the status of or sovereignity over any territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or area. The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law. 2
Source 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.oecdilibrary.org/economics/how-to-achieve-growth-andequity-friendly-fiscal-consolidation_5k407lwvzkkh-en 3
Outline 1. Consolidation needs 2. Ranking consolidation instruments 3. How much consolidation can rely on benign instruments? 4
CONSOLIDATION NEEDS 5
Fiscal consolidation and other objectives 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 6
Defining short- to medium-term and long-term consolidation needs 7
% of potential GDP Further consolidation is needed over the outcomes achieved as of end-2012 Difference between debt-control and baseline underlying primary surplus 20 In the year when initial consolidation ends (short to medium term) In 2060 (long term) 20 15 15 10 10 5 5 0 0 Source: Cournède, Goujard and Pina (2013). 8
RANKING CONSOLIDATION INSTRUMENTS 9
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 10
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 11
Growth and equity effects of fiscal consolidation instruments 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 12
Short-term growth effects 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 13
Positive long-term growth effects Smaller government and better allocation Distortions through subsidies Better pricing (also of environmental services) Cuts in public spending pensions labour utilisation unemployment benefits employment 14
Negative long-term growth effects 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) 15
Effects on equity Many instruments aggravate income inequality cuts in benefits, cuts in public services Many taxes fall disproportionately more on lowerincome 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) 16
Assessing the instruments Growth Equity Current account (a) ST LT ST LT ST Spending cuts Education -- -- - -- + Health services provided in kind -- - - - ++ Other government consumption -- + - + Pensions ++ ++ Sickness and disability payments - + -- - ++ Unemployment insurance - + - ++ Family - - -- -- + Subsidies - ++ + + + Public investment -- -- ++ 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. Revenue increases Personal 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 Ranking from most (highest score) to least (lowest score) desirable instrument of consolidation Subsidies Pensions Other property taxes Unemployment insurance Personal income taxes Corporate income taxes Environmental taxes Rec. taxes on imm. property Other gov. consumption Sales of goods and services Sickness payments Consumption taxes Public investment Health services in kind Social security contributions Childcare and family Education Equal weights Simulated interdecile range 0 2 4 6 8 10 12 14 16 18 Instrument rank 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. Source: Cournède, Goujard and Pina (2013). 18
The optimal use of instruments depends on: 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 19
HOW MUCH CONSOLIDATION CAN RELY ON BENIGN INSTRUMENTS? 20
Two sets of simulations for each country 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 21
Results from short- to medium-term simulations Consolidating more in general implies using more unfavourable marginal instruments (but there are exceptions) 20 Marginal instrument rank 18 16 14 USA GBR JPN 12 10 NZL AUS CAN ISL FIN FRA ESP IRL GRC 8 6 4 2 0 HUN ITA AUT SWE LUX PRT SVN SVK NLD ISR BEL POL CZE 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Achieved consolidation (percent of potential GDP) Source: Cournède, Goujard and Pina (2013). 22
How far down the hierarchy of instruments do countries need to go? 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 23
Results from long-term simulations Consolidating more in general implies using more unfavourable marginal instruments (but there are exceptions) Marginal instrument rank 16 14 NZL AUS USA GBR 12 IRL 10 KOR ISR ESP SVK JPN 8 LUX SVN 6 4 2 0 DEU ISL FIN EST CHE DNK BEL HUN NLD POL CZE CAN FRA GRC SWE AUT PRT 0 1 2 3 4 5 6 7 8 9 10 11 Achieved consolidation (percentage point of potential GDP) Source: Cournède, Goujard and Pina (2013). 24
How far down the hierarchy of instruments do countries need to go? 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 25
Spending vs. taxes in simulated packages 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. 26
FRA FIN BEL SWE AUT ITA SVN GRC HUN NLD LUX ISL PRT CZE GBR ISR NZL POL CAN ESP IRL JPN SVK AUS USA A medium-term increase in the tax share Cyclically-adjusted primary government revenue, % of potential GDP 55 Estimated in 2012 Simulated in 2020 50 45 40 35 30 Source: Economics Department Policy Note No. 20. 27
Conclusions 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 28
The full results are available in: 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. 29