Journal Issue
Share
Chapter

CHAPTER 1 Introduction

Author(s):
Benedict Clements, Juan Toro R., and Victoria Perry
Published Date:
October 2010
Share
  • ShareShare
Show Summary Details

This paper seeks to identify policy tools that could be used for fiscal consolidation in advanced and emerging countries in the wake of the global financial crisis. Issues related to the size and timing of fiscal adjustment, policy coordination, and demand management were addressed in previous papers (Ali Abbas and others, 2010; and IMF, 2010a).

The magnitude of the challenge to revenue and expenditure policies is large, including in light of projected increases in age-related spending. The effects of the crisis have been severe, particularly in advanced countries:

  • In advanced countries, primary deficits rose by 7½ percentage points of GDP between 2007 and 2010, reflecting underlying spending increases, stimulus measures, and cyclical factors (Ali Abbas and others, 2010; and IMF, 2010a, 2010b).1 These increases have come on top of an already rising spending trend, in real per capita terms and also relative to GDP, during this decade (Table 1.1a). Revenues have declined in real terms owing to the collapse in assets prices, financial sector profits, reduced output, and possibly, reduced tax compliance. As a result, general government gross debt is projected to rise by 36 percentage points of GDP between 2007 and 2014. To reduce it to, say, 60 percent of GDP by 2030, an average improvement in the structural primary balance of 8¾ percentage points of GDP on a PPP-weighted basis (unweighted average, 4¾ percentage points of GDP) would be required between 2010 and 2020 (Ali Abbas and others, 2010; and IMF, 2010b).2 This would have to be achieved at a time when age-related spending (health and pensions) will tend to rise by about 4–5 percentage points of GDP.
  • In the emerging economies, revenue growth in 2008–10 has experienced a marked slowdown from the rapid increases observed in the pre-crisis period (2001–07). Primary spending has also been rising rapidly in real terms at a slightly faster pace compared to the pre-crisis period (Table 1.1b). In these countries, the need for adjustment is less severe—on average, 2¾ percentage points of GDP, if the goal is to reduce public debt to a ratio of 40 percent of GDP by 2030.
Table 1.1a.Advanced Economies: Revenue, Expenditure, and Illustrative Adjustment(General government, unless otherwise noted)
IllustrativeRevenue,Primary Exp.,RevenuePrimary ExpenditureGDPPopulation
Adjustment200720072001-072008-102001-072008-102001-072008-102001-2007
(In percent of GDP)(In average annual real growth)
Australia5.235.533.53.1-1.63.64.33.42.21.4
Austria4.748.145.91.5-0.81.32.12.1-0.10.5
Belgium4.748.244.51.70.02.63.51.9-0.40.5
Canada4.440.734.91.6-2.23.24.22.60.31.0
Cyprus5.645.539.17.7-3.25.95.03.60.41.7
Czech Republic3.741.941.45.9-1.34.71.74.5-0.10.1
Denmark4.355.749.41.6-5.61.40.81.6-1.60.3
Finland4.447.440.82.3-2.03.15.13.2-1.90.3
France8.349.649.61.7-1.52.12.21.8-0.10.7
Germany4.043.940.90.4-1.90.92.81.2-0.90.0
Greece9.240.440.03.3-1.34.44.64.2-1.30.2
Hong Kong3.822.214.58.9-8.81.98.14.91.40.5
Iceland0.947.739.75.3-9.04.3-3.14.6-2.91.4
Ireland9.835.834.95.7-5.18.63.75.5-3.92.0
Israel2.844.640.22.6-3.02.21.13.02.61.9
Italy4.146.442.91.5-2.22.20.91.1-1.90.5
Japan13.131.030.92.2-2.80.24.21.6-1.50.1
Korea 1-3.325.019.46.20.46.75.14.72.30.4
Luxembourg6.439.936.03.0-1.33.85.04.3-0.71.3
Malta2.240.339.13.91.62.53.71.80.20.8
Netherlands5.545.543.01.7-1.02.83.51.9-0.30.6
New Zealand 10.933.729.93.3-3.53.33.53.30.41.3
Norway0.158.739.73.4-1.53.03.42.30.40.7
Portugal7.843.242.92.1-3.02.11.41.1-0.80.6
Singapore4.725.412.23.2-5.9-1.622.85.61.61.9
Slovak Republic4.128.829.06.55.43.69.26.21.80.0
Slovenia4.040.539.24.4-0.14.04.74.4-1.00.1
Spain9.441.137.64.5-5.74.14.03.4-1.11.4
Sweden2.353.648.02.0-2.42.32.52.8-1.10.4
Switzerland-0.836.633.22.2-0.32.62.92.00.60.2
United Kingdom9.037.838.32.5-2.64.34.12.6-1.10.5
United States 212.033.933.62.4-3.23.85.32.60.31.0
Average8.737.435.82.5-2.63.04.32.4-0.20.7
Advanced G-209.336.435.32.2-2.63.04.32.3-0.20.7
Sources: World Economic Outlook (WEO) database; and IMF staff estimates.Note: For a description of illustrative adjustment, see footnote 2 of text and notes for Figure 1.1. The illustrative adjustment refers to the change in the cyclically adjusted primary balance needed to stabilize debt at the end-2012 level by 2030 if the respective debt-to-GDP ratio is less than 60 percent (no shading) or to bring the debt ratio to 60 percent in 2030 (shaded). Figures for Greece incorporate latest IMF program data that assume an adjustment of 7.6 percent of GDP in 2010. For Australia, the figures do not take account of the latest federal government budget, released on May 11, which envisages a return to federal government surpluses by 2012–13.

Central government.

Earliest year consistent WEO revenue and expenditure growth series available: 2002.

Sources: World Economic Outlook (WEO) database; and IMF staff estimates.Note: For a description of illustrative adjustment, see footnote 2 of text and notes for Figure 1.1. The illustrative adjustment refers to the change in the cyclically adjusted primary balance needed to stabilize debt at the end-2012 level by 2030 if the respective debt-to-GDP ratio is less than 60 percent (no shading) or to bring the debt ratio to 60 percent in 2030 (shaded). Figures for Greece incorporate latest IMF program data that assume an adjustment of 7.6 percent of GDP in 2010. For Australia, the figures do not take account of the latest federal government budget, released on May 11, which envisages a return to federal government surpluses by 2012–13.

Central government.

Earliest year consistent WEO revenue and expenditure growth series available: 2002.

Table 1.1b.Emerging Economies: Revenue, Expenditure, and Illustrative Adjustment(General government, unless otherwise noted)
IllustrativeRevenue,Primary Exp.,RevenuePrimaryExpenditureGDPPopulation
Adjustment200720072001-072008-102001-072008-102001-072008-102001-2007
(In percent of GDP)(In average annual real growth)
Argentina 11.631.528.87.56.26.510.03.83.71.0
Brazil 12-2.135.732.34.44.34.44.53.83.41.3
Bulgaria-0.840.736.16.4-2.86.02.15.60.3-1.3
Chile3.029.419.97.6-4.32.011.14.32.31.2
China 33.120.519.116.89.212.916.210.49.40.6
Colombia 11.127.124.16.1-1.54.82.54.91.61.2
Croatia0.140.740.25.0-3.23.4-2.14.7-1.20.2
Egypt8.527.730.04.10.97.32.14.65.62.2
Hungary-1.344.945.83.6-2.14.8-3.13.7-2.0-0.2
India7.022.821.711.53.17.410.87.37.31.6
Indonesia 30.318.517.78.70.19.82.35.15.51.4
Malaysia6.825.526.57.82.67.16.15.12.52.1
Mexico 10.521.420.14.00.04.13.32.5-0.41.1
Nigeria6.028.428.43.74.28.811.39.76.22.8
Pakistan1.315.316.56.31.510.2-0.55.22.32.0
Peru1.120.916.07.62.73.213.05.45.61.6
Philippines 30.815.813.15.30.82.95.65.02.82.1
Poland7.240.339.94.92.34.76.74.13.1-0.1
Romania 42.132.334.68.80.48.92.66.10.1-0.3
Russia1.640.032.78.2-3.58.75.26.60.4-0.3
Saudi Arabia 31.750.132.96.20.64.310.93.42.72.5
South Africa3.428.424.66.70.06.89.04.31.51.0
Turkey 50.431.727.49.01.58.85.46.90.31.2
Ukraine2.241.843.111.2-3.911.6-3.77.7-3.5-0.7
Average2.726.924.510.43.78.79.37.05.10.9
Emerging G-202.626.323.511.34.49.210.47.35.60.9
Sources: WEO; and IMF staff estimates.Note: For a description of illustrative adjustment, see footnote 2 of text and notes for Figure 1.1. The illustrative adjustment refers to the change in the cyclically adjusted primary balance needed to stabilize debt at the end-2012 level by 2030 if the respective debt-to-GDP ratio is less than 40 percent or to bring the debt ratio to 40 percent in 2030.

Nonfinancial public sector.

Earliest year consistent WEO revenue and expenditure growth series available: 2002.

Central government.

Earliest year consistent WEO revenue and expenditure growth series available: 2005.

Earliest year consistent WEO revenue and expenditure growth series available: 2003.

Sources: WEO; and IMF staff estimates.Note: For a description of illustrative adjustment, see footnote 2 of text and notes for Figure 1.1. The illustrative adjustment refers to the change in the cyclically adjusted primary balance needed to stabilize debt at the end-2012 level by 2030 if the respective debt-to-GDP ratio is less than 40 percent or to bring the debt ratio to 40 percent in 2030.

Nonfinancial public sector.

Earliest year consistent WEO revenue and expenditure growth series available: 2002.

Central government.

Earliest year consistent WEO revenue and expenditure growth series available: 2005.

Earliest year consistent WEO revenue and expenditure growth series available: 2003.

The adjustments needed to achieve these debt targets vary substantially across countries. For example, among advanced economies, about two-thirds face primary adjustment needs lower than 5 percentage points of GDP, while one-fifth require adjustments greater than 8 percentage points of GDP.

These differences reflect variations, not only in initial debt positions, but also initial primary structural balances. The adjustments needed to offset age-related spending pressures also vary, depending not only on demographics and income levels, but also the coverage and generosity of the systems (Figure 1.1).

Figure 1.1.Illustrative Fiscal Adjustment and Projected Age-Related Spending Increases in 2011–30

(In percent of GDP)

Source: IMF staff estimates.

Notes: Fiscal adjustment refers to improvements in the cyclically adjusted primary balance needed to achieve the illustrative gross general government debt target. Circles indicate debt ratios above 60 percent for advanced economies and 40 percent for emerging economies, projected at end 2012; triangles indicate debt ratios below 60 percent for advanced economies and 40 percent for emerging economies, projected for the same period. For Japan, the target is 200 percent of gross debt (close to the pre-crisis level); even with this less ambitious target, Japan has the highest needed adjustment among all countries. For Greece (not shown), the comparable figures for required adjustment and health and pension spending increases are 9.2 and 7.6 percent of GDP, respectively; this assumes an adjustment of 7.6 percent of GDP is implemented in 2010. For Australia, the figures do not take account of the latest federal government budget, released on May 11, which envisages a return to federal government surpluses by 2012–13. The analysis is illustrative and makes some simplifying assumptions: in particular, up to 2015, an interest rate-growth rate differential of 0 percent is assumed, broadly in line with WEO assumptions, after 2015 differential is 1 percent for all countries. For details on methodology and the country-specific estimates, see Ali Abbas and others (2010), IMF (2010b), and footnote 2 in the text. For a description of projected increases in age-related spending, see Chapter 2. The vertical and horizontal lines represent unweighted averages.

The paper is structured as follows. The rest of this introduction sets out general considerations for balancing revenue and spending measures to achieve fiscal consolidation. Chapter 2 identifies reform options for public spending, also based on new staff projections for age-related spending for a large number of advanced and emerging economies. Chapter 3 considers reform options in tax policy and administration.

Balancing Revenue and Expenditure Measures in Adjustment Strategies

The appropriate mix of adjustment measures will depend on various factors, although, on average, higher reliance on spending cuts will likely be needed, particularly in advanced countries. The literature generally finds expenditure-based adjustments to have been more successful.3 Looking ahead, the mix between revenue and expenditure measures should reflect:

  • Current spending and revenue levels. With tax burdens high in many advanced countries, there may be limited scope to raise tax rates without adverse effects on economic efficiency, with some exceptions, notably carbon pricing. This—together with the fact that the stimulus measures consisted primarily of spending increases, as well as the need to offset the trend increase in age-related spending—will imply higher reliance on spending cuts. But the extent of this will vary with preexisting tax design and implementation: closing the gaps in a porous VAT, for instance, can provide a relatively efficient source of substantial revenue, even in countries with relatively high tax-to-GDP ratios.
  • Size of the needed adjustment. Where this is large, substantial measures are likely needed on both the revenue and expenditure sides. The unprecedented magnitude of the required adjustment will most likely also require revenue measures in many countries. In most advanced economies, for example, a freeze on real per capita expenditures (other than health and pension outlays) over the next 10 years would be insufficient to generate the needed adjustment as shown in the illustrative scenario (Ali Abbas and others, 2010).
  • Impact of reform measures on growth and equity. This would suggest a strong emphasis on reform of inefficient, poorly targeted, and inequitable public spending. In some cases, offsetting measures, such as stronger and better-targeted social safety nets, may be needed to address the effects of reforms.
  • Socio-political views on the role of government. Where there is consensus on a relatively larger role for government, basing fiscal consolidation on revenue expansion may find broader support.

Reflecting these considerations, the focus of country adjustment strategies will vary (Table 1.2). The guidelines below should be seen in the context of strategies for fiscal consolidation, rather than longer-term development goals that could influence revenue and expenditure plans:

Table 1.2.Selected Advanced and Emerging Economies: Adjustment Strategy and Illustrative Adjustment Needs
More Reliance on TaxTax and ExpenditureMore Reliance on Expenditure
High adjustment (>6 percent of GDP)France, India, Ireland, Japan, Portugal, Spain, the United Kingdom, and the United StatesPoland
Moderate adjustment (Between 3 and 6 percent of GDP)Austria, China, Germany, and ItalyAustralia, Belgium, Canada, Finland, the Netherlands, and South Africa
Low adjustment (<3 percent of GDP)Indonesia MexicoIcelandArgentina, Brazil, Russia, Saudi Arabia, Sweden, and Turkey
Note: Adjustment needs are defined as in Figure 1.1, horizontal axis. Therefore, they exclude the measures needed to offset age-related spending increases.
Note: Adjustment needs are defined as in Figure 1.1, horizontal axis. Therefore, they exclude the measures needed to offset age-related spending increases.
  • Where both adjustment needs and tax effort are relatively low, revenue-raising is naturally the main focus (Indonesia and Mexico).
  • Where adjustment needs are low and the impulse from spending has been high, or the tax level is relatively high, adjustment should rely more on expenditure reductions (Argentina, Brazil, Russia, Saudi Arabia, Sweden, and Turkey)—including through improvements in the efficiency of spending. In addition, where there is scope for improving revenues, reforms should include measures in this area (Iceland).
  • For countries with moderate/high adjustment needs, and where structural expenditure has risen rapidly during the crisis and is at a medium to high level, the strategy should focus on expenditure reductions (Australia, Belgium, Canada, Finland, Netherlands, Poland, and South Africa). This is particularly the case where the desire or options for increases in taxes are limited. For others, possibilities for efficiency-enhancing revenue measures, including through administration reforms, should be fully explored (Austria, Germany, and Italy). In addition, where there is scope for significantly improving revenues, reforms should include measures in this area, as well as a reversal of stimulus spending (China).
  • Some countries with high adjustment needs will require measures on both sides. This includes France, Greece, India, Ireland, Japan, Portugal, Spain, the United Kingdom, and the United States.
  • All countries will need to develop a strategy to deal with age-related expenditures. For advanced countries where spending pressures are higher, a reasonable goal would be to keep these outlays constant (relative to GDP) over the medium term. For emerging market economies, the focus would be on improving the efficiency of this spending and program design at an early stage, to ensure that the expansion of coverage over the longer term is fiscally sustainable.

    Other Resources Citing This Publication