Fiscal Affairs Department
©2010 International Monetary Fund
Production: IMF Multimedia Services Division
Typesetting: Alicia Etchebarne-Bourdin
From stimulus to consolidation: revenue and expenditure policies in advanced and emerging economies/a staff team led by Benedict Clements, Victoria Perry, and Juan Toro—Washington, D.C.: International Monetary Fund, 2010.
Includes bibliographical references.
1. Expenditures, Public. 2. Government spending policy. 3. Revenue. 4. Taxation. I. Clements, Benedict J. II. Perry, Victoria J. III. Toro, Juan. IV. International Monetary Fund. HJ7461.F76 2010
Disclaimer: This publication should not be reported as representing the views or policies of the International Monetary Fund. The views expressed in this work are those of the authors and do not necessarily represent those of the IMF, its Executive Board, or its management.
Please send orders to:
International Monetary Fund, Publication Services
P.O. Box 92780, Washington, D.C. 20090, U.S.A.
Telephone: (202) 623-7430 Fax: (202) 623-7201
An extraordinary global effort on fiscal and monetary policy has been required to support economic activity in the wake of the Great Recession. A key challenge now facing the world economy is to ensure that economic growth resumes in a strong, sustained, and balanced way. As the recovery becomes entrenched, policymakers will need to start reducing public debt ratios to more prudent levels.
This paper by the Fiscal Affairs Department (FAD) aims to assist International Monetary Fund (IMF) member countries in this endeavor by providing a strategy for fiscal adjustment that can help support sustainable growth over the longer term. It was presented at an IMF Executive Board seminar in May 2010. It discusses a menu of specific revenue and spending policy measures that could be considered to implement this strategy. On the spending side, the paper suggests a two-pronged strategy focused on stabilizing pension and public health spending ratios to GDP and reducing other outlays, including public wages, untargeted social spending, and subsidies. On the revenue side, particular attention is given to measures that could raise revenues by reducing existing distortions in the tax system.
Many people have contributed to this paper. The work was overseen by Gerd Schwartz and coordinated by Benedict Clements, Victoria Perry, and Juan Toro. The main contributors to the paper were Ernesto Crivelli, Philip Daniel, Luc Eyraud, Borja Gracia, Jack Grigg, Graham Harrison, Benjamin Jones, Izabela Karpowicz, Adam Leive, Oana Luca, Mario Mansour, Thornton Matheson, Priscilla Muthoora, John Norregaard, Geremia Palomba, Joana Pereira, Patrick Petit, John Piotrowski, Mauricio Soto, Anita Tuladhar, Ricardo Varsano, and Asegedech WoldeMariam. Beulah David, Latoya McDonald, Jeff Pichocki, and Mileva Radisavljević helped with administrative and editorial work. Joanne Blake and her team in the External Relations Department helped turn the original paper into this Departmental Paper. Helpful inputs and comments were provided by many colleagues in FAD.
This paper identifies policy tools to support fiscal consolidation in the years ahead. Its starting point is the analysis in recent papers by IMF staff describing strategies for fiscal consolidation (Ali Abbas and others, 2010; and IMF, 2010a), which showed that on current trends, general government debt in advanced countries would rise 36 percentage points of GDP during 2007–14, and that age-related spending (health and pension) would rise rapidly later, further adding to fiscal pressures. Trends are more favorable in emerging economies, but adjustments are needed there too.
The consolidation strategy, particularly in advanced countries, should aim to stabilize age-related spending in relation to GDP, reduce non-age-related expenditure ratios, and increase revenues in an efficient manner. The precise mix will vary across countries, but given the high level of taxation in advanced countries and recent increases in spending, a relatively stronger effort is needed on expenditures.
On the spending side, bold reforms are needed to offset the projected rise in age-related outlays, particularly health care. In pensions, a further increase in statutory retirement ages of two years could offset the projected rise of spending of 1 percentage point of GDP over the next 20 years in advanced economies. In health, the challenge is greater, and has so far been underestimated, particularly in Europe. New staff projections show that health spending could rise by 3½ percentage points of GDP over the next 20 years in advanced countries. Reforms are needed to address supply-side incentives, limit public benefits, or reduce the demand for public health services. But while many countries have managed to reform significantly their pension systems, the difficulty of health reform is underscored by the dearth of prominent reforms in advanced countries aimed primarily at reducing spending.
In other spending areas, in addition to allowing stimulus spending increases to expire, a possible policy goal could be to freeze spending in real per capita terms for 10 years. This would save 3–3½ percentage points of GDP. It would require deep spending reforms. Containing the wage bill has in the past proved to be key to successful fiscal consolidation. Expenditure on social benefits could be reduced, without sacrificing equity objectives, through better targeting. Subsidy spending should also be lowered, including for petroleum products, which absorb about 1 percent of world GDP. There may also be scope for savings on military spending.
On the revenue side, boosting revenues in a global economy requires strengthening broad-based taxes on relatively immobile bases and improving tax compliance, including through better international cooperation. Relatively efficient measures could yield perhaps 2.8 percent of GDP (on a weighted average basis) in G-7 countries from: increasing the yield of the VAT by eliminating exemptions and reduced rates; further developing property taxes; increasing excise rates within the scope of rates already applicable in comparable countries; and introducing (and capturing revenues from) efficient carbon pricing in the United States and Europe. A menu of additional measures—for instance, introducing VAT in the United States, and doubling the very low VAT rate in Japan—could further raise revenues by 4.5 and 2.6 percent of GDP, respectively, in those countries. There is also scope for stronger income taxation, in part to address equity objectives, though efficiency concerns loom larger there.
The potential for improving tax compliance is also significant. Tax systems in many countries suffer from pervasive tax abuse through informality, aggressive tax planning, offshore tax abuse, fraud, and increasing tax debt as a result of the crisis and recession. Improving tax compliance will require enhancing international collaboration in tax information exchange and transparency, strengthening risk management approaches, intensifying use of modern information technology to manage tax compliance, tackling endemic abuses to improve the taxpaying culture in some countries, and improving legal frameworks. Extra revenue equivalent to 0.7 percent of GDP could be collected by reducing the VAT gap in G-20 countries in the coming years.