Appendix: Summary of the IMF’s Global Fiscal Model
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We are grateful to Daniel Citrin and Alessandro Zanello, and seminar participants at the IMF’s Regional Office for Asia and the Pacific in Tokyo for many helpful comments and suggestions.
The 2004 reform of the pension system will help contain longer-term pension outlays by streamlining benefits and gradually increasing the contributions of employees and employers. Most of the remaining pressure on the budget will be related to healthcare.
The model has been applied by IMF staff for background work on recent Article IV consultations with Canada (Bayoumi and Botman, 2005), the United Kingdom (Botman and Honjo, 2006), and the United States (Bayoumi, Botman, and Kumar, 2005). A brief overview of the model is provided in the Appendix.
The tax rates for the VAT, social security contributions by employers, personal income tax, and corporate income tax are calibrated such that the revenue yield as a share of GDP is equal to figures observed in Japan. The tax rate for social security contributions by workers, on the other hand, adjusts endogenously in the model such that the initial steady-state is consistent with a stable debt path—taking into account the revenue from other sources, spending on goods and transfers, and financing costs of the initial level of government debt.
GFM does not include nominal rigidities, which explains the negative correlation between government spending and private consumption. Thus, despite the presence of rule-of-thumb consumers and monopolistic competition, GFM replicates the result obtained in real-business cycle models (see Galí, López-Salido, and Vallés, 2005; Fatás and Mihov, 2001; Blanchard and Perotti, 2002; and Perotti, 2004; for theoretical and empirical work in support of the Keynesian view).
The package includes a reduction in spending of 0.5 percent of GDP during the first two years, followed by a lowering of transfers by 0.5 percent of GDP a year for the next two years, and a 1-percentage point increase in the consumption tax rate in the fifth year.
The model probably understates the sensitivity of investment to taxation as capital is not internationally mobile.
This trade-off increases with the shortening of consumers’ planning horizon as future consolidation measures are less discounted. It should also be noted that GFM does not incorporate menu costs, which may provide an additional reason against a gradual increase particularly in the consumption tax rate.