Spain’s housing boom was supported by rapid economic expansion, strong employment growth, an immigration boom, and low real interest rates. With the abrupt drying up of funding since mid-2007, these factors have eroded quickly. Through 2010, employment and value added in construction are projected to halve as peak housing starts are completed. The authorities have launched efforts to help limit foreclosures and to activate the underdeveloped rental market. In the medium term, housing market cyclicality could be reduced by fading out generous home ownership incentives.


Spain’s housing boom was supported by rapid economic expansion, strong employment growth, an immigration boom, and low real interest rates. With the abrupt drying up of funding since mid-2007, these factors have eroded quickly. Through 2010, employment and value added in construction are projected to halve as peak housing starts are completed. The authorities have launched efforts to help limit foreclosures and to activate the underdeveloped rental market. In the medium term, housing market cyclicality could be reduced by fading out generous home ownership incentives.

III. The Long-run Fiscal Outlook and the Public Sector Balance Sheet70

A. Introduction

82. Between 1995–2007, Spain’s fiscal position improved significantly. During this time, the authorities turned a deficit of 6.5 percent of GDP into a surplus of 2.2 percent and the public debt was cut nearly in half to 36.2 percent of GDP. A key factor was the sustained economic boom supported by lower interest rates (with euro adoption) and strong immigration. In particular, the combination of rising incomes and access to credit with declining risk premia helped engender a housing and consumption surge. Strong corporate profits further increased tax revenues.


Fiscal Balance and Debt

(percent of GDP)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003


Revenue and Expenditure

(percent of GDP)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003

83. Going forward, key tax bases are now eroding, led by the cooling housing market; while changing demographics challenge the fiscal outlook further out. The global financial turmoil has tightened financing conditions and brought the housing boom to a halt. As a result, the fiscal position is deteriorating. What during the boom appeared to be sustainable revenues that allowed strong increases in primary spending is now generating doubt whether the underlying structural fiscal position in fact is as strong as previously thought. Further, Spain faces significant challenges associated with population aging that require major budgetary adjustment over the longer run.

84. The objective of this paper is to assess the long-run fiscal outlook in the current challenging context. Section B presents long-run fiscal projections based on current policies. It examines recent developments in revenue and expenditure, assessing tax bases, and expenditure pressures. Section C presents a preliminary public sector balance sheet that provides a long-run intertemporal view of these fiscal developments to see if current policies are sustainable. Section D concludes.

B. Long-run Fiscal Outlook

85. Spain is coming off a period with buoyant fiscal indicators. The large improvement reflects lower interest payments and strong increases in tax revenues on the back of high growth with a housing boom. The interest bill declined by 3½ percentage points of GDP over a decade, while tax revenue increased by 5 percentage points of GDP. Despite some earlier reforms to reduce personal income taxes71, the revenue elasticity to GDP mostly remained above one, averaging 1.2 for the period. VAT revenues in particular increased steadily on the back of the consumption/housing boom, but more recently, corporate income taxes have also been a key source of revenue.


Tax Revenue

(percent of GDP)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003


Interest and Primary Current Expenditure

(percent of GDP)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003

86. Part of the revenue upswing is structural. Better access to credit with EU integration and the adoption of the euro accelerated income convergence to the euro-area. Rising incomes in turn prompted greater demand for consumption and housing, materially increasing the VAT tax base. Corporate profits associated with real estate also soared. While it is difficult to single out the overall impact of housing market activity on tax revenue, a rough calculation that takes into account the evolution of the VAT tax base for new home purchases, taxes on property and property transaction, and higher gross value added from the construction sector suggest that the housing boom increased tax revenues by as much as 2½-3 percent of GDP during 1995–2007. Thus, housing, residential construction, and its ancillary effects are estimated to have accounted for more than half of total tax revenue increases during the period. This tax base is now declining.

87. The housing collapse that emerged with the global financial turmoil has exposed the unsustainability of the preceding boom. Lower availability of funding and higher credit costs through risk repricing have led to significant adjustment in domestic demand. With the sudden deflation of this key tax base, overall tax revenue is projected to drop by more than 3 percentage points of GDP in 2008 alone. Together with sizeable trend increases in primary spending this puts pressure on the public finances. Since 2001, real primary current spending has outpaced the rate of trend (potential) growth, offset in part by the unusually low interest rates in recent years. As interest rates may now be seen as normalizing, primary spending needs to moderate to prevent total expenditure from taking off.


Current Spending

(change in percent)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003

88. To identify underlying fiscal trends and opportunities in Spain, it is important to assess what changes to the conditions in the economy are permanent or temporary. The standard technique calculates the structural fiscal balance as a function of the output gap. However, the cycles of consumption, housing, and labor compensation, the recent main tax bases, can follow somewhat different timing than the cycle of headline GDP. In addition, the amplitude of the various cycles in each tax base can be different, especially that of consumption, which tends to have smaller amplitude than that of GDP. Against this backdrop, the calculation of the structural position will thus need to take into account the different behaviors of the tax bases relative to GDP.72 With this in mind, this analysis tries to match each main revenue and expenditure component to its underlying tax or expenditure base. On the spending side, unemployment benefits are assessed relative to the equilibrium unemployment rate (NAIRU), while long-term age-related spending (pensions, health, long-term care and education) follow the path (essentially a demographic base) presented by the Spanish authorities in the 2006 Report by the European Commission’s Aging Working Group (AWG).73 A Hoddrick-Prescott (HP) filter is applied on consumption, GDP, and unemployment to separate the cyclical and trend (structural) components. Both effects from the cyclical conditions and changes in the economic structure are evaluated relative to a base year where the output gap is estimated to be zero. Given that actual and trend GDP cross between 1999 and 2000, the average of the two years is used as the base for GDP.

89. This analysis suggests that more than half of the fiscal improvement during 1995-2007 owed to extraordinary cyclical and one-off factors. The total improvement in the headline fiscal position during this period was 8¾ percentage points of GDP. Structural factors contributed 3 percentage points with the structural balance improving from a deficit of 4 percent of GDP in 1995 to a deficit of 1 percent of GDP in 2007. A growing personal income tax base associated with strong employment gains and higher per-capita incomes, and declining interest payments were key contributing factors. The remainder improvement of 5¾ percentage points was broadly transitory, reflecting a cyclical upturn accompanied with the sustained housing boom. In recent years, increasing revenue gains from the buoyant housing asset price and activity had contributed to generating headline fiscal surpluses. But excluding these cyclical and one-off factors, since 1999 the underlying (structural) fiscal position has remained in deficit around 1 percent of GDP.


Decomposition of Fiscal Balance

(percent of GDP)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003

90. Fiscal measures to assist the economy through the downturn, combined with structural effects that alter the composition of tax bases, are estimated to have weakened the structural position by 3.1 percentage points of GDP in 2008. The policy measures include personal and corporate income tax cuts (especially the €400 per person a year tax rebate), family assistance (Cheque bebe), and other stimulus measures. A significant part of the structural drop also reflects the impact of a permanent erosion in the tax base due to the downturn in the housing market (asset revenue base) and the (permanent) slowdown in job creation (the demographic base). Going forward, household debt that was accumulated during the economic boom and the associated increase in debt service burden are likely to constrain consumption for some time, affecting the VAT base. Also, the (permanent) costs of unemployment benefit were likely underestimated and are now projected by staff to put increasing pressures on spending (in view of rigidities in the Spanish labor market). These adverse shifts in tax bases and expenditure obligations contribute some 1 percentage point of GDP to the structural drop in the fiscal balance.

Spain: Main Fiscal Measures

(Percent of GDP)

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91. For the medium-term, the staff baseline scenario assumes some fiscal adjustment to cut back the impact of recent measures (the exit strategy of the fiscal stimulus) as the economy regains strength, so that the structural deficit is reduced to about 1¼ percent of GDP by 2014. The deficits are projected to decline gradually to 3 percent of GDP as the impact of spending measures drops out (the stimulus measures have sun set clauses), and assuming that the government will contain further current spending to bring the deficit back into compliance with the SGP 3-percent limit (Table 1). This corresponds to a small primary surplus of about ¼ percent of GDP in 2014, and a public debt ratio of 56 percent of GDP.

Table 1.

Spain: General Government Operations 2005-2060

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Sources: Ministry of Finance, Bank of Spain; and staff projections.

The Long Run

92. For the long run, Spain is subject to significant spending pressures due to aging and a slowdown in population growth. Costs associated with aging are projected to rise by 8½ percent of GDP through 2050. The projected increase is large compared to other European countries.

Spain: Projected Aging Costs in the Fiscal Accounts

(In percent of GDP)

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Sources: EU Commission, Special Report No. 1/2006 from the Aging Working Group and Ministry of Finance.

Updated projections from the Ministry of Economy and Finance.


Projected Increase in Total Age-related Spending 2004-2050

(in percent of GDP)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003

Source: Commission 2006

93. In addition, there are several other assumptions that need to be explored to arrive at the underlying long-run baseline scenario.

  • Potential real GDP growth is projected by staff to slow from around 2¾ percent in recent years to about 1½ percent by 2060, as demographic changes shrink the labor force. The main impact of aging in Spain kicks in after 2030 when the dependency ratio surges. Until then, growth could still average 2 percent a year or slightly above. Assuming the inflation differential vis-à-vis the euro area dissipates over time, nominal GDP growth is then projected to slow from between 4-5 percent a year in the medium-long run to about 3½ percent a year after 2030. Labor productivity growth is assumed to improve to about 1½ percent.

  • The average real interest rate is assumed to move in line with real GDP growth over the long-run (real interest rate = real GDP growth + 100 basis points). This implies the average nominal interest rate would gradually decline from about 5 percent to 4 percent as potential growth weakens. While Spain has benefited from low real interest rate in the past (averaging 1½ percent since 2000), with risk repricing, marginal interest rates on newly placed government debt have been increasing. In the long run, it is not possible for Spain to continue with a significant interest or inflation differential from euro partners.

  • Revenue is projected to stabilize at a structural level of 38 percent of GDP, as projected from 2014 onward—roughly 3 percentage points of GDP lower than the cyclical peak in 2006-07. Non-aging primary spending is also kept constant to GDP from 2014 onward, so that the variation in overall primary expenditures is governed by aging costs. Aging costs are assumed to unfold as in the AWG report through 2050; they are kept constant to GDP thereafter.74

Spain: Real GDP Growth and Its Composition 1/

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94. Departing from the current fiscal position and policies, projecting the medium-term path (including some recovery), and then following with the long-run path driven by aging, suggests that the debt to GDP ratio will steadily rise in the long run, and thus current fiscal policies will not be sustainable. The analysis suggests that the primary balance deteriorates gradually to a deficit of about 2½ percent of GDP by 2030. After that, and reflecting growing pressures from the aging, the primary deficit steadily rises to as much as 8¼ percent of GDP. The corresponding debt ratio would rise to some 340 percent of GDP. Fiscal policies need to avoid this explosive debt path lest markets lose confidence in the long run fiscal outlook and begin to push up interest rates and risk premia.


Revenue and Primary Expenditure

(Percent of GDP)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003


Fiscal Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003


Projected Expenditure

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003


Public Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003

95. The required adjustment to restore fiscal sustainability appears substantial but early adjustments, if sustained permanently, can make a significant difference. A calculation of the fiscal gap, i.e., the immediate and permanent change in the primary balance that would be needed in 2009 to achieve a debt target of 60 percent by 2060 is about 4¼ percentage points of GDP. While the required adjustment is not small, postponing adjustment, perhaps because the problem seems far away, will only lead to much bigger problems down the line. For example, if no action is taken until 2030 when aging pressures start to kick in sharply, the required adjustment amounts to 7¾ percent of GDP, nearly double of what would be required today. Alternatively, simulations show that introducing annual permanent adjustments of 0.2 percent of GDP year after year from 2009 onwards (rather than a one-time once-for-all adjustment of 4¼ percent) also would ensure that the debt ratio does not exceed 60 percent of GDP by 2060.

Required Adjustment to Primary Balance

(Percent of GDP)

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One-time permanent change to primary balance needed to achieve the target debt ratio in 2060.


Impact of Adjustment in 2009 on Debt

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003

96. More generally, long-term fiscal sustainability can also be expressed in terms of intertemporal solvency—whether the public sector meets a long-run budget constraint. To be solvent over time, the net present value (NPV) of all future primary balances must equal the current level of net debt (net financial wealth), which is about 20 percent of GDP. If the NPV of future primary balances is not sufficient to cover the net debt, the fiscal stance needs to be tightened. Using the long run baseline projections for fiscal policies in place from 2008, the NPV of future primary balances discounted using the average interest rate on the public debt, assuming a 50-year horizon, is estimated to amount to negative €1.7 trillion (158 percent of GDP)—i.e. instead of paying off the existing debt, this path would increase the debt.75 To meet the intertemporal budget constraint, once-for-all permanent measures of 4¾ percent of GDP would be required in 2009.

97. These long-run calculations are invariably subject to uncertainty. In particular, the required change to the primary balance depends critically on the initial and desired target debt ratios, the time horizon and the projected primary balance. The baseline projections assume a gradual pick-up in economic activity accompanied by some fiscal tightening—the duration of the recovery is of course uncertain. Moreover, an important assumption relates to the evolution of health care costs as demographic factors will not be the only important driver of future heath expenditures. Technological advance, productivity, and health status also play a crucial role. Further, uncertainty relates to the projected decline in education spending. A decline may be optimistic given that Spain’s labor productivity is not high, which suggests that human capital formation remains important for a long while. Indeed, the external environment is also uncertain. Thus, the long-run calculations are not meant as a predictor of what will happen, but rather as a framework that needs to be monitored over time and that provides information about the thrust of policies currently in place.

98. To illustrate the sensitivity of the long run scenario, two alternatives are analyzed, one with higher aging costs, and the other with higher productivity growth.

  • Higher aging costs: if health care expenditures increase faster, to be 2 percentage points of GDP higher by 2050 than in the baseline, the primary deficit would increase to nearly 10 percent of GDP in 2050. The resulting additional debt buildup would be substantial—more than 100 percent of GDP.

  • Higher productivity: long-term labor productivity growth is set at 2 percent (instead of 1½ percent in the baseline). With higher growth, wages will be higher, but so will be real interest rates and entitlement benefits so that the elderly or infirm are not left behind in sharing the increase in well-being. As a result, the primary balance path would remain virtually unchanged. While at present pension expenditures are not indexed to wages in Spain but to CPI inflation, over the long-run, aging entitlements are likely become indexed to wages to prevent a sustained income erosion of the elderly. This is especially relevant in European social-democratic countries where income distribution plays an important role. This suggests that higher growth is not a vehicle to escape from aging costs.76


Primary Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003


Public Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003

99. Despite the large uncertainties, the results suggest that introducing sustained improvements in the primary balance early on is key to ensuring fiscal sustainability. This emphasizes the importance of running cautious fiscal policies and maintaining a sound primary surplus to provide margins to cope with unexpected shocks. Moreover, it shows that measures that alter the path of the primary balance on a permanent basis are most potent to secure the long-term public finances. One-off measures such as asset sales help the debt ratio from rising immediately, but provide little relief from long-term fiscal needs.

C. A Preliminary Public Sector Balance Sheet

100. The notion of the long-run budget constraint can be shown in a public sector balance sheet. A balance sheet can be valuable in offering a summary view of the underlying financial health of the state. One of the balance sheet’s advantages is that it shows a wider range of assets and liabilities than just debt, including financial and non-financial assets and liabilities. However, as with debt, conventional balance sheets are mainly backward-looking which limits their use in assessing long-term fiscal sustainability. This can be remedied by including a forward-looking component—the implicit future debt that arises from the stream of projected primary balances, as we have shown above. When including this forward-looking component, the resulting net worth on the public sector balance sheet provides a snapshot of the intertemporal health of the public finances.

101. Table 2 summarizes such a preliminary public sector balance sheet for Spain. There are three components of the balance sheet: financial net worth (the difference between financial assets and liabilities); nonfinancial fixed assets; and the implicit debt calculated as the NPV of the projected future primary balances (discounted at the average interest rate on the public debt, as above). Financial assets include €50 billion of the new FAAF Fund, with its counterpart shown in the government debt on the liability side. Nonfinancial assets refer to the value of the public sector capital stock—public infrastructure, government buildings, and machinery and equipment, net of depreciation. This is included in the balance sheet as the counterpart of the debt incurred to build the public infrastructure. Investments in public infrastructure should enhance the productive capacity of the economy, resulting in a larger tax base in the future. On a preliminary basis, and based on estimates by Kamps (2004), the net capital stock in Spain was about 48 percent of GDP in 2000. For simplicity, this share is used through 2009. The NPV of future primary balances turns out to be one of the largest entries in the balance sheet. It varies year-by-year depending on what structural fiscal measures that are being introduced. As of 2008, the staff estimates it to be around €1.7 trillion, as was noted above.

Table 2.

Spain: Public Sector Balance Sheet


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Sources: Bank of Spain; and IMF staff estimates.

Net present value of 50-year future primary balance projections in the baseline scenario of unchanged policies. The discount rate is equal to the average interest rate on the public debt. Over the long-run the real interest rate = real GDP growth + 100 bp.

Excludes fixed assets as these may not be marketable.

Includes the FAAF.

Includes government guarantees and ICO credit lines assuming their full use.

102. Putting together the three blocks for Spain in 2008 suggests a negative net worth of €1.4 trillion (132 percent of GDP). This is a sizeable weakening from the €250 billion (25 percent of GDP) shortfall in 2006, which mainly reflects the impact of (thus far uncompensated) policy measures introduced in 2007 and 2008 to combat the slowdown, which significantly weakened the future primary balance path.


Change in the NPV 2007-08

(Percent of GDP)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A003

103. The intertemporal financial position implies that at some point taxes need to increase and/or expenditures need to decrease. For instance, a 3 percent of GDP permanent improvement in the primary balance in 2009 would return net worth to its position of approximately 2006. A one-time adjustment such as asset sales to cut debt, or expenditure shifts in time, would have no discernable impact on net worth.

Impact of Measure on Net Worth

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D. Concluding Remarks

104. Spain, like most industrialized countries, faces large challenges associated with population aging that have significant budgetary implications. Despite an improvement in the fiscal position over the past 15 years, the recent collapse of the housing market triggered by the global financial turmoil has exposed that the underlying structural fiscal position is not as strong as was thought to cope with challenges going forward. The analysis of this paper using a long-term baseline scenario and a public sector balance sheet suggests that current fiscal policies are not sustainable. To enhance fiscal transparency and the credibility of policy decisions to tackle these long-term issues, the government should disclose the full extent of risk and uncertainty surrounding its long-term projections.

105. In particular, as a complement to the Stability and Growth Pact (SGP) which is geared to a medium-term objective (MTO), the public sector balance sheet can offer valuable guidance to long-term fiscal policy. The SGP sets a clear rule for the short and medium-run fiscal policy—it does not provide a view on the intertemporal position of the public finances. However, this aspect is crucial when considering the impact of structural reforms and aging on the public finances. Reforms that alter future government liabilities would be captured appropriately in a balance sheet; under the SGP their beneficial effects might not be visible if these occur in the long run. Indeed, some pension reforms with clear NPV benefits actually cost money in the short run and only bring benefits in the long run. The SGP could thus unwittingly discourage such reforms. In this connection, the authorities could publish a long-run fiscal sustainability report which evaluates the intertemporal position—the net worth position—on the balance sheet as a complement to the usual annual budgetary revenue and expenditure accounts. This could help to signal fiscal sustainability problems as an early warning device. If included in the budget, it could be updated annually to reflect the latest fiscal measures.


  • Brunner, A., (2004), “Investment Trends and Business Capital Stock in OECD Countries: Long-Term Developments and Future Prospects”, IMF Country Report No. 04/340

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  • European Commission, (2006), “The Impact of Ageing on Public Expenditure: Projections for the EU25 Member States on Pensions, Health Care, Long-term Care, Education and Unemployment Transfers (2004–2050)”, Special report No. 1/2006.

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  • Faruquee, H., (2002), “Population Aging and its Macroeconomic Implications: A Framework for Analysis”, IMF Working Paper WP/02/16.

  • Kamps, C., (2004), “New Estimates of Government Net Capital Stocks for 22 OECD Countries 1960–2001”, IMF Working Paper No. 67.


Prepared by Keiko Honjo.


Reforms in 1999 and 2003 cut personal income tax rates.


For indirect tax revenue, the permanent component is assessed by evaluating private consumption*/Output* relative to that of the base year (* denotes potential). For direct tax revenue, labor income consistent with NAIRU at each point in time is assessed relative to the base year—the base year being a period in which the output gap is zero.


Pension expenditures reflect updated projections from the Ministry of Economy and Finance in the framework of the forthcoming 2009 AWG Report.


Excluding pension expenditures that are available until 2060.


A precise calculation of the NPV of future primary balances involves considering an infinite time horizon. For convenience, a 50 year horizon is used here.


Increases in aging costs associated with unemployment may be lower but its magnitude is small compared with pressures from health and pension expenditures.

Spain: Selected Issues
Author: International Monetary Fund