Appendix I. Modeling the Impact of Permanent Fiscal Reforms
1. The economic impact of the tax reform package and alternative expenditure policies are analyzed using the IMF’s Global Integrated Monetary and Fiscal model (GIMF).1 GIMF is a general equilibrium model that can help policymakers assess the economic implication of different fiscal and monetary policies. The model has been calibrated to represent Latvia’s characteristics by using historical data and staff projections.
2. The impact of the tax reform is assessed under two financing scenarios. The first scenario, reflecting staff’s current baseline and authorities’ assumptions, assumes the tax reform is partly financed by an increase in excise duties, thus having a negative impact on the fiscal balance, which is debt creating. We also simulate an alternative budget neutral scenario that fully covers the cost of the fiscal reform, where we assume an increase in excises together with an increase in lumpsum taxes (as a proxy for an increase in property taxes). While the tax reform also includes important administrative reforms, which should have a positive impact on tax revenues, these simulations focus only the most direct reforms: the change to the PIT and CIT, which are treated as permanent fiscal measures. A Latvia-specific reform scenario is calibrated using the authorities’ estimates of the change in the effective PIT rates post reform. The CIT reform is calibrated to simulate similar behavioral dynamics as observed in Estonia, given the uncertainty in estimating behavioral dynamics.
Bom, P. and J. Ligthart, 2014: What Have We Learned from Three Decades of Research on the Productivity of Public Capital? Journal of Economic Surveys, Vol. 28, No. 5, pp. 889—916
European Commission, 2017. European Economy – Discussion Paper N. Inequality and Structural Reforms: Methodological Concerns and Lessons from Policy: Workshop Proceedings.
International Monetary Fund, 2010. The Global Integrated Monetary and Fiscal Model (GIMF) – Theoretical Structure. Working Paper No. 10/34
International Monetary Fund, 2013, “Getting to Know GIMF: The Simulation Properties of the Global Integrated Monetary and Fiscal Mode,” Working Paper No. 13/55.
International Monetary Fund, 2016a, “Managing Government Compensation and Employment—Institutions, policies and reform Challenges.
International Monetary Fund, 2016b, “Effective Government for Stronger Growth: Improving the efficiency of public investment and tax administration in CESEE,” CESEE REI Fall.
Organisation for Economic Co-operation and Development (OECD), 2017b, Education at a Glance 2017: OECD Indicators, OECD Publishing, Paris.
Prepared by Karina Garcia (EUR). GIMF simulations done by Michal Andrle (RES).
Throughout this document, advanced economies refer to the income group classification according to WEO.
This estimate is based on official figures of average wages, which do not correct for the impact of the shadow economy on wage estimates. If accounted for, the wage premium could be larger. For the methodology to estimate the wage premium, see IMF (2016a).
Evidence suggest that increases in public sector wages, besides the associated deterioration in fiscal balances, can spill over to overall wages. See IMF (2016a).
Capital stock data is taken from AMECO database, which has some measurement shortcomings with regard to capital stocks in Latvia. Therefore, the purpose of this comparison is to assess relative investment needs in Latvia to those in wealthier EU countries, rather than providing a point estimate of capital stock levels.
For a specific discussion of structural policy priorities in Latvia see IMF Country Report No. 17/195.
This scenario simulates a permanent increase in public investment, financed through a reduction in government consumption. It is based on output elasticity to public investment of 0.2 percent, which is consistent with Bom and Ligthart (2014).
The efficiency frontier shows the level of infrastructure quality at a given capital stock per capita. The closer a country is to the efficiency frontier, the more efficient its public investment. Countries with the highest level of infrastructure coverage and quality. Countries with the highest efficiency scores for a given level of public capital stock and income per capita are assigned the efficiency score of 1 and form the efficiency frontier, while other countries are assigned a score of between 0 and 1, based on their proximity to the frontier. See IMF (2016b)
The data is obtained from the ASPIRE project, which classifies social assistance into the following categories: unconditional cash transfers, cash transfers, social pension, food and in-kind transfers, school feeding, public works, fee waivers, and other social assistance.
Reduction in inequality is calculated as the difference between the Gini coefficient for market income and the Gini coefficient for disposable income.
The reform aims to address shortcomings of the narrow eligibility requirement and the poor adequacy of the program. It aims to: increase the minimum income level to 40 percent of the median disposable income, and set a minimum budget of goods and services for different types of households depending on the territorial dimension.
See OECD (2017).
The “efficiency frontier” analysis was done using FAD’s Data Envelopment Analysis (DAE) and compares Latvia’s relative efficiency both against the efficiency frontier and other countries.
Healthy life expectancy (HALE) is a measure of health expectancy that applies disability weights to health states to compute the equivalent number of years of life expected to be lived in full health.
The authorities commissioned a study to evaluate the economic return of specific indicators and identify key reform objectives. Results of this study and specific measures are summarized in the 2018 Stability Plan.
This should be interpreted carefully as the efficiency frontier analysis assesses the efficiency of total expenditure, and thus a more granular approach would need to be taken to assess the efficiency of public spending separately.