Front Matter Page
IMF POLICY PAPER
FISCAL POLICY AND LONG-TERM GROWTH
June 2015
IMF staff regularly produces papers proposing new IMF policies, exploring options for reform, or reviewing existing IMF policies and operations. The following documents have been released and are included in this package:
The Staff Report on Fiscal Policy and Long-Term Growth, prepared by IMF staff and completed on April 20, 2015 for the Executive Board’s consideration on June 3, 2015.
A Case Study Supplement.
The publication policy for staff reports and other documents allows for the deletion of market-sensitive information.
Electronic copies of IMF Policy Papers are available to the public from http://www.imf.org/external/pp/ppindex.aspx
International Monetary Fund
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© 2015 International Monetary Fund
Front Matter Page
FISCAL POLICY AND LONG-TERM GROWTH
April 20, 2015
Executive Summary
This paper explores how fiscal policy can affect medium- to long-term growth. It identifies the main channels through which fiscal policy can influence growth and distills practical lessons for policymakers. The particular mix of policy measures, however, will depend on country-specific conditions, capacities, and preferences. The paper draws on the Fund’s extensive technical assistance on fiscal reforms as well as several analytical studies, including a novel approach for country studies, a statistical analysis of growth accelerations following fiscal reforms, and simulations of an endogenous growth model.
Fiscal policy is an effective tool for supporting growth. While it is difficult to disentangle the impact of fiscal reforms from other factors and to determine causality with certainty, the analysis suggests that they could lift medium- to long-term growth by ¾ of a percentage point in advanced economies and even more in developing economies.
Fiscal policy promotes growth through macro and structural tax and expenditure policies. At the macro level, it plays an important role in ensuring macroeconomic stability, which is a prerequisite for achieving and maintaining economic growth. At the micro level, through well-designed tax and spending policies, it can boost employment, investment, and productivity. Notably:
Lowering the tax wedge and improving the design of labor taxes and social benefits can strengthen work incentives and induce a positive labor supply response;
Reforming capital income taxes to tax rents reduces distortions and encourages private investment; well-targeted tax incentives can stimulate private investment and enhance productivity through research and development (R&D);
Efficient public investment, especially in infrastructure, can raise the economy’s productive capacity;
More equitable access to education and health care contributes to human capital accumulation, a key factor for growth;
If growth-friendly reforms require fiscal space, revenue measures should focus on broadening the tax base and minimizing distortions; and expenditure measures should aim at rationalizing spending and improving efficiency.
Design and social consensus matter for the success and durability of fiscal reforms. To reap full growth benefits, fiscal reforms also need to be internally consistent and complemented by relevant structural reforms (e.g., labor or trade) and supportive macroeconomic policies. Balancing efficiency and equity objectives and fostering public support through social dialogue are critical.
Approved By
Vitor Gaspar
Prepared by staff from the Fiscal Affairs Department supervised by Sanjeev Gupta, comprising a team led by Bernardin Akitoby and Abdelhak Senhadji, and including Eva Jenkner, Rossen Rozenov, Mark De Broeck, Todd Mattina, Santiago Acosta-Ormaechea, David Amaglobeli, Mai Anh Bui, Serhan Cevik, Carolina Correa, Valerio Crispolti, Jeff Danforth, Salvatore Dell’Erba, Andrew Hodge, Takuji Komatsuzaki, Jimmy McHugh, Jeta Menkulasi, Florian Misch, Tigran Poghosyan, Ivohasina Razafimahefa, John Ricco, Nancy Tinoza, Andreas Tudyka. Production assistance was provided by Juliana Peña, Patricia Quiros, Macarena Torres Girao, and Maria Tramuttola.
Contents
INTRODUCTION
FISCAL POLICY AND LONG-TERM GROWTH: WHAT WORKS?
A. Macroeconomic Stability-A Prerequisite for Sustained Growth
B. How Can Fiscal Structural Reforms Promote Growth?
C. Fiscal Space for Pro-Growth Reforms
D. Growth and Equity
THE “HOW” MATTERS: DESIGN AND IMPLEMENTATION OF REFORMS
LESSONS FOR POLICYMAKERS: AN AGENDA FOR REFORM
ISSUES FOR DISCUSSION
BOX
1. The Synthetic Control Method
FIGURES
1. Fiscal Deficits Post-Reform
2. Debt and Growth: Short- and Long-Term Horizons
3. Evidence from Country Studies: Growth Post-Reform
4. Growth Accelerations
5. Relationship Between the Tax Wedge and Employment Rate
6. Germany: Change in Employment Rate by Age Group, 2000–2013
7. Corporate Income Taxes and Investment Post-Reform
8. Regional Prevalence of Tax Incentives
9. Benefit Incidence of Education and Health Public Spending
10. R&D Expenditure and Growth, 2001–2012
11. Revenue Structure by Country Group, 2009–2013
12. Public Expenditure Composition, 2007–2013
13. Public Wage Bill Post-Reform
14. Trends in Inequality Post-Reform
15. Ireland: Tax Cuts and Wage Moderation
TABLE
1. Menu of Options: Fiscal Policies for Medium- to-Long-Term Growth
REFERENCES
TECHNICAL ANNEXES
I. Fiscal Reforms and Growth Accelerations: A Cross-Country Statistical Analysis
II. Fiscal Policy in an Endogenous Growth Model
Front Matter Page
FISCAL POLICY AND LONG-TERM GROWTH – CASE STUDIES
Approved By
Vitor Gaspar
Prepared by staff from the Fiscal Affairs Department supervised by Sanjeev Gupta, comprising a team led by Bernardin Akitoby and Abdelhak Senhadji and including Eva Jenkner, Rossen Rozenov, Mark De Broeck, Todd Mattina, Santiago Acosta Ormaechea, David Amaglobeli, Mai Anh Bui, Serhan Cevik, Carolina Correa, Valerio Crispolti, Jeff Danforth, Salvatore Dell’Erba, Andrew Hodge, Takuji Komatsuzaki, Jimmy McHugh, Jeta Menkulasi, Florian Misch, Tigran Poghosyan, Ivohasina Razafimahefa, John Ricco, Nancy Tinoza, Andreas Tudyka. Production assistance was provided by Juliana Peña, Patricia Quiros, Macarena Torres Girao, and Maria Tramuttola.
April 20, 2015
Contents
INTRODUCTION
AUSTRALIA: FISCAL POLICY AND LONG-TERM GROWTH
A. Background
FISCAL POLICY INNOVATION AND COMMITMENT TO REFORM
A. Overview
B. Notable Design Features
IMPACT ON LONG-TERM GROWTH
LESSONS: FISCAL REFORM AS A CATALYST FOR ACCELERATING GROWTH
FIGURES
1. Selected Indicators, 1970–2011
2. GDP Growth, 1970–2014
3. Australia versus European Union-15 +3
4. Synthetic Control Method: Australia
5. Growth Decomposition, 1973–2007
6. Australia, Fiscal Policy and Growth, 1970–2012
TABLES
1. Major Fiscal Reforms
2. Economic Growth Predictor Means before Fiscal Reform
3. Selected Indicators
APPENDIX
Robustness Tests For Australia
CHILE: FISCAL POLICY AND LONG-TERM GROWTH
A. Background
FISCAL POLICY REFORMS: FISCAL CONSOLIDATION AND COMPREHENSIVE PUBLIC SECTOR REFORM
A. Overview
B. Notable Design Features
C. Outcomes
IMPACT ON LONG-TERM GROWTH
A. Long-Term Growth Dissected
B. Fiscal Reform: A Game Changer?
LESSONS
FIGURES
1. Pre-Reform Economic Indicators, 1960–1973
2. Real GDP Growth, 1970–2014
3. Chile versus Emerging Market and Middle-Income Latin America
4. Synthetic Control Method: Chile
5. Growth Contributions, 1974–1999
6. Growth Transmission Channels
7. Fiscal Policy and Growth, 1960–2013
TABLES
1. Selected Indicators, 1964–1973
2. Major Fiscal Reforms
3. Economic Growth Predictor Means before Fiscal Reform
4. Selected Indicators
APPENDIX
Robustness Tests for Chile
GERMANY: FISCAL POLICY AND LONG-TERM GROWTH
A. Background
FISCAL POLICY REFORMS: EXPENDITURE-BASED CONSOLIDATION AND LABOR MARKET REFORMS
A. Overview
B. Notable Design Features
C. Economic Performance after the Reform
IMPACT ON LONG-TERM GROWTH
A. Long-Term Growth Dissected
B. Fiscal Reform: A Game Changer?
LESSONS
FIGURES
1. Pre-Reform Economic Indicators, 1991–2002
2. Real GDP Growth, 1991–2013
3. Germany versus European Union-15
4. Synthetic Control Method: Germany
5. Growth Transmission Channels
6. Fiscal Policy and Growth, 1991–2013
TABLES
1. Major Fiscal Reforms
2. Economic Growth Predictor Means before Fiscal Reform
3. Selected Indicators
APPENDIX
Robustness Tests for Germany
IRELAND: FISCAL POLICY AND LONG-TERM GROWTH
A. Background
FISCAL POLICY REFORMS
A. Overview
B. Notable Design Features
C. Outcomes
IMPACT ON LONG-TERM GROWTH
A. Long-Term Growth Dissected
B. Fiscal Reform: A Game Changer?
LESSONS
FIGURES
1. Selected Indicators, 1967–2007
2. Selected Indicators, 1987–2014
3. Real GDP Growth, 1961–2014
4. Ireland versus European Union-15
5. Synthetic Control Method: Ireland
6. Fiscal Policy and Growth, 1967–2013
TABLES
1. Major Fiscal Reforms
2. Economic Growth Predictor Means before Fiscal Reform
3. Selected Indicators
APPENDIX
Robustness Tests for Ireland
MALAYSIA: FISCAL POLICY AND LONG-TERM GROWTH
A. Background
FISCAL POLICY REFORMS: MACROECONOMIC STABILIZATION AND REDUCING THE SIZE OF THE PUBLIC SECTOR
A. Overview
B. Notable Design Features
C. Outcomes
IMPACT ON LONG-TERM GROWTH
A. Long-Term Growth Dissected
B. Fiscal Reform: A Game Changer?
LESSONS
FIGURES
1. Pre-Reform Economic Indicators, 1976–1985
2. Real GDP Growth, 1970–2014
3. Malaysia versus Emerging Market and Middle-Income Asia +5
4. Synthetic Control Method: Malaysia
5. Growth Transmission Channels
6. Fiscal Policy and Growth, 1970–2012
TABLES
1. Major Fiscal Reforms
2. Economic Growth Predictor Means before Fiscal Reform
3. Selected Indicators
APPENDIX
Robustness Tests for Malaysia
NETHERLANDS: FISCAL POLICY AND LONG-TERM GROWTH
A. Background
FISCAL POLICY REFORMS: EXPENDITURE-BASED CONSOLIDATION AND LABOR MARKET REFORMS
A. Overview
B. Notable Design Features
C. Outcomes
IMPACT ON LONG-TERM GROWTH
A. Long-Term Growth Dissected
B. Fiscal Reform: A Game Changer?
LESSONS
FIGURES
1. Pre-Reform Economic Indicators, 1970–1982
2. Real GDP Growth, 1970–2014
3. Netherlands versus European Union-15
4. Synthetic Control Method: Netherlands
5. Growth Transmission Channels
6. Fiscal Policy and Growth, 1970–2012
TABLES
1. Major Fiscal Reforms
2. Economic Growth Predictor Means before fiscal Reform
3. Select Indicators
APPENDIX
Robustness Tests for Netherlands
POLAND: FISCAL POLICY AND LONG-TERM GROWTH
A. Background
FISCAL POLICY REFORMS: PENSION AND TAX SYSTEMS
A. Overview
B. Reform Area 1: Pension System
C. Reform Area 2: Tax System
IMPACT ON LONG-TERM GROWTH
A. Long-Term Growth Dissected
B. Fiscal Reform: A Game Changer?
LESSONS
BOX
1. Political-Economy of Major Fiscal Reform Attempts in Poland
FIGURES
1. Selected Indicators, 1995–2014
2. Real GDP Growth, 1985–2014
3. Poland versus Emerging Market and Middle-Income Europe +3
4. Synthetic Control Method: Poland
5. Fiscal Policy and Growth, 1992–2014
TABLES
1. Major Fiscal Reform
2. Economic Growth Predictor Means before Fiscal Reform
3. Selected Indicators
APPENDIX
Robustness Tests for Poland
TANZANIA: FISCAL POLICY AND LONG-TERM GROWTH
A. Background
FISCAL POLICY REFORMS: FROM FISCAL DOMINANCE TO A STRONG FISCAL FRAMEWORK
A. Overview
B. Notable Design Features
C. Outcomes
IMPACT ON LONG-TERM GROWTH
A. Long-Term Growth Dissected
B. Fiscal Reform: A Game Changer?
LESSONS
FIGURES
1. Pre-Reform Economic Indicators, 1970–1994
2. Real GDP Growth, 1970–2014
3. Tanzania versus Sub-Sahara Africa
4. Synthetic Control Method: Tanzania
5. Growth Transmission Channels
6. Fiscal Policy and Growth, 1980–2012
TABLES
1. Major Fiscal Reforms
2. Economic Growth Predictor Means before Fiscal Reform
3. Selected Indicators
APPENDIX
Robustness Tests for Tanzania
UGANDA: FISCAL POLICY AND LONG-TERM GROWTH
A. Background
FISCAL POLICY REFORMS
A. Overview
B. Notable Design Features
C. Outcomes
IMPACT ON LONG-TERM GROWTH
A. Long-Term Growth Dissected
B. Fiscal Reform: A Game Changer?
LESSONS
FIGURES
1. Selected Indicators, 1964–2014
2. Real GDP Per Capita Growth, 1964–2013
3. Uganda versus Sub-Sahara Africa
4. Synthetic Control Method: Uganda
5. Fiscal Policy and Growth, 1982–2014
TABLES
1. Major Fiscal Reforms
2. Economic Growth Predictor Means before Fiscal Reform
3. Selected Indicators
APPENDIX
Robustness Tests for Uganda
REFERENCES
ANNEXES
I. Sample Selection for Country Case Studies
II. Methodology: The Synthetic Control Method