Mission Concluding Statement 

Austria—2014 Article IV Consultation Preliminary Conclusions

July 1, 2014

Austria has come through the global economic and financial crisis relatively well. Now that the economy is strengthening, this is a good time to resolve crisis legacies and long-standing structural issues. We encourage the authorities to take a three-pronged approach consisting of:

• More decisive expenditure and fiscal federalism reforms to create room for both accelerated debt reduction and lower labor taxation.
• Further strengthening the financial sector by completing the restructuring of nationalized banks, and swiftly transposing the European Banking Union framework.
• Raising potential growth by boosting labor productivity and increasing labor market participation.

1. Austria has come through the global economic and financial crisis relatively well, reflecting the absence of large pre-crisis domestic imbalances. Employment and output have recovered to well above 2008 levels, and unemployment has remained low by international standards. The main impact of the crisis has been on the banking sector and public debt. Several internationally active banks needed temporary support, and three banks had to be fully or partly nationalized. Together with the downturn, this has contributed to an increase in public debt from 60 percent of GDP in 2007 to about 80 percent of GDP in 2014.

2. After a renewed slowdown in 2012 and 2013, the economy is now strengthening, in line with the euro area. Growth should accelerate to around 1½ percent in 2014, provided geopolitical risks do not interfere. Inflation has come down, but is high relative to other euro area countries, and risk of deflation remains low.

3. With the recovery taking hold, this is a good time to resolve crisis legacies and address long-standing structural issues. The agenda includes: expenditure reforms to bring down debt and taxes; completing bank restructuring and strengthening macro-financial stability; and boosting potential growth by moving closer to the technology frontier and raising labor force participation.

Public Expenditure Reforms to Bring Down Debt and Taxes

4. Austria has a high tax burden, especially on labor. This has contributed to relatively low employment among the low-skilled and a high share of part-time workers. And with tax brackets not indexed to inflation, the tax burden tends to drift up over time, holding back growth of real disposable incomes.

5. Underlying the high tax burden is an elevated public expenditure level. This partly reflects social choices, including a generous social safety net. But spending is also higher than in countries with similar social models, such as Germany.

6. Austria’s structural deficit is not high, but as this deficit excludes a number of expenditures, including for bank support, debt dynamics are not as favorable. On current plans, the structural deficit will decline from 1 percent of GDP in 2013 to ½ percent of GDP from 2016 onwards. The debt ratio will decline only from 75 percent in 2013 to around 70 percent in 2020. As a result, from 2014 on, Austria will have the highest debt ratio among European AAA countries. If downside risks materialize, the reduction in debt will be even less. In addition, in the next decade, aging cost pressures will lead to upward pressures on the deficit that, without further reforms, will reverse debt dynamics.

7. A meaningful reduction of the tax burden on labor will only be possible if expenditures are addressed. There is some scope for financing labor tax reductions by selectively abolishing tax exemptions and increasing real estate and environmental taxes. But the yield of such measures should not be overestimated. Moreover, experience suggests that revenue-neutral tax reforms are rare.

8. More decisive expenditure and fiscal federalism reforms would thus help create room for both faster debt reduction and tax cuts.

• Expenditure cuts of about 1 percent of GDP would bring down debt faster. Targeting a structural surplus of ½ percent of GDP by 2018 (instead of a deficit of ½ percent from 2016 onwards), and keeping this until the pre-crisis debt level of 60 percent of GDP is reached, would bring down debt more rapidly and create buffers for absorbing aging cost, potential additional bank restructuring outlays, and other contingent liabilities.
• • Additional expenditure cuts would create scope to reduce the tax burden on labor. While the current debate focuses on income tax rates, consideration should also be given to lowering high social security contributions, which start at a level well below the threshold for income taxation. Social security contribution and tax cuts should be financed and phased in together with well specified expenditure reductions, while ensuring that the more ambitious fiscal balance target will be met.

9. Key expenditure reforms would include: increased statutory retirement ages, including through faster unification of male and female statutory retirement; closing the gap with effective retirement; deeper cuts and ultimately better targeting of subsidies, including through the re-evaluation of expensive infrastructure projects; and more ambitious health care reforms. A closer link of expenditure and revenue responsibilities through the introduction of meaningful tax autonomy at the subnational level would further help prioritize expenditure. These reforms should be decided in conjunction with the next medium-term fiscal framework  2015-19.

Completing Bank Restructuring and Strengthening Macro-Financial Stability

10. The restructuring of fully or partly nationalized banks has made progress. The mission welcomes that a decision has been made on the resolution of Hypo Alpe Adria. The envisaged asset management company should now ensure efficient asset disposal over a limited timeframe. The mission also appreciates the attention the authorities have given to the systemic importance of the bank for some countries in the SEE region, by avoiding Hypo´s bankruptcy. The sale of the Hypo SEE subsidiaries should now be completed as rapidly as possible, while continuing to avoid disruptive effects in host countries. The authorities should reconsider the effective wipeout of the state of Carinthia’s guarantee on €890 million of subordinated debt currently discussed in parliament. While designed and intended as an isolated case, the prospective wipeout risks calling into question similar guarantees issued by other subnational bodies. For the Volksbanken sector, speedy asset disposal in the apex institution (OeVAG) and rapid implementation of a streamlined association structure remain essential in light of a domestic banking market with structurally low profitability.

11. The transition toward a new funding model and the strengthening of capital positions have reduced vulnerabilities of internationally active banks, but risks remain. The ongoing shift to a new funding model for subsidiaries in CESEE has helped reduce external debt of Austrian banks, made both the parent banks and their subsidiaries less vulnerable to funding shocks, and diminished the likelihood of future boom-bust cycles in CESEE countries. As in the past, further transition steps should not be implemented abruptly so as to avoid unduly restraining credit growth in still nascent recoveries. The capital positions of large internationally active banks have been strengthened, but still lag behind those of peers; and risks remain, including from exposures to Russia and Ukraine.

12. The national transposition of the European Banking Union framework should proceed swiftly. Important steps include the designation of a national resolution agency, with strong firewalls in case of intra-agency conflicts of interest. Consideration should also be given to streamlining the deposit guarantee schemes. Also, further progress is needed on the macroprudential front. The macro-financial stability committee members should be appointed without further delay; and new macroprudential instruments focusing on housing market developments should be considered.

Raising Potential GDP Growth

13. High labor utilization has made Austria’s GDP per capita one of the highest in Europe, but labor productivity is less impressive, particularly when compared with the technology frontier. Productivity per hour in Austria is 20 percent lower than in the US: it stopped catching up in the mid 1990s, and has since fallen behind. Falling productivity growth has also affected potential output growth, which has been on a downward trend since the late 1990s.

14. Boosting potential output by raising labor productivity and increasing labor force participation would improve longer-term economic prospects and help mitigate the impact of aging. Enhancing IT adaptation, boosting human capital through improved performance of the education sector, expanding access to financing for start-ups and reducing administrative barriers for new businesses would all help expand the economy’s production frontier. Increasing the labor force by reducing the tax burden on labor, and raising the effective retirement age would further boost economic potential.

The mission would like to thank the authorities for their warm hospitality and open discussions.