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Strategies Needed to Tackle Huge Government Debt Levels

Increasing retirement age by two more years in advanced economies can help restore long-run fiscal sustainability (photo: Newscom)

IMF SPRING MEETINGS

Strategies Needed to Tackle Huge Government Debt Levels

IMF Survey online

April 23, 2010

  • Public debt levels have risen dramatically in advanced countries during crisis
  • Need is to reverse rise and strengthen public finances
  • Will require combination of measures

With the world economy on the mend following the global crisis, policymakers, particularly in advanced economies, should begin to focus on how to bring down the level of their huge government debts through a combination of spending reforms and increased revenues, said John Lipsky, First Deputy Managing Director of the International Monetary Fund.

Governments around the world jacked up spending to help combat the global crisis. But the loss of revenue from the recessions has saddled governments with a dramatic increase in official debts.

The IMF projects that public debt in the advanced economies will rise by over 35 percentage points of GDP between end-2007 and 2015, to 110 percent of GDP. Most of this increase reflects revenue losses arising from the crisis and only one-tenth of the increase came from anti-crisis stimulus measures. IMF Managing Director Dominique Strauss-Kahn noted the rise in debt would have been bigger without the stimulus.

Lipsky said governments must now plan on getting debt levels under control over the next two decades through a process of fiscal consolidation that reverses the rise.

The IMF has said that rising government borrowing represents a growing risk to the recovering global economy, but has advised that stimulus measures in most advanced economies should be completed as planned for 2010 because the recovery remains fragile.

Fiscal consolidation plan

Speaking at a two-day conference on fiscal strategies after the crisis in Washington, Lipsky noted that details of any strategy would need to be country specific. He proposed an outline plan for fiscal consolidation and strengthening public finances in advanced economies that rests on three pillars:

• Stabilizing age-related spending—health and pensions—as a share of GDP (going beyond this is unlikely to be possible given demographic trends);

• Reducing other non-age related spending items in relation to GDP; and

• Raising additional revenues in an efficient and equitable manner.

Reforming healthcare is politically difficult, but there are successful models that can be followed. In contrast, much has already been done on pensions and increasing the retirement age by two more years can help restore long-run sustainability and further efficiencies in healthcare are possible, Lipsky stated.

For other non-age related spending, reforms will need to focus on improving the composition and efficiency of spending, while ensuring the provision of key public services. Again, the approach needs to be country specific. However, the experience of the past suggests that expenditure reforms focused on wages, subsidies, and transfers have been conducive to growth in past consolidation efforts. Reversing recent increases in military spending could also yield substantial savings.

Consumption taxes

On the tax side, boosting revenue in a globalized economy will require strengthening broad-based taxes on relatively immobile bases. These mainly include consumption taxes and externality correcting taxes, such as those applied to petroleum products.

More specifically, Lipsky said there is substantial scope for improving the revenue performance of the Value-Added Tax or VAT in almost all countries. In the largest advanced countries, the reform of exemptions and the elimination of reduced rates could raise a weighted average of about 2 percentage points of GDP, merely by closing half this estimated policy gap. Many countries have scope to increase significantly revenues from excises on tobacco and alcohol.

Property taxes are also an efficient source of revenues with a benign impact on growth. Pricing greenhouse gas emissions—either by taxing carbon or by auctioning emissions permits—could raise large sums.

Altogether, appropriately designed and relatively efficient revenue measures with regard to these taxes in the seven leading advanced economies could raise revenues of close to 3 percent of GDP, on average. And this does not take into account a menu of potential new measures in his area—for instance, introducing VAT in the United States, and doubling the very low VAT rate in Japan—which could contribute substantially to revenue.

In addition, tax compliance gaps are large in many countries, especially emerging economies. Strengthening tax compliance will require renewed efforts to tackle aggressive tax planning, offshore tax abuse, and fraud through stronger legal frameworks and modern information technology systems.