## Long-Term Spending Pressures in Europe (ltspieea)

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### Overview of spending pressures
- European countries face "high, rising, and long-lasting" spending pressures that compound existing fiscal burdens from high deficits and debt ratios exacerbated by recent shocks.
- Five key areas of imminent and growing spending pressures: pensions; health care and long-term care; the costs of the climate transition; increased defense spending; and higher government borrowing costs.
- Some pressures are immediate, whereas others will build up over time; pressures differ in scale across countries and by starting fiscal position and institutional preparedness.
- Distinction: spending pressures are predictable expenditures to fulfill public policy goals, while fiscal risks arise from unforeseen shocks or contingent liabilities.

### Quantified estimates and comparative evidence
- Aggregate projections:
  - Additional expenditures estimated at "5.75 percent of GDP per year by 2050 in Advanced Europe."
  - Additional expenditures estimated at "8 percent of GDP per year by 2050 in Central, Eastern, and Southeastern Europe (CESEE)."
- Cross-study figures reported:
  - "IMF Fiscal Monitor (April 2024) estimates, by 2030, advanced economies could face spending needs amounting to an additional 6.0 to 7.4 percentage points of GDP."
  - "Bouabdallah and others (2024) estimate investments of some € 5.4 trillion (about 3.75 percent of EU GDP) over the next seven years for green transition, digitalization, and strengthening military defense."
  - "EC (2024a) notes public spending on pensions, health care, long-term care, and education together accounted for almost 25 percent of GDP on average in 2022 for the EU."
- Summary headline dynamics:
  - Spending needs on pensions, health care, long-term care; defense; climate; and public borrowing costs average "2.5 percent of GDP across Europe in 2025."
  - These pressures are expected to more than double by 2050, "reaching 6.75 percent of GDP."
  - "Climate and defense account for 70 percent of estimated pressures for 2025."
  - Risks are tilted to the upside due to a no-policy-change baseline and possible reversals of already adopted reforms.

### Major drivers and constraints
- Major drivers:
  - Population aging (pensions, health care, long-term care).
  - Geopolitical shifts (defense spending).
  - Climate transition (mitigation and adaptation investments).
  - Normalized higher interest rates (higher government borrowing costs).
- Offsetting reductions (for example, lower education spending from fewer births or lower unemployment benefits with a shrinking labor force) are estimated to be relatively small and are not incorporated.
- Heterogeneity across countries:
  - Spending pressures larger in CESEE than in Advanced Europe.
  - Institutional capacity and presence of long-term fiscal projections vary considerably.

### Methodology highlights for estimating spending pressures
- Baselines:
  - Health care, long-term care, and pension spending baseline = level (in percent of GDP) of 2023.
  - Defense baseline = higher of 2021 or 2022 (pre-invasion of Ukraine).
  - Interest expenditure baseline = constant fraction of preceding year’s debt stock (evolves with fiscal projections).
  - Climate transition baseline = 45 percent of total spending needs estimated by the European Commission (EC), excluding transport (level considered by EIB to be already taking place).
- Definition: Pressure = difference between estimated total annual costs and the baseline.
- Key data sources and approaches:
  - Pensions, health care, long-term care estimates from the EC (2024a) where available.
  - For countries not covered by the Ageing Report: project pension costs based on projected population aged 65+ (United Nations population projections) and pension levels relative to GDP per capita over past five years.
  - IMF Fiscal Monitor (updated as of March 2024) for health care and long-term care outside the EU.
  - Defense projections based on announced commitments; most NATO members target 2 percent of GDP.
  - EU member-state green transition costs derived from EC and EIB estimates, adjusted for spending already taking place and estimated public sector share (EIB 2020/21 Investment Report).
  - Non-EU climate estimates approximated from IMF-World Bank CPAT model for a 25 percent reduction target.
  - Interest-cost projections assume average interest rate rising gradually to the neutral rate approximated by nominal GDP growth; increase by steps of "0.1 percentage points per year" noted in annex.

### Pensions: projections and drivers
- By 2050 pension spending pressures:
  - "3 percent of GDP in CESEE."
  - "1.75 percent of GDP in Advanced Europe."
- Near-term patterns:
  - Advanced Europe: pension spending set to rise steadily by "0.75 percent of GDP over the next 10 years," with a slowdown in the late-2030s.
  - CESEE: similar initial growth but accelerates from the mid-2030s to "close to more than 1.25 percent of GDP in the decade from the mid-2030s on."
- Drivers:
  - Increase in old-age dependency ratio in CESEE beyond that of Advanced Europe.
  - Total population projections: Advanced Europe projected to rise slightly (because of immigration); CESEE projected to decline by "10 percent in the next quarter-century" based on recent trends and convergence assumptions.
  - Pension adequacy in CESEE: average replacement rate of "33 percent"; adequacy remains an issue and may require more generous public pensions not included in projections.
- Policy levers highlighted:
  - Higher contributions, lower benefits, increases in retirement age, link retirement age to life expectancy, extend contribution period, discourage early retirement, equalize women’s retirement age with men’s, increase role of complementary private pensions.

### Health care and long-term care
- Current spending (averages):
  - CESEE: "5.2 percent of GDP on health care" and "0.7 percent of GDP on long-term care."
  - Advanced Europe: "6.3 percent of GDP on health care" and "1.8 percent of GDP on long-term care."
- Projections and drivers:
  - Long-term care is the fastest-growing component of health-care costs, particularly in higher-income countries.
  - Technological advances and rising wages in a labor-intensive sector drive up costs, especially relevant in CESEE.
  - Life expectancy at age 65 projected to remain about "2.25 years higher in Advanced Europe than CESEE even in 2050."
- Risks:
  - As CESEE income levels converge to Advanced Europe, demand for health and long-term care may increase more rapidly than projected.
  - Even under conservative assumptions, health care and long-term care spending expected to rise faster than per capita GDP and old-age dependency rate growth in countries such as Czech Republic, Slovak Republic, and Slovenia.
- Policy options:
  - Procurement reforms, preventive care, adjust insurance-covered packages, increase co-payments (distributional trade-offs), integrate care and workforce planning, use technology (AI, digitalization) with careful evaluation of cost effects.

### Defense spending
- Defense pressures are high in both Advanced Europe and CESEE; pressures higher in CESEE despite higher starting positions because many CESEE countries aim to spend well beyond NATO’s 2 percent-of-GDP guideline.
- Country examples:
  - Poland planning to boost defense spending to "close to 5 percent of GDP in 2025" and "about 3.5 to 4 percent of GDP in the longer run."
  - Baltic states and Romania aiming at defense spending levels of "about 2.5 to 3 percent of GDP."
- Defense pressures could rise further if perceived or actual threats increase.

### Climate transition: costs, public share, and uncertainties
- Climate spending needs are substantial and immediate in both Advanced Europe and CESEE.
- Emissions intensity and public share:
  - GHG emissions intensity of GDP in non-EU emerging countries in Europe is "more than double that of Advanced Europe."
  - Public budget projected to cover "slightly below two-thirds" of needed climate spending in CESEE.
  - Public budget projected to cover "below 40 percent" of needed climate spending in Advanced Europe.
- Methodology notes:
  - For EU member states and Norway, EIB 2020/21 Investment Report estimates scaled to EC targets (40 percent to 55 percent reductions and RePower EU adjustments); "EIB data indicate about 45 percent of needed spending is, on average, already taking place in sectors other than transport" and was removed from pressures.
  - Transport sector reductions add on average "one additional percentage point of GDP in investment needs."
  - For non-EU members, IMF CPAT model used to estimate carbon taxes required for a 25 percent reduction and tax-base erosion.
- Boxed uncertainty points:
  - Definitional ambiguities about what counts as additional cost (e.g., end-of-life replacements vs. premature retirements).
  - Technology and industrial policy (tariffs, subsidies) can materially change costs.
  - Mitigation instruments vary: carbon taxes/ETS vs. subsidies and public investments; carbon pricing can generate fiscal revenue but may erode fossil-fuel tax bases.
  - Adaptation costs require climatological projections and are highly uncertain; autonomous versus planned adaptation is unclear.

### Fiscal implications, interest costs, and macro effects
- Interest-cost projection assumptions:
  - Average interest rates gradually rise to the neutral rate approximated by nominal GDP growth; increase by steps of "0.1 percentage points per year" in annex methodology.
  - Baseline interest cost set as a constant fraction of the preceding period’s debt stock.
  - Projections assume debt levels evolve broadly consistent with fiscal consolidation under the new EU fiscal framework and that new spending pressures are not financed by higher debt.
- Demographics and productivity:
  - A "1 percentage point increase in the share of workers aged 55 and older is associated with a decrease in total factor productivity growth by about 0.6 ppts," implying average GDP growth in CESEE would be lower by "about 1.2 ppts" and GDP levels "by 31 percent by 2050" than if age structure remained constant.
  - OECD projection: revenues from personal income tax, social contributions, and payroll taxes expected to decline in per capita terms by "9 percent on average," eroding general government revenues in per capita terms by "8 percent on average."

### Fiscal institutions, uncertainty management, and good practices
- Good practices recommended:
  - Integrate comprehensive assessments of aging-related costs, climate change, and defense spending into fiscal frameworks and update regularly.
  - Publish regular long-term forecasts under different scenarios linked to the annual budget; conduct sensitivity analyses.
  - Use medium-term fiscal frameworks (MTFFs) to incorporate long-term pressures with targets and ceilings.
  - Incorporate automatic adjustment mechanisms and built-in prudency factors.
  - Use spending reviews to improve efficiency and free fiscal space.
  - Strengthen independent fiscal institutions and fiscal councils for evaluation and transparency.
- Country examples of practices:
  - Dutch Bureau for Economic Policy Analysis: medium- and long-term macrofiscal projections integrating age-related pressures and climate costs.
  - Sweden: annual long-term projections on pensions, health care, long-term care, and defense over 15–20 years.
  - UK OBR: annual fiscal sustainability reports with long-term projections and sensitivity analyses.
  - Wealth funds and strategies: Greece, Ireland, Norway (wealth funds); Netherlands (stabilize medium-term debt and structural reforms).
- Observed gaps and risks:
  - Few national energy and climate plans are costed; green transition spending is "rarely integrated into MTFFs."
  - CESEE countries, especially the Western Balkans, often lack long-term assessments and have less developed fiscal institutions.
  - EU reformed fiscal governance framework (rolled out in 2024) explicitly accounts for aging-related costs but "only considers aging-related long-term costs, not other spending pressures" such as climate and defense.

### Policy implications and recommendations
- Broad strategy:
  - Urgent fiscal consolidation in some countries to rebuild buffers; others may use available fiscal space temporarily to finance growth-enhancing investment.
  - Build institutional capacity and implement deep structural reforms to contain spending while meeting environmental, social, and security objectives.
  - Strengthen fiscal frameworks, long-term forecasting, and timely data to inform public debate and decision making.
- Sectoral recommendations:
  - Pensions: implement entitlement reforms, raise retirement ages where appropriate, link retirement age to life expectancy, consider contribution and benefit adjustments, promote complementary private pensions with appropriate safeguards.
  - Health care and long-term care: procurement reforms, preventive care, adjust insurance packages, workforce planning, targeted co-payments with protections for vulnerable households.
  - Climate: use fiscal instruments including carbon pricing as part of the policy mix, recycle carbon revenues to compensate vulnerable households, blend public and private funding, prioritize de-risking to crowd in private capital, shift away from subsidies toward predictable carbon pricing.
  - Defense: coordinate procurement at EU level to reduce fragmentation and crowding-out effects; consider common procurement and EU-level fiscal capacity to realize efficiency gains.
- Reducing unproductive spending and revenue mobilization:
  - Phase out energy subsidies: fossil fuel and electricity subsidies in Europe amounted to "3.25 percent of GDP in 2023 on average" ("explicit subsidies: 0.75 percent of GDP"; "implicit subsidies: 2.5 percent of GDP").
  - Potential revenue mobilization: tax-to-GDP ratios could rise by "0.9 percent of GDP per annum in Advanced Europe" and by "1.5 percent of GDP in CESEE."
  - CESEE-specific measures: increase progressivity of income taxation, improve revenue administration, widen tax bases, eliminate tax expenditures and implicit subsidies.
  - Advanced Europe: base-broadening, eliminate preferential treatments, market-valuation property taxes, increase carbon taxes cautiously to avoid adverse effects.
- Role of EU-level fiscal capacity:
  - Strengthen EU fiscal capacity for key common public goods (climate, defense, energy security, R&D) to realize efficiency gains and support members with particularly high pressures.
  - Examples: NGEU provided "€648 billion in grants and loans (4.4 percent of 2021 GDP)" over 2021–26; climate spending in 2021–27 EU budget increased from "21 to 30 percent" of total.
- Sequencing and distributional considerations:
  - Reforms take time and have distributional consequences; protect the most vulnerable and use revenue recycling and targeted measures to mitigate regressivity.
  - Timing should consider savings potential, growth effects, and political feasibility.

### Key statistics and projections (preserved verbatim)
- Spending pressures by 2050:
  - "5.75 percent of GDP in Advanced Europe."
  - "8 percent of GDP in CESEE."
- Europe-wide pressures:
  - Average "2.5 percent of GDP across Europe in 2025."
  - Expected to rise to "6.75 percent of GDP" by 2050.
- 2023 fiscal positions:
  - Fiscal deficits (2023): Advanced Europe "0.9 percent of GDP"; CESEE "3.3 percent of GDP."
  - Public debt levels: CESEE "48 percent of GDP" versus "75 percent (Advanced Europe)."
- Current spending shares:
  - Health care and long-term care averages: CESEE "5.2 percent" and "0.7 percent of GDP"; Advanced Europe "6.3 percent" and "1.8 percent of GDP."
- Energy subsidies (2023 average): total "3.25 percent of GDP" (explicit "0.75 percent"; implicit "2.5 percent").
- Demographic-productivity link: "1 percentage point increase in the share of workers aged 55 and older is associated with a decrease in total factor productivity growth by about 0.6 ppts," implying CESEE GDP growth lower by "about 1.2 ppts" and GDP levels "by 31 percent by 2050" relative to a constant age structure.
- Revenue and taxation:
  - Tax revenues and social security contributions averaged "44.5 percent of GDP in 2023" in most advanced European economies; CESEE averaged "38.5 percent of GDP in 2023."
  - Potential annual tax-to-GDP increases: "0.9 percent of GDP per annum in Advanced Europe" and "1.5 percent of GDP in CESEE."
- Climate methodology: transport sector adds "one additional percentage point of GDP in investment needs" on average; EIB indicates about "45 percent of needed spending is, on average, already taking place in sectors other than transport."

*Source: Executive Summary and selected sections — Long-Term Spending Pressures in Europe (IMF Departmental Papers).*

### Executive Summary.................................................................................................v

### Executive Summary

### Overview of spending pressures
- European countries face high, rising, and long-lasting spending pressures that compound existing fiscal burdens from high deficits and debt ratios exacerbated by recent shocks.
- Five key areas of imminent and growing spending pressures: pensions and health care/long-term care driven by population aging, the costs of the climate transition, increased defense spending, and higher government borrowing costs.
- Some pressures are immediate, whereas others will build up over time; these spending pressures differ in scale across countries and by starting fiscal position and institutional preparedness.
- Spending pressures are distinguished from fiscal risks: spending pressures are predictable expenditures to fulfill public policy goals, while fiscal risks arise from unforeseen shocks or contingent liabilities.

### Quantified estimates and comparative evidence
- Using data from EU institutions, other sources, and IMF staff calculations, additional expenditures are estimated to amount to:
  - 5.75 percent of GDP per year by 2050 in Advanced Europe.
  - 8 percent of GDP per year by 2050 in Central, Eastern, and Southeastern Europe (CESEE).
- Related cross-study figures noted in the Executive Summary and literature review:
  - IMF Fiscal Monitor (April 2024) estimates, by 2030, advanced economies could face spending needs amounting to an additional 6.0 to 7.4 percentage points of GDP.
  - Bouabdallah and others (2024) estimate investments of some € 5.4 trillion (about 3.75 percent of EU GDP) over the next seven years for green transition, digitalization, and strengthening military defense.
  - EC (2024a) notes public spending on pensions, health care, long-term care, and education together accounted for almost 25 percent of GDP on average in 2022 for the EU.
- Large uncertainty surrounds quantifications, especially for climate mitigation spending, and important data gaps exist for some non-EU emerging market countries.

### Drivers and constraints
- Major drivers: population aging (pensions, health care, long-term care), geopolitical shifts (defense spending), climate transition (mitigation and adaptation investments), and normalized higher interest rates (higher government borrowing costs).
- Offsetting spending reductions (for example, lower education spending from fewer births or lower unemployment benefits with a shrinking labor force) are estimated to be relatively small and are not incorporated.
- Some countries have limited fiscal space and need consolidation; others have more room to absorb investment needs. Institutional capacity and the presence of long-term fiscal projections vary considerably.

### Policy implications and recommendations
- Addressing pressures requires large-scale, comprehensive efforts:
  - Build institutional capacity and implement deep structural reforms to contain spending and ensure adequate revenue while meeting environmental, social, and security objectives.
  - Reform pension systems in many countries to ensure long-term sustainability.
  - Use fiscal instruments for climate policy, including carbon pricing as part of the policy mix, with fiscal revenues recycled to compensate vulnerable households.
  - Consider increased revenue mobilization, especially in CESEE where tax rates and fiscal revenue are still relatively low.
  - Reduce inefficient spending (for example, on energy subsidies) to create room for higher-priority spending.
  - Where available and appropriate, use fiscal space temporarily to finance higher spending needs and investments that improve potential growth and benefit future generations.
  - At the European level, strengthen EU fiscal capacity in key areas (climate, defense, energy security, R&D) to realize efficiency gains and support member states facing particularly high spending pressures.
  - Pursue structural reforms to boost growth potential (for example, completing the European single market and the banking and capital markets union, harmonizing rules and regulations, and reducing red tape and inefficiencies).

### Institutional frameworks and public debate
- Well-designed fiscal frameworks that explicitly incorporate long-term spending pressures, supported by comprehensive analysis and data, are essential to inform public debate, evaluate trade-offs, and support policy actions.
- The reformed EU fiscal governance framework (being rolled out in 2024) is a step toward explicitly accounting for spending pressures from the aging population, but spending on the green transition and defense will need integration.
- Estimates of spending pressures need effective integration into member states’ fiscal frameworks to underpin national decision making.

### Urgency, trade-offs, and concluding message
- Because structural reforms take time to yield results, urgent action is needed despite the long-term nature of the challenges.
- The optimal policy mix and sequencing will vary across countries depending on circumstances, the types and amounts of fiscal pressures, and social preferences. Reforms have distributional consequences that policymakers must address, particularly to protect the most vulnerable households.
- Taking no action risks fiscal sustainability or leaving priority spending needs unmet—or both.

*Source: Executive Summary — Long-Term Spending Pressures in Europe (IMF Departmental Papers).*

### 3. Spending Pressures

### 3. Spending Pressures

### A. Direct Pressures — Overview
- Spending needs on pensions, health care, long-term care; defense; climate; and public borrowing costs average 2.5 percent of GDP across Europe in 2025.
- These spending pressures are expected to more than double by 2050, reaching 6.75 percent of GDP.
- Climate and defense account for 70 percent of estimated pressures for 2025.
- Risks to estimates are tilted to the upside due to the no-policy-change baseline and possible reversals of already adopted reforms.
- Spending pressures are larger in CESEE (8 percent of GDP per year in 2050) than in Advanced Europe (5.75 percent annually).

### Methodology for Estimating Spending Pressures (Box 1)
- Baselines:
  - Health care, long-term care, and pension spending baseline = level (in percent of GDP) of 2023.
  - Defense baseline = higher of 2021 or 2022 (pre-invasion of Ukraine).
  - Interest expenditure baseline = constant fraction of preceding year’s debt stock (evolves with fiscal projections).
  - Climate transition baseline = 45 percent of total spending needs estimated by the European Commission (EC), excluding transport (level considered by EIB to be already taking place).
- Pressure = difference between estimated total annual costs and the baseline.
- Data sources and approaches:
  - Pensions, health care, long-term care estimates from the EC (2024a) where available.
  - For countries not covered by the Ageing Report: project pension costs based on projected population aged 65+ (from United Nations population projections) and pension levels relative to GDP per capita over past five years.
  - IMF’s Fiscal Monitor (updated as of March 2024) for health care and long-term care outside the EU.
  - Defense projections based on announced commitments; most NATO members target 2 percent of GDP, with some already above or aiming higher.
  - EU member-state green transition costs derived from EC and EIB estimates, adjusted for spending already taking place and estimated public sector share (based on EIB 2020/21 Investment Report).
  - Non-EU climate estimates approximated from IMF-World Bank CPAT model of carbon taxes required for an assumed 25 percent reduction target and accompanying tax-base erosion.
  - Assumed even time distribution of green transition costs.
  - Interest-cost projections assume average interest rate rising gradually to the neutral rate, approximated by nominal GDP growth rate.

### Pensions
- Pension spending pressures:
  - By 2050: projected at 3 percent of GDP in CESEE and 1.75 percent of GDP in Advanced Europe.
  - In Advanced Europe: pension spending set to rise steadily by 0.75 percent of GDP over the next 10 years, with a slowdown in the late-2030s.
  - In CESEE: pension spending grows similarly initially but accelerates from the mid-2030s to close to more than 1.25 percent of GDP in the decade from the mid-2030s on.
- Drivers:
  - Increase in old-age dependency ratio in CESEE beyond that of Advanced Europe.
  - Total population projections: Advanced Europe projected to rise slightly (because of immigration), CESEE projected to decline by 10 percent in the next quarter-century (based on recent trends and convergence assumptions).
  - Migration patterns changing: migration turned net positive in most CESEE countries in recent years.
  - Pension adequacy in CESEE: average replacement rate of 33 percent; private schemes notwithstanding, adequacy remains an issue likely requiring more generous public pensions (not included in projections).

### Health Care and Long-Term Care
- Trends and drivers:
  - Long-term care is the fastest-growing component of health-care costs, particularly in higher-income countries.
  - Technological advances offer better but costlier treatments; rising wages in a labor-intensive sector drive up costs, particularly relevant in CESEE.
- Projections:
  - Health care and long-term care costs set to rise gradually in both Advanced Europe and CESEE.
  - Higher life expectancy in Advanced Europe implies long-term care costs rising more rapidly there because a large share of these costs occur in the last years of life absent equivalent increases in healthy life expectancy.
  - Life expectancy at age 65 projected to remain about 2.25 years higher in Advanced Europe than CESEE even in 2050.
- Current spending (averages):
  - CESEE: 5.2 percent of GDP on health care and 0.7 percent of GDP on long-term care.
  - Advanced Europe: 6.3 percent of GDP on health care and 1.8 percent of GDP on long-term care.
- Country variation:
  - Health-care spending ranges from 4 percent of GDP in Ireland to 8.4 percent of GDP in France.
- Additional risks:
  - As CESEE income levels converge to Advanced Europe, demand for health and long-term care may increase more rapidly than projected.
  - Even under conservative assumptions, health care and long-term care spending expected to rise by more than per capita GDP and old-age dependency rate growth in countries such as Czech Republic, Slovak Republic, and Slovenia.
- Note on technology: effect on health-care costs is uncertain; past increases may not predict future trends.

### Defense
- Defense spending pressures are high in both Advanced Europe and CESEE owing to shifting geopolitical landscape.
- Pressures higher in CESEE despite higher starting positions because many CESEE countries aim to spend well beyond NATO’s 2 percent-of-GDP guideline in response to the invasion of Ukraine.
- Examples:
  - Poland planning to boost defense spending to close to 5 percent of GDP in 2025 and about 3.5 to 4 percent of GDP in the longer run.
  - Baltic states and Romania aiming at defense spending levels of about 2.5 to 3 percent of GDP.
- Defense spending pressures could become higher if perceived or actual threats increase further.

### Climate Transition
- Climate spending needs are substantial and immediate in both Advanced Europe and CESEE.
- Emerging-Europe higher costs reflect higher emissions intensity; GHG emissions intensity of GDP in non-EU emerging countries in Europe is more than double that of Advanced Europe.
- Public sector share:
  - Public budget projected to cover slightly below two-thirds of needed climate spending in CESEE.
  - Public budget projected to cover below 40 percent of needed climate spending in Advanced Europe.
- Over time, as economic structure shifts toward services, emissions and required abatement spending may decline.
- Greenhouse gas emissions data used are for 2019.

*IMF DEPARTMENTAL PAPERS • Long-Term Spending Pressures in Europe (excerpt).*

### Box 2. The Uncertainty of Assessing the Fiscal Costs of Addressing Climate Change

### Box 2. The Uncertainty of Assessing the Fiscal Costs of Addressing Climate Change

### Key uncertainties in assessing fiscal costs
- Estimating fiscal implications is challenging and beset with uncertainties, yet necessary to set aside resources.
- Fiscal implications of mitigation depend on the timeline and ambition for emissions abatement, the cost and availability of technological solutions, and the fiscal instruments used.
- Definitional issues complicate cost assessment: replacement of a coal plant at end-of-life with wind or solar should not be counted as additional cost, whereas premature retirement should be partially counted as additional cost.
- Many technologies crucial for the energy transition (electric vehicles, carbon capture and storage) are in early stages; their future development paths and associated costs are highly uncertain and can be affected by industrial policy (for example, tariffs on electric vehicle imports and subsidies).

### Mitigation instruments and fiscal revenue implications
- Carbon taxes and emissions trading systems are the most economically efficient mitigation instruments, though they would need to be accompanied by at least partial relief in other areas of taxation.
- Net effect on fiscal revenues depends on the extent to which rising carbon revenue offsets erosion of existing fossil fuel tax bases; the resulting net effect on public finances could even be positive—the higher the carbon intensity of GDP, the larger the revenue gain.
- Countries that subsidize fossil fuels through excise taxes will benefit from higher revenues when implicit or explicit subsidies are removed.
- Other instruments with larger fiscal burdens used to accelerate decarbonization in specific sectors include feebates, targeted subsidies, and public investments.
- Regulations are cost free for the public sector but impose costs on the private sector.
- Countries are likely to pursue a mix of policies, complicating estimation of mitigation costs.

### Adaptation costs and macroeconomic modeling challenges
- Estimating fiscal costs of adaptation requires climatological projection frameworks (uncertain because of future emissions paths and projected effects) and identification of a baseline.
- Modeling climate effects on the macroeconomic framework is highly challenging and compounds uncertainty.
- It is unclear how much adaptation will be autonomous (natural adjustments by individuals and ecosystems) versus planned (government actions); climate change can also affect migration, population size and composition, and direct effects on economic output.

### Interaction with broader fiscal pressures and numerical findings
- Assumptions for interest payments projections: average interest rates are gradually rising to the neutral rate (approximated by the nominal GDP growth rate); projections assume debt levels evolve broadly consistent with fiscal consolidation under the new EU fiscal framework rules and that new spending pressures are not financed by higher debt.
- Spending pressures and fiscal positions: spending pressures in Advanced Europe are relatively smaller than in CESEE—5.75 and 8 percent of GDP, respectively.
- Fiscal deficits (2023): Advanced Europe 0.9 percent of GDP; CESEE 3.3 percent of GDP.
- Public debt levels: CESEE 48 percent of GDP versus 75 percent (Advanced Europe).
- Labor taxation (as of 2022): taxes on labor accounted for 19 percent of GDP in Advanced EU member states, compared with about 15 percent for CESEE EU.
- Demographic effect on productivity and output: a 1 percentage point increase in the share of workers aged 55 and older is associated with a decrease in total factor productivity growth by about 0.6 ppts, implying average GDP growth in CESEE would be lower by about 1.2 ppts and GDP levels by 31 percent by 2050 than if the age structure remained constant.
- OECD projection: revenues from personal income tax, social contributions, and payroll taxes are expected to decline in per capita terms because of population aging—by 9 percent on average—eroding general government revenues in per capita terms by 8 percent on average.

### Costs of inaction
- Postponing decisions on long-term spending pressures risks squeezing out climate commitments and shifting burdens to future generations.
- Delaying climate action and structural reforms has intergenerational consequences and narrows future options; unmanaged climate change disproportionately affects the poorest regions and people.
- Increasing fiscal deficits and debt beyond sustainable levels leads to higher debt servicing costs, higher country risk and spreads, reduced fiscal flexibility to respond to shocks, and can undermine long-term economic and financial stability and growth.

### Fiscal institutions and policy implications (good practices)
- Well-designed fiscal frameworks, accurate long-term forecasting, and timely data are central to managing long-term spending pressures and promoting fiscal sustainability.
- Integrate comprehensive assessments of aging-related costs, climate change, and defense spending into fiscal frameworks and regularly update them; medium- and long-term orientation enables alignment of current fiscal decisions with long-term objectives.
- Medium-term fiscal frameworks (MTFFs) should incorporate long-term spending pressures and include targets and ceilings reflecting macro-fiscal implications.
- Publish regular long-term forecasts under different scenarios linked to the national annual budgetary process; sensitivity analyses to key assumptions are important.
- Incorporate automatic adjustment mechanisms and built-in prudency factors to address uncertainty while maintaining credibility of multiannual frameworks.
- Use spending reviews to improve efficiency and quality of existing spending and create fiscal space; integrate them with the budgetary process.
- Examples of country practices cited:
  - The Dutch Bureau for Economic Policy Analysis produces medium- and long-term macroeconomic, fiscal, and public debt projections integrating age-related pressures and fiscal costs of climate change under current policies.
  - Sweden publishes annual long-term projections focusing on pension, health care, long-term care services, and future defense spending over the next 15 to 20 years.
  - The United Kingdom’s Office of Budget Responsibility publishes annual fiscal sustainability reports with long-term projections and sensitivity analyses.
  - Fiscal strategies: Greece, Ireland, and Norway have established wealth funds to pay for age-related costs and climate commitments; the Netherlands focuses on stabilizing medium-term debt levels and implementing structural reforms.
  - Strong independent fiscal councils conduct independent evaluations of long-term spending pressures and costings (Ireland, Spain, Sweden, the Netherlands, United Kingdom).
- Data and institutional gaps: actuarial projections for pensions and health care are often lacking in non-EU emerging countries in Europe; where projections exist, uneven quality and fragmented data sources can lead to inaccurate spending estimates.

*Box 2. The Uncertainty of Assessing the Fiscal Costs of Addressing Climate Change*

### Box 3. Good Practices to Account for Long-Term Fiscal Pressures in Budgetary

### Box 3. Good Practices to Account for Long-Term Fiscal Pressures in Budgetary Frameworks (Concluded)

### Automatic and quasi-automatic adjustment mechanisms
- Luxembourg: pension reserves must exceed "1.5 times pension expenditures" for the pension system to avoid reassessment.
- Sweden: employs "an automatic balancing mechanism in its public pension system to adjust expenditures downward during shocks."
- Norway: pension reform adjusts benefits based on changes in life expectancy to ensure long-term financial sustainability.
- Spain: a "pension safeguard clause introduced in Spain in 2023 with the pension reform" is quasi-automatic—parliamentary/consultative processes can trigger corrective measures but may lead to delays or inaction for hard decisions.
- Czech Republic and Poland: have fiscal rules with well-specified automatic correction mechanisms as debt approaches their debt-GDP anchor.

### Adapting public financial management to be climate sensitive
- France: "Green Budget since 2023" tracks spending, including tax expenditure, against climate change objectives; tags spending that might hinder achievement of climate goals; links physical targets and financial assessments to control public spending and determine investment requirements to achieve France’s Fit for 55 climate commitments.
- Sweden: climate targets interact with budgetary targets under the MTFF; every four years the government drafts a climate action plan detailing how the climate targets are to be achieved.
- Switzerland: starting with 2024, the fiscal sustainability report incorporates climate mitigation cost projections, in addition to population aging.

### Selected non-European fiscal practices
- United States: the Congressional Budget Office provides Congress with independent projections of the economy, federal budget, and debt "over the next 30 years under current laws." Projections account for growing pressures from health care, social security, defense, and interest expenses and are updated annually.
- New Zealand: every four years, the Treasury issues a mandatory statement on the long-term fiscal position projecting government finances "for the next 40 years." It includes spending pressures from climate change and population aging and assesses their effect on the fiscal balance and debt under current policies. The Minister of Finance presents an annual Fiscal Strategy in the budget, delineating long-term policy objectives and offering at least "10-year projections" to measure progress.

### Observed gaps and risks in Europe
- Few national energy and climate plans are costed to assess fiscal effects of achieving EU-wide climate targets; spending for the green transition is "rarely integrated into MTFFs."
- Defense spending and interest payments are usually well-incorporated into fiscal frameworks, although in some NATO members (for example, Germany) financing to ensure the "2-percent guideline" is reached consistently is not assured.
- Institutional capacity varies: six EU countries (Denmark, Finland, Greece, Ireland, the Netherlands, Spain), plus Norway and the United Kingdom, "regularly and comprehensively assess" medium- to long-term spending pressures. CESEE countries, especially the Western Balkans, often lack long-term assessments and have less developed fiscal institutions.
- Two choices for governments given high deficits and debts after recent shocks: (1) inaction leading to higher deficits and unsustainable debt paths if unanticipated unavoidable spending (pensions and health care given existing legislation) materializes; or (2) sidelining spending pressures—risking underfunding of climate mitigation and other needs and higher costs later.
- Need for clear frameworks to provide transparent information and persuade public action; urgency emphasized because reforms (pension, procurement) are complex, politically difficult, and slow to yield results.

### The EU’s reformed fiscal sustainability framework (April 2024) — design and limitations
- Core features:
  - Targets countries with "debt ratios above 60 percent of GDP" or "fiscal deficits larger than 3 percent of GDP" to make fiscal adjustments restoring long-term fiscal sustainability.
  - Required fiscal adjustment generally implemented over a "four-year period," extendable to a "seven-year period" if the member state undertakes structural reforms or public investments that strengthen growth, resilience, and fiscal sustainability.
  - Assessment requires that if the country—at the end of the adjustment period—keeps fiscal policy unchanged, "debt will decline, and deficit levels will stay moderate for the next 10-year period."
  - Adjustment derivation is based on a country-specific debt sustainability analysis (DSA) that adds expenditure generated by population aging to the primary fiscal balance and subjects long-term debt developments to adverse scenarios and shocks.
- Intended incentives:
  - Link medium-term fiscal policy to long-term sustainability and incentivize structural reforms and investment by allowing a possible extension from four to seven years.
  - Recognizes that policies costly in the short term but generating long-term savings or growth can strengthen long-term fiscal sustainability.
- Limitations and risks:
  - The framework may underestimate aging costs in some cases because the baseline scenario is used.
  - If pension benefits indexation falls behind wage growth (partial wage indexation, built-in sustainability factors), this may lead to declines in pension replacement rates and future ad-hoc increases (top-ups), creating larger spending pressures than those included in the framework.
  - The framework "only considers aging-related long-term costs, not other spending pressures." A more comprehensive identification of emerging spending needs—such as climate mitigation—would improve incentives to implement policies today.

### Policy options overview (Figure 10 summary)
- Central role of fiscal institutions:
  - Comprehensive assessments of long-term fiscal pressures
  - Publication of long-term sustainability reports
  - Integrate long-term pressures into medium-term fiscal frameworks
  - Fiscal strategies supported by fiscal rules and independent fiscal councils
  - Automatic adjustment mechanisms
- Reducing spending pressures:
  - Structural fiscal reforms
  - Pension reforms
  - Health care and long-term care reforms
  - Climate policies
  - Prioritizing spending pressures
- Other policies:
  - Fiscal policies to reduce unproductive spending (fewer subsidies)
  - Revenue mobilization (tax policy, exemptions, revenue administration)
  - Using fiscal space (where available)
  - Complementary policies and growth-enhancing reforms
  - Role of the European Union budget (climate and defense)

### Reducing public spending pressures — sectoral options and trade-offs
- General:
  - Fiscal structural reforms can improve efficiency and effectiveness across pension, health, climate-related investment, and defense spending and can reduce costs in a lasting way.
  - Reforms may shift obligations to the private sector (pensions, climate investments, health care), reducing public spending pressures but increasing private costs and transferring risks to individuals; success depends on strong supervision, developed financial markets, and macroeconomic stability.
- Pensions:
  - Despite past reforms, projections indicate significant pension spending pressures with pension system deficits projected to worsen in many EU countries.
  - Policy levers: higher contributions, lower benefits, increases in retirement age, or combinations thereof; absent higher fiscal transfers, such measures are required.
  - Priority: "More ambitious increases in retirement age in countries where this is still relatively low" and "linking the retirement age to life expectancy" to create automatic adjustment mechanisms.
  - Other measures: extend contribution period for full pension, increase contribution rates, discourage early retirement, equalize women's retirement age with men's (examples: Hungary, Poland), adjust replacement rates where generous, and increase role of complementary private pension schemes (noting medium-term pressures as public contributions fall).
  - Political economy: reforms take time to bear fruit, are often phased in incrementally, and may face reversal; initiating reforms early is recommended for predictability.
- Health care and long-term care:
  - Options include procurement reforms, improved preventive care, adjustments to the basic insurance-covered package, and increasing co-payments (with distributional trade-offs).
  - Integrating care and longer-term workforce planning can improve quality and sustainability.
  - Technological advances (AI, digitalization) could mitigate labor shortages and enhance productivity but may also increase demand for care.
  - Distributional protections (for example, ceilings for out-of-pocket expenses) may contain hardships but not eliminate them.
- Climate policies:
  - Blending public and private funding is needed to scale climate finance for large adaptation and mitigation investments, and de-risking is important to attract private capital and internalize social benefits.
  - The distribution of costs between public and private sectors depends on subsidies, carbon pricing, and regulations. Shifting burden from the public sector will be necessary to reconcile climate policies with fiscal consolidation needs.
  - Public investment can crowd in private investment when it provides high-quality infrastructure or human capital; insufficient investment in low-carbon energy can raise energy costs and hinder private investment.

*Box 3. Good Practices to Account for Long-Term Fiscal Pressures in Budgetary Frameworks (Concluded), IMF Departmental Papers — Long-Term Spending Pressures in Europe*

### Box 5. Recent Fiscal Structural Reforms in Europe

### Box 5. Recent Fiscal Structural Reforms in Europe

### Pension reforms
- Recent reforms have largely focused on pension systems.
- Main reform types implemented:
  - Extending the retirement age or contribution periods (Bulgaria, France, Greece, Spain, Sweden).
  - Introducing automatic adjustment mechanisms:
    - balancing mechanisms that reduce pension indexation if the pension system runs into deficit (Germany, Lithuania, Luxemburg, and Sweden);
    - pension sustainability factors that link benefits to changes in life expectancy through the annuity factor (Finland, France, Italy, Latvia, Norway, Portugal, Sweden);
    - factors that directly link the retirement age to life expectancy (Cyprus, Denmark, Estonia, Finland, Greece, Italy, the Netherlands, Portugal, Slovak Republic, Sweden).
  - Discouraging early retirement (Austria, Czech Republic, Romania, Spain).
  - Raising women’s retirement age to match men’s (Austria, Bulgaria, Romania).
  - Promoting privately funded pensions, including mandatory occupational pension schemes (Denmark, the Netherlands), voluntary schemes, and second pillar pensions (Croatia, Estonia, Latvia, Lithuania, Romania).
- Expected outcomes and risks:
  - Ambitious pension reforms are expected to lead to declining spending pressures from pensions over 2022–70 in Denmark, Estonia, France, Italy, Portugal, and Sweden (OECD 2023; EC 2024a).
  - Some reforms (for example, in Latvia) assume a declining replacement rate and benefit ratio which may raise concerns about adequacy of pension income for persons relying on public pensions.
  - Example of reversal: a sustainability factor introduced in the 2013 pension reform in Spain was recently repealed because of concerns about pension adequacy (OECD 2023).

### Health care reforms
- Reforms since the COVID-19 pandemic have focused on strengthening systems’ resilience and have not led to notable savings.
- Coverage includes hospitals, outpatient care, pharmaceuticals, preventive care, long-term care.
- Reforms often have multiple goals (realize savings, improve access or quality) and are technically difficult to implement.
- Some procurement reforms have led to permanent savings but do not alter the trend of rising costs.
- Long-term care reforms:
  - Pandemic-driven investments increased spending on personal protective equipment, testing of staff, higher wages to boost labor supply, and expanded capacity.
  - Planned reforms to improve coverage and quality of long-term care (Bulgaria, Czech Republic, France, Germany, Portugal, Slovak Republic, Slovenia).
  - Efforts to improve sustainability include legislation to regulate indexation of long-term care benefits to recover costs from private insurance or beneficiaries (France, Germany, Slovenia); such regulations could reduce public long-term care expenditure but would shift risks to the private sector.

### Climate policy, carbon pricing, and subsidies
- Current policy mix relies on subsidies, carbon pricing, and regulations.
  - Most European countries provide subsidies for investments (electronic vehicles, modern heat pumps, rooftop solar panels).
  - Many increase public investments or subsidies for complementary infrastructure (extending transmission lines, building electronic vehicle charging stations).
- Emissions trading system (EU ETS) developments:
  - EU’s emissions trading system introduced in 2005 covers the energy sector, manufacturing, and aircraft operators (about 40 percent of the EU’s emissions) and will be extended in 2029 to cover maritime transport.
  - Emissions trading system 2 is set to expand from 2027 to include buildings, road transport, and fuels for additional sectors, mainly small industry.
  - Carbon border adjustment mechanism, introduced in 2023, places a carbon tariff on carbon-intensive products imported into the EU.
- Coverage of national explicit carbon pricing schemes varies widely: ranging from 30 percent or below in Hungary, Latvia, Lithuania, and Romania to over 70 percent in Germany, Norway, and Sweden.
- Efficiency considerations:
  - Carbon taxes—whether direct or through an ETS—are identified as the most efficient way to incentivize energy saving and GHG reduction, generate fiscal revenues, and reduce the need for public investment.
  - Subsidies for climate-friendly investments or consumption are described as less efficient and effective and a burden to public finances unless coordinated and financing public goods.
  - Recommendation: shift climate policy mix toward a robust, gradually and predictably rising carbon price and de-emphasize subsidies, while providing concurrent policies to mitigate adverse effects on the private sector.
- Distributional and competitiveness mitigations:
  - Social effects:
    - Carbon taxes are generally regressive; a significant part of additional tax revenue generated by carbon taxes will need to be redistributed (direct payments or reductions of other taxes) to mitigate regressivity.
    - Redistributive approaches should be broadly even, implying a net financial gain for households that consume few carbon-intensive products and services.
    - Revenue-neutral feebates (tax-transfer/subsidy schemes) in specific sectors (mobility, buildings, agriculture) are an alternative to gather political support without increasing average net tax burden.
    - Example: Austria’s Climate Bonus scheme increases carbon taxes but redistributes the entire amount raised evenly to residents below a certain annual household income threshold (2022) and based on the ease of regional access to public infrastructure (2023).
  - Competitiveness:
    - Increasing carbon taxes could disadvantage domestic industries where major investments are needed (for example, steel) and may lead to relocation.
    - EU’s carbon border adjustment mechanism aims to address competitiveness concerns by levying tariffs on imports from countries/firms with lower carbon prices, but such schemes can be abused for protectionist purposes and may require compensatory measures (support for climate-friendly investments).

### Defense and security sector reforms
- Defense industry reforms include common EU procurement to prevent crowding-out effects, increase effectiveness of public spending, and reduce fragmentation in defense procurement (European Parliament 2023).
- Other examples:
  - Single-source contract regulations in the United Kingdom that regulate defense contracts awarded without competition (Brooke-Holland 2024).
  - Broader security sector reforms aiming to align security provision, management, and oversight with principles of good governance (Jasutis, Tagarev, and Fuior 2022).

### Prioritizing spending pressures
- Governments can manage spending pressures by prioritizing certain areas over others (examples in the source):
  - Discussion around defense versus welfare spending in Germany.
  - Making defense the top spending priority in Poland.
  - Shift in EU spending priorities from greening the economy to investing in defense.
- Some countries (for example, the Netherlands) take a broader view of long-term spending pressures and aim to align spending with key policy goals as part of the budgetary process.

### Reducing unproductive and inefficient spending
- Energy subsidies are identified as one of the largest inefficiencies in public spending.
  - Fossil fuel and electricity subsidies in Europe amounted to 3.25 percent of GDP in 2023 on average.
    - Explicit subsidies: 0.75 percent of GDP.
    - Implicit subsidies: 2.5 percent of GDP.
  - Subsidies peaked in 2022 because energy prices increased sharply after Russia’s attack on Ukraine; they have since been reduced but remain higher than in 2019 in some countries (Belgium, Bosnia and Herzegovina, Germany, Hungary, Serbia).
- Phaseout benefits and considerations:
  - Reducing or eliminating these subsidies (for example, raising fuel taxes to account for externalities) would improve fiscal balances, create space for new spending needs, support climate mitigation, and reduce economic inefficiencies.
  - In CESEE, large spending pressures from climate mitigation and large subsidies suggest that subsidy phaseout could be the first line of defense, given large potential revenues from reducing implicit subsidies.
  - Phaseout implications:
    - Price increases across sectors with significant distributional effects (for example, transport in rural areas).
    - Potential need for very large private-sector investments that may exceed capacity.
    - Recommended approach: gradual removal of subsidies, preceded or accompanied by investments in green infrastructure (electronic vehicle charging stations, improvements in rural public transport).
    - Note: most energy subsidies are indirect; changing behavior will erode the tax base of carbon taxes, making net fiscal effect smaller than headline figures suggest.
  - Footnote: Implicit energy subsidies (underpricing relative to true social cost) do not represent spending in the IMF’s Government Finance Statistics Manual (GFSM) sense but could potentially generate additional fuel tax revenue.

### Revenue mobilization and fiscal space
- Tax revenues and social security contributions averaged 44.5 percent of GDP in 2023 in most advanced European economies; CESEE countries averaged 38.5 percent of GDP in 2023.
- Potential revenue-raising:
  - Tax-to-GDP ratios have the potential to rise by about 0.9 percent of GDP per annum in Advanced Europe and by 1.5 percent of GDP in CESEE.
- Reasons for lower revenue in CESEE:
  - Less efficient tax collection, larger informal economies, and lower income tax rates compared with advanced European economies.
- Policy options for CESEE:
  - Increase income taxation by making systems more progressive.
  - Increase efficiency of revenue administration.
  - Widen tax bases by eliminating tax expenditures and unwinding implicit subsidies and fiscal support schemes.
  - Complement changes as part of a Medium-Term Tax Reform Strategy.
- Challenges and considerations:
  - Increasing tax rates is politically difficult and may not be accompanied by more generous benefits.
  - Higher taxes should be accompanied by greater efficiency, efforts to ensure intergenerational equity and adequacy of spending, and improved service delivery.
  - Example: Estonia raised taxes in 2023 to finance additional military spending and part of the extra revenues used to finance emerging green transition and infrastructure needs; subsequent tax rate changes include VAT and income tax increases scheduled for 2024 and 2025 (as described in the source).
- Advanced Europe options:
  - Revenue increases could come from base-broadening and nondistortionary revenue measures (eliminating preferential tax treatments and tax exemptions), basing property taxes on market valuation, increasing carbon taxes, and removing tax incentives for high-income households.
  - Measures should be tailored to country-specific circumstances and avoid widening the tax wedge, discouraging investment, or suppressing labor supply.
  - Digitalization reforms offer significant benefits for better revenue collection.

_Imf Departmental Papers — Long-Term Spending Pressures in Europe (Box 5)._

### 2. Revenue versus GDP per Capita

### 2. Revenue versus GDP per Capita

### Revenue, GDP per capita, and tax rates
- Figure axes and categories:
  - GDP per capita (1,000 €, 2023) plotted against Total revenue (% GDP, 2023).
  - PIT and VAT measures use top marginal rates and standard rates, respectively.
  - Tax categories referenced: PIT = personal income tax; VAT = value-added tax; CIT = corporate income tax.
  - Regional aggregates: AE = Advanced Europe; CESEE = Central, Eastern, and Southeastern Europe.
- Data sources: EC; EIB; Eurostat; WEO; and IMF staff estimates and projections.
- Note: Simple averages used.

### Using fiscal space
- Countries with fiscal space are mostly advanced economies in central and northern Europe, notably Germany, Luxemburg, the Netherlands, Nordic Countries, and Switzerland.
- Fiscal space is country specific and dynamic; relevant assessment factors include:
  - current level of government debt, structure and financing profile;
  - market conditions;
  - public assets and contingent liabilities;
  - future spending commitments;
  - fiscal adjustment plans and their credibility;
  - implementation capacity (IMF 2016).
- Policy guidance:
  - Decisions to use fiscal space should follow cost-benefit analysis, considering whether fiscal policy is the best tool, the state of the economy, and expected quality of measures (IMF 2018).
  - Debt-financed public investments are typically justified when long-term benefits accrue across generations.
  - Debt-financing of consumption may be justified to smooth tax/expenditure paths until growth-enhancing reforms yield results.
  - In some countries (for example, Germany, Switzerland), deficit levels could be increased and still reduce public debt, though at a slower pace, without threatening debt sustainability.
  - Where appropriate, debt may be reduced now to allow increases later when spending pressures materialize.
- Institutional constraints:
  - National fiscal rules (for example, the debt brake in Germany) may limit use of fiscal space and would need adjustment to allow appropriate use.
- Suggested uses of available fiscal space in countries like Germany or Switzerland:
  - raise infrastructure and defense spending;
  - support the green transition;
  - invest in digitalization;
  - support research and development (R&D).

### Boosting productivity to create fiscal space
- Structural reforms can create fiscal space by raising growth and the public sector’s debt-carrying capacity.
- Evidence and mechanisms:
  - First-generation reforms linked to lower sovereign risk premia in emerging and developing economies with large structural deficiencies (Budina and others 2023).
  - In advanced economies, labor market reforms associated with sizable and long-lasting reductions in debt-to-GDP ratios, with better outcomes when reforms occur in good times and in countries facing high borrowing costs (Ebeke 2017; Aligishiev and others 2023).
  - Revenue buoyancy contributes to fiscal space (Dudine and Jalles 2017).
- Key EU impediments to higher productivity:
  - insufficient market size and capital market financing;
  - weak business dynamism.
- Recommended EU-level and domestic actions:
  - strengthen the single market by leveling up remaining barriers, enhance competition (especially in services and sectors dominated by public enterprises such as energy and railways);
  - improve border infrastructure and harmonize rules for cross-jurisdiction business operations;
  - complete the banking and capital market union to improve efficiency and risk-sharing and enable firms to achieve economies of scale;
  - focus on public investment and structural change, overcoming NGEU/RRF investment bottlenecks and enhancing the EU budget for investment in public goods;
  - adopt “smart” industrial policies that are limited to addressing market distortions, narrowly targeted, time bound, and avoid negative cross-border spillovers—priorities include R&D, early-stage green technologies, supply-chain resilience, strategic public goods (such as defense), and the green transition.
- Domestic reforms emphasized:
  - address skills shortages;
  - promote active labor market policies;
  - CESEE-specific needs: upgrade infrastructure, raise worker skills, and improve institutions to resume income catch-up.
- Trade-offs:
  - Higher growth may increase spending pressures because:
    - pensions often indexed with wages, raising pension demands;
    - health care is labor intensive and wages for doctors, nurses, and care workers rise with general wages;
    - health care demand and costs grow with rising GDP per capita—health care expenditure tends to grow 1 to 2 percent faster than GDP per capita due to non-demographic factors (Hagist and Kotlikoff 2009; IMF 2010);
    - NATO minimum spending guidelines defined as a share of GDP imply defense spending must increase in line with economic growth to remain compliant, unless a country’s national target is already well above 2 percent of GDP or the country is not part of NATO;
    - CO2 emissions closely associated with GDP, implying higher GDP entails larger climate mitigation costs.
  - Nonetheless, higher growth is expected to have a net positive effect on fiscal space, accommodating spending pressures.

### The role of the EU budget and common public goods
- Rationale for EU-level centralization/increased spending:
  - Alleviate specific country spending pressures where public goods have positive externalities (for example, defense, climate initiatives);
  - Address coordination problems and exploit network effects (for example, cross-border infrastructure, digital transition);
  - Realize economies of scale and reduce duplication (for example, defense procurement standardization).
- Climate and energy:
  - Fighting climate change at EU level can be more cost efficient and overcome coordination problems (for example, for cross-border energy infrastructure) in presence of externalities (Panetta 2022; IMF 2024b).
  - A broad climate policy package could achieve emissions-reduction goals and deliver sizable energy security co-benefits (Dolphin and others 2024).
  - Cross-border energy infrastructure and common electricity market regulation could lower energy costs and electricity prices, increase EU resilience, and support decarbonization.
  - An EU Climate and Energy Security Facility could improve common public goods related to energy security and the green transition.
- Defense:
  - Coordinating defense initiatives through EU-level fiscal capacity with common procurement could reduce duplication and achieve cost savings; the European Defense Industrial Strategy (EC 2024b; ECFR 2024) could fill gaps in military inventories and industrial production capacities.
- Fiscal implications of expanding EU financial resources:
  - Increasing EU financial resources would imply higher contributions by member states or additional resources.
  - Aggregate additional EU resources would primarily come from efficiency gains; for some member states common financing would be supplementary and redistributive.
  - Common financing can strengthen capacity in member states facing particularly high spending pressures and enable more efficient allocation (for example, channel funds where mitigation effects are highest).
- NGEU example:
  - NGEU provides €648 billion in grants and loans (4.4 percent of 2021 GDP, and more than 10 percent in countries like Croatia and Greece) over 2021–26.
  - EU fiscal resources were boosted to ensure fiscal stabilization and provide common public goods funding green and digital transition projects.
  - Funds for climate policy increased in the 2021–27 EU budget from 21 to 30 percent of the total, with climate integrated into all spending areas.
- Scope to expand common public goods provision in defense, energy efficiency and security, and R&D.

### Key projections and long-term pressures
- By 2050, long-term expenditures are estimated to be:
  - 5.75 percent of GDP in Advanced Europe;
  - 8 percent of GDP in CESEE.
- Policy priorities to address pressures:
  - urgent fiscal consolidation now to safeguard sustainable public finances and rebuild buffers in an environment of low growth, consecutive shocks, and heightened uncertainty;
  - spending prioritization and comprehensive structural reforms to ensure adequate revenue, contain spending, and meet environmental, social, and security objectives;
  - build institutional capacity and strengthen fiscal frameworks, forecasting, and timely data for policy decisions with long-term implications.
- Specific policy recommendations:
  - implement entitlement reforms (noting they take time to have effect);
  - redistribute burden between state and private sector where appropriate;
  - use carbon pricing to promote savings and clean energy adoption, with fiscal revenues recycled to compensate vulnerable households;
  - reduce unproductive spending (for example, fuel subsidies);
  - increase revenue mobilization, especially in CESEE;
  - use fiscal space where available and appropriate;
  - strengthen EU fiscal capacity in key areas (climate, defense, energy security, R&D) to expand provision of common public goods and support member states with high spending pressures;
  - pursue structural reforms to boost growth potential and fiscal maneuvering room.
- Sequencing of reforms should consider savings potential, effect on growth and efficiency, and distributional consequences given limited political capital.

### Annex: Methodology highlights for spending pressures
- Spending pressures are calculated as the difference between baseline spending levels and projected future spending levels.
- Interest cost projections:
  - Baseline interest cost set as a constant fraction of the preceding period’s debt stock.
  - Future interest rates projected to gradually rise to the neutral rate approximated by the nominal GDP growth rate.
  - The increase to that level is gradual, by steps of 0.1 percentage points per year.
  - It is assumed any spending pressures are fully absorbed and the debt stock after spending pressures remains unchanged from the baseline.
  - Debt stock projected based on the evolution of fiscal balances broadly in line with the new EU fiscal rules.
- Defense spending projections:
  - Baseline defense spending set at the lower of 2021 or 2022 levels (as a share of GDP).
  - Data from NATO (available through 2023) or WDI/SIPRI.
  - Projected future defense spending set based on country announcements; in most NATO members this implies an increase to 2 percent of GDP, though some target higher levels.
  - Where no announcements were made, defense spending as a share of GDP assumed constant.
- Pensions projections:
  - Baseline pension spending set at the level (as a share of GDP) of 2023.
  - Data from Eurostat where available or from desks.
  - Projections for EU member states and Norway use the baseline scenario of the EC (2024a).  

*IMF DEPARTMENTAL PAPERS — Long-Term Spending Pressures in Europe*

### 2023. In some cases, this can lead to low levels of pensions. Where this is the case, the EC has calculated

### ltspieea - 2023. In some cases, this can lead to low levels of pensions. Where this is the case, the EC has calculated

### Pensions
- For countries where reforms could lead to low levels of pensions, the EC’s “no benefit loss” scenario is used instead of the baseline.
- For other countries, pension spending projections are based on:
  - Eurostat projections of population and age structure as of 2023, and
  - the average share per pensioner in GDP per capita in recent years.

### Health and long-term care
- Baseline spending is set at the level (as a share of GDP) of 2023.
- Data sources:
  - Eurostat where available, or
  - the WDI database.
- Projections:
  - For EU member states and Norway: baseline scenario of the EC (2024a), which is projected based on legislation as of the end of 2023.
  - For other countries: projections from the IMF’s Fiscal Monitor (updated as of March 2024).

### Green transition spending estimates and methodology
- No single reliable estimate exists uniformly across countries.
- For EU member states and Norway:
  - Used European Investment Bank (EIB) 2020/21 Investment Report (EIB 2021) country-by-country estimates of annual investment needs to reach the 40 percent greenhouse gas (GHG) reduction target by 2030.
  - Scaled those estimates up to the average of:
    - estimates for total investment needs to reach a 55 percent reduction of GHG emissions, and
    - new total estimates by the EC to reach the more ambitious targets set in the RePower EU plan.
  - Adjusted for spending already in baseline:
    - EIB data indicate about 45 percent of needed spending is, on average, already taking place in sectors other than transport—this portion was removed from spending pressures because it is already in the baseline.
    - Reducing emissions in the transport sector adds on average one additional percentage point of GDP in investment needs.
  - Distribution between public and private sectors based on EIB estimates, which are derived from national plans and are not available for all countries; averages for Central, Eastern, and Southeastern Europe and for other countries (as reported by the EIB) were applied uniformly to each country.
  - Note: the share of the public sector is higher in Central, Eastern, and Southeastern European countries than in western Europe.
- For non-EU member states:
  - Used IMF CPAT model estimates of the carbon taxes required to achieve a 25 percent reduction in GHG emissions and the accompanying erosion of the tax base as an approximation (because these countries are not bound by the EU’s targets).

### Cross-country presentation and visualization
- Annex Figure 2.1 presents the evolution of annual spending pressures beyond baseline for 2030–50 (Percent of GDP) across:
  - Advanced Europe and Central, Eastern, and Southeastern Europe country groupings.
- Categories shown include: Climate, Defence, Health, Pensions, Interest, and Total.
- Sources for figures: EC; EIB; WEO; and IMF staff estimates and projections.
- Note: Estimates may differ from authorities’ projections because a consistent methodology is applied.

*Source: https://www.imf.org/-/media/files/publications/dp/2025/english/ltspieea.pdf*

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_Source: https://www.imf.org/-/media/files/publications/dp/2025/english/ltspieea.pdf_