## fm1701 ## Source details **Canonical URL:** [fm1701](https://www.imf.org/-/media/files/publications/fiscal-monitor/2017/april/pdf/fm1701.pdf) ## Other formats - [Markdown version](/-/media/files/publications/fiscal-monitor/2017/april/pdf/fm1701.pdf.md) - [Structured JSON version](/-/media/files/publications/fiscal-monitor/2017/april/pdf/fm1701.pdf.json) --- ### Preface — Overview and purpose - Global economy undergoing major transformations: productivity slowdown, technological change, global economic integration; fiscal policy must facilitate transformations and cushion adverse effects. - Fiscal policy role: foster sustainable and inclusive growth while managing high uncertainty and stretched government balance sheets. - Projections and methodological notes: - Projections based on IMF staff projections (April 2017 WEO and GFSR database). - Fiscal projections refer to the general government unless otherwise indicated. - Short-term projections based on officially announced budgets, adjusted for macro assumptions; medium-term incorporate measures judged likely to be implemented. ### Executive summary — Fiscal stance, priorities, and trade-offs - Fiscal stance and near-term guidance: - Many countries should withdraw fiscal support to rebuild buffers; flexibility to stabilize cycle remains important. - United States: economy close to full employment; "fiscal consolidation could start next year" to put debt on a downward path. - China: "augmented" fiscal deficit should decline in the medium term; reallocate resources from off-budget public investment to on-budget social spending. - Growth-friendly and inclusive priorities: - Use tax and expenditure measures to support physical capital, labor force, and productivity. - Case for increased public investment remains strong; emphasize careful project selection, management, and evaluation. - Business tax systems: focus on taxing rents and reducing burdensome tax administration practices. - Labor policies: reduce labor taxation where high; use active labor market policies; boost female labor force participation. - Inclusion: expand conditional cash transfers in some emerging markets and developing economies; improve access to education, training, and health; use social insurance to help adaptation. - Financing and fiscal space: - For countries with fiscal room: additional borrowing permissible if returns outweigh costs; IMF developed a new framework to assess “fiscal space.” - For countries without fiscal space: raise revenue or save on expenditures in ways least harmful to growth (broaden tax base, raise indirect/property taxes, better-target spending). - Reallocating within a budget envelope may be politically difficult. ### Chapter 1 — A greater role for fiscal policy: developments, outlook, and risks - Recent shifts in fiscal positions: - Advanced economies eased fiscal stance by one-fifth of 1 percent of GDP in 2016. - Advanced-economy aggregate fiscal stance expected broadly neutral in 2017 and following years. - Public debt in advanced economies should stabilize in the medium term, averaging more than 100 percent of GDP. - Emerging market and developing economies: deterioration appears to have ended; improvement depends on commodity markets. - Oil exporters: fiscal deficits expected to fall by about $150 billion between 2016 and 2018. - Key aggregate fiscal numbers (preserved exactly): - General government overall balance (percent of GDP): - World: 2016 = –3.6; 2017 = –3.4; 2018 = –3.1. - Advanced Economies: 2016 = –2.9; 2017 = –2.7; 2018 = –2.7. - Emerging Market and Middle-Income Economies: 2016 = –4.8; 2017 = –4.4; 2018 = –3.9. - Low-Income Developing Countries: 2016 = –4.4; 2017 = –4.4; 2018 = –3.9. - Cyclically adjusted primary balance (percent of potential GDP): - Advanced Economies: 2016 = –1.1; 2017 = –1.2; 2018 = –1.2. - Emerging Market and Middle-Income Economies: 2016 = –2.1; 2017 = –1.9; 2018 = –1.5. - Gross debt (percent of GDP): - World: 2016 = 83.6; 2017 = 83.6; 2018 = 82.8. - Advanced Economies: 2016 = 105.4; 2017 = 107.6; 2018 = 107.1. - Emerging Market and Middle-Income Economies: 2016 = 44.5; 2017 = 47.4; 2018 = 48.6. - Low-Income Developing Countries: 2016 = 40.4; 2017 = 41.9; 2018 = 41.6. - Select country gross debt: - United States: 2016 = 105.6; 2017 = 107.4; 2018 = 108.3. - Japan: 2016 = 238.0; 2017 = 239.2; 2018 = 239.2. - Saudi Arabia: 2016 = 12.4; 2017 = 15.6; 2018 = 19.1. - Net debt (percent of GDP) highlights: - World net debt 2016 = 62.3; 2017 = 62.4; 2018 = 62.5. - Advanced Economies net debt 2016 = 70.1; 2017 = 71.4; 2018 = 71.4. - Japan net debt 2016 = 119.8; 2017 = 119.9; 2018 = 120.1. - Three fiscal-response cases and calibration: - Case 1 (countercyclical in downturns): discretionary fiscal expansion when fiscal space exists and monetary policy constrained; combine with structural reforms and monetary accommodation. - Case 2 (withdraw support in upturns): economies near potential (e.g., United States, China) should reduce deficits; United States could start consolidation after near-term neutrality. - Case 3 (procyclical when unavoidable): countries with limited buffers must prioritize fiscal sustainability (commodity exporters example); calibrate pace and composition to mitigate growth drag. - Risks to outlook: - Fiscal policy uncertainty at decade high (Baker, Bloom, and Davis 2016); main source: lack of specificity about future U.S. policies. - Other risks: elections in Europe, China party congress, faster interest-rate increases, stronger U.S. dollar, lower commodity prices, materialization of contingent liabilities. - Nonfinancial private sector debt at all-time high; private deleveraging could migrate liabilities to government balance sheets. - Fiscal risk management (four-step strategy): - Step 1: Identify risks, magnitude, likelihood. - Step 2: Reduce probability and exposure. - Step 3: Create budgetary buffers. - Step 4: Set safe fiscal targets. - Box 1.4 numeric experiments on interest–growth differential (preserved exactly): - Average forecast fall in interest–growth rate differential (2012 to 2022): 1.6 percentage points. - Estimated increase in debt limits from a transitory 1.6 percentage point fall: about 2 percent of GDP (on average). - Permanent decline assumed in experiment: 1 percentage point. - Increase in maximum sustainable debt level from a permanent 1 percentage point decline: average of 25 percent of GDP; range across countries: 10 percent of GDP to 40 percent of GDP. ### Chapter 1 — Country group specifics and assumptions - Advanced economies: - Aggregate fiscal stance eased by one-fifth of 1 percent of GDP in 2016; debt-to-GDP reached 107.6 percent in 2016. - United States: assumes a fiscal impulse of about 1 percent of GDP spread over 2018−19 based on lower personal and corporate income taxes; U.S. debt ratio projected to increase continuously over the five-year WEO forecast horizon (until 2022). - Euro area: expansionary in 2017 led by France, Germany, Italy; constraints from Stability and Growth Pact noted. - Japan: announced stimulus raising spending in 2017; VAT hike postponed to October 2019; commitment to 2020/21 primary surplus goal but no new measures specified. - United Kingdom: slowed pace of consolidation; cyclically adjusted primary balance increase about 2⁄3 percentage point of GDP per year until fiscal year 2019/20. - Emerging Market and Middle-Income Economies (EMMIEs): - Headline deficits rose to 4.8 percent of GDP in 2016 (two-decade high); average debt ratio rose by about 10 percentage points to 47.4 percent of GDP in 2016. - China: on-budget deficit 2015 = 2.8 percent of GDP; 2016 = 3.7 percent of GDP; “augmented” deficit 2015 = 9.5 percent of GDP; 2016 = 10.3 percent of GDP. - Oil exporters/Gulf: average fiscal deficit about 6 percent of GDP in 2016; Saudi Arabia fiscal deficit expected to decline by 7 percent of GDP in 2017. - Baseline projections: overall deficit to decline to 4.4 percent of GDP in 2017 and to 3.1 percent by 2022; debt ratios set to rise from 48.6 percent of GDP in 2017 to 52.4 percent in 2022. - Low-Income Developing Countries (LIDCs): - Average fiscal deficit increased to 4.4 percent of GDP in 2016; average debt-to-GDP reached 40.4 percent (rise of 4.3 percentage points). - Exchange rate depreciation contributed to debt accumulation; where public debt denominated in foreign currency above 50 percent, currencies depreciated about 5 percent in 2016 on average. - Fiscal scenario for 2017 sensitive to commodity market assumptions; deficits forecast to stabilize in percent of GDP under current projections. ### Chapter 2 — Upgrading the tax system to boost productivity: scope and findings - Framing and measurement: - Resource misallocation defined as poor distribution of labor and capital across firms reducing aggregate TFP. - Methodology follows Hsieh and Klenow (2009); data: ORBIS for advanced economies, WBES for emerging and low-income countries. - Key quantitative findings (preserved exactly): - Eliminating distortions that cause resource misallocation could lift annual real GDP growth rates by roughly 1 percentage point for about 20 years. - Panel counterfactuals (moving to the efficiency level of a top performer): - Manufacturing — median TFP gains: - Advanced economies: 16 percent. - Emerging market economies: 30 percent (rise to 52 percent at the 75th percentile). - Low-income developing countries: 20 percent (rise to 58 percent at the 75th percentile). - Services — advanced economies: 23 percent (median). - Transitional GDP growth effects (20-year transition to top-performer efficiency): - Advanced economies: higher annual real GDP growth rate of 0.7 percent. - Emerging market economies: higher annual real GDP growth rate of 1.3 percent. - Low-income developing countries: higher annual real GDP growth rate of 0.9 percent. - Channels and tax-system implications: - Disparities in EMTRs across asset types and sources of financing cause misallocation. - Empirical estimates: - Eliminating tax disparity (EMTR on machinery equal to EMTR on buildings) would raise resource allocation efficiency in machinery-intensive industries by 7¼ percentage points in emerging market economies and by 5½ percentage points in low-income developing countries. - If the median advanced economy reduced its debt bias to the 10th percentile, it could raise resource allocation efficiency for R&D-intensive industries by 3 percentage points. - Informality: firms that report only 30 percent of sales have 4 percent lower TFP than tax-compliant firms. - Policy prescriptions on tax design: - Minimize differentiated tax treatments across assets and financing (reduce tax disparity across capital asset types). - Policy options to remove debt bias: - Allowance for Corporate Equity (ACE) system: deduction for an imputed return on equity; implemented in Belgium, Cyprus, Italy, Turkey (requires careful design to mitigate revenue risks). - Cash Flow Tax (CFT): immediate expensing, no deductibility of interest/dividends; no country has adopted a comprehensive business CFT—transition complexities noted. - Level the playing field: - Strengthen tax administration to reduce unfair advantages of informal firms. - Reduce tax compliance costs (electronic filing, simplification) to help small and young firms. - Target tax relief to new firms rather than to all small firms to avoid the “small business trap.” - Antiavoidance and international coordination: - Antiavoidance measures (transfer-pricing regulations) can reduce profit shifting but may reduce multinational affiliate investment modestly (estimated average reduction of 1–3 percentage points in investment as percent of fixed assets in treated specifications). - Tax administration and compliance: - TAQI (Tax Administration Quality Index): higher TAQI scores associated with higher labor productivity among small and young firms. - Colombia case study (2012 reform): - Payroll taxes reduced by 13.5 percentage points; total payroll contributions fell from 60.3 to 46.8 (percent of wage rate). - Evidence: informality in metropolitan areas fell by 6½ percentage points by four years after reform; various study estimates of employment increases ranging from 3.1 to 7.4 percent and informality reductions between 1.4 and 6.8 percentage points depending on coverage and method. - Empirical magnitudes and regression findings (selected exact estimates): - Annex Table 2.5.1 — developing countries: Disparity in EMTRs_k × Machinery as Share of Total Assets_j coefficients (examples): –1.172*, –1.267*, –1.678***, –1.144*, –1.263*, –1.663*** (standard errors reported in source). - Annex Table 2.5.2 — advanced economies: Debt Bias_k × R&D Intensity_j coefficients (examples): –0.00781***, –0.00815***, –0.00900*** (standard errors reported in source). - Annex Table 2.6.1 — firm-level TFP: Sales Reported coefficients: 0.0016***; 0.0018***; 0.0018*** (implying firms reporting only 30 percent of sales have 4 percent lower TFP than compliant firms). - TAQI interactions: Small × TAQI coefficients: 0.563***; 0.508*** (interpreted: one unit increase in TAQI implies labor productivity 51 percent higher for small firms and 16 percent higher for young firms in specified specifications). ### Destination-Based Cash Flow Tax (DBCFT) — design, implications, and uncertainties - Design features: - Cash flow: immediate full deduction for capital expenses; denial of deduction for net interest expense. - Destination-based: border adjustment exempting exports and taxing imports (tax base at location of final consumption). - Implications: - As a rent tax, DBCFT would not affect marginal investment decisions and would reduce debt bias. - Border adjustment theoretically offset by exchange rate appreciation and domestic price changes; real effects uncertain in practice. - Implementation challenges and distributional considerations: - Refunds for perpetual exporter tax losses politically difficult and fraud-prone. - Treatment of financial transactions and transition of existing investments remain underdeveloped. - Distributional impact depends on adjustment channel: - If via domestic prices: burden falls on those spending domestically from nonwage income (relatively wealthy). - If via nominal exchange rate: burden falls on those spending domestically from incomes denominated in foreign currency. - WTO and treaty implications, winners and losers across industries, and potential adverse cross-country spillovers if adopted by subset of countries. ### Annex, methodological notes, and data conventions (selected exact values) - Sample coverage and data sources: - World divided into three groups: 35 advanced economies, 40 emerging market and middle-income economies, 40 low-income developing countries. - Data compiled on information available through April 6, 2017. - Selected country-group time series (preserved exactly where presented): - Advanced economies — General government overall balance (percent of GDP) average series includes: 2008 –3.5; 2009 –8.7; 2010 –7.6; 2011 –6.2; 2012 –5.4; 2013 –3.6; 2014 –3.1; 2015 –2.6; 2016 –2.9; 2017 –2.7; 2018 –2.7; through 2022 –2.7. - Advanced economies — Gross debt (percent of GDP): 2008 79.2; 2009 92.6; 2010 99.3; 2011 103.5; 2012 107.7; 2013 106.3; 2014 105.6; 2015 105.4; 2016 107.6; 2017 107.1; 2018 106.7; 2019 106.4; 2020 106.0; 2021 105.8; 2022 105.6. - Gross financing need (selected, 2017): Japan total financing need 40.8; United States 19.3; Italy 16.5; France 13.2; average maturing debt sample 13.8; average total financing need 16.6. ### Policy synthesis — prioritized actions (enumerated) - Countercyclical stance: - Use automatic stabilizers primarily; apply discretionary measures when monetary policy constrained and fiscal space exists. - Anchor expansions in credible medium-term fiscal frameworks. - Growth-friendly tax and spending: - Reorient spending toward productive public investment, human capital, and policies that boost labor force participation (particularly female participation). - Upgrade tax systems: reduce tax discrimination across assets and financing; consider ACE or cash flow tax designs where feasible and well designed. - Protect targeted expenditures and improve public investment management. - Inclusion and redistribution: - Use transfers and tax instruments to improve redistribution efficiently (expand conditional cash transfers where appropriate). - Invest in education, training, health, and social insurance to promote equality of opportunity. - Fiscal risk management: - Identify and mitigate contingent liabilities; create buffers; set safe fiscal targets; improve transparency and institutions. - Revenue and expenditure measures for constrained budgets: - Revenue: broaden base by eliminating exemptions, raise indirect and property taxes, improve revenue administration. - Expenditure: perform comprehensive expenditure reviews; eliminate generalized subsidies; better target transfers; contain wage bills while preserving service quality. - International coordination: - Coordinate antiavoidance measures to limit adverse effects on multinational investment and to preserve cross-border tax bases. - Consider multilateral aspects of major tax reforms (for example, DBCFT) to minimize spillovers. *International Monetary Fund | April 2017 — Fiscal Monitor: Achieving More with Less (fm1701)* ### Preface ### Preface ### Overview and purpose - The global economy is undergoing major transformations, including a productivity slowdown, technological change, and global economic integration. These changes create new demands for public policies to facilitate transformations and cushion effects on those negatively affected. - Fiscal policy has a greater role to play in fostering sustainable and inclusive growth, while high uncertainty and stretched government balance sheets require better understanding and management of risks. - Fiscal policy faces the task of achieving more and better in a more constrained environment. ### Shifts in fiscal positions and elevated risks - Advanced economies eased their fiscal stance by one-fifth of 1 percent of GDP in 2016, breaking a five-year trend of gradual fiscal consolidation. - Advanced-economy aggregate fiscal stance is expected to remain broadly neutral in 2017 as well as in the following years. - Public debt in advanced economies should stabilize in the medium term, averaging more than 100 percent of GDP, rather than decline as previously expected. - In emerging market and developing economies, the deterioration in fiscal positions appears to have come to an end, though the expected improvement depends crucially on developments in commodity markets. - Oil exporters are implementing large consolidation plans; their fiscal deficits are expected to fall by about $150 billion between 2016 and 2018 (with the improvement next year coming mainly from the non-oil balance). - In oil importers, the fiscal deficit should remain broadly stable as a share of GDP in 2017, followed by a gradual consolidation over the medium term. - Key sources of policy and macroeconomic uncertainty include: - Lack of specificity about the size and composition of the expected fiscal stimulus in the United States. - A number of elections in Europe. - The upcoming party congress in China. - For emerging market and developing economies: a more rapid increase in interest rates, a significant appreciation of the U.S. dollar, and lower commodity prices — any of which could exacerbate debt vulnerabilities and trigger the materialization of contingent liabilities, particularly implicit government guarantees on corporate borrowing. ### Setting the course for fiscal policy - The role of fiscal policy has been reassessed in the past decade, reflecting the global financial crisis and new academic research; fiscal policy is seen as a powerful tool for promoting inclusive growth and stabilizing the economy, especially during deep recessions and when monetary policy is less effective. - High debt levels, long-term demographic challenges, and elevated fiscal risks place a premium on sound public financial management. - Policies should be anchored within a credible medium-term framework that: - Ensures debt sustainability. - Manages risks adequately. - Encourages countries to build buffers during upturns. ### Guiding objectives and implementation priorities - Three main objectives should guide the conduct of fiscal policy, although limited budgetary room and trade-offs may constrain simultaneous pursuit: - Fiscal policy should be countercyclical: - Rely mostly on automatic stabilizers. - Be symmetric (expand in bad times and tighten in good times). - In economies with protracted lack of demand and constrained monetary policy (for example, Japan), discretionary fiscal support, combined with structural reforms and continued monetary accommodation, can be used to raise nominal GDP and help escape debt-deflation traps. - In the euro area, the aggregate cyclical position argues for a slightly more expansionary aggregate fiscal stance in 2017. - At the other end of the spectrum, economies with limited economic slack and signs of inflationary pressures should pursue appropriate stances consistent with macro conditions. ### Projections and assumptions (methodological notes) - The projections included in this issue of the Fiscal Monitor are based on the same database used for the April 2017 World Economic Outlook and Global Financial Stability Report (referred to as “IMF staff projections”). - Fiscal projections refer to the general government unless otherwise indicated. - Short-term projections are based on officially announced budgets, adjusted for differences between national authorities and IMF staff regarding macroeconomic assumptions. - Medium-term fiscal projections incorporate policy measures judged by IMF staff as likely to be implemented. - For countries supported by an IMF arrangement, medium-term projections are those under the arrangement. - When IMF staff have insufficient information to assess authorities’ budget intentions and prospects for policy implementation, an unchanged cyclically adjusted primary balance is assumed, unless indicated otherwise. *International Monetary Fund | April 2017 — Preface (Fiscal Monitor: Achieving More with Less, fm1701)* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Fiscal stance and policy priorities - In many countries, fiscal policy should, in general, withdraw fiscal support to rebuild buffers. - In the United States, where the economy is close to full employment, fiscal consolidation could start next year to put debt firmly on a downward path. - In China, given robust employment levels and the expected pickup in inflation, the “augmented” fiscal deficit should decline in the medium term to support economic rebalancing, with fiscal resources reallocated from off-budget public investment toward on-budget spending for social assistance, education, and health. - Fiscal policy should be flexible to stabilize the economic cycle, but using fiscal policy flexibly is not always feasible; fiscal consolidation may be warranted regardless of cyclical conditions to ensure fiscal sustainability in the face of large shocks (for example, in commodity exporters) or to restore market confidence. ### Fiscal policy should be growth friendly - Tax and expenditure measures can be used as structural instruments to support the three engines of long-term growth: the stock of physical capital, the labor force, and productivity. - The case for increasing public investment remains strong in many countries in light of low borrowing costs and substantial deficiencies in infrastructure; careful project selection, management, and evaluation should ensure that investment is efficient. - More growth-friendly business tax systems that focus on taxing rents and reducing burdensome tax administration practices can promote private investment. - Example: In the United States, reforming corporate taxation could help revitalize business dynamism and investment. - Policies to create a better environment for job creation: - In advanced economies: reduce labor taxation where it is high, make more intensive use of active labor market policies, and adopt targeted spending measures for vulnerable groups. - In emerging markets and developing economies: improve access to health care and education. - Almost all countries need to boost female labor force participation. - To foster productivity and innovation, a range of policies can be used, including tax measures that reduce the misallocation of resources across firms (see summary of Chapter 2). ### Fiscal policy should promote inclusion - Global economic integration and technological change have contributed to economic growth and prosperity, lifting one billion people out of poverty since the 1980s. - Gains at a global level have not always been widely shared within countries; in advanced economies, the incomes of the top 1 percent have grown almost three times faster than those of the rest of the population over the past 30 years. - Fiscal policy can help ensure the poor and the middle class share in the growth dividend by identifying transfer and tax instruments that promote inclusiveness while maintaining incentives to invest and work. - Conditional cash transfer programs—transfers to poor households that require, in some cases, children to attend health clinics and school—could be expanded in a number of emerging markets and developing economies. - Inclusive fiscal policies also include better access to quality education, training, and health services, as well as social insurance to help people participate in and adapt to a changing economy. ### Achieving sustainable and inclusive growth while coping with high debt - Limited fiscal buffers require countries to be selective in budgetary choices; if additional resources are necessary, they should be raised in a way that is the least harmful for growth while keeping debt on a sustainable path. - For countries with fiscal room: - One option is to finance policies through additional borrowing, but debt should be used wisely: the return on debt-financed projects should clearly outweigh the cost and risks that higher leverage creates. - The IMF has developed a new framework that combines a variety of indicators and tools to assess “fiscal space” more systemically and consistently across countries. - The persistent decline in interest rates may have relaxed government budget constraints in advanced economies; if the differential between interest rates and GDP growth were to remain durably lower than it has been in past decades, countries could be able to sustain higher levels of public debt. - For countries without fiscal space: - Room must be created within budgets by raising more revenue or saving on expenditures to implement desired policies in a budget-neutral way. - On the revenue side, identifying the least distortionary measures—those that least reduce incentives to work, save, and invest—should be a priority. - Options include broadening the tax base (by eliminating tax exemptions and preferential tax rates) and raising indirect taxes and property taxes. - Example: In China, significantly raising taxes on fossil fuel would raise revenue, while helping curtail emissions and improve energy efficiency. - On the spending side, better targeting of expenditure and increasing efficiency, preferably as part of comprehensive expenditure reviews, can often generate savings. - Countries can eliminate generalized subsidies that disproportionately benefit higher-income groups in favor of targeted measures to those in need. - Reallocating taxes and expenditures within a given budget envelope may be difficult politically. ### Upgrading the tax system to boost productivity (Chapter 2) - Raising total factor productivity is a top challenge; growth-friendly fiscal policies, including tax system upgrades, can reduce distortions and boost productivity. - Key findings: - Countries can reap substantial productivity gains by reducing resource misallocation across firms. Estimates show that eliminating the distortions that cause resource misallocation could generate sizable productivity gains and lift annual real GDP growth rates by roughly 1 percentage point for about 20 years. - Upgrading tax-system design helps ensure firms’ decisions are made for business and not tax reasons. Important productivity gains can come from reducing tax discrimination by asset type, by sources of financing, or by firm characteristics such as formality and size. - Minimizing differentiated tax treatments across capital asset types and financing can help tilt firms’ decisions toward investments that are more productive rather than more tax favored. - Tax treatments that favor debt over equity financing create resource misallocation by imposing a higher marginal tax on research and development investment, which is more dependent on equity compared to other capital spending. - Disparity in taxes across capital asset types also affects firms’ investment decisions. These distortions can be eliminated by shifting to a cash flow tax or by adopting an allowance for corporate equity system, which allows a tax deduction for the normal rate of return on equity. - Governments should encourage the growth of productive firms by leveling the playing field. - Informal firms, by evading taxes, are able to stay in business despite low productivity; stronger tax administration can reduce the unfair cost advantage these firms enjoy over more productive, tax-compliant competitors. - Encourage growth and productivity among small firms by reducing tax compliance costs and by targeting tax relief to new firms rather than small firms to avoid disincentives to growth that result in the “small business trap.” - In sum: how governments tax matters for productivity. Improving tax policy design helps remove distortions holding more productive firms back, generating a positive impact on aggregate productivity and growth. ### Reassessment of fiscal policy and its three functions - Fiscal policy has recently gained prominence in public debate and governments’ policy agendas; a reassessment stresses its greater role in fostering sustainable and inclusive growth and smoothing the economic cycle. - The report uses Musgrave’s classification of public finances into three functions—stabilization, allocation, and redistribution—to frame analysis and policy advice: - Stabilization: Fiscal policy can smooth short-term economic fluctuations via automatic stabilizers and discretionary measures; discretionary fiscal policy can have strong effects when monetary policy is constrained, the financial sector is weak, and there is significant and protracted slack in the economy. Under normal circumstances, preferred approach remains a combination of monetary policy with free operation of automatic stabilizers. - Allocation: Fiscal policy can affect trend growth by supporting employment, capital accumulation, and productivity. Recent research and micro data have strengthened the toolkit and evidence that tax and expenditure measures can be used as structural instruments to improve medium- to long-term growth. - Redistribution: Rising income inequalities have increased attention to distributional effects of tax and spending policies. Advances in measurement and policy design (including use of household survey and administrative data) have improved the design and implementation of inclusive fiscal policies. *Fiscal Monitor: Achieving More with Less — EXECUTIVE SUMMARY* ### CHAPTER 1 A gReATeR ROLe FOR FISCAL POLICY ### CHAPTER 1 A gReATeR ROLe FOR FISCAL POLICY ### Broad framing and implications - Administrative data have improved calibration of tax, transfer, and social insurance measures and incidence analysis (Brewer, Saez, and Shephard 2010; Chetty and Finkelstein 2013; Lustig, Pessino, and Scott 2014). - Debate on efficiency cost of progressive taxation: some argue redistributive benefits of higher marginal income tax rates exceed costs (Diamond and Saez 2011; Piketty, Saez, and Stantcheva 2014); debate continues (Mankiw, Weinzierl, and Yagan 2009). - Recent research suggests equity-enhancing fiscal measures may be consistent with sustainable economic growth (Ostry, Berg, and Tsangarides 2014). - Implication: in certain cases, scope exists to improve income distribution without undermining incentives to work and invest (IMF 2014a; Fabrizio and others 2017). ### Chapter structure and focus - The chapter: - Reviews recent fiscal developments and finds fiscal policy already assumes a broader role in several countries. - Argues there remains room for more stabilizing, growth-friendly, and inclusive policies globally. - Discusses “Can Fiscal Policy Do More and How?” by translating the three objectives of fiscal policy into specific policy recommendations, taking into account country circumstances and constraints. ### Recent fiscal developments and outlook (aggregate findings) - The section examines developments for three country groups: advanced economies; emerging market and middle-income economies (EMMIEs); low-income developing countries. (Tables 1.1a, 1.1b, and 1.2 referenced.) - Since the early 2000s, potential growth has decelerated dramatically (Figure 1.2 referenced). - The benefits of growth have been shared less evenly over the last three decades; change in disposable income inequality presented for selected countries, 1985–2015 (Figure 1.3 referenced). ### Advanced economies: turning to fiscal relaxation in 2016 - Aggregate fiscal stance in advanced economies eased by one-fifth of 1 percent of GDP in 2016. - Main contributors to the change in aggregate stance: Italy, Spain, and the United States; to a smaller extent, Canada and Germany. - Advanced economies’ debt-to-GDP ratio increased by about 2 percentage points in 2016, reaching 107.6 percent of GDP, and is expected to remain elevated and relatively flat in the medium term (contrast to April 2016 Fiscal Monitor projection of a moderate and steady decline). - Japan’s debt path data: starting from 2015, the path of debt ratios in Japan was reduced by more than 10 percent of GDP owing to a comprehensive revision of national accounts that pushed up nominal GDP. ### Reasons for fiscal loosening in 2016 (three broad factors) - Support for the recovery amid heightened uncertainty over economic prospects: - Countries where short-term growth and employment were key factors include Italy, Spain, and the United States. - In Japan, authorities adopted a supplementary budget in response to weaker domestic and external environment at the beginning of 2016. - Fiscal policy has become gradually more countercyclical in advanced economies over the past 20 years, reflected in a rise in the fiscal stabilization coefficient (Figure 1.4, panel 3). - Growing concerns about medium-term growth and support for public investment: - Canada stimulus package equivalent to 1¼ percent of GDP spread over fiscal years 2016/17 and 2017/18; more than 40 percent allocated to infrastructure projects; plans to establish a new infrastructure bank to leverage private sector capital. - Other countries increasing public investment share include Australia and New Zealand. - Pursuit of social objectives: - Germany: increase in primary spending corresponding to 0.5 percent of GDP directed toward higher pension outlays and refugee-related spending. - Japan: part of higher spending in 2016 channeled to cash transfers to low-income pensioners. ### Near-term stance and country heterogeneity - For 2017, fiscal policy is expected to be broadly neutral, with substantial cross-country differences: - Canada and the euro area expected to continue relaxing fiscal positions. - Korea and the United Kingdom plan to tighten in 2017. - Countries with greater economic slack are expected to conduct a more supportive fiscal policy (Figure 1.4, panel 4). - In 2018–19, aggregate fiscal stance projected to remain neutral, with significant heterogeneity across countries. - United States policy considerations (as of preparation of this Fiscal Monitor): potential business and personal income tax cuts; comprehensive corporate tax reform; overhaul of the health care system; more defense and homeland security spending offset by large cuts in various domestic programs and foreign aid. Uncertainties about future policies are noted. ### Key fiscal numbers and projections (selected figures from Tables 1.1a, 1.1b, and 1.2) - General government overall balance (percent of GDP): - World: 2016 = –3.6; 2017 = –3.4; 2018 = –3.1. Difference from April 2016 Fiscal Monitor for 2016 = 0.0; 2017 = –0.2; 2018 = –0.4. - Advanced Economies: 2016 = –2.9; 2017 = –2.7; 2018 = –2.7. Difference from April 2016 FM for 2016 = 0.0; 2017 = –0.2; 2018 = –0.5. - Emerging Market and Middle-Income Economies: 2016 = –4.8; 2017 = –4.4; 2018 = –3.9. Difference from April 2016 FM for 2016 = –0.1; 2017 = –0.3; 2018 = –0.2. - Low-Income Developing Countries: 2016 = –4.4; 2017 = –4.4; 2018 = –3.9. Difference from April 2016 FM for 2016 = 0.1; 2017 = –0.4; 2018 = –0.1. - Cyclically adjusted primary balance (percent of potential GDP): - Advanced Economies: 2016 = –1.1; 2017 = –1.2; 2018 = –1.2. Difference from April 2016 FM for 2016 = –0.1; 2017 = –0.4; 2018 = –0.6. - Emerging Market and Middle-Income Economies: 2016 = –2.1; 2017 = –1.9; 2018 = –1.5. Difference from April 2016 FM for 2016 = –0.3; 2017 = –0.6; 2018 = –0.5. - Gross debt (percent of GDP): - World: 2016 = 83.6; 2017 = 83.6; 2018 = 82.8. Difference from April 2016 FM for 2016 = –0.1; 2017 = –0.3; 2018 = 0.3. - Advanced Economies: 2016 = 105.4; 2017 = 107.6; 2018 = 107.1. Difference from April 2016 FM for 2016 = 0.0; 2017 = 0.0; 2018 = 0.9. - Emerging Market and Middle-Income Economies: 2016 = 44.5; 2017 = 47.4; 2018 = 48.6. Difference from April 2016 FM for 2016 = –0.1; 2017 = –0.4; 2018 = –0.4. - Low-Income Developing Countries: 2016 = 40.4; 2017 = 41.9; 2018 = 41.6. Difference from April 2016 FM for 2016 = 3.5; 2017 = 5.4; 2018 = 5.0. - Select country figures: - United States gross debt: 2016 = 105.6; 2017 = 107.4; 2018 = 108.3. Difference from April 2016 FM for 2016 = –0.1; 2017 = 0.9; 2018 = 2.2. - Japan gross debt: 2016 = 238.0; 2017 = 239.2; 2018 = 239.2. Difference from April 2016 FM for 2016 = –10.2; 2017 = –11.7; 2018 = –12.4. - Saudi Arabia gross debt: 2016 = 12.4; 2017 = 15.6; 2018 = 19.1. Difference from April 2016 FM for 2016 = –4.8; 2017 = –10.2; 2018 = –14.2. - Net debt (percent of GDP) highlights: - World net debt 2016 = 62.3; 2017 = 62.4; 2018 = 62.5. Difference from April 2016 FM for 2016 = –0.9; 2017 = –0.9; 2018 = –0.3. - Advanced Economies net debt 2016 = 70.1; 2017 = 71.4; 2018 = 71.4. Difference from April 2016 FM for 2016 = –1.4; 2017 = –1.2; 2018 = –0.4. - Japan net debt 2016 = 119.8; 2017 = 119.9; 2018 = 120.1. Difference from April 2016 FM for 2016 = –9.8; 2017 = –11.3; 2018 = –12.0. ### Fiscal policy assessment and indicators - Fiscal stance classification rule used: tightened if structural primary balance to potential GDP improves by at least 0.25 percent per year; loosened if deteriorates by at least 0.25 percent per year; otherwise neutral. - Fiscal stabilization coefficient (FISCO) captures combined effect of discretionary policy and automatic stabilizers; positive coefficient implies countercyclical fiscal response. *Italic: International Monetary Fund | April 2017* ### 1.2 assumes a fiscal impulse of about 1 percent of ### fm1701 - 1.2 assumes a fiscal impulse of about 1 percent of ### Advanced economies: U.S., euro area, Japan, United Kingdom - United States - Assumes a fiscal impulse of about 1 percent of GDP spread over 2018−19, based on lower personal and corporate income taxes. - These policies are expected to generate rising deficits over the medium term. - U.S. debt ratio is projected to increase continuously over the five-year forecast horizon of the April 2017 World Economic Outlook (until 2022). - Euro area - Fiscal stance expected to be expansionary in 2017, principally because of policies in France, Germany, and Italy. - France: spending-based consolidation carried out since 2014 has slowed; the structural primary deficit is projected to increase marginally in 2017, partly reflecting security needs and an increase in the public sector wage bill. - Germany: 2017 federal budget priorities involve personal income tax relief, higher infrastructure spending, and more funding for research and development. - Italy: intends to enact a corporate tax cut and a range of new spending initiatives (higher pensions, wage bill, and public investment). - Japan - Announced another fiscal stimulus package in the summer of 2016 that will raise spending in 2017. - Measures include cash transfers to low-income individuals, an increase in wages of caregivers for children and the elderly, and infrastructure investment. - Some progress on labor market reforms; more fundamental reforms to remove labor market duality and eliminate disincentives to regular work have fallen short. - Planned value-added tax (VAT) hike pushed back from April 2017 to October 2019. - Authorities remain committed to their 2020/21 primary surplus goal, but no new measures have been specified to meet this target. - United Kingdom - Announced last year that it would slow the pace of fiscal consolidation and revised medium-term fiscal targets accordingly. - Planned increase in the cyclically adjusted primary balance is now about 2⁄3 percentage point of GDP per year until fiscal year 2019/20, lower than previously envisaged. - Easing of the pace of adjustment reflects a policy choice in the face of heightened uncertainty and a decision to increase infrastructure investment. ### Emerging Markets and Middle-Income Economies: adapting to new realities - Aggregate recent trends and drivers - Headline fiscal deficits increased for the fourth year in a row, from an average of 0.9 percent of GDP in 2012 to 4.8 percent in 2016, reaching a two-decade high. - Increase mainly driven by slower growth and lower commodity prices, combined with political and geopolitical factors—and, in China, stimulatory fiscal measures. - Brazil, China, and oil exporters accounted for most of the overall deficit increase between 2012 and 2016. - Over the same period, the average debt ratio rose by about 10 percentage points for the group, reaching 47.4 percent of GDP in 2016. - China - Main contributor to the 2016 increase in the overall deficit: on-budget deficit moved from 2.8 percent of GDP in 2015 to 3.7 percent in 2016 on the back of strong public infrastructure spending and tax cuts. - The “augmented” deficit is estimated to have increased from 9.5 percent of GDP in 2015 to 10.3 percent in 2016 as off-budget debt-financed investment remained strong. - Oil exporters and Gulf countries - Rebound of oil prices and consolidation measures helped stabilize the average fiscal deficit at about 6 percent of GDP in 2016. - Fiscal position of Gulf countries continued to worsen despite improvements in underlying non-oil balances. - Gulf countries are Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. - Saudi Arabia: fiscal deficit expected to decline by 7 percent of GDP in 2017 largely because of higher oil revenues and a decline in arrears payments; announced measures include further reduction in energy subsidies, introduction of excises and fees, public wage restraint, and enhanced selection of investment projects. - Russia: medium-term federal budget proposal for 2017−19 based on $40 a barrel envisages an annual fiscal adjustment of 1 percentage point of GDP; new mechanism introduced in February to save excess oil revenues into the reserve fund. - Other notable country developments - Mexico: one-off transfer of central bank profits to the budget and strong non-oil tax revenues reduced the deficit by more than 1 percent of GDP. - Brazil: overall deficit declined by more than 1 percentage point to 9 percent of GDP in 2016; primary fiscal deficit continued to increase. - India: returned to fiscal consolidation in fiscal year 2016/17, supported by near-elimination of fuel subsidies and enhanced targeting of social benefits. - Turkey: overall deficit widened to 2.3 percent of GDP in 2016 from 1.2 percent a year earlier due to higher minimum wages, higher security spending, and temporary tax relief. - Projections and medium-term outlook (EMMIEs) - Baseline projections envisage a gradual decline in the overall deficit by about half a percentage point to 4.4 percent of GDP in 2017 and to 3.1 percent of GDP by 2022. - Debt ratios set to continue rising from an average of 48.6 percent of GDP in 2017 to 52.4 percent in 2022, as deficits should remain above debt-stabilizing levels in a majority of countries. - Projected deficit and debt trajectories remain broadly unchanged compared with April 2016 Fiscal Monitor forecasts, with an improvement in oil exporters offsetting developments in other countries, notably China. - Country-specific medium-term notes - China intends to maintain a fiscal stance supportive of aggregate demand in 2017; government spending expected to increase modestly and more tax breaks and reductions in administrative fees are planned, keeping the on-budget deficit close to its 2016 level. - India: headline deficit projected to decline modestly in fiscal year 2017/18; budget envisages growth-friendly fiscal adjustment with expenditure cuts that protect infrastructure investment and more progressive individual income taxes; aims for a debt-to-GDP ratio of 60 percent by fiscal year 2022/23. - Brazil: expected to exit a two-year recession in 2017; constitutional amendment establishes a ceiling for federal non-interest spending in real terms for the next two decades; headline deficit projected to stabilize in 2017; public debt ratio expected to continue rising for several years despite spending freeze. ### Low-Income Developing Countries (LIDCs): fiscal pressures and outlook - Recent trends and causes - For the third consecutive year, the average fiscal deficit increased in low-income developing countries, reaching 4.4 percent of GDP. - Deficit increase was larger for commodity exporters than for the rest of the group. - Drivers vary: declining commodity revenues for commodity exporters; increased public investment in some countries; larger current spending in others; revenue drops in a few cases; rising interest expenses in many countries. - Example country notes: - Nigeria: decline in oil production and lower oil prices; deficit at 4.4 percent of GDP in 2016; authorities’ efforts to boost non-oil revenue offset by a recession. - Kyrgyz Republic and Zimbabwe: public investment ratios increased significantly. - Cambodia: larger current spending driven by public sector pay hikes. - Ethiopia: larger current spending due to drought-related social expenses. - Uzbekistan: revenue drop owing to tax cuts. - Zimbabwe: revenue drop as a result of an economic recession. - Uganda: notable increase in interest bill partly resulting from domestic borrowing at elevated rates. - Debt and debt-service dynamics - Average debt-to-GDP ratio for the group reached 40.4 percent, a rise of 4.3 percentage points from a year ago. - Exchange rate depreciation contributed to debt accumulation; in countries where the share of public debt denominated in foreign currency was above 50 percent, currencies depreciated by about 5 percent in 2016, on average. - Debt increases highest among commodity exporters, many of which relied on borrowing to cushion collapsing revenues. - In countries with market access, average interest payments in frontier markets have increased markedly as a share of revenue—doubling since 2011. - Higher interest bill explained by both higher coupon rates on new debt and greater reliance on nonconcessional external financing. - 2017 scenario and sensitivity - Fiscal scenario for 2017 is very sensitive to assumptions about developments in commodity markets. - Under current projections, fiscal deficits are forecast to stabilize in percent of GDP, halting the trend of the past few years. - Prospects vary within the low-income group: fiscal position of commodity exporters expected to improve, with the notable exception of Nigeria, where deficits should continue widening because of planned increases in capital projects. *Italic: Source — IMF staff estimates and text from the April 2017 Fiscal Monitor chapter.* ### CHAPTER 1 A gReATeR ROLe FOR FISCAL POLICY ### CHAPTER 1 A gReATeR ROLe FOR FISCAL POLICY ### Fiscal Outlook and Debt Projections - Slower increases in debt ratios are expected for 2017, with the average debt ratio projected to rise by about 1.6 percentage points, about one-third of this year’s increase. - The projected smaller debt accumulation is principally the result of more favorable interest–growth rate differentials, mostly driven by higher GDP growth in commodity exporters. - Lower deficits also play a mitigating role in debt dynamics in about two-thirds of the countries in this group. - Nigeria is an exception: an increasing fiscal deficit and clearance of arrears are expected to push up the debt-to-GDP ratio by 4.7 percentage points in 2017. - In remaining low-income developing countries, fiscal positions are projected to deteriorate slightly (example: Bangladesh—deficit increase reflects delay in the VAT rollout and higher wage bill and transfers). ### Risks to the Fiscal Outlook - Fiscal risks remain elevated and on the downside, although some upside risks have also increased recently. - Two main reasons fiscal outcomes may differ from baseline projections: - Uncertainties about fiscal policies (scope and design) have risen in the past year. - Governments’ balance sheets remain vulnerable to a wide range of risks. - Key risk factors and observations: - The global debt of the nonfinancial sector is at an all-time high, two-thirds of which consist of private sector liabilities (October 2016 Fiscal Monitor). - Private sector deleveraging could migrate liabilities to government balance sheets. - Other risks: a growth slowdown, tighter financial conditions, weaker currencies, lower commodity prices, and the materialization of contingent liabilities. - Fiscal policy uncertainty: - Policy uncertainty, as measured by Baker, Bloom, and Davis (2016), has reached a decade high. - Main current source of uncertainty: lack of specificity about future U.S. policies, including the size and composition of the expected fiscal stimulus. - Political events increasing uncertainty: upcoming elections in euro area countries (France, Germany, possibly Italy), Brexit implementation arrangements, China’s upcoming fall party congress, political instability or gridlock in several large emerging market and developing economies, and geopolitical tensions (Middle East, Africa, migration/refugee flows, terrorism). - Weak growth and retreat from cross-border integration: - Risks to global growth are assessed to be on the downside, though some upside risks exist. - Support for inward-looking policies has risen, increasing risk of policy shifts that could limit trade, financial flows, and migration with potentially large negative effects on global growth. - Other growth risks: adverse feedback loops between weak demand, low inflation, and low potential output; insufficient progress addressing crisis legacies and productivity-enhancing reforms in Europe; disruptive private sector deleveraging in emerging markets and middle-income economies; sharper slowdown in China from rapid credit expansion; delays in adjustment and diversification in commodity exporters. - Tighter financial conditions and stronger U.S. dollar: - A more rapid increase in interest rates and appreciation of the U.S. dollar could raise borrowing costs and depreciate currencies of emerging market and developing economies. - In these economies, almost half of public debt is issued in foreign currency, on average. - Lower energy prices: - The OPEC and other producers’ agreement to cut oil production in 2017 may not materialize as planned; excess supply could keep oil prices lower than expected. - Fiscal positions could worsen in oil exporters, where one-third of fiscal revenues, on average, rely directly on oil production; oil importers would benefit from lower energy costs. - Contingent liabilities: - Any of the above risks could trigger materialization of contingent liabilities with severe public finance costs. - In Europe, weaker growth amid already-weak bank profitability and slow bank balance-sheet repair raises the risk of banking distress and sovereign recapitalization needs. - In emerging markets and developing economies, heavy firm borrowing—especially in foreign currency—and nonfinancial corporate debt at a historical high raise the risk of corporate defaults and calls on sovereign guarantees. - Persistently lower energy prices could squeeze state-owned energy companies in commodity exporters and necessitate government support. - In low-income developing countries, rapid growth in public-private partnerships over the past 15 years has accumulated contingent liabilities related to government guarantees; project failures could lead these guarantees to be called on. ### Managing Fiscal Risks - Overall, risks to public balance sheets are high, stressing the importance of better understanding fiscal exposures and implementing risk management strategies. - Four-step fiscal risk management strategy (as discussed in April 2016 Fiscal Monitor): - Step 1: Identify risks, their magnitude, and their likelihood. - Step 2: Reduce the probability of risks occurring and government exposure. - Step 3: Create buffers in the budget to absorb the remaining risks. - Step 4: Set safe fiscal targets. - Examples of mitigating measures: - Limits on fiscal exposure, regulations to reduce risky behavior, mechanisms to transfer risks to third parties, or active debt maturity management. - Creation of sufficient buffer funds in budgets to absorb unmitigated risks. - Account for large or poorly measured risks when setting long-term fiscal targets and ensure sufficient safety margins relative to debt ceilings. ### Can Fiscal Policy Do More and How? - Views have evolved: fiscal policy is seen as a powerful tool to stabilize the economy and promote inclusive growth, particularly when combined with monetary policy and structural reforms (a framework dubbed the “three-pronged approach”). - Constraints: high debt, long-term demographic challenges, and elevated fiscal risks limit leeway for new policies and place a premium on sound public financial management. - Governments must be selective and make difficult budget choices; sound fiscal policy objectives should be clearly defined across three categories—economic stabilization, allocation, and redistribution—while recognizing these functions are intertwined. - Fiscal policy should be countercyclical: - In normal times, rely on automatic stabilizers provided fiscal space is available; discretionary fiscal actions only in special circumstances. - Fiscal policy should respond symmetrically to the business cycle (expand in bad times, tighten in good times). - Case 1: Countercyclical fiscal policy in downturns: - Applies where demand is lacking and fiscal space is available, especially when monetary policy is constrained (nominal interest rates close to the effective lower bound and inflation expectations are low). - Passive response relying solely on automatic stabilizers may be insufficient; a discretionary fiscal expansion combined with structural reforms and monetary accommodation can raise nominal GDP and break debt-deflation traps. - Country examples: Canada and Japan—need supportive fiscal policies to continue in near term; Korea—authorities should remain open to a new fiscal stimulus if the output gap widens; euro area—aggregate cyclical position argues for a slightly more expansionary fiscal stance in 2017 but individual-country fiscal space limitations and Stability and Growth Pact rules complicate national action. - A centralized fiscal capacity at the euro-area level could better cushion shocks (could be a new institution or extension of existing centralized schemes). - Three factors that can greatly amplify the effect of countercyclical fiscal support in bad times (Gaspar, Obstfeld, and Sahay 2016): - Monetary accommodation: fiscal stimulus is more effective when monetary policy keeps interest rates low, even if it implies modest and temporary overshooting of the central bank’s inflation target. - Anchoring fiscal expansions in a sound and credible medium-term fiscal framework consistent with sustainable public debt paths to avoid loss of impact from expectations of future tax increases or higher risk premia. - (Third factor described in original source beyond the provided excerpt; follow-up in source.) *International Monetary Fund | April 2017* ### CHAPTER 1 A gReATeR ROLe FOR FISCAL POLICY ### CHAPTER 1 A gReATeR ROLe FOR FISCAL POLICY ### Fiscal policy responses: three cases and calibration - Case 1 (implied in surrounding text): Fiscal expansions are more effective when coordinated across countries; “fiscal spillovers” are particularly large among countries with strong trade and financial links, especially in bad economic times (Auerbach and Gorodnichenko 2013). - Case 2: Countercyclical fiscal policy in upturns - For economies with limited or no slack and signs of inflationary pressures, fiscal support should generally be withdrawn to rebuild fiscal space and prevent macroeconomic and fiscal imbalances. - United States: economy is close to full employment; output is near potential; inflation is expected to rise moderately above the target in the near term; fiscal stance should remain neutral this year, and fiscal consolidation could start afterward to put debt firmly on a downward path. Some reorientation of the current fiscal envelope toward more infrastructure spending would help boost growth over the medium term. - China: given robust employment levels, growth above sustainable levels, and expected pickup in inflation, the augmented deficit should decline to stabilize the augmented debt and support economic rebalancing. - Russia and Vietnam: initiating a medium-term fiscal consolidation is the best course of action now that output is approaching or at potential. - Case 3: Procyclical fiscal policy in downturns - Some countries have no option but procyclical fiscal policies because they built insufficient fiscal buffers or face high debt and fiscal vulnerabilities; fiscal sustainability considerations may prevail over smoothing the cycle. - Commodity exporters have experienced an average decline in commodity prices of almost 50 percent from the 2011 peak; main priority is consolidation to put debt on a sustainable path. - Nigeria: an up-front fiscal adjustment centered on the mobilization of non-oil revenues is deemed critical. - Mexico: despite envisaged near-term economic slack, commitment to ongoing fiscal consolidation needs to remain firm to maintain investor confidence in a volatile financial market environment. - Mitigating necessary procyclicality - Pace and composition of adjustment should be calibrated to reduce short-term drag on activity; speed of adjustment should be adjusted to avoid undermining recovery. - United Kingdom: slower pace of fiscal consolidation announced in the Autumn Statement 2016 is appropriate amid subdued growth outlook and heightened uncertainty. - Italy: an evenly phased adjustment with an improved progrowth composition of the policy mix will support recovery and increase credibility of adjustment. - Commodity exporters with large financial buffers should phase in deficit reduction measures gradually to contain negative impact on growth (Husain and others 2015). - Composition matters: avoid indiscriminate tax increases or spending cuts; consider near-term growth impact. Spain: a preannounced gradual increase in preferential VAT rates toward the standard rate could support growth in the near term by bringing households’ consumption forward. ### Fiscal policy should be growth friendly - Motivation - Deceleration of potential output in a majority of countries (April 2015 World Economic Outlook, Chapter 3). - Debt sustainability: historically, public debt reduction efforts have been far more successful in high-growth environments (Abbas and others 2013). - Definition and channels - “Growth-friendly fiscal policies” affect medium- to long-term growth (trend), as opposed to countercyclical policies that smooth fluctuations around trend. - Direct channel: structural tax or expenditure policies that boost employment, accumulation of physical and human capital, and productivity. - Indirect channel: enhancing effectiveness and implementation of structural reforms in labor and product markets. - Tax policy measures - Scope exists in almost all countries to achieve a more growth-friendly tax system: cut distortionary taxes and inefficient tax expenditures, better target tax incentives, and lower burdensome tax administration practices. - Empirical evidence: IMF (2015a) finds that reducing tax rates on either labor or capital income by 5 percentage points in a revenue-neutral manner could add about ¼ percentage point to long-term economic growth in advanced economies. - Country-specific examples: - United States: reform of corporate taxation needed to revitalize business dynamism and investment; some options could entail negative international spillovers (see Box 1.1). - France and Italy: scope for further reducing labor tax wedges to improve incentives to work. - Germany and Japan: eliminating tax-induced work disincentives for secondary earners (Germany) and spousal income tax deductions (Japan) could help boost female labor force participation. - Expenditure-side priorities - Orient resources toward more productive spending that supports physical and human capital, labor force participation, and productivity. - Public investment case is strong globally given low long-term borrowing costs and substantial infrastructure deficiencies (October 2014 World Economic Outlook, Chapter 3). - Advanced economies including Germany, the United Kingdom, and the United States should bring forward planned investments in the current environment of low potential growth and funding costs. - Emerging market and developing economies should address infrastructure bottlenecks; countries with limited fiscal space (for example, Brazil) should put in place incentives for private sector participation and financing and improve public investment management (IMF 2015b). - Labor force measures: - Advanced economies with rising dependency ratios and shrinking populations (Germany, Italy, Japan): use active labor market policies and targeted spending for groups such as women and migrant workers (for example, greater provision of child care) to elicit larger labor supply responses. - Emerging market and developing economies: improve access to health and education through well-designed social transfers and better-targeted spending to create a larger and more productive labor force. India: continue progress in reducing gender inequality in education and health and add spending on gender-targeted skills training. - Productivity measures: subsidies for research and development can foster innovation (October 2016 Fiscal Monitor, Chapter 2). Australia is reviewing existing R&D subsidy policies to ensure cost effectiveness and simplicity. - Well-targeted transfers and subsidies can support repair of bank balance sheets and create incentives for private debt restructuring—important for eliminating excessive private debt levels that constrain long-term growth (October 2016 Fiscal Monitor). - Fiscal support for structural reforms - Under weak economic conditions, a temporary fiscal stimulus can enhance the growth effect of certain reforms by mitigating short-term macroeconomic and distributional costs (April 2016 World Economic Outlook, Chapter 3; Banerji and others 2017). - Fiscal relaxation to accompany reforms is country- and reform-specific and depends on fiscal position and likely financial market reaction. - Japan: fiscal support could ensure structural reforms boosting labor supply do not create deflationary pressures. - Germany: despite absence of slack, a looser fiscal position could be justified to finance policies that lift potential growth, including tax and expenditure reforms to increase incentives for female labor force participation and integrate low-skilled migrants. - Implementation caveat - Not all growth-friendly policies carry short- or medium-term budgetary costs; they should be pursued everywhere. In countries with limited fiscal space, reforms must be budget-neutral or compensated along the envisaged consolidation path. - India: growth-friendly consolidation should reorient expenditure away from untargeted subsidies (food and fertilizers) toward capital and social spending. - Spain: broaden VAT base and increase excise duties and environmental levies; use additional revenues to fund active labor market programs and public research and development. ### Fiscal policy should promote inclusion - Global trends - Global integration and technological change have lifted millions out of poverty; many emerging market and developing economies, especially in Asia, have seen income convergence toward advanced economies over the last 30 years. - Global Gini index has declined since the late 1980s (Lakner and Milanovic 2016; Bourguignon 2015). - Poverty reduction: the number of people living in poverty has diminished by more than 1 billion and their share in the world population has decreased from 50 percent to about 10 percent since the early 1980s. - Poverty metric: in the referenced figure, the poverty limit is defined as $1.90 per day in 2011 dollars at purchasing-power parity. - Rising within-country inequality and uncertainty - Income inequalities have increased within most advanced economies and the largest emerging markets (in particular, China and India). - In advanced economies, incomes of the top 1 percent have grown at annual rates almost three times higher than those of the rest of the population over the past three decades. - After some narrowing at the onset of the global financial crisis, income distributions have widened again over the past five years (OECD 2016a). - Economic uncertainty has increased for many worker groups amid a downward trend in labor income shares (April 2017 World Economic Outlook, Chapter 3). - International Labour Organization (2014): longer average durations of unemployment in the past decade in advanced economies. - Prevalence of nonstandard work arrangements is high in many countries; a large and growing share of the labor force has limited coverage from social protection programs against unemployment due to restrictive qualifying conditions. - Share of labor force with limited coverage is even higher in emerging market and developing economies with large informal sectors (ILO 2015). - Consequences of inequality and uncertainty - Excessively high and increasing inequality and uncertainty are detrimental to welfare and growth: channels include lower human capital investment, poorer health outcomes, more challenging political climates for reforms, excessive household saving that lowers demand, and reduced firm willingness to hire and invest (Berg and Ostry 2011; Ostry, Berg, and Tsangarides 2014; Dabla-Norris and others 2015; OECD 2015; Bloom 2014). - Longer unemployment durations can cause skill depreciation and lower labor productivity. - Role of fiscal policy - Fiscal policy can do more to ensure benefits of growth are more widely shared through taxes and transfers and by promoting equality of opportunity via investment in human capital and protection against risk. - In a majority of advanced economies, fiscal policy has been less effective at narrowing income disparities over the last 20 years due to reductions in social benefit generosity and less progressive taxation (Caminada, Goudswaard, and Wang 2012; IMF 2014a). - Recent benefit cuts have reinforced this trend (OECD 2016a), though heterogeneity exists (Italy and Japan improved redistributive roles). - In emerging market and developing economies, the redistributive impact of fiscal policy remains modest, partly because of lower tax revenues and a lower share of spending allocated to social transfers; lack of access to public education and health among the poor reduces integration of low-skilled and vulnerable groups into the productive economy (IMF 2014a). - Policy implication - Fiscal policy should be part of a comprehensive approach—including labor, product market, and financial sector reforms—to promote inclusive growth through better use of taxes and transfers and by investing in equality of opportunity. *Italic: International Monetary Fund | April 2017* ### part in the fast-changing global economy. ### fm1701 - part in the fast-changing global economy. ### Inclusive fiscal policy: two complementary aims - Aim 1 — Achieve desired level of income redistribution efficiently: - Improved design of transfers to households: - Broader use of in-work tax credits in advanced economies supports low-income families while encouraging work; example: United States—an extension of the Earned Income Tax Credit in combination with a raise in the minimum wage could promote employment for low-income workers while ensuring higher wages. - Conditional cash transfer programs in emerging and developing economies (examples include Indonesia, Jamaica, Pakistan) could support poor households and incentivize human capital development through improved school attendance and better health outcomes. - More progressive tax systems: - Reduce regressive tax exemptions (example: mortgage interest payment exemptions in the United States and, to a lesser extent, Sweden). - Use and improve property and wealth taxes in countries including Ireland, Italy, and the Netherlands; recurrent value-based property taxes are efficient and progressive. - In emerging market and developing economies, expand personal income tax coverage by reducing exemptions and formalizing firms and individuals; example: China—reducing the level of the basic personal income tax exemption to ensure more middle-income earners are liable to pay some tax could increase revenues in a fair manner. - Aim 2 — Promote “equality of opportunity” by enabling skill acquisition, health, and risk insurance: - Public education and training: - Governments should help workers acquire and maintain skills amid global integration and technological change. - United Kingdom: further expand vocational training and apprenticeship programs (apprenticeship program in England is being expanded and reformed, funded by a new apprenticeship levy; U.K. government announced expansion in vocational training in its FY2017/18 budget). - Canada: expand vocational and specialized skills training to facilitate labor mobility and shift into high-value-added activities. - Emerging and developing economies: focus education reform on improving access for low-income groups to primary and secondary education, especially for girls and in rural areas. - Public health care: - Better access to basic health services contributes to inclusion by improving schooling outcomes and labor market participation. - United States: further subsidies to health care for the poor would help reduce persistence of poverty. - Nigeria: ensure efficient delivery and broader coverage of health services for the poor. - Thailand: coordinate fragmented health insurance schemes to achieve more equal coverage in benefits and contributions. - Employment and social insurance: - Prevent workers drifting away from the core labor market after shocks. - United States: reform disability insurance to create better incentives for beneficiaries to work part-time rather than drop out of the labor force entirely. - France: enhance active labor market policies, such as job-search support for recipients of unemployment and welfare benefits. - Japan: clarify legal framework and provide subsidies to convert nonregular workers to “intermediate” contracts to reduce labor market duality and encourage skill acquisition. - China: reform the household residency system to improve equity and insurance components of social security for migrants vs. urban dwellers. - Implementation note: - Inclusive policies can be implemented without increasing the overall budget envelope and fiscal deficit, but in countries with limited fiscal space they must be accompanied by offsetting measures (examples: Egypt—full implementation of the VAT and tax administration reform could free resources for higher spending on health, education, and social protection; Nigeria—better non-oil revenue mobilization could finance education access, enhanced social safety nets, and scaling up of vocational training). - IMF program experience indicates it is possible to enhance social spending along a path of fiscal adjustment while mitigating negative impacts on vulnerable groups. ### Financing greater fiscal policy use and fiscal space - Some countercyclical, growth-friendly, and inclusive policies require additional resources; these should be made available in ways least harmful to growth. - Options for countries with fiscal room: - Finance policies through additional borrowing but use debt wisely; returns on debt-financed projects should outweigh costs and risks. - IMF developed a new approach to measuring “fiscal space” based on various tools and indicators (Annex 1.1). - Factors increasing fiscal space in some advanced economies: - The interest rate minus GDP growth differential may be persistently lower than in the past for reasons including lagging expectations to low-growth low-inflation environment, declining risk-free rate, or structural demographic effects on interest rates vs. growth. - Box finding: a permanent decline of 1 percentage point in the interest–growth rate differential could allow advanced economies to borrow safely an additional 25 percent of GDP, on average. - Many countries have contained age-related spending; the stock of implicit debt in advanced economies has shrunk by 25 percent of GDP in the past six years, creating more room to accumulate “explicit” debt (Figure 1.15). - Cautions: - The additional space related to pension reforms is not guaranteed; age-related spending remains high in many countries and reforms can be reversed. - No one-to-one equivalence between implicit and explicit debts—a one-dollar reduction in pension obligations does not translate automatically into the ability to borrow an additional dollar. - Role of fiscal institutions: - Sound fiscal institutions improve credibility and can lower interest risk premia; credible commitment mechanisms (well-designed medium-term budget frameworks and fiscal rules) can create budgetary room. - Empirical evidence suggests credible fiscal rules can reduce borrowing costs, but rules must be well designed, calibrated, and regularly reviewed; poorly designed rules can unduly constrain use of fiscal space or increase fiscal sustainability risks. - Example: proposals for central fiscal capacity in the euro area could borrow at favorable rates and on-lend to member states, creating fiscal space but requiring safeguards to preserve fiscal discipline and reform incentives. - For countries without fiscal space: - Create room within the budget by raising revenue or cutting expenditures to implement policies in a budget-neutral manner. - Revenue-side priorities: - Identify revenue-enhancing measures that are least “distortionary.” - Broaden the tax base by eliminating tax exemptions and preferential rates or raise indirect and property taxes, which are less detrimental to growth. - Country examples: - United States: introducing a federal-level VAT could generate revenues and efficiency gains but faces coordination challenges with state sales taxes. - Italy: rationalize large tax expenditures, broaden tax base, create a modern real estate tax. - United Kingdom: scale back distortionary tax expenditures (such as nonstandard zero VAT rates). - Japan: raise the consumption tax in a preannounced and gradual manner to generate stable revenue in an aging society. - Gulf countries: continue working on introducing a VAT. - China: significantly raise taxes on fossil fuel and pollution (carbon or coal tax) to generate revenue and improve energy efficiency. - India: continue raising taxes on petroleum products while oil prices remain low. - Consider initial tax burden: almost half of low-income developing countries have a tax ratio below 15 percent of GDP, suggesting ample room to mobilize revenues (Figure 1.16). Recent research shows raising tax revenue in countries with tax ratios significantly below this threshold is critical for state capacity building and long-term growth (Gaspar, Jaramillo, and Wingender 2016). - Improve revenue administration to strengthen tax compliance; increasingly important in advanced economies where compliance worsened during the financial crisis. - Spending-side priorities: - Generate savings by improving targeting and efficiency through comprehensive expenditure reviews; in almost all spending categories there is room to achieve outcomes at lower cost (Figure 1.17). - Eliminate generalized subsidies that disproportionately benefit higher-income groups in favor of targeted measures tied to need (examples: India—overhaul food and fertilizer subsidy regime through better targeting and efficiency; Nigeria—implement automatic fuel-price-setting mechanism to eliminate recurrent fuel subsidies). - Increase targeting of social transfers (example: France—expand means testing for family and housing allowances) to yield savings without harming social outcomes. - Reduce government wage bills while preserving public service quality (example: France—reduce public employment at local level and limit wage drift; Argentina—strengthen payroll management, undertake a census to identify ghost workers, implement attrition-based systems). - Pension and health reforms could substantially improve fiscal outlook in many advanced and emerging market economies (example: Brazil—pension and other benefits represent nearly half of federal noninterest spending; containing expenditures depends on social security reform due to strong real-term growth momentum of outlays). ### Key statistics and numeric findings (preserved exactly as in source) - In advanced economies, the incomes of the top 1 percent have grown three times faster than those of the rest of the population over the last three decades. - Box result: a permanent decline of 1 percentage point in the interest–growth rate differential could allow advanced economies to borrow safely an additional 25 percent of GDP, on average. - The stock of implicit debt in advanced economies has shrunk by 25 percent of GDP in the past six years. - Almost half of low-income developing countries have a tax ratio below 15 percent of GDP. - Specific program/budget note: U.K. apprenticeship expansion funded by a new apprenticeship levy; expansion announced in FY2017/18 budget. - Figure references preserved from source: Figure 1.13, Figure 1.14, Figure 1.15, Figure 1.16, Figure 1.17 (figures described in text). *International Monetary Fund | April 2017* ### CHAPTER 1 A gReATeR ROLe FOR FISCAL POLICY ### CHAPTER 1 A gReATeR ROLe FOR FISCAL POLICY ### The Destination-Based Cash Flow Tax (DBCFT) — design and rationale - The DBCFT combines two features: - "Cash flow": immediate full deduction for capital expenses (in lieu of depreciation allowances) and denial of deduction for net interest expense. This makes it a "rent tax" that taxes only profits above the minimum required by the investor and eliminates the tax bias toward debt finance. - "Destination-based": border adjustment by exempting exports and taxing imports (or equivalently, not taxing imports at the border but denying companies a deduction for them when calculating tax liability), putting the tax base at the location of final consumption rather than where production occurs. - Key implications of the design: - As a rent tax, it would not affect marginal investment decisions. - Cash flow treatment reduces incentives for debt finance and related-party loan use to avoid tax. - Border adjustment, in theory, has no direct impact on real activity in the DBCFT described in Auerbach and others 2017 because relative prices would be offset by some combination of an exchange rate appreciation and an increase in domestic prices. - By taxing at the destination, the DBCFT aims to eliminate the tax advantage of locating production or profits in low-tax jurisdictions and reduce BEPS (base erosion and profit-shifting) activities. ### DBCFT in a global setting — collective gains and potential spillovers - If all countries replaced source-based income taxes with destination-based taxes, collective efficiency gains would likely occur and opportunities for profit shifting would be reduced. - If only a subset of countries adopted the DBCFT: - Countries that do not adopt would likely suffer a loss of real investment and increased incentives for outward profit shifting, since source-based tax rates in adopter countries would effectively be zero. - Nonadopters would likely react (for example, by measures to protect bases or by eventually adopting DBCFT-like systems), though the exact response is uncertain. - Legal, practical, and political challenges: - WTO consistency is a fundamental concern. - Double tax treaties may be affected, given they allocate taxing rights among signatories. - Winners and losers would emerge across industries; importers fear that loss of deductions for inputs would not be offset by price or exchange rate adjustments in practice. ### Implementation considerations and uncertainties - Operational challenges to realize theoretical properties: - Exporters would have perpetual tax losses and should receive refunds for the tax to operate as a rent tax; refunds are politically difficult and carry fraud risk. - Uniform tax treatment across sectors and transactions is required for efficiency but may be hard to sustain under lobbying pressures. - Key design areas remain undeveloped, notably the treatment of financial transactions. - Transition issues—such as treatment of "old" investments—require careful attention. - The impact on exchange rates and prices is highly uncertain, calling for caution regarding effects on both adopters and nonadopters. ### Distributional effects of the DBCFT - As a tax on rents, the DBCFT in itself has the potential to be mildly progressive. - The precise distributional impact depends on adjustment channels: - If adjustment occurs mainly through domestic prices: - The burden would fall on those spending domestically from nonwage income—largely the relatively wealthy and those on unindexed nominal incomes. - If adjustment occurs predominantly through the nominal exchange rate: - The tax would burden those spending domestically from incomes denominated in foreign currency (such as foreign corporate earnings). - Additional distributional considerations: - Final effects depend on any accompanying changes to personal taxes. - Adoption would produce windfall gains to foreigners with income or assets in the currency of the adopter and potential impacts abroad from debts and contracts specified in the appreciating currency. *Source: CHAPTER 1 A gReATeR ROLe FOR FISCAL POLICY (fm1701 - CHAPTER 1 A gReATeR ROLe FOR FISCAL POLICY), International Monetary Fund | April 2017* ### Box 1.4. Can Countries Sustain Higher Levels of Public Debt? ### Box 1.4. Can Countries Sustain Higher Levels of Public Debt? ### Experiments on the interest–growth rate differential - Transitory decline in the interest–growth rate differential: - The experiment compares the model-generated debt limit in 2012 with that consistent with the World Economic Outlook forecast for 2022 (to allow for the dissipation of expected monetary policy changes). - Between these two points, the interest–growth rate differential is forecast to fall by an average of 1.6 percentage points for the countries in the sample. - Result: this fall could increase debt limits by about 2 percent of GDP, on average. - Permanent decline in the interest–growth rate differential: - Implemented by shifting to the left the distribution of the differential by 1 percentage point (assumes decline is permanent). - Key finding: a permanent decline of 1 percentage point increases the maximum sustainable debt level by an average of 25 percent of GDP in the sample. - Cross-country range: from a low of 10 percent of GDP to a high of 40 percent of GDP. - Uncertainty about permanence: - It is difficult in reality to assess whether the observed decline is transitory or permanent. - Even if only a portion of the decline is permanent, the impact on debt limits is likely to be large. ### Intuition and model dependencies - Intuitive explanation: - Public debt issued today is rolled over and repaid over long periods; sustainability is driven principally by future interest–growth rate differentials, which depend on the shape of the distribution. - Simplifying assumptions of the model: - Debt is short term. - Growth is exogenous. - Shocks to the surpluses are uncorrelated with growth. - Robustness and external validation: - Results are robust to various estimation periods of the process for the interest–growth rate differential. - Results are of similar magnitude to those found in other studies, such as OECD 2016b. ### Key numeric findings (preserved exactly) - Average forecast fall in interest–growth rate differential (2012 to 2022): 1.6 percentage points. - Estimated increase in debt limits from a transitory 1.6 percentage point fall: about 2 percent of GDP (on average). - Permanent decline assumed in experiment: 1 percentage point (leftward shift of distribution). - Increase in maximum sustainable debt level from a permanent 1 percentage point decline: average of 25 percent of GDP; range across countries: 10 percent of GDP to 40 percent of GDP. *International Monetary Fund | April 2017* ### CHAPTER 1 A gReATeR ROLe FOR FISCAL POLICY ### CHAPTER 1 A gReATeR ROLe FOR FISCAL POLICY ### Selected Potential Indicators of Fiscal Space — Current and Future Debt Burden (continued) (Columns correspond to: Public Debt, 2016 (percent of GDP); Public Debt Change, 2016–22 (percent of GDP); Gross Financing Needs, 2017 (percent of GDP); 10-Year Sovereign Yield Spreads (Against U.S.), data as of March 31, 2017 (percent); Projected Interest Rate–Growth Differential, 2017–22 (percent); Share of Foreign Currency Public Debt, 2017 (percent of total); Nonresident Holding of General Government Debt, 2016 (percent); Share of Short-Term External Debt, 2017 (percent); Primary Gap in 2017 (percent of GDP); Primary Gap in 2022 (percent of GDP); Health and Pension Spending Change, 2022–50 (percent of GDP)) - Saudi Arabia: 12.4; 14.1; . . .; . . .; 0.3; 38.6; . . .; 27.5; 10.6; 2.5; 7.7 - South Africa: 50.5; 3.2; 11.9; 6.5; 0.1; 10.4; 32.1; 27.4; 0.1; –1.4; 4.0 - Sri Lanka: 77.3; –11.0; 17.0; . . .; –2.4; . . .; 39.8; 16.8; –1.8; –3.2; 2.5 - Thailand: 42.2; –0.4; 7.3; 0.3; –1.5; 5.1; 12.3; 40.3; 0.0; 0.1; 7.1 - Turkey: 29.1; –0.1; 8.1; 3.1; –1.5; 36.4; 35.3; 24.0; 0.1; –0.5; 3.9 - Ukraine: 81.2; –21.1; 7.2; 5.5; –5.2; 70.9; 48.3; 13.9; –7.4; –4.1; 7.0 - United Arab Emirates: 19.3; –1.2; . . .; . . .; –4.6; . . .; . . .; 20.0; 0.9; –1.2; 4.4 - Uruguay: 60.9; 3.1; 12.3; . . .; –3.7; 50.9; 43.7; 11.0; –1.4; –3.0; 5.6 - Venezuela: 28.2; –10.4; . . .; . . .; –95.2; 3.2; . . .; . . .; –10.9; 0.0; 5.6 - Vietnam: 62.4; 4.8; . . .; . . .; –6.1; 47.0; . . .; 12.3; –0.2; . . .; . . . - Group Median: 44.2; –0.3; 9.0; 3.1; –2.9; 35.1; 35.4; 15.7; 0.1; –1.1; 3.9 ### Key definitions, data sources, and methodological notes - Sources: Bloomberg L.P.; Joint External Debt Hub, Quarterly External Debt Statistics; national authorities; and IMF staff estimates and projections. - Note 1: Gross financing need is defined as the projected overall deficit and maturing government debt in 2017; for more details on the assumptions, see note 1 in Table A23. Data are from Bloomberg L.P. and IMF staff projections. - Note 2: Data are as of March 31, 2017. - Note 3: Interest rate refers to the interest payments divided by outstanding debt at the end of previous year in nominal terms. Growth rate refers to the nominal GDP growth rate. - Note 4: Nonresident holdings of general government debt data are for the fourth quarter of 2016 or latest available from the Joint External Debt Hub (JEDH), Quarterly External Debt Statistics, which include marketable and nonmarketable debt. For some countries, tradable instruments in the JEDH are reported at market value. External debt in U.S. dollars is converted to local currency, then taken as a percentage of 2015 gross general government debt. - Note 5: Primary gap in 2017 refers to the change in primary balance in 2017 (relative to the forecast in the World Economic Outlook) to stabilize the debt-to-GDP ratio at the 2016 level. - Note 6: Primary gap in 2022 refers to the change in primary balance in 2022 (relative to the forecast in the World Economic Outlook) to stabilize the debt-to-GDP ratio at the 2021 level. - Note 7: Projections rely on authorities’ estimates when these are available. For the European Union countries, pension projections are based on The 2015 Ageing Report of the European Commission. When authorities’ estimates are not available, IMF staff projections use the methodology described in Clements, Eich, and Gupta 2014. Staff projections for health care spending are driven by demographic and other factors. The difference between the growth of health care spending and real GDP growth that is not explained by demographics (“excess cost growth”) is assumed at the advanced economy historical average by 2050 (0.8 percent). - Note 8: The IMF staff projects an increase in pension spending in Brazil to 5.9 percent of GDP by 2030. See IMF 2016e. *Sources: Bloomberg L.P.; Joint External Debt Hub, Quarterly External Debt Statistics; national authorities; and IMF staff estimates and projections.* ### Introduction ### fm1701 - Introduction ### Challenge and context - A top challenge for policymakers is how to raise productivity, the key driver of living standards over the long term. - In advanced economies, productivity growth was declining well before the global financial crisis, and the trend worsened in its aftermath. - A slowdown in productivity has also taken place in developing countries since the crisis, hampering their convergence toward higher income levels. - The IMF’s policy agenda emphasizes using all policy levers, in particular growth-friendly fiscal policies, to boost productivity and potential output. ### Resource misallocation: definition and significance - Total factor productivity (TFP) at the country level reflects the productivity of individual firms, weighted by firm size. - Aggregate TFP depends on firms’ individual TFP and how available resources (labor and capital) are allocated across firms. - Resource misallocation is the poor distribution of resources across firms, reducing total output obtainable from existing capital and labor. - Manifestation: wide dispersion in firm revenue productivities across firms, even within narrowly defined industries. - Consequence: when distortions allow less productive firms to gain market share, aggregate TFP suffers because efficient firms produce too little and inefficient firms produce too much. - Examples quantifying the role of reallocation: - Baily, Hulten, and Campbell (1992) find that 50 percent of manufacturing productivity growth in the United States during the 1980s can be attributed to reallocation of factors across plants and to firm entry and exit. - Barnett and others (2014) find that labor reallocation across firms explained 48 percent of labor productivity growth for most sectors in the U.K. economy in the five years prior to 2007. ### Measurement and methodology - The chapter measures potential TFP gains from reducing resource misallocation following the framework proposed by Hsieh and Klenow (2009). - Key methodological points and assumptions of the Hsieh and Klenow (2009) model include: - monopolistic competition with distinct varieties aggregated via a constant elasticity of substitution aggregator; - a specific production technology for each industry identical across countries; - presence of firm-specific input and output distortions. - Resource allocation efficiency is calculated as the industry’s actual TFP (with distortions) divided by the industry’s efficient TFP (without distortions). - TFP gains are calculated as the inverse of resource allocation efficiency. - Empirical coverage: - For advanced economies: firm-level data from ORBIS covering 73 manufacturing industries and 76 services industries (four-digit NAICS) in nine countries over 2006–13. - For emerging market economies and low-income developing countries: firm-level data from the World Bank Enterprise Surveys covering 18 manufacturing industries (two-digit ISIC) in 54 countries. - Illustration from prior application: Hsieh and Klenow (2009) show that if dispersion of firm revenue productivities in China and India were reduced to levels observed in the United States, TFP would increase by 30 to 50 percent in China and by 40 to 60 percent in India. - Additional Hsieh and Klenow (2009) estimates (manufacturing, fully equalizing revenue productivities across firms): - boost aggregate manufacturing TFP by 86 to 115 percent in China, - 100 to 128 percent in India, - 30 to 43 percent in the United States. ### Main questions addressed - What is the extent of resource misallocation within countries? What are the potential TFP and growth payoffs from reducing resource misallocation? - How does the tax system affect resource misallocation? To what extent does differential tax treatment of firms affect productivity? - What tax policy measures can be implemented to reduce distortions and hence misallocation? ### Key findings - Potential TFP gains from reducing resource misallocation are substantial and could lift the annual real GDP growth rate by roughly 1 percentage point. - Payoffs are higher for emerging market and low-income developing countries than for advanced economies, with considerable variation across countries. - Reforms to tackle resource misallocation will have winners and losers; the transition needs careful management. - Upgrading tax-system design can help reduce resource misallocation by ensuring firms’ decisions are made for business reasons rather than tax reasons. - Significant TFP gains can be achieved if countries address tax treatments that discriminate by asset type, sources of financing, or firm characteristics such as informality and size. - How governments tax matters for productivity: - Minimize differentiated tax treatments across assets and financing to avoid tilting firms’ investment decisions toward more tax-favored but less productive assets. - The current debt bias in some tax systems distorts financing decisions and hampers productivity, especially in advanced economies. - Disparity in taxes across capital asset types—present in all country groups—affects firms’ investment decisions. - Adopting a well-designed allowance for corporate equity (ACE) system or a cash flow tax can eliminate these distortions. - Level the playing field across firms to encourage growth of productive firms. - In emerging market and low-income developing countries, stronger tax administration could reduce the unfair cost advantage of informal firms that underreport sales, allowing more productive, tax-compliant firms to gain market share. - Reduce tax compliance costs to encourage growth and productivity among small firms; target tax relief to new rather than small firms to avoid the “small business trap.” ### Policy caveats and broader objectives - Eliminating differences in tax treatments across firms may not always be feasible or desirable. - Tax policy might intentionally influence resource allocation to address externalities (for example, underinvestment in research or excessive carbon emissions). - Tax reform priorities must consider productivity impacts alongside other government objectives, including income distribution and revenue mobilization needs. *fm1701 - Introduction* ### CHAPTER 2 UpGRAdING THE TAx SySTEM TO BOOST pROdUCTIVITy ### CHAPTER 2 UpGRAdING THE TAx SySTEM TO BOOST pROdUCTIVITy ### Resource allocation efficiency across countries and sectors - Countries are "well below 100 percent" in resource allocation efficiency (actual sector TFP as a percent of efficient level of sector TFP), indicating ample room to increase efficiency. - Dispersion of firm revenue productivities is much tighter in more efficient countries; less efficient countries can reap substantial gains by reallocating resources from lower-revenue-productivity firms (left tail) to higher-revenue-productivity firms (right tail). - A top performer is defined as a country at the 90th percentile of the sample distribution of resource allocation efficiency. - In the manufacturing sector, the top performer corresponds to Sweden (both WBES and ORBIS samples). - In the services sector, the top performer corresponds to Slovenia. - Estimates of resource allocation efficiency follow Hsieh and Klenow (2009). ### Estimated gains in total factor productivity (TFP) from narrowing dispersion of firm revenue productivities - Panel 1 (fully equalizing revenue productivity across firms): "all country groups could achieve quite substantial TFP gains." - Panel 2 (moving to efficiency level of a top performer, i.e., a country at the 90th percentile): - Manufacturing: - Advanced economies: TFP gains estimated at 16 percent at the median. - Emerging market economies: median TFP gains estimated at 30 percent; rise to 52 percent at the 75th percentile of the distribution. - Low-income developing countries: median TFP gains amount to 20 percent; rise to 58 percent at the 75th percentile of the distribution. - Services: - Advanced economies: TFP gains estimated at 23 percent at the median. - Caveats noted in the chapter: - These numbers could overstate potential efficiency gains because of measurement error and omitted factors (for example adjustment costs and price markup variation). - Estimates control for some biases by measuring gains relative to a top performer. - Calculations are limited to first-round effects and do not consider feedback from higher TFP into greater aggregate investment. ### Estimated transitional real GDP growth effects from reducing resource misallocation - Assuming a transition path of 20 years and reducing resource misallocation by moving to the efficiency level experienced by a top performer: - Higher annual real GDP growth rate of 0.7 percent for advanced economies. - Higher annual real GDP growth rate of 1.3 percent for emerging market economies. - Higher annual real GDP growth rate of 0.9 percent for low-income developing countries. - Note: These estimates are for the median country in each country group and assume that estimated TFP gains in manufacturing could be similarly achieved across other sectors and that there are no adjustment costs. ### Channels driving misallocation and the role of taxation - Drivers of resource misallocation summarized (Restuccia and Rogerson 2013, 2016): 1. Legislated provisions that vary by firm characteristics (for example tax incentives that depend on size or location, tariffs applied to particular goods, employment protection measures, and product market regulations that limit market access). 2. Discretionary government provisions that favor specific firms (for example subsidies, selective tax enforcement, and preferential loans granted to specific firms because of corruption). 3. Market imperfections (for example monopoly power and incomplete financial markets). - The chapter emphasizes that both tax policy and tax administration are important when tackling productivity challenges, adding to literature on level and composition of taxes and growth. ### Effective marginal tax rates (EMTRs) and firm-level tax heterogeneity - The effective marginal tax rate (EMTR) on capital income measures an investor’s tax burden on returns from an investment (see Box 2.1 and Annex 2.4 in source). - Even with uniform statutory rules, heterogeneous firms will face firm-specific tax rates if taxation differs by asset type, source of financing, or firm characteristics. - If EMTRs are the same across assets, financing, and firm characteristics, then all firms in a given industry face the same tax rate; when EMTRs differ, firms in the same narrowly defined industry face different effective tax rates because of variation in asset composition, financing, ownership structure, and profitability (for example whether the firm has incurred losses). - Empirical strategy: exploit that firms or industries have intrinsic exposure to specific tax distortions and use a difference-in-differences approach (as proposed by Rajan and Zingales 1998) to test whether tax distortions reduce resource allocation efficiency. ### Disparities in EMTRs across capital asset types and investment effects - Disparities in EMTRs across capital asset types arise because of differences between tax depreciation and economic depreciation. - A wider disparity in EMTRs across asset types can result in over- or underinvestment in particular types of capital assets. - Empirical observations: - Tax disparity measured as EMTR on machinery minus EMTR on buildings is above zero in half the countries in the sample, regardless of country group. - For some emerging market economies and low-income developing countries, the tax disparity is sizable. - For developing countries, those with high tax disparity (higher tax for machinery than for buildings) tend to have a lower share of machinery compared to countries with lower tax disparity, suggesting taxes affect firms’ investment decisions. - The chapter notes empirical evidence that greater tax disparity across capital asset types is associated with higher misallocation. - Mozambique is cited as an example where dispersion in EMTRs can be compounded by additional tax incentives (see Box 2.3 in source). *International Monetary Fund | April 2017* ### CHAPTER 2 UpGRAdING THE TAx SySTEM TO BOOST pROdUCTIVITy ### CHAPTER 2 UpGRAdING THE TAx SySTEM TO BOOST pROdUCTIVITy ### Tax disparity between machinery and buildings: effects on resource allocation - Analysis across 54 emerging market economies and low-income developing countries finds machinery-intensive industries have lower resource allocation efficiency where the tax disparity between machinery and buildings is higher (Annex 2.5). - Eliminating the tax disparity (an EMTR on machinery equal to the EMTR on buildings) would raise resource allocation efficiency in machinery-intensive industries by: - 7¼ percentage points in emerging market economies. - 5½ percentage points in low-income developing countries. - Evidence from advanced economies corroborates effects on investment composition: - For the United States, Liu (2011) finds that differences in EMTRs by asset type cause underinvestment in computing and electronic equipment by about 25 percent and overinvestment in machinery and transportation equipment by about 18 percent. - For 11 advanced economies, Fatica (2013) finds differential taxation leads on average to underinvestment in capital related to information and communications technology and overinvestment in other machinery and equipment. - Figure 2.7 (described): Eliminating the tax disparity to the benchmark (country at the 10th percentile of the distribution for tax disparity) significantly raises resource allocation efficiency in machinery-intensive industries (Percent of industry TFP). ### Reducing distortions across sources of financing: corporate debt bias and policy options - Corporate debt bias arises when interest expenses are deductible but returns to equity are not, raising the cost of equity relative to debt and distorting financing choices—especially for R&D investment that relies on equity. - Rationale note: both interest and equity returns are returns on capital; there is no a priori reason to tax them differently (De Mooij 2012). - Innovative firms and start-ups tend to rely on equity for R&D because of lack of collateral requirements and sharing of upside returns (Stiglitz 1985; Hall 2002; Brown, Fazzari, and Petersen 2009). - Debt bias can create resource misallocation by imposing a higher marginal tax on R&D investment compared with other capital spending and poses a stability risk by contributing to excessive private sector leverage (IMF 2016b). - Empirical results for nine advanced economies (Annex 2.5): - Debt bias (measured as EMTR on equity minus EMTR on debt) remains high across country groups (Figure 2.8). - R&D-intensive industries exposed to higher debt bias have lower resource allocation efficiency. - If the median advanced economy reduced its debt bias to the level observed in the 10th percentile of the sample distribution, it could raise resource allocation efficiency of more R&D-intensive industries by 3 percentage points (Figure 2.9). - The effects on overall productivity would extend beyond these estimates because higher R&D would also help expand the technology frontier. - Policy options to eliminate distortions from debt bias and tax disparities across asset types: - Allowance for Corporate Equity (ACE) system: - Investments that earn a “normal” return are exempt from taxation through a deduction for an imputed return on equity. - By allowing a deduction for both interest and the normal rate of return on equity, ACE charges no tax on projects with a return that matches the cost of capital; it taxes economic rents. - ACE does not distort the choice between debt and equity and removes distortions induced by differences between economic depreciation and tax depreciation. - Accelerated tax depreciation reduces the book value of assets, thereby reducing the ACE in later years, exactly offsetting benefits from earlier depreciation in present-value terms. - ACE systems have been effectively applied in Belgium, Cyprus, Italy, and Turkey, but require careful design to mitigate potential revenue loss due to narrowing of the corporate tax base (IMF 2016b). - Cash Flow Tax (CFT): - A CFT is a tax levied on money entering the business less money leaving the business. - A CFT entails immediate expensing of all investment expenditures (100 percent first-year depreciation allowances) and no deductibility of either interest payments or dividends. - Well designed and implemented, a CFT does not affect the decision to invest, the scale of investment, or discriminate across sources of financing. - No country has adopted a comprehensive business cash flow tax; complexities in transition likely contribute to this. - The United States is considering a destination-based form of a cash flow tax, which raises distinct issues including the possibility of adverse cross-country spillovers if implemented by only a subset of countries (Auerbach, Devereux, and Simpson 2010; Auerbach and others 2017). ### Informality, tax administration, and productivity - Informality reduces productivity by interfering with creative destruction through firm entry and exit; informal firms gain a relative cost advantage via tax evasion and circumvention of regulations, allowing less productive firms to persist and gain market share at the expense of more productive, tax-compliant firms (Fajnzylber 2007; Levy 2008; Pagés 2010; Busso, Fazio, and Levy 2012). - Measures of informality consistently show informal firms are typically less productive than formal firms (Figure 2.10). Four indicators used as proxies for informality: - Self-employment. - Noncontributors to a retirement pension scheme. - Share of unregistered firms. - Prevalence of “cheats” (registered firms that underreport sales). - Empirical firm-level results for manufacturing in emerging market economies and low-income developing countries (Annex 2.6): - Cheats that report only 30 percent of their sales (firms at the 25th percentile of the distribution of cheats) have a 4 percent lower TFP than tax-compliant firms in both emerging market economies and low-income developing countries. - Similar results obtained using alternative country-level measures of informality. - Tax policy and tax administration affect informality and productivity: - Colombia’s 2012 tax reform reducing payroll taxes incentivized a shift from informal to formal employment (Box 2.2). - Leal Ordóñez (2014) finds taxes and regulations play an important role in explaining informality in Mexico. - Fajnzylber, Maloney, and Montes-Rojas (2011) show tax reductions and simplification in Brazil increased formal firms with higher revenues and profits. - Strong tax administration can mitigate the effect of higher corporate tax rates on cheating: - For 130 developing countries, a higher corporate tax rate increases the prevalence of cheats among small manufacturing firms, lowering the share of sales reported for tax purposes; an effective and efficient revenue administration diminishes this effect (Annex 2.6). - Figure 2.11: The negative effect of the corporate income tax rate on sales reported for tax purposes by small manufacturing firms is considerably lower when tax administrations are stronger. - The regression analysis uses proxies for tax administration that are imperfect; a more comprehensive measure is the tax gap, currently available only for a limited set of countries and mainly for VAT. - IMF Fiscal Affairs Department’s Revenue Administration Gap Analysis Program (RA-GAP) aims to identify and address tax gaps; RA-GAP reports for 22 countries have been completed so far. - Measures to strengthen tax administrations to reduce unfair advantages of informal firms: - Ensure taxpayers are registered, knowledgeable about obligations, and that reporting is accurate. - Taxpayer segmentation by size (large, medium-sized, small, micro) to tailor services and enforcement. - Risk-based audits that are well trained to encourage accurate reporting and higher declarations. - Integrate tax and customs agencies to strengthen enforcement capacity when agencies work together to identify risks and develop response strategies (IMF 2011). - Semiautonomous revenue agencies can help, but international experience has been mixed (Crandall 2010). - IMF (2015a) discusses additional options to improve tax compliance in detail. - Figure 2.11 specific data notes: - The figure shows the effect for every percentage point of corporate income tax (CIT). - The tax administration cost is expressed as a percentage of total revenue; the median tax administration cost across the sample is 1 percent of revenue. - Tax administration features shown include Integrated tax and customs agencies, SARA (semiautonomous revenue agency), and LTO (large taxpayer office). ### Preferential tax treatment by firm size: small business traps and productivity costs - Preferential tax treatment based on firm size can stunt firm growth and affect aggregate productivity when more productive firms choose to stay small to remain below eligibility thresholds (Pagés 2010; Bobbio 2016). - Many countries offer lower corporate income tax rates for firms below a certain size (profits, turnover, or employees) to support employment and entrepreneurship, but this can create misallocation and a “small business trap.” - Evidence of disincentive effects: - Figure 2.12 shows older firms are much smaller in countries with lower tax rates for small firms than in countries without a preferential regime. - Mozambique demonstrates strong “bunching” of firms with income just below the threshold where the size-based tax preference is removed (Box 2.3; Figure 2.3.1). - Empirical analysis for 54 emerging market economies and low-income developing countries: - Preferential tax treatment for small firms is associated with lower productivity. - Among industries with a high share of small firms, resource allocation efficiency is lower by 1½ percentage points in countries that provide lower tax rates for small firms (Annex 2.5). - Complementary findings: - Benedek and others (forthcoming) find that firms receiving more size-related tax incentives experience lower TFP growth in selected European countries. - Potential TFP gains for small and medium-sized enterprises from eliminating size-related tax incentives range between 0.8 percent and 2.9 percent when weighted by firm employment. - Policy guidance: - Preferential treatment aimed at compensating for specific constraints should be targeted to new firms rather than to small firms generally, supporting young firms while preserving incentives to grow. - Targeted rules are needed to limit potential abuse (for example, creating new legal entities to renew preferences). - Alleviating tax compliance costs can encourage higher productivity among small firms by reducing the burden to comply. *International Monetary Fund | April 2017* ### CHAPTER 2 UpGRAdING THE TAx SySTEM TO BOOST pROdUCTIVITy ### CHAPTER 2 UpGRAdING THE TAx SySTEM TO BOOST pROdUCTIVITy ### Tax compliance costs, TAQI, and firm productivity - Compliance costs include the opportunity cost of employees' time and the cost of professional tax advice; they have substantial fixed components (for example, filing a value-added tax return costs the same regardless of the net amount remitted) and so are a disproportionate burden on small businesses. - Dabla‑Norris and others (forthcoming) compile a Tax Administration Quality Index (TAQI) drawing on the Tax Administration Diagnostic Assessment Tool (TADAT). The TAQI captures efforts to improve the quality and flow of information to taxpayers, simplify tax system structure, and streamline reporting requirements and procedures affecting tax compliance costs for firms. - Empirical findings reported: - Countries with a high TAQI score (that is, lower tax compliance costs) see higher labor productivity among small firms and young firms (Figure 2.14). - Labor productivity is measured as sales divided by the number of employees. Small firms have fewer than 20 employees; young firms are less than seven years old. A higher TAQI score implies lower tax compliance costs. - Countries with a low (high) TAQI score are those at the 25th (75th) percentile of the sample distribution. - Electronic filing availability from the Revenue Administration Fiscal Information Tool (RA‑FIT) is used as a proxy for lower tax compliance costs in robustness checks. ### Resource misallocation: measurement, limitations, and cross-sector effects - The Hsieh and Klenow (2009) framework measures misallocation within sectors, not across sectors. - Cross-sector reallocation can also raise aggregate productivity; Dabla‑Norris and others (2015) show that TFP gains from improving factor allocation across sectors average about 9 percent for selected advanced economies. - Other limitations and caveats: - The approach may overestimate gains from reallocation because of measurement error or model misspecification; estimating misallocation relative to a top performer can mitigate this limitation. - The framework is static and does not capture dynamic shifts in firm productivity distributions or entry and exit of firms. - Estimates of TFP gains from reducing resource misallocation do not take into account adjustment costs. Improving allocation will affect the mix of firms and workers; there will be winners and losers, requiring careful transition management. - In international taxation, narrowing tax treatment differences between domestic and multinational companies has ambiguous productivity effects: multinationals may pay lower taxes due to profit shifting but can be at the global productivity frontier and provide positive externalities to local firms. Antiavoidance measures can raise revenues and curb unfair competition but may also reduce multinationals’ investment and presence, highlighting the importance of international coordination and using some revenues to support productivity-enhancing investments. ### Key quantitative findings on productivity gains and firm heterogeneity - TFP gains from reducing resource misallocation could add roughly 1 percentage point to annual real GDP growth, based on estimates for a sample of 54 developing countries and 9 advanced economies. Payoffs would be higher for emerging market economies and low-income developing countries than in advanced economies, with considerable variation across countries. - Firm-level patterns: - Small firms are typically less productive than medium-sized and large firms (Figure 2.13). - Multinational companies are often more productive than domestic firms (Figure 2.15). ### Policy recommendations to reduce misallocation via tax-system upgrades - Minimize differentiated tax treatment across assets and financing to tilt investment decisions toward more productive assets rather than more tax-favored assets. - If well designed, an ACE system or a cash flow tax can address distortions across asset types and financing sources. - Level the playing field across firms to encourage growth of productive firms: - Reduce compliance costs (for example, through easy filing). - Promote compliance by ensuring taxpayers are registered, knowledgeable of obligations, and that reporting is accurate. - Follow a risk-based approach in tax administration that includes strong audit capacity and taxpayer segmentation. - To encourage growth and productivity among small and young firms: - Reduce tax compliance costs. - To avoid the “small business trap,” target tax relief to new firms rather than to all small firms. - In implementing antiavoidance legislation: - Pursue international coordination to limit revenue losses from multinationals relocating or reducing investment. - Consider using revenues from antiavoidance measures to strengthen institutions, human capital, and infrastructure. ### Effective Marginal Tax Rates (EMTRs) - EMTRs summarize the tax burden applied to before-tax capital income realized over an investment’s lifetime, as implied by major provisions of a country’s corporate tax code (statutory federal tax rates, surcharges, local tax rates, depreciation rules, treatment of inventories, interest deductibility). - Variation in EMTRs across capital asset types arises from differences between tax depreciation (the rate at which a tax code allows cost deduction) and economic depreciation (the rate at which assets wear out). - Greater acceleration in tax depreciation relative to economic depreciation lowers the EMTR. - Variation in EMTRs across sources of financing arises when deductibility differs between interest expenses and returns to equity. - EMTR estimates used in the chapter are provided by the Oxford University Center for Business Taxation, following Devereux and Griffith 1998, and are calculated across capital asset types (machinery, buildings, intangibles, and inventories) and across sources of financing (debt, equity, and retained earnings) for each country-year in the data set. ### Colombia case study: shifting tax burden from labor to corporate income - Context and pre‑reform measures: - In 2012, Colombia introduced tax code changes to increase labor formality by significantly reducing nonwage labor costs and partially shifting the tax base from labor to corporate income to finance social programs. - Before the 2012 reform, nonwage labor costs accounted for 60.3 percent of the average wage rate. - The informality rate in the 13 main metropolitan areas fell by 6½ percentage points, to 51 percent, by four years after the reform; part of the decrease has been attributed to the reform. - Specific policy changes and quantitative impacts: - Payroll taxes were reduced by 13.5 percentage points for workers earning up to 10 times the minimum wage. - Employer contributions eliminated included: training (2 percentage points), in-kind transfers for low-income households (3 percentage points), and health (8.5 percentage points). - The payroll tax fell by 22.4 percent as a result. - A new tax, Contribución Empresarial para la Equidad (CREE), equivalent to a corporate income tax of 8 percent (temporarily set at 9 percent for 2013–15), was created; simultaneously, the corporate income tax rate was decreased from 33 to 25 percent. Overall, the reform partially shifted the tax base from labor to corporate income while leaving the total tax rate on corporate income largely unchanged. - Empirical evidence on labor-market and macro effects: - Several studies find the reform increased formal jobs and wages and had positive effects on employment, investment, and GDP: - Inter-American Development Bank–commissioned studies found the reform increased the number of formal jobs by between 3.1 and 3.4 percent and increased wages by between 1.9 and 4.4 percent, with most impact among small and medium-sized enterprises. - The IMF (2015c) finds that the reduction in payroll taxes had a positive effect on employment, investment, and GDP. - General equilibrium models (Steiner and Forero 2015; Anton 2014; Hernández 2012) find the tax reform increased formal employment. *International Monetary Fund | April 2017 — CHAPTER 2 UpGRAdING THE TAx SySTEM TO BOOST pROdUCTIVITy* ### Box 2.2. Colombia: Labor Tax Reform and the Shift from Informal to Formal Employment ### Box 2.2. Colombia: Labor Tax Reform and the Shift from Informal to Formal Employment ### Key Empirical Findings on Employment and Informality - The 2012 reform increased employment by between 3.4 and 7.4 percent of total employment and lowered informality by between 1.4 and 4.2 percent. - Fernández and Villar (2016), using a matching difference-in-differences approach, find that the tax reform reduced the informality rate of the workers affected by the reform in the country’s 13 main metropolitan areas by between 4.3 and 6.8 percentage points, which translates to a reduction in the national informality rate of between 2.0 and 3.1 percentage points, given that only 45 percent of the working population was affected by the reform. ### Payroll Tax Change (Table 2.2.1) - The 2012 reform reduced payroll taxes by 13.5 percentage points. - Contribution rates (Percent of wage rate) — Prereform / Postreform: - Pensions: 16.0 / 16.0 - Employer: 12.0 / 12.0 - Employee: 4.0 / 4.0 - Health Care: 12.5 / 4.0 - Employer: 8.5 / . . . - Employee: 4.0 / 4.0 - Professional Risks: 2.0 / 2.0 - Other Payroll Contributions: 9.0 / 4.0 - Training (SENA): 2.0 / . . . - In-Kind Transfers (ICBF): 3.0 / . . . - Compensation Funds: 4.0 / 4.0 - Paid Vacations: 4.2 / 4.2 - Severance Pay: 8.3 / 8.3 - Mandatory Bonuses: 8.3 / 8.3 - Total: 60.3 / 46.8 - Employer: 52.3 / 38.8 - Employee: 8.0 / 8.0 - Source for table: Antón 2014. - Note: ICBF = Instituto Colombiano de Bienestar Familiar; SENA = Servicio Nacional de Aprendizaje. ### Interpretation and Scope - Reported effects distinguish between impacts on workers directly affected by the reform (metropolitan-area estimates) and implications for the national informality rate, accounting for the fact that only 45 percent of the working population was affected. - Magnitude of estimated reductions in informality differs by estimation approach and population scope (affected workers vs. national aggregates). *International Monetary Fund | April 2017* ### Annex 2.2. Calculation of Resource Allocation ### Annex 2.2. Calculation of Resource Allocation Efficiency Using Firm-Level Data ### Data sources and sample construction - Developing-country firm-level data source: World Bank Enterprise Surveys (WBES). - Advanced-economy firm-level data source: ORBIS (Bureau van Dijk); unconsolidated statements used. - WBES sample coverage after cleaning: - 30 emerging market economies, 24 low-income developing countries, and 3 advanced economies. - Period: 2002–16. - ORBIS sample coverage after cleaning: - 9 countries over the 2006–13 period (Belgium, the Czech Republic, France, Italy, Portugal, the Slovak Republic, Slovenia, Spain, and Sweden). - Data sets are analyzed separately because of differences in observation counts, panel dimension, and industry classification. ### Cleaning and inclusion rules (WBES) - Removal of observations with negative sales, capital, labor, and value added. - Removal of implausibly high values of sales per worker. - Removal of the bottom 2.5 and top 97.5 percentiles of computed output wedges, capital wedges, and total factor productivity. - Industry-country-year exclusion rules: - Exclude all firms in industries for particular countries and years if they have fewer than five observations. - Exclude if less than half of the original number of observations remain in the sample for that industry-country-year. - Country-year exclusion rules: - Drop all firms in countries for particular years if fewer than 40 observations remain in total across all industries. - Drop if fewer than 40 percent of the original number of observations in total across all industries remain. - Resulting sample described above (30 EMEs, 24 LIDCs, 3 AEs; 2002–16). ### Cleaning and inclusion rules (ORBIS) - Standard cleaning procedure follows Kalemli-Ozcan and others (2015). - Additional misallocation-literature cleaning steps: - Remove top and bottom percentiles of wedges and TFP. - Remove the 1 percent tails of the firm-level to industry-level total factor (revenue) productivity ratios. - Firm-level and industry-country-year exclusion rules: - Remove all firms in industries in particular countries and years with fewer than 10 observations. - Drop firms with fewer than 10 employees. - Drop firms that had fewer than 20 employees in the first year they appear in the sample. - Countries included only if at least 50 percent of manufacturing observations retained after omitting negative, missing, and extreme values, or if TFP sample accounts for at least roughly 70 percent of the manufacturing sector. - Countries with large idiosyncratic year-to-year fluctuations in the number of firms are omitted. ### Measurement and estimation approach - Resource allocation efficiency estimated following Hsieh and Klenow (2009) (see Annex 2.1). - Industry aggregation level: - WBES: manufacturing sector at two-digit ISIC industry level. - ORBIS: manufacturing sector at four-digit NAICS industry level. - Services sector resource allocation efficiency calculated for advanced economies (ORBIS) but not for developing countries (WBES) due to data constraints. - Choice of parameter values: - Output elasticity of labor and capital for each industry approximated by their cost shares in the United States from the Bureau of Economic Analysis. - Elasticity of substitution between output of different firms set to 3. - Rental price of capital set to 0.1, assuming a real interest rate of 5 percent and a depreciation rate of 5 percent. - Cost of labor measured by labor cost at the firm level to account for differences in hours worked and human capital. ### Sample counts and key statistics (Annex Table 2.2.1) - Coverage: - WBES: 30 EMEs, 24 LIDCs, 3 AEs. - ORBIS: 9 AEs (manufacturing); ORBIS also covers services sector for 9 AEs. - Number of industries: - WBES manufacturing: 187. - ORBIS manufacturing: 376. - Number of years: - WBES: 1 year for most countries. - ORBIS: 8 years, 2006–13. - Revenue productivity: firm-level observations: - WBES Total: 26,649. - ORBIS manufacturing: 364,357. - ORBIS services: 306,908. - Sector-Country-Year averages: - WBES: 459. - ORBIS manufacturing: 6,115. - ORBIS services: 115. - Country-Year averages: - WBES: 375. - ORBIS manufacturing: 5,061. - ORBIS services: 4,263. - Resource allocation efficiency: country-industry observations: - WBES: 590. - ORBIS manufacturing: 3,784. - ORBIS services: 2,930. ### Simple illustrative example: distortive taxes and misallocation (Annex 2.3) - Conceptual setup: managerial productivity A_i drawn from a Pareto density; production technology with decreasing returns to scale; managerial talent determines firm-level TFP. - Nondistortionary tax example parameters: - τ_s^K = 0.35, τ_s^Y = 0.4 for all firms in the industry. - Under nondistortionary taxes, capital input perfectly correlated with firm-level productivity. - Distortive tax functional form example: - 1 + τ_is^K = a + b(A_i) with b > 0 (taxes increase with firm productivity). - 1 − τ_is^Y = c − d(A_i) with d > 0 (taxes penalize more productive firms). - Qualitative result: distortive taxes that are correlated with productivity can allocate more capital to less productive firms and reduce aggregate TFP; the specific capital distribution shape depends on the tax function, but the general result (resource misallocation and loss in aggregate TFP) is robust. ### Effective Marginal Tax Rate (EMTR) estimation (Annex 2.4) - EMTR estimates provided by the Oxford University Center for Business Taxation (unless otherwise noted). - EMTR calculation follows Devereux and Griffith (1998) using Hall and Jorgenson (1967) user cost of capital. - User cost of capital (p̃) conceptual components and notation included: - τ = statutory corporate tax rate. - π = expected inflation rate. - δ = economic rate of depreciation. - A = τφ(1 + ρ)/(ρ + φ) = net present value of the depreciation allowance, with φ the rate at which capital expenditure can be offset against tax. - ρ = (1 − m_i) i / (1 − z) = shareholders’ nominal discount rate, with m_i the personal tax rate on interest income, i the nominal interest rate, and z the accruals-equivalent capital gains tax rate. - γ = (1 − m_d)/((1 − c)(1 − z)) = term measuring tax discrimination between new equity and distributions, with m_d the personal tax rate on dividend income and c the rate of tax credit available on dividends paid. - F_t captures additional cost of raising external finance; formulas specified for Retained earnings, New equity, and Debt: - Retained earnings: F_t = 0 (A2.4.1). - New equity: F_t = −ρ(1 − γ)/((1 + ρ)(1 − φτ)) (A2.4.2). - Debt: F_t = γ(1 − φτ)/((1 + ρ)){ρ − i(1 − τ)} (A2.4.3). - EMTR definition for new investment: - EMTR = (p̃ − r) / p̃, where r is the expected after-tax rate of return. - Limitations noted: - EMTRs sensitive to underlying assumptions (interest rate, inflation). - EMTR models may omit special credits, deductions, rates, and other provisions. - EMTR calculations generally ignore investment tax credits or individual-level taxes. - Assumes firms use all available deductions and credits, which may be invalid for firms with losses or unused carry-forwards. - Assumes all investors are subject to corporate tax, ignoring tax avoidance and international capital flows. ### Empirical estimation of taxes on within-industry resource allocation (Annex 2.5) - Approach: difference-in-differences (DID) following Rajan and Zingales (1998); analyses conducted separately for advanced and developing economies due to data constraints. - Focus for Emerging Market and Low-Income Developing Countries: - Research question: Do disparities in EMTRs across asset types (machinery vs. buildings) increase resource misallocation within industries? - Tax disparity measure: - Tax disparity = country-level EMTR on machinery − EMTR on buildings (in absolute terms). - Identification strategy: - Industries with higher machinery capital intensity are more affected by a higher tax disparity. - Industry denoted by j, country by k. Estimated equation (A2.5.1): - RAE_{j,k} = α + δ_j + γ_k + β_1(tax disparity_k * machinery share_j) + B_x X_{j,k} + ε_{j,k}. - RAE = resource allocation efficiency (country-industry-specific). - Machinery share = industry-specific capital intensity in machinery as a share of total capital; measured using U.S. asset share in industry capital income to address endogeneity. - Fixed effects: δ_j (industry) and γ_k (country). - Control vector X_{j,k} includes: - Share of small firms in that industry. - Share of young firms in that industry. - Share of exporting firms in that industry. - Log of capital intensity in that industry. - Share of firms with two or more competitors (proxy for competition). - Self-reported perception of access to finance as an obstacle to business (industry average) to proxy financing constraints. - Interpretation: - β_1 is the DID estimate of the effect of tax disparity on resource allocation efficiency in machinery-intensive industries. - Expected sign: negative if higher tax disparity reduces resource allocation efficiency. - Data specifics for this analysis: - Country-industry-specific variables from WBES firm-level data. - Country-level EMTRs from the Oxford University Center for Business Taxation. - Asset shares in industry capital income for the United States from the Bureau of Labor Statistics. - Maximum of 573 observations across 18 industries for 30 emerging market and 24 low-income developing countries. *Source: IMF staff compilations (Annex 2.2: Calculation of Resource Allocation Efficiency Using Firm-Level Data).* ### Annex Table 2.5.1 presents the main regression results. ### Annex Table 2.5.1 presents the main regression results. ### Developing countries: Resource allocation efficiency and disparity in effective marginal tax rates across asset types - Specification overview: - Column (1) corresponds to equation (A2.5.1) with controls for the share of firms with more than two competitors and financing constraints. - Columns (2) and (3) add additional country-industry-specific controls. - Columns (3)–(6) add an interaction between the share of small firms in the industry and the perception of financing constraints. - Key estimated effect: - A 1 percentage point reduction in tax disparity is associated with a 1–1.5 percentage point increase in resource allocation efficiency in industries that are more capital intensive in machinery. - Counterfactual and median impacts: - Reducing tax disparity to that observed at the 10th percentile of the distribution (zero tax disparity): - The median emerging market economy could increase resource allocation efficiency by 7¼ percentage points in industries more capital intensive in machinery. - The median low-income developing country could increase resource allocation efficiency by 5½ percent in such industries. - Selected regression coefficients from Annex Table 2.5.1 (Dependent variable: Resource Allocation Efficiency at Industry Level in Manufacturing): - Disparity in EMTRs_k × Machinery as Share of Total Assets_j: –1.172*, –1.267*, –1.678***, –1.144*, –1.263*, –1.663*** (six column values shown in table) - Standard errors (in parentheses) for these six estimates: (–0.642), (–0.617), (–0.518), (–0.631), (–0.622), (–0.526) - Firm Capital Intensity_j,k: 0.039, 0.035, 0.037, 0.033 (with standard errors (–0.023), (–0.024), (–0.021), (–0.022)) - Share of Young Firms_j,k: –0.044, 0.023, 0.008, 0.076 (with standard errors (–0.103), (–0.106), (–0.119), (–0.117)) - Share of Small Firms_j,k: –0.027, 0.025, –0.226, –0.138 (with standard errors (–0.234), (–0.245), (–0.547), (–0.534)) - Share of Exporting Firms_j,k: 0.004***, 0.004*** (standard errors (–0.001), (–0.001)) - Share of Firms with 2+ Competitors_j,k: –0.017, –0.013, 0.006, –0.021, –0.013, 0.005 (standard errors (–0.085), (–0.081), (–0.08), (–0.086), (–0.083), (–0.082)) - Median Perception of Access to Finance as an Obstacle_j,k: 0.025, 0.028, 0.031 (standard errors (–0.024), (–0.024), (–0.023)) - Share of Small Firms_j,k × Perception of Access to Finance as an Obstacle_j,k: 0.029, 0.155, 0.127 (standard errors (–0.112), (–0.287), (–0.278)) - Number of Observations: 286 (for each column) - R^2: 0.513, 0.525, 0.552, 0.51, 0.521, 0.547 - Country Fixed Effects: Y (all columns) - Industry Fixed Effects: Y (all columns) - Notes: - Disparity in EMTRs is defined as EMTR on machinery minus EMTR on buildings. - Standard errors are in parentheses and are clustered by industry. - Significance: *p < 0.1; **p < 0.05; ***p < 0.01. ### Advanced economies: Corporate debt bias and industry-level resource allocation efficiency - Economic mechanism: - Corporate debt bias arises when interest is deductible but returns to equity are not, raising the cost of equity relative to debt. - Innovative and R&D-intensive firms rely more on equity for R&D because R&D investments are risky, long-horizon, lack collateral, and share upside returns with shareholders. - Debt bias therefore can impose a higher marginal tax on R&D investment than on other capital spending, creating resource misallocation particularly in R&D-intensive industries. - Empirical strategy: - Difference-in-differences (DID) estimation exploiting cross-industry variation in R&D intensity: - Equation (A2.5.2): RAE_j,k,t = α + δ_j + γ_k + χ_t + β1 (debtbias_k,t * R&D intensity_j) + ε_j,k,t - debtbias = country-level EMTR on equity-financed investment minus EMTR on debt-financed investment. - R&D intensity measured using average industrial R&D expenditures normalized by value added across OECD member countries. - External equity dependence used as an alternative interaction variable. - Fixed effects: industry (δ_j), country (γ_k), and time (χ_t). - Data: - Country-level EMTRs: Oxford University Center for Business Taxation. - R&D intensity and external equity dependence: Brown and Martinsson 2016. - Main estimation sample: unbalanced panel of 3,784 observations across nine advanced economies over 2006–13. - Key estimated effects and counterfactuals: - A 1 percentage point reduction in debt bias is associated with a 0.01 percentage point increase in resource allocation efficiency in R&D-intensive industries (column (3) result). - Reducing debt bias to the 10th percentile of the distribution (29 percentage points): - The median advanced economy could increase resource allocation efficiency in R&D-intensive industries by 3 percentage points. - The median debt bias reduction in the sample is 13 percentage points. - Using equity dependence as the interaction term: - A 1 percentage point reduction in debt bias is associated with a 0.02 percentage point increase in resource allocation efficiency in industries more dependent on equity. - Reducing debt bias to the 10th percentile would increase resource allocation efficiency in equity-dependent industries by 3 percentage points for the median advanced economy. - Selected regression coefficients from Annex Table 2.5.2 (Dependent variable: Resource Allocation Efficiency at Industry Level in Manufacturing): - Debt Bias_k × R&D Intensity_j: –0.00781***, –0.00815***, –0.00900*** (standard errors (0.00120), (0.00126), (0.00163)) - Debt Bias_k × Equity Dependence_j: –0.0198***, –0.0204***, –0.0231*** (standard errors (0.00307), (0.00322), (0.00422)) - Number of Observations: 3,784 (each column) - R^2: 0.301, 0.318, 0.411, 0.301, 0.318, 0.411 - Fixed effects configurations vary by column (see table): Country Fixed Effects, Industry Fixed Effects, Time Fixed Effects, Country × Time Fixed Effects, Industry × Time Fixed Effects, Country-Industry Fixed Effects (presence indicated per column in table). - Robust standard errors are in parentheses and are clustered by country and industry. - Significance: *p < 0.1; **p < 0.05; ***p < 0.01. ### Emerging markets and low-income developing economies: Preferential tax regime for small firms and industry-level resource allocation efficiency - Mechanism: - Preferential tax treatment for small firms can stunt firm growth by creating incentives for more productive firms to remain small to retain preferential status, preventing them from exploiting economies of scale and scope and shifting aggregate output toward smaller, less efficient firms. - Empirical strategy: - DID estimation exploiting industry variation in the share of small firms: - Equation (A2.5.3): RAE_j,k = α + δ_j + γ_k + β1 (preferential_treatment_k * share_small_j,k) + βx X_j,k + ε_j,k - preferential_treatment_k = 1 if country offers lower tax rates for small firms. - X_j,k includes share of small firms, share of young firms, share of exporting firms, log of capital intensity; competition proxy; financing-constraint proxy. - Data: - Firm-level data from World Bank Enterprise Surveys. - Countries with lower tax rates for small firms identified from KPMG database. - Maximum of 501 observations across 18 industries in 30 emerging market economies and 24 low-income developing countries. - Key estimated effects: - Countries that provide lower tax rates for small firms exhibit lower resource allocation efficiency. - For industries with a larger share of small firms, resource allocation efficiency is lower by between 1.2 and 1.6 percentage points in countries offering lower tax rates for small firms compared with countries that do not. - Selected regression coefficients from Annex Table 2.5.3 (Dependent variable: Revenue Allocation Efficiency at Industry Level in Manufacturing): - Lower Tax for Small Firms Dummy_k × Share of Small Firms_j: –1.193**, –1.587** (standard errors (–0.477), (–0.63)) - Capital Intensity_jk: 0.014*** (standard error (–0.004)) - Share of Young Firms_jk: –0.051 (standard error (–0.066)) - Share of Small Firms_jk: 0.055 (standard error (–0.336)) - Share of Exporting Firms_jk: 0.001* (standard error (–0.001)) - Share of Firms with 2+ Competitors_jk: –0.092*** (standard error (–0.018)) - Median Perception of Access to Finance as an Obstacle_jk: 0.011 (standard error (–0.013)) - Number of Observations: 501, 484 - R^2: 0.079, 0.127 - Country Fixed Effects: Y - Industry Fixed Effects: Y - Standard errors are clustered by industry. - Significance: *p < 0.1; **p < 0.05; ***p < 0.01. ### Firm-level productivity, informality, and the tax system - Conceptual link: - Informal firms (those that underreport or fail to pay full taxes) gain a relative cost advantage over tax-compliant competitors, allowing lower-productivity informal firms to survive and expand market share at the expense of more productive, compliant firms. - Empirical specifications: - Equation (A2.6.1): TFP_i,j,k = γ_k + δ_j + β1 salesreported_i,j,k + β2 Z_i,j,k + ε_i,j,k - salesreported = share of sales reported to tax authorities; TFP calculated following Levinsohn and Petrin (2003). - β1 expected negative if underreporting reduces TFP. - DID specification (A2.6.2) for sales reporting: - salesreported_i,j,k = γ_k + δ_j + β1 (small_i,j,k × CIT_k) + β2 (small_i,j,k × CIT_k × taxadmin_k) + β3 Z_i,j,k + ε_i,j,k - small = firm with fewer than 20 workers. - CIT_k = statutory corporate income tax rate. - taxadmin_k = dummy for stronger tax administration characteristics (integrated tax and customs agency; functionally organized tax administration; semiautonomous revenue agency (SARA); large taxpayer office (LTO)). - β1 expected negative (higher CIT reduces reporting by small firms); β2 expected positive (stronger tax administration offsets negative effect). - Country-level corroboration: - Equation (A2.6.3): TFP_k = α + λ Z_k + β1 noncontributors_k + ε_k - noncontributors = fraction of labor force not contributing to a retirement pension scheme (proxy for informality). - β1 expected negative. - Equation (A2.6.4): noncontributors_k = α + λ Z_k + β1 CIT_k + β2 (CIT_k × taxadmin_k) + ε_k - β1 expected positive; β2 expected negative. - Instrumental variables used for informality proxies: secondary enrollment rate, intellectual property protection, independence of the judiciary (two-stage least-squares to address reverse causality). - Data: - Firm-level data from World Bank Enterprise Surveys covering 130 countries; sales reported data available for 2002–10. - Tax administration characteristics from U.S. Agency for International Development Tax Database (2007–12): tax administration costs as percentage of total revenue; integrated tax and customs agency; functionally organized tax administration; SARA; LTO. - Statutory CIT rates from IMF Tax Policy Database. - Country-level TFP from Penn World Table 9.0. - Fraction of labor force not contributing to pensions from World Bank Human Development Network Social Protection pensions database (116 countries, 2000–15). - Self-employment as share of total employment from World Bank World Development Indicators. - Measurement notes: - Sales reported to tax authorities is elicited from Enterprise Survey question: “What percentage of total annual sales would you estimate the typical firm in your area of business reports for tax purposes?” - The sales-reported proxy has precedent in the literature and correlates with other informality measures (self-employment share; fraction not contributing to pension schemes). - Tax administration characteristics are imperfect proxies for enforcement capacity; a broader measure like the tax gap is limited in availability. *Source: IMF staff calculations, Annex Tables and regression results contained in the Annex of the Fiscal Monitor: Achieving More with Less (April 2017).* ### Annex Table 2.6.1 provides the results linking firm- ### fm1701 - Annex Table 2.6.1 provides the results linking firm- ### Firm-level productivity and informality (Annex Table 2.6.1) - Dependent Variable: Firm-Level Total Factor Productivity. - Baseline finding: - Column (1) (country and industry fixed effects): A 1 percentage point increase in sales reported is associated with a 0.001 percentage point increase in firm-level TFP. - Sales Reported coefficients: 0.0016*** (column (1)); 0.0018*** (column (2)); 0.0018*** (column (3)). (Standard errors reported as (0.000).) - Implication on cheats versus compliant firms: - Firms that report only 30 percent of their sales (equivalent to the firm at the 25th percentile of the distribution of cheats) have a 4 percent lower TFP than tax-compliant firms. - Other coefficients (selected): - Age: 0.0065*** (col (1)); 0.0063*** (col (2)); 0.0065*** (col (3)). (Standard errors (0.001).) - Corruption: –0.001 (col (1)); –0.004 (col (2)); 0.001 (col (3)). (Standard errors (0.008), (0.008), (0.009).) - Sample and fit: - Number of Observations: 11,499 (cols (1) and (2)); 10,604 (col (3)). - R^2: 0.421 (col (1)); 0.432 (col (2)); 0.446 (col (3)). - Industry Fixed Effects: Y in all columns. - Country Fixed Effects: Y in all columns. ### Country-level aggregate productivity and informality (Annex Table 2.6.2) - Dependent Variable: Log Total Factor Productivity at Country Level. - Alternative informality proxies used: - Noncontributors to pensions (log) coefficient: –0.540* (col (1)). (Standard error (–0.281).) - Self-employment (log) coefficient: –0.419** (col (2)). (Standard error (–0.161).) - Other regressors (selected): - GDP (log): 0.058 (col (1)); 0.0419 (col (2)). (Standard errors (–0.05) and (–0.048).) - Population size (log): –0.0443 (col (1)); –0.0141 (col (2)). (Standard errors (–0.075) and (–0.07).) - Sample and diagnostics: - Number of Countries: 101 (col (1)); 103 (col (2)). - Underidentification (p-value): 0.001 (col (1)); 0.002 (col (2)). - Weak-identification (KP F-stat): 5.883 (col (1)); 12.774 (col (2)). - Weak-instrument (SW S-stat): 0.068 (col (1)); 0.155 (col (2)). - Hansen (p-value): 0.153 (col (1)); 0.326 (col (2)). - Interpretation: - Country-level results confirm firm-level findings that lower informality is associated with higher productivity. ### Firm-level informality, tax rates, and tax administration (Annex Table 2.6.3) - Dependent Variable: Percent of Total Sales Reported for Tax Purposes. - Key covariates and selected coefficients: - Age: 0.0338 (col (1)); 0.0599*** (col (2)); 0.0525** (col (3)); 0.0511** (col (4)); 0.0537** (col (5)). (Standard errors reported.) - Licensing/Permit Constraints: –1.640*** (col (1)); –0.904** (col (2)); –1.116** (col (3)); –1.079** (col (4)); –1.176** (col (5)). (Standard errors (0.543), (0.454), (0.453), (0.449), (0.473).) - Perception of Corruption as a Constraint: –0.292 (col (1)); –0.852** (col (2)); –0.753** (col (3)); –0.775** (col (4)); –0.734** (col (5)). (Standard errors (0.409), (0.363), (0.349), (0.349), (0.354).) - CIT × Small Firm interaction: –0.172 (col (1)); –0.458*** (col (2)); –0.316** (col (3)); –0.227* (col (4)); –0.221 (col (5)). (Standard errors (0.119), (0.167), (0.138), (0.116), (0.160).) - Tax administration interaction terms (columns report alternative admin characteristics): - CIT × Tax Administration Cost × Small Firm: 0.0714*** (col (1)). (Standard error (0.027).) - CIT × Functional Organization × Small Firm: 0.333** (col (2)). (Standard error (0.135).) - CIT × Integrated Tax and Customs Agency × Small Firm: 0.0913 (col (3)). (Standard error (0.056).) - CIT × Semi-Autonomous Revenue Agency × Small Firm: 0.102* (col (4)). (Standard error (0.053).) - CIT × Large Taxpayer Office × Small Firm: 0.0574 (col (5)). (Standard error (0.126).) - Sample and fit: - Number of Observations: 4,695 (col (1)); 8,993 (col (2)); 9,573 (col (3)); 9,675 (col (4)); 9,278 (col (5)). - R^2: 0.099 (col (1)); 0.167 (col (2)); 0.174 (col (3)); 0.175 (col (4)); 0.159 (col (5)). - Industry Fixed Effects: Y in all columns. - Country Fixed Effects: Y in all columns. - Interpretation: - Firm-level DID regressions show that a stronger tax administration can help offset the effect of a higher tax rate on the percentage of sales reported by small firms. ### Country-level informality, tax rates, and tax administration (Annex Table 2.6.4) - Dependent Variable: Noncontributors to Pensions at Country Level (log). - Selected coefficients: - GDP (log): –0.120*** (col (1)); –0.114*** (col (2)); –0.0935*** (col (3)); –0.0958*** (col (4)); –0.103*** (col (5)). (Standard errors reported.) - Population Size (log): 0.225*** (col (1)); 0.178*** (col (2)); 0.149*** (col (3)); 0.155*** (col (4)); 0.159*** (col (5)). (Standard errors reported.) - Log_CIT: 0.103 (col (1)); 0.231 (col (2)); 0.127 (col (3)); 0.0195 (col (4)); 0.266 (col (5)). (Standard errors reported.) - Integrated Tax and Customs Agency: –1.579** (col (3)). (Standard error (0.758).) - Log_CIT × Integrated Tax and Customs Agency: 0.456** (col (3)). (Standard error (0.221).) - Semiautonomous Revenue Agency: –1.355** (col (4)). (Standard error (0.535).) - Log_CIT × Semiautonomous Revenue Agency: 0.421*** (col (4)). (Standard error (0.160).) - Sample and fit: - Number of Countries: 47 (col (1)); 89 (col (2)); 100 (col (3)); 102 (col (4)); 93 (col (5)). - R^2: 0.486 (col (1)); 0.442 (col (2)); 0.460 (col (3)); 0.453 (col (4)); 0.545 (col (5)). - Interpretation: - Country-level results reiterate firm-level findings that a stronger tax administration can help reduce the incidence of informality. ### Tax compliance costs and firm labor productivity (Annex 2.7 and Table 2.7.1) - Concept: - Tax compliance costs include employee time and cost of professional advice spent to comply with taxation; these costs are especially burdensome for small firms and young businesses. - The Tax Administration Quality Index (TAQI) is measured on a scale of 0 to 4, with a higher score implying lower compliance costs. TAQI is constructed from TADAT across 33 dimensions grouped into four categories: supporting taxpayer information; filing and payment; postfiling processes; and accountability and transparency. - Empirical strategy: - Difference-in-differences approach exploiting the differential impact of TAQI on small and young firms versus larger/mature firms. - Two specifications: PROD = ... + β0 small + β1(small × TAQI) + ... and PROD = ... + β0 young + β1(young × TAQI) + .... - PROD is labor productivity (in logs). Small = 1 if fewer than 20 employees. Young = 1 if younger than seven years old (25th percentile of age distribution). - Main estimation results (Annex Table 2.7.1): - Baseline coefficients: - Small: –1.230*** (col (1)); –1.143*** (col (2)); –0.224*** (cols (3)–(5) variants). (Standard errors reported.) - Young: –0.163*** (col (1)); –0.134*** (col (2)); –0.199*** (col (3)); –0.498*** (col (4)); –0.412*** (col (5)). (Standard errors reported.) - Exporter: 0.330*** (col (1)); 0.307*** (col (2)); 0.374*** (col (3)); 0.323*** (col (4)); 0.305*** (col (5)). (Standard errors reported.) - Foreign: 0.308*** (col (1)); 0.326*** (col (2)); 0.365*** (col (3)); 0.310*** (col (4)); 0.323*** (col (5)). (Standard errors reported.) - Interaction terms: - Small × TAQI: 0.563*** (col (1)); 0.508*** (col (2)). (Standard errors (0.088) and (0.094).) - Small and Medium-Sized Enterprises × TAQI: 0.690*** (col (3)). (Standard error (0.118).) - Young × TAQI: 0.190*** (col (4)); 0.158** (col (5)). (Standard errors (0.065) and (0.064).) - Sample and fit: - Number of Observations: 11,354 in all reported columns. - R^2: 0.584 (col (1)); 0.598 (col (2)); 0.581 (col (3)); 0.580 (col (4)); 0.594 (col (5)); 0.579 (col (6) where applicable). - Number of Countries: 21 in reported specifications. - Number of Industries: 23 in reported specifications. - Quantitative interpretation (from text): - Based on specifications (2) and (5): For every one unit increase in the TAQI, labor productivity is 51 percent higher for small firms and 16 percent higher for young firms. - Specification (2) implies: In countries with a low TAQI score (25th percentile), productivity of small firms is about 40 percent of the productivity of larger firms; in countries with a high TAQI score (75th percentile), productivity differences between small and larger firms are much smaller. - Specification (5) implies: Productivity of young firms is only 75 percent of the productivity of mature firms in countries with a low TAQI score; productivity differences narrow substantially at higher TAQI scores. - Robustness: - Results robust to alternative definitions of small and young firms (e.g., small < 100 employees; young2 < 5 years), and to inclusion of interactions with governance and regulatory quality indicators. ### Antiavoidance legislation and investment by multinational firms (Annex 2.8) - Policy context: - Antiavoidance legislation, including transfer-pricing regulations (TPRs), aims to narrow gaps between effective tax rates of multinational and domestic firms and restrict profit shifting. - Unilateral introduction of TPRs raises the effective tax rate on multinational companies and could reduce multinational investment and employment, potentially lowering long-term domestic tax revenue and welfare. - Empirical strategy: - Difference-in-differences (DID) specification: - Investmenti,k,t = φi + χt + βtpr(MNCi * TPRk,t) + βX Xi,k,t + βZ Zk,t + εi,k,t (equation A2.8.1). - Dependent variable: gross investment scaled by book value of fixed capital assets in year t – 1; net investment used as an alternative. - Treatment indicator: TPRk,t = 1 after introduction of a TPR in host country k. - Treated group: multinational affiliates (MNCi = 1); control group: domestic company groups in the same host country. - Controls and fixed effects: - Firm fixed effects φi, time dummies χt, firm-level controls X (sales, cash flow per dollar of fixed assets, profitability, lagged sales growth), time-varying country characteristics Z (GDP per capita, population size, unemployment rate, governance and financial stability indices). - Specifications include statutory CIT rate or country-year fixed effects, industry-by-year interactions, and country-by-year interactions. - Data and scope: - Analysis focuses on TPRs recently introduced in 27 countries. - Expected sign: - βtpr expected to be negative if TPR introduction is associated with a reduction in multinational affiliate investment. - Identification considerations: - Firm fixed effects control for unobserved firm-specific and parent company characteristics and subsume host-country fixed effects. - Time dummies capture aggregate macro shocks (including global financial crisis). - Sensitivity analyses performed (details not reported in the excerpt). *Source: IMF staff calculations.* ### Annex Figure 2.8.1. Countries with Transfer-Pricing ### Annex Figure 2.8.1. Countries with Transfer-Pricing Regulations ### Data and methodology - Primary data set: an unbalanced panel of 130,062 companies in 27 countries for the years 2006–14. - Data constructed from unconsolidated financial statements of affiliates in the ORBIS database. - Definition of multinational affiliate: ultimate parent owns at least 50 percent of shares and is located in a foreign country. - Definition of domestic affiliate: ultimate parent owns at least 50 percent of shares, is located in the same country, and all other affiliates of its parent company are located in the same country. - Key explanatory variables and controls included firm-level non-tax determinants of investment, firm fixed effects, year fixed effects, and various country- and industry-level fixed effects in robustness checks. - MNC_complex is a dummy variable equal to 1 if the number of countries (or companies) in which a particular multinational company’s group operates is above the median number of countries (companies) in the sample. - Share of intangible assets defined as the average share of intangible fixed assets relative to total fixed assets for each firm. ### Main estimation results (Annex Table 2.8.1) - Coefficient on MNC_i × TPR_kt: - Column (1): –0.027*** (0.003) - Column (2): –0.024*** (0.003) - Column (3): –0.011*** (0.003) - Column (4): –0.010*** (0.003) - Column (5): –0.010*** (0.003) - Triple interaction with statutory tax rate (Column (6)): - MNC_i × TPR_kt × CIT_kt: –0.021*** (0.004) - Other reported coefficients (example covariates): - Log(Sales_t–1): –0.094*** (0.003); –0.096*** (0.003); –0.088*** (0.003); –0.088*** (0.003); –0.088*** (0.003) - Cash Flow per Dollar of Fixed Assets: 0.018*** (0.000) (repeated across columns) - Profitability_t–1: 0.076** (0.007); 0.072** (0.007); 0.065** (0.007); 0.064** (0.007); 0.064** (0.007); 0.016** (0.008) - Sales Growth Rate_t–1: 0.031*** (0.003); 0.029*** (0.003); 0.027*** (0.003); 0.027*** (0.003); 0.027*** (0.003); –0.013*** (0.003) - Number of observations and fit: - Number of Observations: 679,555 (Columns (1)–(5)); 492,087 (Column (6)) - R^2: 0.3170; 0.3180; 0.3240; 0.3250; 0.3250; 0.359 - Fixed effects included by column: - Firm Fixed Effects: Y in all columns - Year Fixed Effects: Y in all columns - Country-Year Fixed Effects: added in Column (3) onward - Industry-Year Fixed Effects: added in Column (4) onward - Country-Industry Fixed Effects: added in Column (5) onward - Note: Standard errors clustered by country and industry. CIT = corporate income tax; MNC = multinational company; TPR = transfer-pricing regulation. Significance: *p < 0.1; **p < 0.05; ***p < 0.01. ### Robustness and heterogeneity (Annex Table 2.8.2 and Annex Figure 2.8.2) - Annex Table 2.8.2 — Transfer-Pricing Regulations and Investments for Complex Multinationals: - Dependent variable: Investment per Dollar of Fixed Assets - Coefficients: - MNC_it × TPR_Kt: –0.005 (0.009) in column (1); –0.006 (0.008) in column (2) - MNC_it × TPR_Kt × MNC_Complex,it: –0.016* (0.008) in column (1); –0.017** (0.008) in column (2) - Number of Observations: 605,908 (both columns) - R^2: 0.2730 - Fixed effects: firm and year fixed effects; country-year, industry-year, and country-industry fixed effects indicated as used - Note: Standard errors clustered by country and industry. MNC = multinational company; TPF = transfer-pricing regulation. Significance: *p < 0.1; **p < 0.05; ***p < 0.01. - Annex Figure 2.8.2 — Estimated relationship with intangible assets: - Reported linear relationship: - Mean Effect = – 0.011 + 0.001 × Share of Intangible Assets - Visual scale shown from –1.2 to 0.6 (mean investment effect of transfer-pricing regulation, percent of fixed assets) and share of intangible assets axis from 0 to 15 in the figure context. ### Interpretation and quantitative implications - On average, introduction of transfer-pricing regulations would decrease investment as a percentage of fixed assets among multinational affiliates by 1–3 percentage points (as evidenced by the MNC × TPR coefficients across specifications). - Given that multinational affiliates invest about 30 cents per dollar of their fixed assets, this implies a reduction of 3–5 percent in multinational investment in response to the introduction of TPRs. - Heterogeneity: - The negative impact of TPRs on investment is mainly concentrated in large, more complex multinationals (see Annex Table 2.8.2 coefficients on MNC_Complex interaction). - The negative effect is smaller for multinationals with a higher share of intangible assets, consistent with the linear relationship Mean Effect = – 0.011 + 0.001 × Share of Intangible Assets reported in Annex Figure 2.8.2. - Policy-relevant insight: - TPRs have a moderate effect on multinational investment; this trade-off should be taken into account when evaluating the overall impact of antiavoidance provisions on tax revenues and national welfare. *Source: IMF staff calculations; figures and tables from Annex Figure 2.8.1 and related annex tables and figures in the provided content.* ### CHAPTER 2 UpGRAdING THE TAx SySTEM TO BOOST pROdUCTIVITy ### CHAPTER 2 UpGRAdING THE TAx SySTEM TO BOOST pROdUCTIVITy ### Country abbreviations - Country codes and names (selected examples as listed): - AFG Afghanistan - AGO Angola - ALB Albania - ARE United Arab Emirates - ARG Argentina - ARM Armenia - ATG Antigua and Barbuda - AUS Australia - AUT Austria - AZE Azerbaijan - BDI Burundi - BEL Belgium - BEN Benin - BFA Burkina Faso - BGD Bangladesh - BGR Bulgaria - BHR Bahrain - BHS Bahamas, The - BIH Bosnia and Herzegovina - BLR Belarus - BLZ Belize - BOL Bolivia - BRA Brazil - BRB Barbados - BRN Brunei Darussalam - BTN Bhutan - BWA Botswana - CAF Central African Republic - CAN Canada - CHE Switzerland - CHL Chile - CHN China - CIV Côte d’Ivoire - CMR Cameroon - COD Congo, Democratic Republic of the - COG Congo, Republic of - COL Colombia - COM Comoros - CPV Cabo Verde - CRI Costa Rica - CYP Cyprus - CZE Czech Republic - DEU Germany - DJI Djibouti - DMA Dominica - DNK Denmark - DOM Dominican Republic - DZA Algeria - ECU Ecuador - EGY Egypt - ERI Eritrea - ESP Spain - EST Estonia - ETH Ethiopia - FIN Finland - FJI Fiji - FRA France - FSM Micronesia, Federated States of - GAB Gabon - GBR United Kingdom - GEO Georgia - GHA Ghana - GIN Guinea - GMB Gambia, The - GNB Guinea-Bissau - GNQ Equatorial Guinea - GRC Greece - GRD Grenada - GTM Guatemala - GUY Guyana - HKG Hong Kong SAR - HND Honduras - HRV Croatia - HTI Haiti - HUN Hungary - IDN Indonesia - IND India - IRL Ireland - IRN Iran - IRQ Iraq - ISL Iceland - ISR Israel - ITA Italy - JAM Jamaica - JOR Jordan - JPN Japan - KAZ Kazakhstan - KEN Kenya - KGZ Kyrgyz Republic - KHM Cambodia - KIR Kiribati - KNA St. Kitts and Nevis - KOR Korea - KWT Kuwait - LAO Lao P.D.R. - LBN Lebanon - LBR Liberia - LBY Libya - LCA Saint Lucia - LKA Sri Lanka - LSO Lesotho - LTU Lithuania - LUX Luxembourg - LVA Latvia - MAR Morocco - MDA Moldova - MDG Madagascar - MDV Maldives - MEX Mexico - MHL Marshall Islands - MKD Macedonia, former Yugoslav Republic of - MLI Mali - MLT Malta - MMR Myanmar - MNE Montenegro - MNG Mongolia - MOZ Mozambique - MRT Mauritania - MUS Mauritius - MWI Malawi - MYS Malaysia - NAM Namibia - NER Niger - NGA Nigeria - NIC Nicaragua - NLD Netherlands - NOR Norway - NPL Nepal - NZL New Zealand - OMN Oman - PAK Pakistan - PAN Panama - PER Peru - PHL Philippines - PLW Palau - PNG Papua New Guinea - POL Poland - PRT Portugal - PRY Paraguay - QAT Qatar - ROU Romania - RUS Russia - RWA Rwanda - SAU Saudi Arabia - SDN Sudan - SEN Senegal - SGP Singapore - SLB Solomon Islands - SLE Sierra Leone - SLV El Salvador - SMR San Marino - SOM Somalia - SRB Serbia - STP São Tomé and Príncipe - SUR Suriname - SVK Slovak Republic - SVN Slovenia - SWE Sweden - SWZ Swaziland - SYC Seychelles - SYR Syria - TCD Chad - TGO Togo - THA Thailand - TJK Tajikistan - TKM Turkmenistan - TLS Timor-Leste - TON Tonga - TTO Trinidad and Tobago - TUN Tunisia - TUR Turkey - TUV Tuvalu - TWN Taiwan Province of China - TZA Tanzania - UGA Uganda - UKR Ukraine - URY Uruguay - USA United States - UZB Uzbekistan - VCT St. Vincent and the Grenadines - VEN Venezuela - VNM Vietnam - VUT Vanuatu - WSM Samoa - YEM Yemen - ZAF South Africa - ZMB Zambia - ZWE Zimbabwe ### Glossary — key fiscal and macro definitions - Active labor market policies: Policies that help unemployed people get back to work; they include job placement services, benefit administration, and labor market programs such as training and job creation. - Automatic stabilizers: Revenue and some expenditure items that adjust automatically to cyclical changes in the economy (example: as output falls, revenue collections decline and unemployment benefits increase). - Budget-neutral policies: Policies that keep a country’s fiscal deficit unchanged. - Contingent liabilities: Obligations not explicitly recorded on government balance sheets and that arise only in the event of a particular discrete situation, such as a crisis. - Countercyclical discretionary fiscal policy: Active changes in expenditure and tax policies to smooth the economic cycle (in contrast to automatic stabilizers). - Cyclically adjusted balance (CAB): Difference between the overall balance and the automatic stabilizers; equivalently, an estimate of the fiscal balance that would apply under current policies if output were equal to potential. - Cyclically adjusted primary balance (CAPB): Cyclically adjusted balance excluding net interest payments (interest expenditure minus interest revenue). - Effective lower bound: Level below which the monetary policy rate cannot be further lowered; may be negative or positive but is near zero. - Effective marginal tax rate: Tax burden applied to before-tax capital income realized over an investment’s lifetime, as implied by the major provisions of a country’s corporate tax code. - Expansionary fiscal policy: Discretionary fiscal policy that boosts domestic demand through tax cuts and/or higher government spending. - Fiscal buffer: Fiscal space created by saving budgetary resources and reducing public debt in good times. - Fiscal consolidation (also fiscal adjustment): Policies to reduce debt and debt accumulation though reductions in government spending and/or revenue-enhancing measures. - Fiscal multiplier: Measures the short-term impact of discretionary fiscal policy on output; usually defined as the ratio of a change in output to an exogenous change in the fiscal deficit with respect to their respective baselines. - Fiscal rule: Long-lasting constraint on fiscal policy through numerical limits on budgetary aggregates. - Fiscal space: See definition in Annex 1.1. - Fiscal stabilization: Contribution of fiscal policy to output stability through its impact on aggregate demand. - General government: All government units and all nonmarket, nonprofit institutions that are controlled and mainly financed by government units; comprises central, state, and local governments and includes social security funds. - Gini index: Measures income distribution inequality; 0 represents perfect equality, 1 implies perfect inequality. - Gross debt: All liabilities that require future payment of interest and/or principal by the debtor to the creditor; includes special drawing rights, currency, deposits, debt securities, loans, insurance, pension, standardized guarantee programs, and other accounts payable. - Labor tax wedge: Difference between the labor cost for an employer and the after-tax wage for an employee. - Net debt: Gross debt minus financial assets corresponding to debt instruments (monetary gold, special drawing rights, currency and deposits, debt securities, loans, insurance, pension, and standardized guarantee programs, and other accounts receivable). - Nonfinancial public sector: General government plus nonfinancial public corporations. - Output gap: Deviation of actual from potential GDP, in percent of potential GDP. - Overall fiscal balance (headline fiscal balance): Net lending and borrowing, defined as the difference between revenue and total expenditure, using the IMF’s 2001 Government Finance Statistics Manual (GFSM 2001). - Potential growth: Growth in potential output. - Potential output: Estimate of the level of GDP that can be reached if the economy’s resources are fully employed. - Primary balance: Overall balance excluding net interest payment (interest expenditure minus interest revenue). - Primary spending: Government expenditure excluding interest payments. - Procyclical discretionary fiscal policy: Fiscal policy that amplifies the economic cycle (example: raising taxes or cutting expenditures during a downturn). - Public debt: See gross debt. - Public sector: General government sector plus government-controlled entities (public corporations) engaging in commercial activities. - Resource misallocation: Poor distribution of resources across firms, reducing total output from existing capital and labor. - Structural fiscal balance: Extension of the cyclically adjusted balance that also corrects for other nonrecurrent effects beyond the cycle (one-off operations, asset and commodity prices, output composition effects). ### Methodological and statistical appendix — data, conventions, and country-specific notes - Appendix structure: - Four sections: “Data and Conventions”; “Fiscal Policy Assumptions”; “Definition and Coverage of Fiscal Data”; statistical tables A1 to A27. - Data in tables compiled on the basis of information available through April 6, 2017. - Data sources and compilation: - Country-specific data and projections for key fiscal variables are based on the April 2017 World Economic Outlook database, unless indicated otherwise, and compiled by IMF staff. - Historical data and projections are gathered by IMF country desk officers; structural breaks may be adjusted through splicing and other techniques. - IMF staff estimates serve as proxies when complete information is unavailable; Fiscal Monitor data can differ from official data and IMF’s International Financial Statistics. - Sources for fiscal data and projections not covered by the WEO database are listed in respective tables and figures. - Country classification and coverage: - World divided into three major groups: 35 advanced economies, 40 emerging market and middle-income economies, and 40 low-income developing countries. - Seven largest advanced economies by GDP (Canada, France, Germany, Italy, Japan, United Kingdom, United States) constitute the G7 subgroup. - Euro area members distinguished as a subgroup; composite data for the euro area cover current members for all years. - Low-income developing countries defined by PRGT eligibility review and per capita GNI less than $2,390 in 2011 (World Bank Atlas method); Zimbabwe included. - Emerging market and middle-income economies include those not classified as advanced or low-income developing. - Most fiscal data refer to general government for advanced economies; for emerging market and developing economies, data often refer to central government or budgetary central government only. - All fiscal data refer to calendar years except for Bangladesh, Egypt, Ethiopia, Haiti, Hong Kong SAR, India, Islamic Republic of Iran, Lao P.D.R., Myanmar, Nepal, Pakistan, Singapore, and Thailand (fiscal year). - Composite data for country groups are weighted averages of individual-country data, weighted by annual nominal GDP converted to U.S. dollars at average market exchange rates as a share of the group GDP. - G20 aggregate refers to the 19 country members and does not include the European Union. - Accounting frameworks: - In many countries, fiscal data follow the IMF’s 2001 Government Finance Statistics Manual (GFSM 2001). - Overall fiscal balance refers to net lending (+) and borrowing (–) of the general government; in some cases refers to total revenue and grants minus total expenditure and net lending. - The term “country” may cover territorial entities that are not states but whose statistical data are maintained separately. - Select country-specific notes (exact excerpts): - Argentina: Total expenditure and the overall balance account for cash interest only. The primary balance excludes profit transfers from the central bank of Argentina. Before 2016, interest expenditure is net of interest income from the social security fund. For CPI data, see the “Country Notes” section in the Statistical Appendix of the April 2017 World Economic Outlook. - Australia: For cross-country comparability, gross and net debt levels reported by national statistical agencies for countries that have adopted the 2008 System of National Accounts (2008 SNA) (Canada, Hong Kong Special Administrative Region, United States) are adjusted to exclude unfunded pension liabilities of government employees’ defined-benefit pension plans. - Bangladesh: Data are on a fiscal year basis. - Brazil: General government data refer to the nonfinancial public sector—which includes the federal, state, and local governments, as well as public enterprises (excluding Petrobras and Eletrobras)—and are consolidated with those for the sovereign wealth fund. Revenue and expenditures of federal public enterprises are added in full to the respective aggregates. Transfers and withdrawals from the sovereign wealth fund do not affect the primary balance. Disaggregated data on gross interest payments and interest receipts are available from 2003 only. Before 2003, total revenue of the general government excludes interest receipts; total expenditure of the general government includes net interest payments. Gross public debt includes the Treasury bills on the central bank’s balance sheet, including those not used under repurchase agreements. Net public debt consolidates general government and central bank debt. The national definition of nonfinancial public sector gross debt excludes government securities held by the central bank, except the stock of Treasury securities used for monetary policy purposes by the central bank (those pledged as security reverse repurchase agreement operations). According to this national definition, gross debt amounted to 69.9 percent of GDP at the end of 2016. - Canada: For cross-country comparability, gross and net debt levels reported by national statistical agencies for countries that have adopted the 2008 SNA (Australia, Hong Kong Special Administrative Region, United States) are adjusted to exclude unfunded pension liabilities of government employees’ defined-benefit pension plans. - Chile: Cyclically adjusted balances include adjustments for commodity price developments. - China: Public debt data include central government debt as reported by the Ministry of Finance, explicit local government debt, and shares—less than 19 percent, according to the National Audit Office estimate—of contingent liabilities the government may incur. IMF staff estimates exclude central government debt issued for the China Railway Corporation. Relative to the authorities’ definition, consolidated general government net borrowing includes (1) transfers to and from stabilization funds, (2) state-administered state-owned enterprise funds and social security contributions and expenses, and (3) off-budget spending by local governments. Deficit numbers do not include some expenditure items, mostly infrastructure investment financed off budget through land sales and local government financing vehicles. Fiscal balances are not consistent with reported debt because no time series of data in line with the National Audit Office debt definition is published officially. - Colombia: Gross public debt refers to the combined public sector, including Ecopetrol and excluding Banco de la República’s outstanding external debt. - Egypt: Data are on a fiscal year basis. - Greece: General government gross debt includes short-term debt and debt of state-owned enterprises. - Haiti: Data are on a fiscal year basis. - Hong Kong SAR: Data are on a fiscal year basis. Cyclically adjusted balances include adjustments for land revenue and investment income. For cross-country comparability, gross and net debt levels reported by national statistical agencies for countries that have adopted the 2008 SNA (Australia, Canada, United States) are adjusted to exclude unfunded pension liabilities of government employees’ defined-benefit pension plans. - India: Data are on a fiscal year basis. - Ireland: General government balances between 2010 and 2015 reflect the impact of banking sector support and other one-off measures. Fiscal balance estimates excluding these measures are –10.9 percent of GDP for 2010, –8.5 percent of GDP for 2011, –7.8 percent of GDP for 2012, –5.7 percent of GDP for 2013, –3.7 percent of GDP for 2014, and –1.0 percent of GDP for 2015. Cyclically adjusted balances reported in Tables A3 and A4 exclude financial sector support and other one-off measures. Ireland’s 2015 national accounts were recently revised as a result of restructuring and relocation of multinational companies, which resulted in a level shift of nominal and real GDP. - Japan: Gross debt is equal to total unconsolidated financial liabilities for the general government. Net debt is calculated by subtracting financial assets from financial liabilities for the general government. - Lao P.D.R.: Data are on a fiscal year basis. - Latvia: The fiscal deficit includes bank restructuring costs and thus is higher than the deficit in official statistics. - Libya: Reliability of Libya’s data, especially medium-term projections, is low due to civil war and weak capacities. - Madagascar: Using the latest available data on budget and project grants has led to a sizable upward revision of total central government revenue. From 2016, total revenue plus grants exceeds 14.5 percent of GDP over the forecast horizon. - Mexico: “General government” refers to the central government, social security, public enterprises, development banks, the national insurance corporation, and the National Infrastructure Fund, but excludes subnational governments. - Nigeria: Using the latest available data on interest payments, the general government overall balance would increase to 4.7 percent of GDP in 2016. This is consistent with the data published in the IMF Staff Report for the 2017 Article IV Consultation. - Norway: Cyclically adjusted balances correspond to the cyclically adjusted non-oil overall or primary balance. These variables are in percent of non-oil potential GDP. - Pakistan: Data are on a fiscal year basis. - Peru: Cyclically adjusted balances include adjustments for commodity price developments. - Singapore: Data are on a fiscal year basis. Historical fiscal data have been revised to reflect the migration to GFSM 2001, which entailed some classification changes. - Spain: Overall and primary balances include financial sector support measures estimated to be –0.1 percent of GDP for 2010, 0.3 percent of GDP for 2011, 3.7 percent of GDP for 2012, 0.3 percent of GDP for 2013, 0.1 percent of GDP for 2014, 0.0 percent of GDP for 2015, and 0.2 percent of GDP for 2016. - Sweden: Cyclically adjusted balances take into account output and employment gaps. - Switzerland: Data submissions at the cantonal and commune level are received with a long and variable lag and are subject to sizable revisions. Cyclically adjusted balances include adjustments for extraordinary operations related to the banking sector. - Thailand: Data are on a fiscal year basis. - Turkey: Information on the general government balance, primary balance, and cyclically adjusted primary balance differs from that in the authorities’ official statistics or country reports, which include net lending and privatization receipts. - United States: Cyclically adjusted balances exclude financial sector support estimated at 2.4 percent of potential GDP for 2009, 0.3 percent of potential GDP for 2010, 0.2 percent of potential GDP for 2011, 0.1 percent of potential GDP for 2012, and *International Monetary Fund | April 2017* ### 0.0 percent of potential GDP for 2013. For cross- ### fm1701 - 0.0 percent of potential GDP for 2013. For cross- ### Data and conventions - Historical data and projections of key fiscal aggregates are aligned with April 2017 World Economic Outlook unless noted otherwise. - For cross-country comparability, the United States’ expenditure and fiscal balances are adjusted to exclude: - the imputed interest on unfunded pension liabilities, and - the imputed compensation of employees, which are counted as expenditure under the 2008 SNA adopted by the United States but not in countries that have not yet adopted the 2008 SNA. - Gross and net debt levels reported by national statistical agencies for countries that have adopted the 2008 SNA (Australia, Canada, Hong Kong SAR, United States) are adjusted to exclude unfunded pension liabilities of government employees’ defined-benefit pension plans. - Historical data start at 2001 for most series because data compiled according to GFSM 2001 may not be available for earlier years. ### Fiscal policy assumptions and projection treatment - Short-term fiscal projections: - Based on officially announced budgets, adjusted for differences between national authorities and IMF staff regarding macroeconomic assumptions and projected fiscal outturns. - Medium-term fiscal projections: - Incorporate policy measures judged likely to be implemented. - If insufficient information on authorities’ intentions and implementation prospects, an unchanged structural primary balance is assumed (unless stated otherwise). - United States specific assumptions: - Fiscal projections are based on the January 2017 Congressional Budget Office baseline adjusted for IMF staff policy and macroeconomic assumptions. - Baseline incorporates key provisions of the Bipartisan Budget Act of 2015. - IMF staff assumes corporate and personal income tax cuts during 2017–19 cumulatively worth about 1.8 percent of 2017’s GDP. - Projections incorporate the Protecting Americans From Tax Hikes Act of 2015 and are converted to a general government basis. - Projections for many countries are explicitly tied to national budget documents and program forecasts (examples listed include Argentina, Australia, Brazil, Canada, China, Germany, India, Japan, Mexico, Saudi Arabia, United Kingdom, and many others). ### Country-specific coverage and notable adjustments (selected highlights) - Uruguay: - Data are for the consolidated public sector: nonfinancial public sector (as presented in authorities’ budget documentation), local governments, Banco Central del Uruguay, and Banco de Seguros del Estado. - Public debt includes the debt of the central bank, which increases recorded public sector gross debt. - Venezuela: - Fiscal accounts for 2010–22 correspond to budgetary central government and Petróleos de Venezuela S.A. (PDVSA). - Fiscal accounts before 2010 correspond to budgetary central government, public enterprises (including PDVSA), Instituto Venezolano de los Seguros Sociales (IVSS), and Fondo de Garantía de Depósitos y Protección Bancaria (FOGADE). - Projection complications: lack of recent Article IV consultations (last in 2004), long data intervals, information gaps, and estimated foreign exchange profits transferred from the central bank are included in revenue for 2016–22 IMF staff estimates. - Libya and Yemen: data reliability and projections are noted as low or heavily conditional because of conflict and capacity constraints (Libya: reliability low; Yemen: hydrocarbon projections use WEO price assumptions and authorities’ production projections; authorities use $55 a barrel). ### Coverage definitions and accounting practice (summary) - Coverage codes used throughout tables: - CG = central government; GG = general government; LG = local governments; SG = state governments; SS = social security funds; MPC = monetary public corporations; NFPC = nonfinancial public corporations; PS = public sector; NMPC = nonmonetary financial public corporations; BCG = budgetary central government; CPS = combined public sector; TG = territorial governments; NFPS = nonfinancial public sector. - Accounting practice codes: - C = cash; NC = noncash; “Other” used where different national conventions apply. - Valuation of debt reported as: - Nominal, Face, or Current market (definitions provided): - Nominal = nominal values. - Face = undiscounted principal to be repaid at (or before) maturity. - Current market = market prices for debt securities; other assets valued at equivalent market principles. ### Key fiscal aggregates and illustrative country-level figures (selected exact values from tables) - Advanced economies — General government overall balance (percent of GDP), Average series: - Average overall balance (Table A1): 2008 –3.5; 2009 –8.7; 2010 –7.6; 2011 –6.2; 2012 –5.4; 2013 –3.6; 2014 –3.1; 2015 –2.6; 2016 –2.9; 2017 –2.7; 2018 –2.7; 2019 –2.8; 2020 –2.7; 2021 –2.7; 2022 –2.7. - Advanced economies — General government primary balance (Table A2), Average: - Average primary balance: 2008 –1.9; 2009 –7.1; 2010 –5.9; 2011 –4.4; 2012 –3.6; 2013 –2.0; 2014 –1.5; 2015 –1.1; 2016 –1.4; 2017 –1.3; 2018 –1.2; 2019 –1.2; 2020 –1.0; 2021 –0.9; 2022 –0.7. - Advanced economies — Cyclically adjusted balance (percent of potential GDP), Average (Table A3): - Average cyclically adjusted balance: 2008 –4.0; 2009 –5.8; 2010 –6.6; 2011 –5.6; 2012 –4.4; 2013 –3.2; 2014 –2.7; 2015 –2.4; 2016 –2.6; 2017 –2.7; 2018 –2.8; 2019 –2.9; 2020 –2.8; 2021 –2.9; 2022 –2.9. - Advanced economies — Revenue and expenditure (percent of GDP), illustrative averages (Tables A5–A6): - Average revenue (Table A5): 2008 36.4; 2009 35.0; 2010 34.9; 2011 35.5; 2012 35.6; 2013 36.9; 2014 36.9; 2015 36.5; 2016 36.1; 2017 35.9; 2018 35.6; 2019 35.4; 2020 35.6; 2021 35.3; 2022 35.7. - Average expenditure (Table A6): 2008 39.9; 2009 43.7; 2010 42.6; 2011 41.7; 2012 41.0; 2013 40.5; 2014 40.5; 2015 40.1; 2016 39.0; 2017 38.6; 2018 38.3; 2019 38.2; 2020 38.3; 2021 38.3; 2022 38.4. - Advanced economies — Gross debt (percent of GDP), Average (Table A7): - Average gross debt: 2008 79.2; 2009 92.6; 2010 99.3; 2011 103.5; 2012 107.7; 2013 106.3; 2014 105.6; 2015 105.4; 2016 107.6; 2017 107.1; 2018 106.7; 2019 106.4; 2020 106.0; 2021 105.8; 2022 105.6. - Advanced economies — Gross financing need (selected countries, Table A23, 2017): - Japan: Maturing Debt 36.8; Budget Deficit 4.0; Total Financing Need 40.8. - United States: Maturing Debt 15.3; Budget Deficit 4.0; Total Financing Need 19.3. - Italy: Maturing Debt 14.1; Budget Deficit 2.4; Total Financing Need 16.5. - France: Maturing Debt 9.9; Budget Deficit 3.2; Total Financing Need 13.2. - Average (selected sample): Maturing Debt 13.8; Budget Deficit 2.9; Total Financing Need 16.6. - Emerging Market and Middle-Income economies — Average overall balance (Table A9): - Average overall balance: 2008 0.8; 2009 –3.7; 2010 –2.1; 2011 –1.0; 2012 –0.9; 2013 –1.4; 2014 –2.4; 2015 –4.4; 2016 –4.8; 2017 –4.4; 2018 –3.9; 2019 –3.5; 2020 –3.3; 2021 –3.2; 2022 –3.1. - Emerging Market and Middle-Income economies — Fiscal financing needs (selected countries, Table A24, 2017–18): - Argentina (2017): Maturing Debt 4.4; Budget Deficit 6.1; Total Financing Need 10.5. (2018): Maturing Debt 3.9; Budget Deficit 5.1; Total Financing Need 9.0. - Brazil (2017): Maturing Debt 8.3; Budget Deficit 9.1; Total Financing Need 17.4. (2018): Maturing Debt 13.0; Budget Deficit 7.5; Total Financing Need 20.5. - Egypt (2017): Maturing Debt 33.9; Budget Deficit 10.9; Total Financing Need 44.8. (2018): Maturing Debt 37.2; Budget Deficit 9.8; Total Financing Need 47.0. - Average across sample (Table A24): 2017 Maturing Debt 6.0; Budget Deficit 4.7; Total Financing Need 10.7. 2018 Maturing Debt 6.7; Budget Deficit 4.1; Total Financing Need 10.8. - Structural fiscal indicators (selected advanced-economy averages, Table A25): - Average projected Pension Spending Change, 2015–30: 0.9 (percent of GDP). - Average Net Present Value of Pension Spending Change, 2015–50: 22.7 (percent of GDP). - Average Gross Financing Need, 2017: 16.7 (percent of GDP). - Average Projected Interest Rate–Growth Differential, 2017–22: –1.0 (percent). - Average Precrisis Overall Balance, 2000–07: –2.2 (percent of GDP). - Average Projected Overall Balance, 2017–22: –2.7 (percent of GDP). - Average Nonresident Holding of General Government Debt, 2016: 37.4 (percent of total). ### Methodological notes and special treatments - Many tables distinguish between cash and noncash accounting practices and note when historical data are reported on different bases (e.g., Cyprus historical data until 2012 reported on an accrual basis because general government cash data were not available). - Several country notes indicate deviations from standard series (examples): - Brazil gross debt refers to the nonfinancial public sector, excluding Eletrobras and Petrobras, and includes sovereign debt held on the central bank balance sheet. - Mexico coverage uses PS (public sector) for overall balance and face valuation for gross debt. - Thailand data do not include the debt of specialized financial institutions (SFIs/NMPC) without government guarantee. - For cyclically adjusted series, the IMF follows the World Economic Outlook convention; cyclically adjusted primary balance defined as cyclically adjusted balance plus net interest payable/paid. - Valuation notes: - Face values are used in some country presentations where nominal or market values are not available; IMF cautions on comparability when face values are used. *Italic: Source — Fiscal Monitor: Achieving More with Less, Methodological and Statistical Appendix, International Monetary Fund | April 2017* ### Conclusion and Risk Assessment April 2012, Chapter 7 ### Conclusion and Risk Assessment April 2012, Chapter 7 ### Global outlook and risk balance - Global economic activity has accelerated since the second half of 2016; headline inflation has generally risen following a rebound in commodity prices; financial market sentiment has strengthened. - Global growth is expected to pick up further in 2017–18, reflecting a stronger-than-expected recovery in many advanced economies and projected higher growth in many emerging market and developing economies, including from improved conditions in several commodity exporters. - Growth momentum is still modest and downside risks continue to dominate, with heightened policy uncertainty and persistent structural headwinds. - The balance of risks remains tilted to the downside, especially over the medium term. ### Sources of downside risk and vulnerabilities - Advanced economies: output remains below potential and unemployment above precrisis levels in many countries; population aging, low labor productivity growth, and crisis legacies are weighing on growth potential. - Emerging market and developing economies: medium-term prospects are closely linked to developments in commodity markets, global financial conditions, the ongoing economic transition in China, and progress in resolving domestic imbalances and structural challenges in some economies. - Elevated political and policy uncertainties cited include faster-than-expected normalization of interest rates; a rollback of financial regulation that could spur excessive risk taking; and a potential rise in protectionist and inward-looking policies. - External negative spillovers for emerging market and developing economies: sudden reversal of market sentiment, sharp volatility in capital flows and exchange rates. ### Policy framework and recommendations - Use all policy tools at the national level and strengthen multilateral cooperative efforts to sustain a stronger recovery, ward off downside risks, safeguard gains in global integration and financial stability, and promote inclusion. - Need for comprehensive, consistent, and well-communicated policy actions to achieve strong, sustainable, and balanced growth; enhance resilience; and ensure benefits of economic integration and technological progress are shared more widely. - Fiscal policy principles: - Fiscal policy should be countercyclical, be growth friendly, and promote inclusion, anchored in a credible medium-term framework that ensures debt sustainability. - Depending on country-specific circumstances (economic slack, fiscal space, debt levels), policy choices range from discretionary fiscal support to budget recomposition and rebuilding of fiscal buffers. - Monetary policy: - Where core inflation is persistently low and/or the risk of deflation remains tangible, unconventional monetary policies remain appropriate to support economic activity and lift inflation expectations, while closely monitoring potential negative consequences on financial stability. - Structural policies and reforms: - Boost potential output through fiscal and structural reforms tailored to country-specific priorities: upgrade public infrastructure where needed; improve labor force participation and skills; eliminate product market distortions; reform corporate income taxation to promote private investment, research and development, and resource reallocation to productive areas. - Resist retreat from global economic integration. - Design inclusive fiscal policies (transfers and taxes) that balance redistribution with maintaining incentives to invest and work; improve education, training, health services, social insurance, and pension systems; consider active labor market policies as an effective short-term tool in some cases. ### Financial stability and market structure priorities - Solidifying improvements in financial stability and market expectations requires concerted efforts across countries. - United States: authorities should be vigilant to increases in leverage and deterioration in credit quality related to tax reform and financial deregulation and should take preemptive measures against excessive risk taking. - Europe: further efforts needed to adjust bank business models, facilitate disposal of nonperforming loans, and remove structural impediments to bank profitability. - China: pay special attention to rapid growth in assets among smaller banks, increasing reliance on wholesale funding, and close interconnections between shadow products and interbank markets. - At the global level, completing the regulatory reform agenda remains important; a rollback of regulatory standards should be resisted. ### Recommendations for emerging market and developing economies - Maintain sound policies and strong frameworks, including exchange rate flexibility and a robust macroprudential toolkit. - Capital flow management measures may be used temporarily as warranted, though not as a substitute for warranted macroeconomic adjustment. - Priorities include proactively monitoring vulnerabilities, addressing weaknesses in the corporate and banking sectors, improving corporate governance, reducing infrastructure bottlenecks and barriers to entry, developing a local investor base, fostering depth and liquidity in equity and bond markets, and upgrading the tax system to promote efficient use of resources. ### Low-income and commodity-exporting countries - Commodity-exporting low-income developing countries have faced a difficult adjustment process since the commodity cycle turned in 2014. - In light of rising debt and weaker external positions in several of these economies, intensified policy efforts are needed to mobilize revenue, improve tax administration, enhance spending efficiency, and contain the buildup of debt. - For many diversified countries, priorities are to build fiscal buffers while growth remains relatively strong and to achieve a better balance between meeting social and developmental needs and securing debt sustainability. - A common challenge across all low-income developing countries is to maintain progress toward attaining their sustainable development goals. ### Inclusiveness and labor income share - Technological progress appears to be the main factor explaining the decline in labor income share in advanced economies; trade integration seems to be the dominant driver in emerging market economies. - Policies should tackle adverse side effects of technological change and trade integration through inclusive fiscal policy design and improvements in education, training, health, social insurance, and pensions. *IMF Executive Board discussion remarks, conclusion of the Fiscal Monitor, Global Financial Stability Report, and World Economic Outlook on April 4, 2017.* --- _Source: https://www.imf.org/-/media/files/publications/fiscal-monitor/2017/april/pdf/fm1701.pdf_