## fmc1 - Introduction ## Source details **Canonical URL:** [fmc1 - Introduction](https://www.imf.org/-/media/files/publications/fiscal-monitor/2018/april/pdf/fmc1.pdf) ## Other formats - [Markdown version](/-/media/files/publications/fiscal-monitor/2018/april/pdf/fmc1.pdf.md) - [Structured JSON version](/-/media/files/publications/fiscal-monitor/2018/april/pdf/fmc1.pdf.json) --- ### Global debt levels and recent trends - Global debt reached the record peak of US$164 trillion in 2016, equivalent to 225 percent of global GDP. - The world is now 12 percent of GDP deeper in debt than the previous peak in 2009, with China as a driving force. - Public debt is a major contributor to the surge in global debt, with little improvement expected over the medium term. - Advanced economies: debt-to-GDP ratios have plateaued since 2012 above 105 percent of GDP and are expected to fall only marginally over the medium term. - Emerging market and middle-income economies: debt-to-GDP ratios in 2017 reached almost 50 percent and are expected to continue on an upward trend. - Low-income developing countries: average debt-to-GDP ratios exceeded 40 percent in 2017, climbing by more than 10 percentage points since 2012, and are not expected to decline much over the medium term. - Primary deficits underpin debt dynamics: large primary deficits are at their highest in decades for emerging market and developing economies; for advanced economies, there has been little improvement in primary balances since 2015. ### Why high government debt and deficits matter - Rollover risk and market access: - High government debt increases vulnerability to rollover risk because of large gross financing needs, particularly when maturities are short. - Market access could be disrupted if global financing conditions tighten abruptly or if investor sentiment shifts. - A high debt-to-GDP ratio could cause a spike in risk premiums if investors become skeptical about a country’s ability or willingness to pay. - Empirical evidence shows that in a number of countries debt is at or above levels at which fiscal crises occurred in the past. - Large unexpected shocks to public debt: - Across 179 episodes of debt spikes in 90 countries, the biggest driver was sudden increases in the stock of debt (realization of contingent liabilities, quasi-fiscal spending, correction of underreporting), not primary deficits, output contractions, or higher interest payments. - Fiscal risks can be highly correlated and tend to bunch during crisis periods. - Historical evidence (United States and United Kingdom as far back as 1790) shows infrequent but large negative shocks; optimal policy in normal times is to reduce debt ratios gradually and persistently. - Constraints on countercyclical policy: - High public debt limits the ability to conduct countercyclical policies, especially during financial crises. - Entering a financial crisis with a weak fiscal position worsens the depth and duration of the ensuing recession, particularly in emerging market economies. - Decline in output following a financial crisis is less than 1 percent when a country possesses monetary and fiscal policy space, but almost 10 percent when it has neither. - The fiscal stabilization coefficient (FISCO) tends to be lower in advanced economies with higher debt-to-GDP ratios, indicating less countercyclical fiscal policy where debt is high. - Potential drag on growth: - High government debt could crowd out private investment and create uncertainty about higher future distortionary taxation. - Empirical findings on debt thresholds are mixed; some studies find thresholds between 67 and 95 percent of GDP beyond which public debt lowers potential growth, while other studies find thresholds to be nonexistent or highly country-specific. ### Policy implications and recommendations - Immediate need for decisive action to strengthen fiscal buffers and take advantage of the broad-based pickup in economic activity. - Follow countercyclical fiscal policy in good times to build fiscal space for future downturns. - In economies operating at or near potential output and with high debt-to-GDP ratios: implement fiscal adjustment. - Where output gaps remain and fiscal space is constrained: continue consolidation efforts; fiscal expansions without a sufficiently high growth dividend could exacerbate fiscal risks. - For a few advanced economies with ample fiscal space and close to capacity: fiscal policy can facilitate structural reforms to boost potential growth and help narrow unduly large current account surpluses. - Commodity exporters: continue to adjust spending to align with medium-term revenue prospects despite partial recovery in commodity prices. - Low-income countries: make room in budgets to implement infrastructure plans by mobilizing revenues, rationalizing spending, and improving spending efficiency. - All countries should pursue growth-friendly fiscal adjustment: - Focus on structural fiscal measures that raise medium- to long-term growth by incentivizing human and physical capital accumulation and raising productivity. - Avoid declines in public investment; seek efficiency gains in spending and rationalize entitlements to make room for public investment, incentives for labor market participation, and improvements in education and health. - Emerging market and developing economies: prioritize revenue mobilization to finance critical investment and social spending. - Address excessive inequality through better-targeted transfers, more progressive tax systems, and greater access to quality education and health care, tailored to country-specific circumstances. - Allow automatic stabilizers to operate fully and aim to put deficits and debt firmly on a downward path toward medium-term targets. - Calibrate the size and pace of adjustment to country cyclical conditions and available fiscal space to avoid dragging on growth; base adjustment on policies that raise medium-term growth. ### Recent developments and outlook: High debt is of concern - A large number of countries have high debt-to-GDP ratios relative to IMF debt sustainability critical thresholds. - In 2017: - More than one-third of advanced economies had debt above 85 percent of GDP, three times more countries than in 2000. - One-fifth of emerging market and middle-income economies had debt above 70 percent of GDP. - One-fifth of low-income developing countries had debt above 60 percent of GDP, compared with almost none in 2012. - Several low-income developing countries now have debt-to-GDP levels close to those seen when debt relief was decided under the Heavily Indebted Poor Countries (HIPC) initiative. - A few countries are already facing debt default or restructuring (Chad, Republic of Congo, Mozambique, Sudan). - When implicit liabilities linked to pension and health care spending are included, average debt-to-GDP ratios double to 204 percent among advanced economies. *International Monetary Fund | April 2018* ### Global and regional gross debt levels and projections (General Government, percent of GDP) - World gross debt: 2012 = 79.8; 2013 = 78.5; 2014 = 78.8; 2015 = 80.0; 2016 = 83.1; 2017 = 82.4; 2018 = 82.1; 2019 = 81.9; 2020 = 81.6; 2021 = 81.3; 2022 = 81.0; 2023 = 80.6. - Advanced Economies gross debt: 2012 = 106.7; 2013 = 105.4; 2014 = 104.8; 2015 = 104.4; 2016 = 106.9; 2017 = 105.4; 2018 = 103.9; 2019 = 103.1; 2020 = 102.4; 2021 = 101.7; 2022 = 101.2; 2023 = 100.4. - Emerging Market and Middle-Income Economies gross debt: 2012 = 37.4; 2013 = 38.6; 2014 = 40.7; 2015 = 44.0; 2016 = 47.0; 2017 = 49.0; 2018 = 51.2; 2019 = 52.9; 2020 = 54.3; 2021 = 55.6; 2022 = 56.7; 2023 = 57.6. - Low-Income Developing Countries gross debt: 2012 = 31.1; 2013 = 31.5; 2014 = 31.8; 2015 = 38.0; 2016 = 40.8; 2017 = 44.3; 2018 = 45.5; 2019 = 44.9; 2020 = 44.1; 2021 = 43.5; 2022 = 42.8; 2023 = 41.9. ### Debt sustainability risks and interest burdens - Interest payments among low-income developing countries (2017): interest payments reached 18 percent of tax revenue and 9 percent of total expenditure. - Country examples: Ghana and Nigeria have seen interest-to-tax revenue ratios climb to more than 30 percent in 2017. - IMF’s Debt Sustainability Analysis critical thresholds: 85 percent of GDP for advanced economies and 70 percent of GDP for emerging market economies. - Joint World Bank–IMF Debt Sustainability Framework for Low-Income Countries critical thresholds: 49, 62, and 75 percent of GDP depending on institutional quality. - Figure-based finding: A large number of countries have debt-to-GDP ratios above critical levels. ### Composition of debt and exposure to financing and exchange rate risk - Low-income developing countries: share of nonconcessional financing reached 46 percent of total debt in 2016. - External commercial borrowing (including commodity traders) and instruments such as Eurobonds and syndicated loans have grown quickly from a low base. - Foreign-currency-denominated general government debt (2017): about one-third of general government debt in emerging market and middle-income economies; about two-thirds in low-income developing countries. - Risks amplified: increased refinancing risk from shorter maturities and grace periods of nonconcessional instruments; risk of capital-flow reversal from nonresident participation in domestic debt markets; vulnerability of first-time and lower-rated issuers. ### Debt management and market developments - Average term to maturity (ATM) of outstanding debt (number of years): - High Income weighted ATMM: 2009 = 5.8; 2017 = 7.2. - Median ATM: 2009 = 5.6; 2017 = 7.3. - Since 2009, average maturities have risen by 1.4 years in high-income countries and close to 1 year for emerging market and developing economies. - Ultra-long government bonds (more than 30 years): among OECD countries, annual volume of ultra-long bond sales tripled and the number of issues doubled between 2006 and 2016; outstanding stock of ultra-long bonds comprised 9 percent of central government marketable debt in OECD countries as of December 2016. - Some policymakers have chosen not to aggressively raise average maturity to avoid upward pressure on long-term rates for the private sector and to take advantage of negative bond yields at the shorter end of the yield curve. - Deepening of local bond markets in some emerging markets has reduced potential risk of capital-flow reversals. ### Gross financing needs and IMF cautionary thresholds - IMF Debt Sustainability Analysis flags: gross financing needs above 20 percent of GDP for advanced economies and above 15 percent of GDP for emerging market economies are areas of concern. - Selected averages: Selected advanced economies average total financing need (2018) = 18.4 percent of GDP; selected emerging market and middle-income economies average total financing need (2018) = 9.5 percent of GDP. ### Fiscal stance and deficits in advanced economies - Fiscal stance in advanced economies (2017): broadly neutral; overall deficits remained unchanged at 2.6 percent of GDP on average. - Advanced economies overall deficits (percent of GDP): 2017 = –2.6; projections: 2018 = –2.7; 2019 = –2.8; 2020 = –2.4; 2021 = –2.3; 2022 = –2.3; 2023 = –2.0. - United States overall balance (percent of GDP): 2012 = –7.9; 2017 = –4.6; 2018 = –5.3; 2019 = –5.9; 2020 = –5.5; 2021 = –5.5; 2022 = –5.4; 2023 = –5.0. - Japan overall balance (percent of GDP): 2012 = –8.6; 2017 = –4.2; 2018 = –3.4; 2019 = –2.8; 2020 = –2.2; 2021 = –2.1; 2022 = –2.0; 2023 = –2.0. - Since 2012 overall deficits have fallen via policy action, cyclical gains, and lower interest payments, though less so since 2014. Spending has declined by 1.6 percent of GDP on average since 2012; revenues improved by 0.7 percentage point on average, largely from cyclical gains. ### Fiscal outlook and debt trajectory in advanced economies - Fiscal stance expected to be mildly expansionary in 2018 and 2019, followed by gradual adjustment in outer years. - Debt in advanced economies is set to decline only marginally, to about 100 percent of GDP by 2023. - The small reduction in debt is achieved mainly thanks to higher projected inflation (from low levels). ### Advanced Economies: fiscal and investment notes, United States outlook - Several advanced economies intend to remain expansionary in the near term (Germany, United States); some plan gradual consolidation (Japan, United Kingdom); a few expect a neutral stance in 2018, resuming consolidation later (Canada, Italy). - United States fiscal outlook: - Increase in spending authority by US$150 billion (0.7 percent of GDP) per year for the next two years. - Lower corporate and personal income tax rates will give rise to overall deficits in excess of US$1 trillion over the next three years (above 5 percent of GDP). - Government debt projected to increase to 117 percent of GDP by 2023. - Part of the expansion expected to be unwound when certain provisions expire: full expensing of equipment in 2023 and personal income tax cuts in 2025. - Near-term growth in the United States is expected to strengthen with some short-term positive spillovers on trading partners’ growth. - Investment and spending patterns in advanced economies: - Investment spending has been insufficient to offset depreciation (net investment negative in several countries). - Change in total expenditure, 2012–17: investment declined by –0.98 percent of GDP. - Distributional effects of U.S. tax reform (stylized model results): - All income groups would benefit, with those in the top quintile gaining the most, followed by those in the lower quintile. - The middle’s increase in consumption is substantially outpaced by increases at the top and bottom, potentially contributing to hollowing out of the middle of the income distribution. ### Emerging Market and Middle-Income Economies: recent progress and gaps - Aggregate fiscal change: - Overall fiscal deficits fell marginally in 2017 for emerging market and middle-income economies, from 4.8 percent of GDP in 2016 to 4.4 percent of GDP in 2017. - Diverging country developments: commodity exporters improved headline balances; major non–commodity exporters relaxed fiscal positions to provide stimulus (China, India, Thailand). - China’s rising fiscal deficits (including off-budget spending) largely drive the average trend. - Revenue and spending trends, 2012–17: - Tax-to-GDP ratios have been declining among non–commodity exporters since 2012 by 1 percentage point of GDP. - 40 percent of emerging market and middle-income economies continue to have tax-to-GDP ratios below 15 percent. - All expenditure categories have been rising as a share of GDP on average across all countries, except investment spending which remained flat. - Medium-term outlook and policy directions: - For 2018 and over the medium term, spending restraint is expected to keep deficits in check; countries aim to contain current expenditure growth below nominal GDP growth, including the wage bill. - Investment spending expected to increase slightly for non–commodity exporters, but to continue contracting for commodity exporters. - Total revenues expected to decline slightly in the forecast period: small improvement in tax revenue (less than ½ percent of GDP) will not offset deterioration in nontax revenue from moderating oil prices. - Expected improvement in overall balances will be insufficient to stabilize debt for many countries. - Selected country highlights: - Brazil: overall deficit declined from 9.0 to 7.8 percent of GDP in 2017. - China: on-budget deficit rose to 4 percent of GDP in 2017. - India: federal consolidation paused in fiscal year 2017/18. - Mexico: overall deficit cut to 1.1 percent of GDP in 2017. - Russia: overall deficit projected to have fallen by over 2 percentage points to 1.5 percent of GDP in 2017. - Saudi Arabia: overall deficit reduced from over 17 percent of GDP in 2016 to 9 percent in 2017; driven by non–oil revenue measures and spending cuts close to 2.5 percent of GDP largely in capital expenditures. ### Low-Income Developing Countries (LIDCs): vulnerabilities and debt dynamics - Average fiscal outcomes: - Overall fiscal deficits broadly unchanged at 4.3 percent of GDP on average. - Deficits deteriorated among commodity exporters despite commodity price improvements. - Spending composition and investment: - Commodity exporters implemented cuts to both current and capital expenditure; public wage bill remained flat as a percentage of GDP. - Non–commodity exporters let spending drift upward across most items, except investment spending which remained unchanged. - Some countries increased education spending, though this accounted for a relatively small share of spending increases. - Revenue mobilization: - Limited progress in mobilizing revenue; tax-revenue-to-GDP ratios in half of low-income developing countries still below 15 percent. - Debt dynamics and distress: - Debt-to-GDP increased by 13 percentage points on average since 2012, reaching 44 percent of GDP in 2017. - Debt was rising in about two-thirds of low-income developing countries in 2017. - Drivers of rising debt since 2012: deteriorating primary deficits and rising interest burdens; other contributors included exchange rate depreciations (Côte d’Ivoire, Senegal, Zambia), financial sector bailouts (Moldova), and reporting of previously undisclosed debt (Republic of Congo, Mozambique). - In 2017, eight countries were classified as in debt distress. - Country-level examples: - Indonesia: overall deficit remained at 2.5 percent of GDP in 2017; spending rebalanced toward education, health, and social protection; improved efficiency in energy subsidy targeting. - Thailand: overall balance weakened by slightly over 1 percent of GDP in 2017 as sales of licenses and income tax revenues declined. ### Fiscal outcomes and projections (2000–23) - Spending control is expected to help bring fiscal deficits down in 2018 and over the medium term. - Overall deficits would decline by close to 1 percent of GDP between 2018 and 2023. - Medium-term revenue forecasts for commodity exporters are disappointing: an expected pickup in commodity revenues in 2018 is projected to moderate over the medium term, with little improvement envisaged in tax mobilization. - Some non–commodity exporters are expected to expand tax collection by about 1 percent of GDP or more over the next five years (Ethiopia, Uganda). - Debt buildup is expected to slow moderately over the medium term: - The average debt ratio is projected to stabilize in 2018 at about 45 percent of GDP and then to start declining slightly. - Narrowing deficits contribute to declining debt in about one-third of the countries (Cameroon, Ghana, Kenya). ### Vulnerabilities observed (LIDCs) - For countries in debt distress: - The average effective interest rate has risen by about 100 basis points since 2014. - Interest payments to tax revenue ratios have risen by over 12 percentage points since 2014. - Government debt to GDP has risen among low-income developing countries to unprecedented levels since the global financial crisis. ### Risks to the fiscal outlook - Near-term risks appear broadly balanced because of the economic upswing; upside: stronger cyclical recovery and higher commodity prices. - Key downside risks: - A sudden tightening in global financial conditions (faster-than-expected increase in global interest rates) would add to public debt burdens and could disrupt market access. - Divergence in monetary policy rates or shifts in investors’ risk appetite could appreciate the US dollar and strain countries with foreign currency debt. - Large depreciation or correction in asset prices could strain private sector balance sheets and materialize contingent liabilities. - Global policy uncertainty and difficulties implementing consolidation policies may undermine market confidence. - A slowdown in potential growth would raise debt-to-GDP ratios and add to debt via weaker primary balances. - Uncertainty in oil prices: oil exporters could face significant revenue drops; in countries with administered fuel prices, lower oil prices would reduce subsidies and support fiscal positions. - Long-term demographic changes and aging populations pose fiscal sustainability challenges (examples cited: Germany, Japan, Korea, United States). ### Policy guidance: saving for a rainy day and enhancing resilience - The ongoing recovery presents an opportunity to rebuild fiscal buffers and raise potential growth: - Allow automatic stabilizers to operate fully. - Make concerted efforts to bring deficits and debt toward medium-term targets. - Tailor the size and pace of adjustment to country-specific circumstances, cyclical conditions, and available fiscal space. ### Country and group-specific recommendations (selection) - Advanced economies: turn to consolidation over the medium term, with near-term support where needed. - United States: recalibrate fiscal policy to ensure government debt-to-GDP declines over the medium term by mobilizing higher revenues and gradually curbing public spending dynamics while shifting composition toward infrastructure investment. - United Kingdom: pursue steady but gradual fiscal consolidation with greater reliance on revenue measures. - Belgium: continue fiscal consolidation with efficiency-oriented spending reforms. - Ireland: potential need to accelerate consolidation to rebuild buffers as capacity is approached. - Spain: consolidation of the structural primary balance of about 0.5 percent of GDP is advisable for 2018. - France: reduce public spending as a share of GDP (wage bill and local government spending), improve efficiency, and create room to reduce taxes. - Italy: start credible and ambitious fiscal consolidation: cut current primary spending while supporting the vulnerable, raise capital spending, lower tax rates on productive factors, shift taxation toward wealth/property/consumption, and broaden the tax base. - Germany and Netherlands: use fiscal space to support medium-term growth via public investment, education, research and development, childcare, and tax burden relief on labor. - Korea: reduce the structural balance toward zero by at least 0.5 percentage point a year during the coming years; estimated to increase growth by 0.2 percentage point each year (IMF 2017d). - Japan: avoid a premature drop in fiscal support while anchoring the debt trajectory with a credible medium-term consolidation plan. - Emerging market and developing economies: focus on consolidation, especially where adjusting to lower commodity prices; speed can be fine-tuned. - Brazil: quicken the pace of consolidation and front-load the fiscal effort. - Argentina: primary deficit targets for 2018–20 are on the right track; a faster pace of deficit reduction would reduce financing needs and support disinflation. - Turkey: implement stronger, front-loaded fiscal consolidation by rationalizing untargeted transfers, containing wage bill increases and subsidies, and cutting discretionary investment incentives. - India: return to gradual, growth-friendly fiscal consolidation; full and smooth implementation of the new goods and services tax is necessary. - China: consolidation of 0.5 percent of GDP a year of the “augmented” deficit is necessary over the medium term and recompose spending away from infrastructure investment toward health, education, and social security. - Commodity exporters: do not let commodity price pickup derail rebuilding fiscal buffers. - Angola: medium-term non-oil primary balance needs to improve by at least 4.5 percent of GDP to put public debt firmly on a downward path. - Mongolia: 2018 budget commitment to save any revenue overperformance will help avoid repeat overborrowing. - Nigeria: front-load non-oil revenue mobilization while increasing public investment to raise growth and reduce the ratio of interest payments to federal government revenue. - CEMAC members: advance steadfast fiscal adjustment, increase non-oil revenues, and ensure sufficient financing to smooth adjustment path. - Non–commodity exporting low-income developing countries: retain focus on addressing fiscal vulnerabilities (examples: Ethiopia, Ghana, Tajikistan). - Sudan: deficit reduction could support disinflation by reducing central bank direct budget financing. - Vietnam: better identify concrete measures where consolidation paths have been planned. - Guinea, Tanzania: mobilize revenues, rationalize spending, and improve investment spending efficiency to create fiscal space for infrastructure plans. - Countries with fiscal space: - Saudi Arabia: appropriately slow projected budgetary retrenchment starting in 2018 to smooth economic activity. - Malaysia: proceed gradually with consolidation; prioritize revenue measures including broadening the tax base and raising the tax rate on goods and services. ### Structural fiscal policies and tax reforms to boost growth - Adjustment strategies should center on structural fiscal policies that strengthen medium-term growth prospects, reducing volatility and facilitating productivity-enhancing structural reforms. - Tax system upgrades to make firm decisions tax-neutral: - Focus on reducing distortionary taxes, cutting inefficient tax expenditures, better targeting tax incentives, and lowering burdensome tax administration practices. - Evidence indicates budget-neutral changes in tax structure can support stronger growth. - Measures that broaden tax bases (e.g., limiting interest deduction, preferential tax rates and relief) can raise significant tax revenues without negative medium-term growth impacts. - Advanced economies: opportunities to make tax systems more growth friendly: - United States: expand eligibility/generosity of the earned income tax credit; consider federal-level consumption tax, broad-based carbon tax, and higher federal gas tax. - France: complement labor, corporate income, and capital tax cuts and wealth tax narrowing with reforms removing threshold effects for small businesses. - Italy, Spain, United Kingdom: reducing VAT gaps would remove distortions and create room for growth-friendly spending. - VAT compliance: - Even among advanced economies there is room to improve VAT compliance. ### European Union: VAT compliance and policy gaps (2015) - VAT compliance and policy gaps measured as: - "Percent of potential revenue". - "Percent of GDP". - Key findings: - "Many countries have room to raise revenues by narrowing VAT compliance and policy gaps." - Revenue mobilization is crucial for continued progress by low-income developing countries toward their 2030 Sustainable Development Goals. - Recommended actions: - Improving tax administration. - Broadening the tax base. - Improving collection from non–commodity taxes. - Using a well-designed Medium-Term Revenue Strategy (MTRS) as a road map. - Country examples: - Indonesia: working toward putting in place an MTRS aimed at raising revenue by at least 3 percentage points over the medium term by streamlining tax administration, removing exemptions to VAT and income taxes, and introducing excise taxes on vehicles and fuel. - Papua New Guinea: an MTRS will aim at rebalancing the tax mix, broadening the tax base, and, in the short-term, introducing new excise rates and undertaking administrative initiatives to strengthen revenue institutions. - Digitalization: - Digital technologies can improve tax compliance and enforcement by improving access to taxpayer data, monitoring revenue collection in real time, performing audits, and identifying anomalous taxpayer behavior. - Caution: "digitalization may also create new fraud opportunities, for example, the use of cryptocurrencies to accumulate wealth outside the reach of tax authorities or digital identity theft to illegally claim benefits." ### Box 1.2 — The Distributional Effects of Income Tax Cuts in the United States - Modeled policy changes: - Corporate income tax (CIT) statutory federal rate cut from 35 percent to 21 percent. - Reduction in effective CIT rate approximated using the 1986 reform experience (statutory rates 48 percent to 35 percent) corresponding to a decline of about 4 percentage points in the effective CIT rate. - Financing assumption for permanent revenue loss: - Optimistic assumption that revenue losses can be offset by cuts to unproductive government spending to keep the government deficit unchanged. - Empirical input: - Static costing by the Joint Committee on Taxation points to revenue losses from the TCJA of about US$1.5 trillion over 10 years; these values were used as inputs for the WEO forecasts. - Key distributional findings: - Top quintile: increase in consumption highest; reform is regressive in that sense. - Lower quintiles: model suggests they also benefit via higher labor demand and wages in services; contrasts with static estimates from other institutions. - Middle quintile: benefits the least; capital substitution effects reduce gains. - Inequality: Gini coefficient estimated to remain constant; polarization (hollowing out of the middle) deepens because the middle gains less than top and bottom. - Sensitivity to alternative fiscal consolidation paths: - Regressive expenditure cuts would wipe out gains for the three bottom quintiles. - Introduction of a value-added tax to offset revenue losses would lower gains for all income groups, particularly middle and bottom. - No offsetting action (higher deficits and market financing) could push interest rates higher, hurting growth and all income groups. - Policy implication: - The United States would need to address the revenue losses from the reform with a careful mix of spending and tax measures. *International Monetary Fund | April 2018* ### Introduction ### fmc1 - Introduction ### Global debt levels and recent trends - Global debt reached the record peak of US$164 trillion in 2016, equivalent to 225 percent of global GDP. - The world is now 12 percent of GDP deeper in debt than the previous peak in 2009, with China as a driving force. - Public debt is a major contributor to the surge in global debt, with little improvement expected over the medium term. - Advanced economies: debt-to-GDP ratios have plateaued since 2012 above 105 percent of GDP and are expected to fall only marginally over the medium term. - Emerging market and middle-income economies: debt-to-GDP ratios in 2017 reached almost 50 percent and are expected to continue on an upward trend. - Low-income developing countries: average debt-to-GDP ratios exceeded 40 percent in 2017, climbing by more than 10 percentage points since 2012, and are not expected to decline much over the medium term. - Primary deficits underpin debt dynamics: large primary deficits are at their highest in decades for emerging market and developing economies; for advanced economies, there has been little improvement in primary balances since 2015. ### Why high government debt and deficits matter - Rollover risk and market access: - High government debt increases vulnerability to rollover risk because of large gross financing needs, particularly when maturities are short. - Market access could be disrupted if global financing conditions tighten abruptly or if investor sentiment shifts. - A high debt-to-GDP ratio could cause a spike in risk premiums if investors become skeptical about a country’s ability or willingness to pay. - Empirical evidence shows that in a number of countries debt is at or above levels at which fiscal crises occurred in the past. - Large unexpected shocks to public debt: - Across 179 episodes of debt spikes in 90 countries, the biggest driver was sudden increases in the stock of debt (realization of contingent liabilities, quasi-fiscal spending, correction of underreporting), not primary deficits, output contractions, or higher interest payments. - Fiscal risks can be highly correlated and tend to bunch during crisis periods. - Historical evidence (United States and United Kingdom as far back as 1790) shows infrequent but large negative shocks; optimal policy in normal times is to reduce debt ratios gradually and persistently. - Constraints on countercyclical policy: - High public debt limits the ability to conduct countercyclical policies, especially during financial crises. - Entering a financial crisis with a weak fiscal position worsens the depth and duration of the ensuing recession, particularly in emerging market economies. - Decline in output following a financial crisis is less than 1 percent when a country possesses monetary and fiscal policy space, but almost 10 percent when it has neither. - The fiscal stabilization coefficient (FISCO) tends to be lower in advanced economies with higher debt-to-GDP ratios, indicating less countercyclical fiscal policy where debt is high. - Potential drag on growth: - High government debt could crowd out private investment and create uncertainty about higher future distortionary taxation. - Empirical findings on debt thresholds are mixed; some studies find thresholds between 67 and 95 percent of GDP beyond which public debt lowers potential growth, while other studies find thresholds to be nonexistent or highly country-specific. ### Policy implications and recommendations - Immediate need for decisive action to strengthen fiscal buffers and take advantage of the broad-based pickup in economic activity. - Follow countercyclical fiscal policy in good times to build fiscal space for future downturns. - In economies operating at or near potential output and with high debt-to-GDP ratios: implement fiscal adjustment. - Where output gaps remain and fiscal space is constrained: continue consolidation efforts; fiscal expansions without a sufficiently high growth dividend could exacerbate fiscal risks. - For a few advanced economies with ample fiscal space and close to capacity: fiscal policy can facilitate structural reforms to boost potential growth and help narrow unduly large current account surpluses. - Commodity exporters: continue to adjust spending to align with medium-term revenue prospects despite partial recovery in commodity prices. - Low-income countries: make room in budgets to implement infrastructure plans by mobilizing revenues, rationalizing spending, and improving spending efficiency. - All countries should pursue growth-friendly fiscal adjustment: - Focus on structural fiscal measures that raise medium- to long-term growth by incentivizing human and physical capital accumulation and raising productivity. - Avoid declines in public investment; seek efficiency gains in spending and rationalize entitlements to make room for public investment, incentives for labor market participation, and improvements in education and health. - Emerging market and developing economies: prioritize revenue mobilization to finance critical investment and social spending. - Address excessive inequality through better-targeted transfers, more progressive tax systems, and greater access to quality education and health care, tailored to country-specific circumstances. - Allow automatic stabilizers to operate fully and aim to put deficits and debt firmly on a downward path toward medium-term targets. - Calibrate the size and pace of adjustment to country cyclical conditions and available fiscal space to avoid dragging on growth; base adjustment on policies that raise medium-term growth. ### Recent developments and outlook: High debt is of concern - A large number of countries have high debt-to-GDP ratios relative to IMF debt sustainability critical thresholds. - In 2017: - More than one-third of advanced economies had debt above 85 percent of GDP, three times more countries than in 2000. - One-fifth of emerging market and middle-income economies had debt above 70 percent of GDP. - One-fifth of low-income developing countries had debt above 60 percent of GDP, compared with almost none in 2012. - Several low-income developing countries now have debt-to-GDP levels close to those seen when debt relief was decided under the Heavily Indebted Poor Countries (HIPC) initiative. - A few countries are already facing debt default or restructuring (Chad, Republic of Congo, Mozambique, Sudan). - When implicit liabilities linked to pension and health care spending are included, average debt-to-GDP ratios double to 204 percent among advanced economies. _International Monetary Fund | April 2018_ ### CHAPTER 1 SAvINg FOR A RAINy dAy ### CHAPTER 1 SAvINg FOR A RAINy dAy ### Global and regional gross debt levels and projections - World gross debt (General Government, percent of GDP): 2012 = 79.8; 2013 = 78.5; 2014 = 78.8; 2015 = 80.0; 2016 = 83.1; 2017 = 82.4; 2018 = 82.1; 2019 = 81.9; 2020 = 81.6; 2021 = 81.3; 2022 = 81.0; 2023 = 80.6. - Advanced Economies gross debt (percent of GDP): 2012 = 106.7; 2013 = 105.4; 2014 = 104.8; 2015 = 104.4; 2016 = 106.9; 2017 = 105.4; 2018 = 103.9; 2019 = 103.1; 2020 = 102.4; 2021 = 101.7; 2022 = 101.2; 2023 = 100.4. - Emerging Market and Middle-Income Economies gross debt (percent of GDP): 2012 = 37.4; 2013 = 38.6; 2014 = 40.7; 2015 = 44.0; 2016 = 47.0; 2017 = 49.0; 2018 = 51.2; 2019 = 52.9; 2020 = 54.3; 2021 = 55.6; 2022 = 56.7; 2023 = 57.6. - Low-Income Developing Countries gross debt (percent of GDP): 2012 = 31.1; 2013 = 31.5; 2014 = 31.8; 2015 = 38.0; 2016 = 40.8; 2017 = 44.3; 2018 = 45.5; 2019 = 44.9; 2020 = 44.1; 2021 = 43.5; 2022 = 42.8; 2023 = 41.9. ### Debt sustainability risks and interest burdens - Interest payments among low-income developing countries (2017): interest payments reached 18 percent of tax revenue and 9 percent of total expenditure. - Country examples: Ghana and Nigeria have seen interest-to-tax revenue ratios climb to more than 30 percent in 2017. - The IMF’s Debt Sustainability Analysis critical thresholds: 85 percent of GDP for advanced economies and 70 percent of GDP for emerging market economies. The Joint World Bank–IMF Debt Sustainability Framework for Low-Income Countries finds critical thresholds of 49, 62, and 75 percent of GDP depending on institutional quality. - Figure-based finding: A large number of countries have debt-to-GDP ratios above critical levels. ### Composition of debt and exposure to financing and exchange rate risk - Low-income developing countries: share of nonconcessional financing reached 46 percent of total debt in 2016. - External commercial borrowing (including commodity traders) and instruments such as Eurobonds and syndicated loans have grown quickly from a low base. - Foreign-currency-denominated general government debt (2017): about one-third of general government debt in emerging market and middle-income economies; about two-thirds in low-income developing countries. - Risks amplified: increased refinancing risk from shorter maturities and grace periods of nonconcessional instruments; risk of capital-flow reversal from nonresident participation in domestic debt markets; vulnerability of first-time and lower-rated issuers. ### Debt management and market developments - Average term to maturity (ATM) of outstanding debt (number of years): High Income weighted ATMM: 2009 = 5.8; 2017 = 7.2. Median ATM: 2009 = 5.6; 2017 = 7.3. - Since 2009, average maturities have risen by 1.4 years in high-income countries and close to 1 year for emerging market and developing economies. - Ultra-long government bonds (more than 30 years): among OECD countries, annual volume of ultra-long bond sales tripled and the number of issues doubled between 2006 and 2016; outstanding stock of ultra-long bonds comprised 9 percent of central government marketable debt in OECD countries as of December 2016. - Some policymakers have chosen not to aggressively raise average maturity to avoid upward pressure on long-term rates for the private sector and to take advantage of negative bond yields at the shorter end of the yield curve. - Deepening of local bond markets in some emerging markets has reduced potential risk of capital-flow reversals. ### Gross financing needs and IMF cautionary thresholds - IMF Debt Sustainability Analysis flags: gross financing needs above 20 percent of GDP for advanced economies and above 15 percent of GDP for emerging market economies are areas of concern. - Selected average (Table 1.3/Table 1.4): Selected advanced economies average total financing need (2018) = 18.4 percent of GDP; selected emerging market and middle-income economies average total financing need (2018) = 9.5 percent of GDP. ### Fiscal stance and deficits in advanced economies - Fiscal stance in advanced economies (2017): broadly neutral; overall deficits remained unchanged at 2.6 percent of GDP on average. - Advanced economies overall deficits (Table 1.5, percent of GDP): 2017 = –2.6; projections: 2018 = –2.7; 2019 = –2.8; 2020 = –2.4; 2021 = –2.3; 2022 = –2.3; 2023 = –2.0. - United States overall balance (percent of GDP): 2012 = –7.9; 2017 = –4.6; 2018 = –5.3; 2019 = –5.9; 2020 = –5.5; 2021 = –5.5; 2022 = –5.4; 2023 = –5.0. - Japan overall balance (percent of GDP): 2012 = –8.6; 2017 = –4.2; 2018 = –3.4; 2019 = –2.8; 2020 = –2.2; 2021 = –2.1; 2022 = –2.0; 2023 = –2.0. - Since 2012 overall deficits have fallen via policy action, cyclical gains, and lower interest payments, though less so since 2014. Spending has declined by 1.6 percent of GDP on average since 2012; revenues improved by 0.7 percentage point on average, largely from cyclical gains. ### Fiscal outlook and debt trajectory in advanced economies - Fiscal stance expected to be mildly expansionary in 2018 and 2019, followed by gradual adjustment in outer years. - Debt in advanced economies is set to decline only marginally, to about 100 percent of GDP by 2023. - The small reduction in debt is achieved mainly thanks to higher projected inflation (from low levels). *Source: IMF staff estimates and projections (Fiscal Monitor — April 2018).* ### CHAPTER 1 SAvINg FOR A RAINy dAy ### CHAPTER 1 SAvINg FOR A RAINy dAy ### Advanced Economies: Fiscal stance, investment, and United States outlook - Several advanced economies intend to remain expansionary in the near term (Germany, United States); some plan gradual consolidation (Japan, United Kingdom); a few expect a neutral stance in 2018, resuming consolidation later (Canada, Italy). - United States fiscal outlook: - Increase in spending authority by US$150 billion (0.7 percent of GDP) per year for the next two years. - Lower corporate and personal income tax rates will give rise to overall deficits in excess of US$1 trillion over the next three years (above 5 percent of GDP). - Government debt projected to increase to 117 percent of GDP by 2023. - Part of the expansion expected to be unwound when certain provisions expire: full expensing of equipment in 2023 and personal income tax cuts in 2025. - Near-term growth in the United States is expected to strengthen with some short-term positive spillovers on trading partners’ growth. - Investment and spending patterns in advanced economies: - Investment spending has been insufficient to offset depreciation (net investment negative in several countries; see figure context). - Investment spending has also been cut: “Investment spending has not been spared from cuts.” - Change in total expenditure, 2012–17: investment declined by –0.98 percent of GDP (figure labels show totals and categories; other specific components listed in source). - Cyclicality and primary balances: - Cyclical factors have helped countries contain their primary balances (change in CAPB and cyclical component noted in figures). - Distributional effects of U.S. tax reform (stylized model results): - All income groups would benefit, with those in the top quintile gaining the most, followed by those in the lower quintile. - The middle’s increase in consumption is substantially outpaced by increases at the top and bottom, potentially contributing to hollowing out of the middle of the income distribution. ### Emerging Market and Middle-Income Economies: Recent progress and persistent gaps - Aggregate fiscal change: - Overall fiscal deficits fell marginally in 2017 for emerging market and middle-income economies, from 4.8 percent of GDP in 2016 to 4.4 percent of GDP in 2017. - Diverging country developments: commodity exporters improved headline balances (supported by pickup in commodity prices and expenditure cuts); major non–commodity exporters relaxed fiscal positions to provide stimulus (China, India, Thailand). - China’s rising fiscal deficits (including off-budget spending) largely drive the average trend. - Revenue and spending trends, 2012–17: - Tax-to-GDP ratios have been declining among non–commodity exporters since 2012 by 1 percentage point of GDP; causes include stimulus measures (China, Turkey) and cyclical factors. - Commodity exporters also suffered tax revenue declines, sometimes from lower corporate income tax collection from oil companies. - 40 percent of emerging market and middle-income economies continue to have tax-to-GDP ratios below 15 percent. - All expenditure categories have been rising as a share of GDP on average across all countries, except investment spending which remained flat. - Medium-term outlook and policy directions: - For 2018 and over the medium term, spending restraint is expected to keep deficits in check; countries aim to contain current expenditure growth below nominal GDP growth, including the wage bill. - Investment spending expected to increase slightly for non–commodity exporters, but to continue contracting for commodity exporters. - Total revenues expected to decline slightly in the forecast period: small improvement in tax revenue (less than ½ percent of GDP) will not offset deterioration in nontax revenue from moderating oil prices. - Expected improvement in overall balances will be insufficient to stabilize debt for many countries. - Selected country developments (high-level highlights from table summaries): - Brazil: consolidation continued in 2017; overall deficit declined from 9.0 to 7.8 percent of GDP. - China: on-budget deficit rose to 4 percent of GDP in 2017; stimulus included VAT reforms and tax cuts for some small enterprises. - India: federal consolidation paused in fiscal year 2017/18; implementation of new goods and service tax affected revenues and spending patterns. - Mexico: overall deficit cut to 1.1 percent of GDP in 2017. - Russia: overall deficit projected to have fallen by over 2 percentage points to 1.5 percent of GDP in 2017. - Saudi Arabia: overall deficit reduced from over 17 percent of GDP in 2016 to 9 percent in 2017; driven by non–oil revenue measures and spending cuts close to 2.5 percent of GDP largely in capital expenditures. - Forward-looking fiscal stances vary: some countries plan continued consolidation (Brazil, Russia), some plan expansion or neutral stances (China, Thailand, Turkey). ### Low-Income Developing Countries (LIDCs): Rising vulnerabilities and debt dynamics - Average fiscal outcomes: - Overall fiscal deficits broadly unchanged at 4.3 percent of GDP on average. - Deficits deteriorated among commodity exporters despite commodity price improvements. - Spending composition and investment: - Commodity exporters implemented cuts to both current and capital expenditure; public wage bill remained flat as a percentage of GDP. - Non–commodity exporters let spending drift upward across most items, except investment spending which remained unchanged. - Some countries increased education spending, though this accounted for a relatively small share of spending increases. - Revenue mobilization: - Limited progress in mobilizing revenue for both commodity and non–commodity exporters; tax-revenue-to-GDP ratios in half of low-income developing countries still below 15 percent. - Debt dynamics and distress: - Debt-to-GDP increased by 13 percentage points on average since 2012, reaching 44 percent of GDP in 2017. - Debt was rising in about two-thirds of low-income developing countries in 2017. - Debt increases were highest among commodity exporters, many of which relied on debt financing to cushion falling revenues. - Drivers of rising debt since 2012: deteriorating primary deficits and rising interest burdens; other contributors in specific cases included exchange rate depreciations (Côte d’Ivoire, Senegal, Zambia), financial sector bailouts (Moldova), and reporting of previously undisclosed debt (Republic of Congo, Mozambique). - In 2017, eight countries were classified as in debt distress. - Country-level examples on 2017 fiscal stances (selected from table summaries): - Indonesia: overall deficit remained at 2.5 percent of GDP in 2017; spending rebalanced toward education, health, and social protection; improved efficiency in energy subsidy targeting. - Thailand: overall balance weakened by slightly over 1 percent of GDP in 2017 as sales of licenses and income tax revenues declined. - Saudi Arabia and other GCC measures noted under emerging market summaries (impacts on low-income comparisons). *International Monetary Fund | April 2018 — CHAPTER 1 SAvINg FOR A RAINy dAy* ### 1. Tax Revenue, 2000–23 ### 1. Tax Revenue, 2000–23 ### Fiscal outcomes and projections (2000–23) - Spending control is expected to help bring fiscal deficits down in 2018 and over the medium term. - Overall deficits would decline by close to 1 percent of GDP between 2018 and 2023. - Medium-term revenue forecasts for commodity exporters are disappointing: an expected pickup in commodity revenues in 2018 is projected to moderate over the medium term, with little improvement envisaged in tax mobilization. - Some non–commodity exporters are expected to expand tax collection by about 1 percent of GDP or more over the next five years (Ethiopia, Uganda). - Debt buildup is expected to slow moderately over the medium term: - The average debt ratio is projected to stabilize in 2018 at about 45 percent of GDP and then to start declining slightly. - Narrowing deficits contribute to declining debt in about one-third of the countries (Cameroon, Ghana, Kenya). ### Vulnerabilities observed (low-income developing countries) - For countries in debt distress: - The average effective interest rate has risen by about 100 basis points since 2014. - Interest payments to tax revenue ratios have risen by over 12 percentage points since 2014. - Government debt to GDP has risen among low-income developing countries to unprecedented levels since the global financial crisis (see Figure 1.20 in source). ### Risks to the fiscal outlook - Near-term risks appear broadly balanced because of the economic upswing; upside: stronger cyclical recovery and higher commodity prices. - Key downside risks, especially for medium and longer term: - A sudden tightening in global financial conditions (faster-than-expected increase in global interest rates) would add to public debt burdens and could disrupt market access. - Divergence in monetary policy rates or shifts in investors’ risk appetite could appreciate the US dollar and strain countries with foreign currency debt. - Large depreciation or correction in asset prices could strain private sector balance sheets and materialize contingent liabilities. - Global policy uncertainty and difficulties implementing consolidation policies may undermine market confidence. - A slowdown in potential growth would raise debt-to-GDP ratios and add to debt via weaker primary balances. - Uncertainty in oil prices: oil exporters could face significant revenue drops; in countries with administered fuel prices, lower oil prices would reduce subsidies and support fiscal positions. - Long-term demographic changes and aging populations pose fiscal sustainability challenges (examples cited: Germany, Japan, Korea, United States). ### Policy guidance: saving for a rainy day and enhancing resilience - The ongoing recovery presents an opportunity to rebuild fiscal buffers and raise potential growth: - Allow automatic stabilizers to operate fully. - Make concerted efforts to bring deficits and debt toward medium-term targets. - Tailor the size and pace of adjustment to country-specific circumstances, cyclical conditions, and available fiscal space. ### Country and group-specific recommendations Advanced economies - Turn to consolidation over the medium term, with near-term support where needed. - United States: - Recalibrate fiscal policy to ensure government debt-to-GDP declines over the medium term by mobilizing higher revenues and gradually curbing public spending dynamics while shifting composition toward infrastructure investment. - United Kingdom: - Pursue steady but gradual fiscal consolidation with greater reliance on revenue measures. - Belgium: - Continue fiscal consolidation with efficiency-oriented spending reforms due to lower future revenues from recent tax-wedge reductions. - Ireland: - Potential need to accelerate consolidation to rebuild buffers as capacity is approached. - Spain: - A consolidation of the structural primary balance of about 0.5 percent of GDP is advisable for 2018, with room for measures mostly on the revenue side. - France: - Reduce public spending as a share of GDP (wage bill and local government spending), improve efficiency (targeting social benefits and health spending), and create room to reduce taxes. - Italy: - Start credible and ambitious fiscal consolidation: cut current primary spending while supporting the vulnerable, raise capital spending, lower tax rates on productive factors, shift taxation toward wealth/property/consumption, and broaden the tax base. - Germany and Netherlands: - Use fiscal space to support medium-term growth via public investment, education, research and development, childcare, and tax burden relief on labor. - Korea: - Reduce the structural balance toward zero by at least 0.5 percentage point a year during the coming years through higher expenditures on social policies and structural reforms (including targeted transfers and increased spending on childcare and active labor market policies); this could increase growth by an estimated 0.2 percentage point each year (IMF 2017d). - Japan: - Avoid a premature drop in fiscal support while anchoring the debt trajectory with a credible medium-term consolidation plan. Emerging market and developing economies - Fiscal policy appropriately focused on consolidation, especially where adjusting to lower commodity prices; speed of adjustment can be fine-tuned and sometimes made more ambitious. - Brazil: - Quicken the pace of consolidation and front-load the fiscal effort. - Argentina: - Primary deficit targets for 2018–20 are on the right track; a faster pace of deficit reduction would reduce financing needs and support disinflation. - Turkey: - Implement stronger, front-loaded fiscal consolidation by rationalizing untargeted transfers, containing wage bill increases and subsidies, and cutting discretionary investment incentives. - India: - Return to gradual, growth-friendly fiscal consolidation; full and smooth implementation of the new goods and services tax is necessary to avoid revenue underperformance and cuts to capital expenditures. - China: - Consolidation of 0.5 percent of GDP a year of the “augmented” deficit is necessary over the medium term and recompose spending away from infrastructure investment toward health, education, and social security. - Commodity exporters: - Do not let commodity price pickup derail rebuilding fiscal buffers. - Angola: medium-term non-oil primary balance needs to improve by at least 4.5 percent of GDP to put public debt firmly on a downward path. - Mongolia: the 2018 budget commitment to save any revenue overperformance will help avoid repeat overborrowing. - Nigeria: front-load non-oil revenue mobilization while increasing public investment to raise growth and reduce the ratio of interest payments to federal government revenue. - CEMAC members: advance steadfast fiscal adjustment, increase non-oil revenues, and ensure sufficient financing to smooth adjustment path. - Non–commodity exporting low-income developing countries: - Retain focus on addressing fiscal vulnerabilities (examples: Ethiopia, Ghana, Tajikistan). - Sudan: deficit reduction could support disinflation by reducing central bank direct budget financing. - Vietnam: better identify concrete measures where consolidation paths have been planned. - Guinea, Tanzania: mobilize revenues, rationalize spending, and improve investment spending efficiency to create fiscal space for infrastructure plans. - Countries with fiscal space: - Saudi Arabia: appropriately slow projected budgetary retrenchment starting in 2018 to smooth economic activity. - Malaysia: proceed gradually with consolidation; prioritize revenue measures including broadening the tax base and raising the tax rate on goods and services. ### Structural fiscal policies and tax reforms to boost growth - Adjustment strategies should center on structural fiscal policies that strengthen medium-term growth prospects, reducing volatility and facilitating productivity-enhancing structural reforms. - Tax system upgrades to make firm decisions tax-neutral: - Focus on reducing distortionary taxes, cutting inefficient tax expenditures, better targeting tax incentives, and lowering burdensome tax administration practices. - Evidence indicates budget-neutral changes in tax structure can support stronger growth. - Measures that broaden tax bases (e.g., limiting interest deduction, preferential tax rates and relief) can raise significant tax revenues without negative medium-term growth impacts. - Advanced economies: opportunities to make tax systems more growth friendly: - United States: expand eligibility/generosity of the earned income tax credit; consider federal-level consumption tax, broad-based carbon tax, and higher federal gas tax. - France: complement labor, corporate income, and capital tax cuts and wealth tax narrowing with reforms removing threshold effects for small businesses. - Italy, Spain, United Kingdom: reducing VAT gaps would remove distortions and create room for growth-friendly spending. - VAT compliance: - Even among advanced economies there is room to improve VAT compliance (referenced Figure 1.22 in source). *Italic: International Monetary Fund | April 2018* ### 1. European Union: VAT Compliance and Policy Gaps in 2015 ### 1. European Union: VAT Compliance and Policy Gaps in 2015 ### VAT compliance and policy gap measures - The content unit presents VAT compliance and policy gaps for the European Union in 2015 measured as: - "Percent of potential revenue" (labelled in the source). - "Percent of GDP" (labelled in the source). ### Key findings and context - "Many countries have room to raise revenues by narrowing VAT compliance and policy gaps." - "Revenue mobilization is also crucial for continued progress by low-income developing countries toward their 2030 Sustainable Development Goals." - Recommendations for revenue mobilization emphasize: - Improving tax administration. - Broadening the tax base. - Improving collection from non–commodity taxes. - Using a well-designed Medium-Term Revenue Strategy (MTRS) as a road map. ### Country examples and targets - Indonesia: - Is "working toward putting in place an MTRS aimed at raising revenue by at least 3 percentage points over the medium term by streamlining tax administration, removing exemptions to VAT and income taxes, and introducing excise taxes on vehicles and fuel." - Papua New Guinea: - An MTRS "will aim at rebalancing the tax mix, broadening the tax base, and, in the short-term, introducing new excise rates and undertaking administrative initiatives to strengthen revenue institutions." ### Digitalization, risks, and administration - Digital technologies can improve tax compliance and enforcement by: - Improving access to taxpayer data to reconcile payment differences. - Monitoring revenue collection in real time. - Performing audits and identifying anomalous taxpayer behavior. - Helping tackle tax evasion from cross-border fraud and lowering revenue losses from personal income and wealth sheltered in tax havens. - Cautionary note: "digitalization may also create new fraud opportunities, for example, the use of cryptocurrencies to accumulate wealth outside the reach of tax authorities or digital identity theft to illegally claim benefits." ### Policy implications - For most emerging market and developing economies, priorities include: - Improving tax administration. - Broadening tax bases. - Improving collection from non–commodity taxes. - Developing and implementing an MTRS covering policy, administration, and legal components over four to six years. - Strengthening tax capacity in commodity exporters can "make room for spending on human capital and infrastructure, as well as on other structural reforms to facilitate diversification." *International Monetary Fund — Fiscal Monitor (April 2018), Chapter excerpt on VAT compliance and policy gaps* ### Box 1.2. The Distributional Effects of Income Tax Cuts in the United States ### Box 1.2. The Distributional Effects of Income Tax Cuts in the United States ### Modeling assumptions and approach - Policy changes modeled: - Corporate income tax (CIT) statutory federal rate cut from 35 percent to 21 percent. - In absence of readily available estimates of the change in effective tax rates from the TCJA, the model uses the reduction in effective tax rates from the 1986 reform (statutory rates 48 percent to 35 percent), corresponding to a decline of about 4 percentage points in the effective CIT rate, as a rough and imperfect approximation. - Treatment of PIT provisions: - Where provisions under current legislation are ambiguous, the model is based on expectations that they are permanent. - Financing assumption for permanent revenue loss: - Optimistic assumption that revenue losses from the reform can be offset by cuts to unproductive government spending to keep the government deficit unchanged. - Alternate financing assumptions are considered and discussed in the analysis. - Empirical input: - Static costing by the Joint Committee on Taxation points to revenue losses from the TCJA of about US$1.5 trillion over 10 years; these values were used as inputs for the WEO forecasts. - Simulated outcomes: - General equilibrium long-term effects on consumption across the income distribution are illustrated (Figure 1.2.1 in source). - Static estimates from the Tax Policy Center (2018) are used for comparison. ### Key distributional findings - Top quintile: - The increase in consumption of households in the top quintile of the distribution is higher than the rest, making the reform, in that sense, regressive. - Upper income quintiles gain the most because they receive higher cuts in PIT; the CIT reform (which directly benefits the return on capital) further strengthens gains for higher-income households because they hold most of the wealth. - Lower quintiles: - The model suggests that the lower quintiles of the income distribution also benefit from the reform. - Mechanisms: - CIT cuts raise the profitability of businesses, increasing demand for labor and hence wages. - PIT cuts push up the prices of nontradables, particularly services, leading to higher demand for labor and wages in that sector, which benefits lower-income individuals who tend to work in the services sector. - This result contrasts with static estimates from the Joint Committee on Taxation, the Tax Policy Center, and the Tax Foundation, which show lower-income households gaining the least. - Important caveats: - If the PIT provisions expire in 2025 as foreseen in the TCJA, the demand for services would be dampened, shrinking the benefits of the reform for the working poor. - If consumption of services were weaker than estimated by the model, the benefits of the reform would tilt further in favor of higher-income households. - Middle quintile: - The middle quintile benefits the least from the reform. - Reason: tax cuts (in particular CIT cuts) stimulate capital investment, and capital tends to be a substitute particularly for middle-skill individuals. - Inequality and polarization: - Inequality, as measured by the Gini coefficient, is estimated to remain constant. - Two opposing effects offset one another: higher gains of the upper quintiles compared with the middle increase the Gini coefficient, while higher gains of the bottom quintiles compared with the middle reduce it. - Polarization (hollowing out of the middle) deepens because the increase in consumption for the middle is substantially outpaced by increases at the top and bottom of the distribution. - This hollowing out is noted as a characteristic of the United States in recent decades. ### Sensitivity to alternative fiscal consolidation paths - Baseline simulation context: - Shows a permanent revenue loss of 1 percent of GDP, offset by cuts to unproductive spending (acknowledged as optimistic and potentially difficult to achieve in practice). - Alternative fiscal responses and distributional implications: - Regressive expenditure cuts: - If implemented, the estimated gains for the three bottom quintiles of the distribution would be wiped out. - Introduction of a value-added tax to offset revenue losses: - Estimated gains would be lower for all income groups, in particular those in the middle and bottom of the distribution. - No offsetting action (higher deficits and market financing): - Higher deficits would need to be market financed, which could push interest rates higher, taking a toll on growth that affects all income groups. - Policy implication: - The United States would need to address the revenue losses from the reform with a careful mix of spending and tax measures. *International Monetary Fund | April 2018 — Box 1.2. 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