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---

### Introduction and context
- Low growth and investment, adverse shocks, and low inflation and interest rates in recent years placed fiscal policy at the forefront.
- The COVID-19 pandemic of 2020 strengthened the case for fiscal policy action and heightened its urgency.
- Key background observations:
  - Growth has been subdued in advanced economies; moderation in capital accumulation is a factor.
  - Inflation has trended down since the 1980s and is currently below targets in two-thirds of inflation-targeting countries.
  - In advanced economies, inflation expectations are anchored at low levels.
  - The natural rate of interest is estimated to have fallen significantly and is now below zero in some economies.
  - The effective lower bound on policy rates binds more frequently; the nominal interest rate on new government borrowing is currently negative in many advanced economies.
  - These patterns were exacerbated by the COVID-19 pandemic, resulting in a global recession in 2020 and likely persisting into the post-shutdown recovery.

### IDEAS framework to respond to weaker growth
- Policy pillars summarized by IDEAS:
  - Investing for the future: infrastructure, low-carbon technologies, health care, education, and research.
  - Discretionary measures: measures deployable contingent upon a particular state of the economy.
  - Enhancing Automatic Stabilizers: improve unemployment benefits and social safety nets (noncontributory transfer programs financed by general government revenue).
- Emphasis: maximize benefits from sustainable, resilient public investment and improve social safety nets.

### Fiscal context and fiscal multipliers
- Low-for-long interest rates create opportunity for quality public investment to boost growth.
- Discretionary fiscal policies can have larger fiscal multipliers when:
  - policy rates are at the effective lower bound,
  - economic slack exists,
  - fiscal space exists.
- With significant supply disruptions (for example, during pandemics), fiscal multiplier sizes are more uncertain during the pandemic and before recovery.
- High public debt remains a vulnerability and constrains countercyclical fiscal policy.
- When public debt is high, multiplier effects of discretionary fiscal policies are lower.
- Automatic stabilizers remain effective at reducing macroeconomic fluctuations even at high debt levels; strengthening social safety nets is an urgent priority tailored to the pandemic.

### Investment for growth — observations and magnitudes
- Slowing global growth is linked in part to moderation of capital accumulation.
  - In advanced economies, total investment per person (public and private) was $9,867 in 2007 and $9,991 in 2017, in constant 2017 US dollars (IMF Investment and Capital Database).
- High-return public investment can lift productivity, create jobs, and spur private investment.
- Infrastructure bottlenecks hinder long-term development in many emerging market and developing countries.

### Sustainable investment needs (global and regional)
- Additional global investment needs:
  - 1.3 percent of global GDP per year, or cumulatively exceeding $20 trillion (measured in current US dollar terms) over the next two decades (estimates subject to uncertainty).
- Breakdown of additional needs:
  - Infrastructure: 0.5 percent of global GDP per year (mostly transportation; health infrastructure needs also large).
  - Climate change (adaptation and transition): 0.6 percent of global GDP per year to limit rise in global temperatures to below 2 degrees Celsius this century compared with preindustrial levels.
  - Other SDGs (clean water, sanitation, affordable electricity): 0.2 percent of global GDP per year up to 2030.
- Additional notes:
  - Climate adaptation needs are estimated at $1.8 trillion globally cumulatively over 2020–30, or 0.2 percent of global GDP per year (Global Commission on Adaptation 2019).
  - Additional SDG investment needs are mostly concentrated in sub-Saharan Africa and other low-income developing countries, amounting to 5 percent of regional GDP per year in Africa.
  - Including health and education investment toward the SDGs could add another 0.2 percent of global GDP per year.

### Investment management — risks, inefficiencies, and reforms
- Risk of scaling up public investment too much and too fast: exceed absorptive capacity and create waste rather than sustained output growth.
- Cross-country inefficiencies:
  - On average, more than one-third of funds for public infrastructure are estimated to be lost owing to inefficiencies.
- Causes of poor outcomes: optimism bias in project appraisal, limited interagency coordination, corruption, weak budget processes, fragmentation where subnational governments execute much investment (examples: Germany, Italy, India, Bolivia).
- Potential gains from reform:
  - Improving public investment management to the 90th percentile of best performers in each income group could halve the size of investment inefficiencies across countries.
- Policy measures to improve outcomes:
  - Establish central register of infrastructure projects.
  - Tighten financial rules on public-private partnerships.
  - Disclose more ex post reviews and audits of capital projects.
  - Strengthen links among national planning, long-term capital plans, and budgeting processes.

### Sustainable financing and country constraints
- Many advanced economies: government borrowing costs declined to unprecedented low levels while rates of return on private capital largely held up.
- If risk-adjusted social return on new public investment exceeds government financing costs, more public projects are worth undertaking and crowding out is less likely.
- In high debt-to-GDP countries, adverse market reactions to large investment scale-ups could raise financing costs and increase debt vulnerabilities; budget-neutral increases in investment may be preferable.
- Challenges for emerging market and developing economies:
  - Loans from China accounted for 17 percent of total public external debt of low-income developing countries in 2018—a fourfold increase from 2008 levels.
  - Direct private investment and financing are critical and can be facilitated by structural reforms (for example, improving the business environment).
  - Supranational coordinated investment projects can help when challenges surpass individual country capacity (example: cross-country renewable energy networks).
- To balance debt sustainability risks and investment benefits, countries need:
  - stronger governance and institutions,
  - better capture of investment returns,
  - management of fiscal risks from public-private partnerships,
  - greater debt transparency,
  - improved coordination with creditors.
- Meeting SDGs in low-income developing countries would likely imply new borrowings on nonconcessional terms and could lead to a substantial increase in average interest rates by 110 basis points.
- Financing strategies: increase tax-to-GDP ratios, seek concessional financing, involve the private sector.

### Macroeconomic effects of scaling up public investment (model estimates)
- Global efficient-investment scenario (assumptions and outcomes over 20 years):
  - Additional public investment initially of 1.3 percent of global GDP (assumed to decline gradually).
  - Cumulative public investment injection over 20 years is 18 percent of global GDP.
  - Estimated increase in GDP is 28 percent cumulatively (assuming efficient investment); cumulative multiplier is above 1.
  - Estimated annual effects on average over 20 years:
    - Global GDP: increase by an estimated 1.4 percent per year, on average, over a 20-year horizon.
    - Inflation: increase by 66 basis points per year initially.
    - Real interest rate: increase by 14 basis points over the 20-year horizon.
  - Impact on public debt-to-GDP ratio would be limited in this efficient-investment scenario.
- Composition of the 1.3 percent of global GDP initial needs:
  - infrastructure: 0.5 percent of GDP,
  - low-carbon energy investment: 0.6 percent of GDP,
  - investment in other SDGs: 0.2 percent of GDP.

### EU illustrative case: 0.6 percent of EU GDP on infrastructure and decarbonization
- Simulation assumptions and outcomes:
  - Public investment increase of 0.6 percent of EU GDP on infrastructure and decarbonization would increase EU output by 0.7 percent per year, on average, over a 20-year horizon.
  - Green investment needs of 0.25 percent of EU GDP are assumed for illustration to be new financing rather than rebalanced EU budget expenditure.
  - A public investment increase would:
    - add to inflation initially,
    - raise long-term interest rates modestly,
    - result in a modest rise in the public debt-to-GDP ratio (see panels 1 and 3 of Figure 2.6 in source).
- If supply-side bottlenecks and absorptive capacity constraints are binding:
  - investment efficiency would be lower,
  - scaling up public investment would have smaller effects on growth and inflation (little support for monetary policy in achieving inflation targets),
  - and would lead to a large rise in debt-to-GDP ratios (see panels 2 and 4 of Figure 2.6).
- Composition of additional investment needs for the European Union (initially 0.6 percent of regional GDP, declining gradually):
  - infrastructure: 0.35 percent of GDP,
  - low-carbon investment: 0.25 percent of GDP.

### Discretionary measures and timing
- Discretionary measures face information, decision, and implementation lags; policymakers should identify high-quality measures deployable quickly when downside risks materialize.
- Historical observations:
  - Discretionary measures in the United States came late in half of previous recessions (Figure 2.7 in source).
  - US county-level evidence shows the discretionary stimulus from the American Recovery and Reinvestment Act during the Great Recession was not well targeted to areas where the recession was more severe.
- Well-prepared countercyclical discretionary measures can be effective because fiscal multipliers tend to be larger in downturns.
- Rules-based fiscal stimulus option:
  - Enact discretionary measures that will be automatically activated when economic conditions deteriorate (for example, triggers like a decline in job creation below a threshold or a large increase in the unemployment rate).
  - Design rules-based fiscal stimulus to prevent continued debt buildup over the long term.
- Examples of temporary revenue-side measures:
  - temporary value-added tax cuts,
  - flat, refundable tax rebate targeted at low-income households,
  - cyclical investment tax credits affecting firms.
- Examples of temporary expenditure-side measures:
  - temporary extensions of coverage and duration of unemployment benefits (for example, emergency unemployment compensation programs in the United States),
  - well-targeted transfers to low-income or liquidity-constrained households.
- To avoid policy lags for public investment:
  - maintain a pipeline of appraised projects (especially upgrades, maintenance, and repairs),
  - review pipeline now, identify bottlenecks, prepare ready-to-implement projects for deployment when supply disruptions ease,
  - accelerate implementation of smaller projects in downturns.
- Some governments (Australia, Ireland, New Zealand, Norway) maintain a rolling pipeline of public infrastructure projects within a long-term budget constraint to provide timing, sequencing, and scale details.

### Enhancing automatic stabilizers
- Definition and role:
  - Automatic stabilizers are budget mechanisms that adjust spending and taxes when the economy slows or expands; primary components include progressive income taxes (revenue side) and unemployment benefits and social safety nets (spending side).
  - In downturns, automatic stabilizers support aggregate demand promptly, reach affected populations, and phase out when conditions improve.
- Empirical magnitudes:
  - Automatic stabilizers account for more than one-half of overall fiscal stabilization—measured as sensitivity of the overall budget balance to the output gap—in two-thirds of advanced economies.
  - Automatic stabilizers account for 30 percent of total fiscal stabilization in emerging market and developing economies, with large cross-country variation.
  - Automatic stabilizers provided a sizable boost to output during the Great Recession—about 2 percent of GDP in the United States and slightly less in the euro area.
  - Several studies suggest automatic stabilizers can absorb one-third of income shocks and 40 percent of unemployment shocks in major advanced economies.
- Policy options to strengthen automatic stabilizers:
  - Improve tax design (see Box 2.2 in source).
  - Strengthen social safety nets.
  - Introduce two-pillar unemployment benefit systems:
    - Pillar 1: unemployment insurance financed from contributions.
    - Pillar 2: unemployment assistance financed from government revenues for those who have not contributed or have exhausted insurance benefits.
  - Increase generosity, take-up, benefit levels, and duration of transfer programs based on predefined formulas; ease eligibility criteria during recessions.
  - Design benefits to balance demand support and work disincentives (for example, gradually removing benefits as employment income increases).

### Spending-side automatic stabilizers and social safety nets
- Rationale: Strengthening unemployment benefits and social safety nets reinforces spending-side automatic stabilizers and protects households.
- Evidence and magnitudes:
  - A 1 standard deviation increase in the generosity of US unemployment insurance would attenuate the effect of adverse shocks on employment growth by 7 percent (Di Maggio and Kermani 2016).
  - Payments tied to consumption of low-income households play a large role in aggregate demand stabilization.
- Cross-country variations and statistics:
  - Size of income stabilization by tax-benefit systems varies from 95 percent in Denmark to below 20 percent in the United States.
  - Social safety nets typically include cash transfers, food stamps, child allowances, social pensions, in-kind transfers, income-support schemes conditional on education or health, public works, and fee waivers.
  - Social safety nets have contributed to a reduction of poverty gaps by 45 percent worldwide, on average.
  - Size of social safety nets:
    - averages 2.7 percent of GDP in OECD countries,
    - averages 1.5 percent of GDP at the global level.
  - In most OECD countries, unemployment insurance and other benefits replace on average 70 percent of last employment income for a typical household, though long spells can exhaust insurance benefits and replacement rates vary by country.

### Social safety nets: coverage, adequacy, and design attributes
- Coverage and adequacy findings:
  - Social safety nets in emerging market and developing countries cover less than one-fifth of the poorest quintile of households, on average.
  - The average transfer accounts for only 13 percent of the consumption of the bottom 20 percent of the income distribution (World Bank 2018).
  - Regional spending is relatively low in South Asia and Middle East and North Africa.
  - In sub-Saharan Africa, coverage of the poorest quintile is small but the adequacy of benefits for this group is relatively high.
- Four desirable attributes of strong social safety nets (Grosh and others 2008):
  - Broad coverage and adequate, progressive benefits within the overall tax-benefit system (IMF 2019c).
  - Cost effectiveness by avoiding fragmentation and beneficiary overlaps.
  - Preservation of work incentives and enhancement of human capital by linking transfers to programs (public works, health care, education, training).
  - Financial sustainability within the overall expenditure envelope and consistency with other social protection programs.
- Practical instruments to improve targeting:
  - mobile money,
  - in-kind provision of goods and services (health care, water, transportation),
  - use of existing social registries,
  - community-based methods to identify those in need.
- Example: Aadhaar in India—1.2 billion residents enrolled—serves as an example for mapping bank-account information to a unique identification number for direct cash transfers, subject to privacy and security safeguards.

### Strengthening spending-side automatic stabilizers while preserving work incentives
- Two-pillar unemployment benefit systems and guaranteed minimum income:
  - Two-pillar systems provide both income insurance and assistance in recessions; examples include Austria, Germany, Finland, Ireland, New Zealand, Spain, United Kingdom.
  - Guaranteed minimum income programs are typically selective, conditional, and means tested; most OECD countries have centralized minimum-income programs for working-age individuals.
- Typical design features and trade-offs:
  - Benefit calibration should reflect basic needs without causing welfare dependence; additional housing allowances and health care are common.
  - Incentive-preserving features: conditional in-work tax credits, marginal income disregard for part-time work, gradual benefit phaseouts, back-to-work bonuses.
  - Conditionality: participation in active labor market programs where capacity exists.
- Practical recession measures:
  - Subsidize reduced working hours (example: Germany).
  - Relax eligibility criteria and loosen work requirements to increase coverage during recessions.
  - Improve targeting and administrative capacity (example: suggestions to improve Italy’s citizenship income program).
- Trade-offs observed:
  - Denmark and Finland provide strong income support but face effective tax rates of 90 percent on labor income when recipients find a job, which can discourage participation.
  - Countries without unemployment assistance (Turkey, United States) emphasize work incentives and have low effective tax rates upon return to work.
  - If Estonia or the United States upgraded benefit systems to the median OECD country, household incomes would fall by one-third less when workers lose their jobs during recessions.
- Complementary policies: in-work wage subsidies (example: earned income tax credit in the United States) can preserve work incentives while enhancing stabilization.

### Drivers of subdued growth and role of high-return investment
- Competing explanations:
  - Demand inadequacy: aging populations, globalization and preference for safe assets, rising income inequality.
  - Weak supply potential: slowing productivity growth, weak capital accumulation, shrinking labor force in some economies.
  - Debt supercycle: financial boom preceding the Great Recession, public and private debt overhang, credit expansions with diminishing returns.
- Policy implication:
  - Consensus on need for more high-return investment.
  - If weak demand persists, high-return public investment in a low interest rate environment could spur private activity.
  - If supply constraints drive weakness, investment in physical and human capital and R&D, complemented by structural reforms, can raise long-term growth.
  - Evidence indicates high-return investment, particularly when combined with reforms, can durably raise long-term growth.

### Tax design to strengthen automatic stabilizers (high-level instruments)
- Stabilization role of tax design:
  - Progressive tax systems stabilize because taxpayers pay lower taxes in recessions than in booms; among OECD countries, income taxes can automatically stabilize between 20 and 50 percent of income shocks (OECD 2019).
  - Taxes on income (personal and corporate) respond most to the cycle; taxes on goods and services, payroll taxes, and social security contributions move with the cycle but less so.
- Tax instruments to strengthen automatic stabilizers and pandemic response:
  - Bonus depreciation: allows firms to deduct a substantial portion of new investment from taxable profits during recessions; evidence of boosting investment in the United States during the global financial crisis (Zwick and Mahon 2017).
  - Accelerated depreciation or super-deductions: encourage investment in health or hygiene products undersupplied during a pandemic.
  - Cyclical loss-carry backward: automatically allow deduction of current corporate losses against past tax payments to provide immediate tax refunds; previously applied in Canada, France, Germany, United Kingdom, United States, and during the current pandemic.
  - Link property taxes more closely to the real estate cycle by assessing property values annually (example: United States).

### Box 2.2 — Tax Policy and Automatic Stabilizers (high-level takeaways)
- Tax policy can be used to increase collections during property booms and reduce taxes during slumps.
- Corporate tax collections based on current-year estimated income allow tax collections to be linked more closely to the current state of the economy, making stabilization timelier.
- Personal income tax design:
  - Tax credits are preferable to deductions for encouraging socially valuable activities while smoothing the cycle.
  - Uniform personal income tax credits are recommended because deductions deliver larger relief to higher-income individuals under a progressive tax system.
- Investment tax credits are stabilizing because they reduce cost of capital and stimulate investment during recessions.
- Historical example: Sweden’s cyclical investment tax credits (mid-1950s to mid-1970s) allowed firms to deduct up to 40 percent of taxable profit to an investment fund for use during downturns.
- Practical implications: shifting toward tax credits and aligning corporate tax collection timing with current-year conditions can strengthen automatic stabilization by:
  - Providing fixed, predictable support to disposable income (tax credits).
  - Lowering the cost of capital to counteract procyclical investment declines (investment tax credits).
  - Allowing tax revenue to decline quickly in recessions and rise in recoveries when collections are based on current-year estimates.

*Source: ch2 - Fiscal Monitor: Policies to Support People During the COVID-19 Pandemic (April 2020), International Monetary Fund.*

### Introduction

### ch2 - Introduction

### Context and motivation
- Low growth and investment, adverse shocks, and low inflation and interest rates in recent years placed fiscal policy at the forefront.
- The COVID-19 pandemic of 2020 strengthened the case for fiscal policy action and heightened its urgency.
- Key background observations from the chapter:
  - Growth has been subdued in advanced economies, reflecting various factors including a moderation in capital accumulation.
  - Inflation has trended down since the 1980s and is currently below targets in two-thirds of inflation-targeting countries.
  - In advanced economies, inflation expectations are anchored at low levels.
  - The natural rate of interest is estimated to have fallen significantly and is now below zero in some economies.
  - The effective lower bound on policy rates binds more frequently; the nominal interest rate on new government borrowing is currently negative in many advanced economies.
  - These patterns have been exacerbated by the COVID-19 pandemic, resulting in a global recession in 2020 and likely persisting into the post-shutdown recovery.

### IDEAS framework to respond to weaker growth
- The chapter explores fiscal policy responses summarized by IDEAS:
  - Investing for the future in infrastructure, low-carbon technologies, health care, education, and research.
  - Enacting Discretionary measures that can be deployed contingent upon a particular state of the economy.
  - Enhancing Automatic Stabilizers—particularly by improving unemployment benefits and social safety nets (noncontributory transfer programs financed by general government revenue).
- Emphasis is placed on maximizing benefits from sustainable, resilient public investment and improving social safety nets.

### Fiscal context and multipliers
- Low-for-long interest rates present an opportunity for quality public investment to boost growth.
- Discretionary fiscal policies can have larger fiscal multipliers when policy rates are at the effective lower bounds and economic slack and fiscal space exist, because policies can spur private consumption and investment through higher inflation expectations and lower real interest rates.
- With significant supply disruptions (for example, during pandemics), the size of fiscal multipliers is more uncertain during the pandemic and before the recovery phase.
- High levels of public debt remain a vulnerability and constrain the use of countercyclical fiscal policies in downturns.
- When public debt is high, the multiplier effects of discretionary fiscal policies are lower.
- Automatic stabilizers can still be effective at reducing macroeconomic fluctuations at high debt levels; strengthening social safety nets is thus an urgent priority tailored to the pandemic situation.

### Investment for Growth — key observations
- The slowdown in global growth is linked in part to a moderation of capital accumulation:
  - In advanced economies, total investment per person (public and private) was $9,867 in 2007 and $9,991 in 2017, in constant 2017 US dollars (IMF Investment and Capital Database).
- High-return public investment could act as a bridge to sustainable, resilient, and inclusive economic growth by lifting productivity, creating jobs, and spurring private sector investment.
- In many emerging market and developing countries, infrastructure bottlenecks are impediments to long-term development.

### Sustainable investment areas and estimated needs
- Additional global investment needs are estimated at 1.3 percent of global GDP per year, or, on a cumulative basis, exceeding $20 trillion (measured in current US dollar terms) over the next two decades (estimates subject to uncertainty).
- Breakdown of additional investment needs (as presented):
  - Infrastructure: an additional investment of 0.5 percent of global GDP per year over the next two decades to cover infrastructure gaps, mostly for transportation; investment needs for upgrading health infrastructure are also large.
  - Climate change (adaptation and transition to cleaner energy systems): an additional investment of 0.6 percent of global GDP per year to limit the rise in global temperatures to below 2 degrees Celsius in this century compared with preindustrial levels.
  - Other Sustainable Development Goals (access to clean water, sanitation, affordable electricity): an additional 0.2 percent of global GDP in investment per year up to 2030.
- Note: Investment needs for climate adaptation are estimated at $1.8 trillion globally cumulatively over 2020–30, or 0.2 percent of global GDP per year (Global Commission on Adaptation 2019).
- Additional SDG investment needs are mostly concentrated in sub-Saharan Africa and other low-income developing countries, amounting to 5 percent of regional GDP per year in Africa.
- Including health and education investment toward the Sustainable Development Goals could add an additional 0.2 percent of global GDP per year to global investment needs.

### Investment management — risks and efficiency
- Scaling up public investment too much and too fast, beyond a country’s absorptive capacity, risks waste rather than sustained output growth.
- Across countries, losses and waste in public investment are prevalent: on average, more than one-third of funds for public infrastructure are estimated to be lost owing to inefficiencies.
- Critical factors behind inefficiencies and poor investment outcomes include optimism bias in project appraisal, limited interagency coordination, corruption, and weak budget processes—particularly affecting allocation and implementation of public investment.
- In countries where subnational governments execute a large share of investment, fragmentation of delivery, local capacity constraints, or unclear land rights can be obstacles to large public investment (examples noted: Germany, Italy, India, Bolivia).
- Improving public investment management could materially reduce inefficiencies:
  - Improving public investment management to the 90th percentile of best performers in each income group could halve the size of investment inefficiencies across countries.
- Policy measures to improve outcomes include establishing a central register of infrastructure projects, tightening financial rules on public-private partnerships, disclosing more ex post reviews and audits of capital projects, and strengthening links among national planning, long-term capital plans, and budgeting processes.

### Sustainable financing and country constraints
- Government borrowing costs in many advanced economies have declined to unprecedented low levels while rates of return on private capital have largely held up.
- If the risk-adjusted social return on new public investment is higher than government financing costs, a greater set of public investment projects is worth undertaking; public investment is less likely to crowd out private activity in that environment.
- However, in countries with high debt-to-GDP ratios (including several advanced economies), adverse market reactions to a large public investment scale-up could raise financing costs and increase debt vulnerabilities—making budget-neutral increases in investment preferable in those cases.
- For many emerging market and developing economies, meeting large investment needs in a fiscally responsible way is challenging:
  - Loans from China accounted for 17 percent of total public external debt of low-income developing countries in 2018—a fourfold increase from 2008 levels.
  - Direct private investment and financing are critical and can be facilitated by structural reforms (for example, improving the business environment).
  - Supranational coordinated investment projects can play a role when challenges surpass the capacity of individual countries (example: cross-country renewable energy networks).
- To balance debt sustainability risks against investment benefits, countries need stronger governance and institutions, better capture of investment returns, management of fiscal risks from public-private partnerships, greater debt transparency, and improved coordination with creditors.
- Meeting the Sustainable Development Goals in low-income developing countries would likely imply new borrowings on nonconcessional terms and could lead to a substantial increase in average interest rates by 110 basis points.
- Increasing tax-to-GDP ratios, seeking concessional financing, and involving the private sector are critical financing strategies.

### Macroeconomic effects of scaling up public investment (model-based estimates)
- A general equilibrium model was used to quantify growth and debt implications of meeting global investment needs, and separately, of addressing Europe’s green investment and infrastructure needs.
- When public investment is efficient (assuming demand inadequacy but not supply constraints), a sustained increase in public investment across the world (1.3 percent of global GDP initially, then declining very gradually) could produce the following estimated effects over a 20-year horizon:
  - Global GDP: increase by an estimated 1.4 percent per year, on average, over a 20-year horizon.
  - Inflation: increase by 66 basis points per year initially.
  - Real interest rate: increase by 14 basis points over the 20-year horizon.
  - The impact on the public debt-to-GDP ratio would be limited in this scenario.

*Source: ch2 - Introduction, Fiscal Monitor: Policies to Support People During the COVID-19 Pandemic (April 2020), International Monetary Fund.*

### 0.6 percent of EU GDP on infrastructure and decar-

### ch2 - 0.6 percent of EU GDP on infrastructure and decar-

### Simulated macroeconomic effects of public investment push
- A public investment increase of 0.6 percent of EU GDP on infrastructure and decarbonization would increase EU output by 0.7 percent per year, on average, over a 20-year horizon.
- For illustrative purposes, the green investment needs of 0.25 percent of EU GDP are assumed to be new financing rather than from rebalanced EU budget expenditure.
- A public investment increase would also:
  - add to inflation initially,
  - raise long-term interest rates modestly,
  - result in a modest rise in the public debt-to-GDP ratio (see panels 1 and 3 of Figure 2.6).
- If supply-side bottlenecks and absorptive capacity constraints (skills, institutions, and management) are binding:
  - investment efficiency would be lower,
  - scaling up public investment would have smaller effects on growth and inflation (with little support for monetary policy in achieving inflation targets),
  - and would lead to a large rise in debt-to-GDP ratios (see panels 2 and 4 of Figure 2.6).

- Model- and scenario-specific numeric assumptions preserved from source:
  - The cumulative public investment injection over 20 years is 18 percent of global GDP and the increase in GDP is estimated to be 28 percent (assuming efficient investment). Thus, the cumulative multiplier is above 1 in both simulation exercises.
  - Additional global investment needs are estimated at 1.3 percent of global GDP initially and are assumed to decline gradually over time. Those needs are composed of:
    - infrastructure: 0.5 percent of GDP,
    - low-carbon energy investment: 0.6 percent of GDP,
    - investment in other SDGs: 0.2 percent of GDP.
  - Additional investment needs for the European Union are estimated at 0.6 percent of regional GDP initially and are assumed to decline gradually over time. Those needs are composed of:
    - infrastructure: 0.35 percent of GDP,
    - low-carbon investment: 0.25 percent of GDP.

### Discretionary measures and timing
- Discretionary measures suffer from information, decision, and implementation lags; policymakers should identify high-quality measures that can be deployed quickly when downside risks materialize.
- Historical observations:
  - Discretionary measures in the United States came late in half of previous recessions (Figure 2.7).
  - US county-level evidence shows the discretionary stimulus from the American Recovery and Reinvestment Act during the Great Recession was not well targeted to areas where the recession was more severe.
- Well-prepared countercyclical discretionary measures can be effective because fiscal multipliers tend to be larger in downturns than in normal times.
- Rules-based fiscal stimulus as an option:
  - Enact discretionary measures that will be automatically activated (a rules-based fiscal stimulus) when economic conditions deteriorate (for example, a decline in job creation below a certain threshold or a large increase in the unemployment rate above a certain level or duration).
  - Design rules-based fiscal stimulus to prevent continued debt buildup over the long term.
- Examples of temporary revenue-side measures:
  - temporary value-added tax cuts,
  - tax policies targeted at low-income households (such as a flat, refundable tax rebate),
  - tax policies affecting firms (such as cyclical investment tax credits).
- Examples of temporary expenditure-side measures:
  - temporary extensions of the coverage and duration of unemployment benefits (for example, emergency unemployment compensation programs in the United States),
  - well-targeted transfers to low-income or liquidity constrained households.
- To avoid policy lags for public investment:
  - maintain a pipeline of appraised projects (especially upgrades, maintenance, and repairs) for timely implementation,
  - review the pipeline now, identify bottlenecks, and prepare a set of ready-to-implement projects that can be deployed when supply disruptions ease,
  - accelerate implementation of smaller projects in downturns.
- Some governments (Australia, Ireland, New Zealand, Norway) have a rolling pipeline of public infrastructure projects within a budget constraint over the long term to provide details on timing, sequencing, and scale.

### Enhancing automatic stabilizers
- Automatic stabilizers are budget mechanisms that adjust spending and taxes when the economy slows or expands; primary components include progressive income taxes (revenue side) and unemployment benefits and social safety nets (spending side).
- Key roles and empirical points:
  - In downturns, automatic stabilizers support aggregate demand promptly, reach affected populations, and phase out when conditions improve.
  - Automatic stabilizers account for more than one-half of overall fiscal stabilization—measured as the sensitivity of the overall budget balance to the output gap—in two-thirds of advanced economies.
  - Automatic stabilizers account for 30 percent of total fiscal stabilization in emerging market and developing economies, with large cross-country variation.
  - Automatic stabilizers provided a sizable boost to output during the Great Recession—about 2 percent of GDP in the United States and slightly less in the euro area.
  - Several studies suggest automatic stabilizers can absorb one-third of income shocks and 40 percent of unemployment shocks in major advanced economies.
- Policy options to strengthen automatic stabilizers:
  - Improve tax design (see Box 2.2 in source),
  - Strengthen social safety nets,
  - Introduce two-pillar unemployment benefit systems:
    - Pillar 1: unemployment insurance financed from contributions,
    - Pillar 2: unemployment assistance financed from government revenues for those who have not contributed or have exhausted insurance benefits.
  - Increase generosity, take-up, benefit levels, and duration of transfer programs based on predefined formulas; ease eligibility criteria during recessions.
  - Design benefits to balance demand support and work disincentives (for example, gradually removing benefits as employment income increases).

### Spending-side automatic stabilizers and social safety nets
- Rationale: Strengthening unemployment benefit systems and social safety nets both reinforces spending-side automatic stabilizers and protects households by providing adequate income support.
- Evidence and magnitudes:
  - A 1 standard deviation increase in the generosity of US unemployment insurance would attenuate the effect of adverse shocks on employment growth by 7 percent (Di Maggio and Kermani 2016).
  - Well-designed unemployment benefit systems and social safety nets can play a large role in aggregate demand stabilization because payments are directly tied to consumption of low-income households.
- Cross-country variations and statistics:
  - The size of income stabilization by tax-benefit systems varies from 95 percent in Denmark to below 20 percent in the United States.
  - Social safety nets are noncontributory transfer programs targeted at low-income households or the vulnerable and typically include cash transfers, food stamps, child allowances, social pensions, in-kind transfers, income-support schemes conditional on education or health, public works, and fee waivers (including for health care).
  - Social safety nets have contributed to a reduction of poverty gaps by 45 percent worldwide, on average.
  - The size of social safety nets averages 2.7 percent of GDP in OECD countries and 1.5 percent of GDP at the global level.
  - In most OECD countries, unemployment insurance and other benefits replace on average 70 percent of last employment income for a typical household, though long spells can exhaust insurance benefits and replacement rates vary by country.

*Source: IMF, April 2020, Chapter 2 (FISCAL MONITOR: POLICIES TO SUPPORT PEOPLE DURING THE COVID-19 PANDEMIC).*

### CHAPTER 2 IDEAS TO RESPOND TO WEAKER GROWTH

### CHAPTER 2 IDEAS TO RESPOND TO WEAKER GROWTH

### Social safety nets: coverage, adequacy, and design attributes
- Findings on current coverage and adequacy
  - Social safety nets in emerging market and developing countries cover less than one-fifth of the poorest quintile of households, on average.
  - The average transfer accounts for only 13 percent of the consumption of the bottom 20 percent of the income distribution (World Bank 2018).
  - Regional spending is relatively low in South Asia and Middle East and North Africa (Figure 2.11).
  - In sub-Saharan Africa, while social safety nets cover a small share of the poorest quintile, the adequacy of benefits for this group is relatively high (Figure 2.13).
- Four desirable attributes of a strong social safety net (Grosh and others 2008)
  - Broad coverage and adequate, progressive benefits within the overall tax-benefit system (IMF 2019c).
  - Cost effectiveness by avoiding program fragmentation and beneficiary overlaps.
  - Preservation of work incentives and enhancement of human capital by linking transfers to required or voluntary programs (public works, health care, education, training).
  - Financial sustainability within the overall expenditure envelope and consistency with other social protection programs.
- Common gaps and practical instruments to improve targeting
  - Programs are often fragmented (example: Mexico), involve beneficiary overlaps, and lack appropriate incentive features.
  - Very few of the poor are covered by unemployment insurance, shifting the burden of income support onto social safety nets.
  - Instruments effective in reaching those most in need include mobile money, in-kind provision of goods and services (health care, water, transportation), use of existing social registries, and community-based methods to identify those in need.
  - In Middle East and North African countries, targeted cash transfers could be more progressive than subsidies.
  - Aadhaar in India—1.2 billion residents enrolled—serves as an example for economies that can map bank-account information to a unique identification number to implement direct cash transfers, subject to privacy and security safeguards.

### Strengthening spending-side automatic stabilizers while preserving work incentives
- Two-pillar unemployment benefit systems and guaranteed minimum income
  - A two-pillar unemployment benefit system provides both income insurance and assistance in recessions, serving as an effective automatic stabilizer (examples: Austria, Germany, Finland, Ireland, New Zealand, Spain, United Kingdom) (Immervoll 2010).
  - A guaranteed minimum income program is typically selective, conditional, and means tested; most OECD countries have centralized minimum-income programs for working-age individuals.
- Typical features of guaranteed minimum income programs (Table 2.1)
  - Coverage: Able-bodied working-age individuals in poverty and their households; means-testing requires verification of income and assets, which may be challenging in settings with large informal sectors and limited administrative capacity.
  - Benefit Levels: The benefit should reflect basic needs without causing welfare dependence; calibration is relative to the poverty line; most countries provide additional housing allowances and health care.
  - Incentives: Program design should include conditional in-work tax credits, marginal income disregard for part-time/casual work, gradual benefit phaseouts, and back-to-work bonuses to reduce disincentives from high withdrawal rates.
  - Conditionality: Participation in active labor market programs is essential where implementation capacity exists to reduce fiscal cost and disincentives to work.
- Practical measures during recessions
  - Subsidizing reduced working hours (example: Germany).
  - Increasing coverage and benefits of unemployment benefits and social safety nets by relaxing eligibility criteria and loosening work requirements in recessions.
  - Improving targeting and administrative capacity (example: Italy’s citizenship income program could be improved by reducing benefit generosity, improving targeting, and building controls and local administrative capacity).
- Trade-offs and observed outcomes
  - Some countries (Denmark, Finland) provide strong income support when unemployed but face a large effective tax rate of 90 percent on labor income when recipients find a job—this can discourage labor market participation.
  - Countries without unemployment assistance (Turkey, United States) tend to emphasize work incentives and have low effective tax rates upon return to work (Figure 2.14).
  - If Estonia or the United States upgraded benefit systems to the median OECD country, household incomes would fall by one-third less when workers lose their jobs during recessions.
- Complementary policies
  - In-work wage subsidies (example: earned income tax credit in the United States) can preserve work incentives while enhancing stabilization.

### Drivers of subdued growth and the role of high-return investment
- Competing explanations for low growth, low inflation, low interest rates, and high debt (Box 2.1)
  - Inadequacy of demand: Aging populations, globalization and preference for safe assets, rising income inequality.
  - Weak supply potential: Slowing productivity growth, weak capital accumulation, shrinking labor force in advanced and some large emerging economies.
  - Debt supercycle: Financial boom preceding the Great Recession, public and private debt overhang, and credit expansions with diminishing returns (for example, in China).
- Policy implication: consensus on need for more high-return investment
  - If weak demand persists (debt overhang, pessimistic expectations, rising inequality, aging), the real return on private investment remains low; high-return public investment, especially in a low interest rate environment, could spur private activity.
  - If supply constraints drive weakness, investing in physical and human capital and R&D, complemented by structural reforms that foster competition and innovation, can raise long-term growth (IMF 2015b; Bakker 2019).
  - Evidence indicates high-return investment, particularly when combined with reforms, can durably raise long-term growth.

### Tax design and tax-related instruments to strengthen automatic stabilizers
- Stabilization role of tax system design
  - A progressive tax system helps stabilize the economy because taxpayers pay lower taxes in a recession than in a boom; among OECD countries, income taxes can automatically stabilize between 20 and 50 percent of income shocks (OECD 2019).
  - Taxes on income (personal and corporate) respond most to the cycle; taxes on goods and services, payroll taxes, and social security contributions move with the cycle but less so.
  - Some tax items contribute little to stabilization: tax deductions, earmarked proceeds, nontax revenues loosely related to nominal GDP, specific infrequently indexed taxes (excises), and delayed-collected taxes.
- Tax instruments to strengthen automatic stabilizers, including pandemic response
  - Bonus depreciation: allows firms to deduct a substantial portion of new investment from taxable profits during recessions, which seems to have boosted investment in the United States during the global financial crisis (Zwick and Mahon 2017).
  - Accelerated depreciation or super-deductions: can encourage investment in health or hygiene products undersupplied during a pandemic.
  - Cyclical loss-carry backward: automatically allow deduction of current corporate losses against past tax payments to provide immediate tax refunds to struggling companies; previously applied in Canada, France, Germany, United Kingdom, United States, and during the current pandemic.
  - Linking property taxes more closely to the real estate cycle by assessing property values annually (example: United States) to smooth the cycle.

*Source: CHAPTER 2 IDEAS TO RESPOND TO WEAKER GROWTH, Fiscal Monitor: Policies to Support People During the COVID-19 Pandemic, International Monetary Fund, April 2020.*

### Box 2.2. Tax Policy and Automatic Stabilizers

### Box 2.2. Tax Policy and Automatic Stabilizers

### Role of tax policy in cyclical stabilization
- Tax policy can be used to increase tax collections during property booms and reduce taxes during slumps.
- Corporate income tax collections based on current-year estimated income—as opposed to a corporate income tax based on actual income of the previous year—allow tax collections to be linked more closely to the current state of the economy, making stabilization timelier because tax collections would fall during downturns and reverse during a recovery.

### Design of personal income tax measures
- Tax credits are preferable to deductions as a way of encouraging socially valuable activities (such as education and charitable contributions) while smoothing the cycle.
  - The impact of tax credits on disposable income is fixed, whereas the impact of deductions declines during downturns as disposable income falls.
- Uniform personal income tax credits (that is, an equal credit for all individuals) are recommended because, under a deduction-based system, higher-income individuals would receive higher effective tax relief.
  - This proposed measure applies when the personal income tax is progressive.

### Investment tax credits and corporate measures
- Investment tax credits are stabilizing because they reduce the cost of capital and stimulate investment when it tends to fall during recessions—that is, at a time when the stabilization is most needed.
- Historical example: In Sweden, cyclical investment tax credits through the Swedish Investment Fund successfully served as countercyclical fiscal measures between the mid-1950s and the mid-1970s.
  - During normal times, firms could deduct up to 40 percent of their taxable profit, allocate it to an investment fund, and draw on this fund freely for investment during downturns.

### Practical implications for automatic stabilizers
- Shifting tax instruments toward credits (personal and investment) and aligning corporate tax collection timing with current economic conditions can strengthen automatic stabilization by:
  - Providing fixed, predictable support to disposable income across the cycle (tax credits).
  - Lowering the cost of capital to counteract procyclical declines in investment (investment tax credits).
  - Allowing tax revenue to decline quickly in recessions and rise in recoveries when collections are based on current-year estimates.

*Source: Box 2.2. Tax Policy and Automatic Stabilizers, Fiscal Monitor: Policies to Support People During the COVID-19 Pandemic (IMF, April 2020).*

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_Source: https://www.imf.org/-/media/files/publications/fiscal-monitor/2020/april/english/ch2.pdf_