## _042015 ## Source details **Canonical URL:** [_042015](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_042015.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_042015.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_042015.pdf.json) --- ### Executive summary — purpose, approach, and main findings - Purpose and approach: - Explores how fiscal policy can affect medium- to long-term growth and identifies main channels and practical lessons for policymakers. - Draws on: 9 country studies (12 reform episodes), a novel 10-year post-reform SCM technique, a statistical analysis of growth accelerations within 5 years, and simulations of an endogenous growth model. - Notes limits: attribution and causality are difficult when reforms coincide with other factors. - Main quantitative findings on growth impacts: - Advanced countries (excluding Ireland): per capita growth estimated about ¾ percentage points higher following fiscal reforms. - Developing economies (average SCM divergence): almost 2½ percentage points higher post-reform. - Endogenous growth model simulations: - Budget-neutral tax reform enhancing tax efficiency may lift long-term growth by as much as ½ percentage point. - Shifting spending composition toward infrastructure investment could add ¼ percentage point. - Increasing responsiveness of fiscal policy to output by one standard deviation could boost annual growth by about 0.3 percentage point in advanced economies. - Statistical analysis (sample of 112 countries, 1975–2013): - Revenue reforms followed by growth accelerations in 26.0 percent of reform cases. - Expenditure reforms followed by growth accelerations in 20.5 percent of reform cases. - Combined revenue and expenditure reform packages followed by growth accelerations in 60.0 percent of cases. - For comprehensive packages, conditional P(accel|reform) by group: Advanced countries 80 percent; Emerging countries 67 percent; Low-income countries 38 percent. ### Channels through which fiscal policy promotes growth - Macro channel: - Ensuring macroeconomic stability (reduce volatility, preserve price signals, maintain investor confidence). - High public debt can hamper growth; OECD literature suggests debt above 85 percent of GDP may drag growth. - Micro channels via tax and expenditure design: - Labor supply: lower tax wedge, redesign labor taxes and social benefits, ALMPs increase participation. - Physical capital: reform capital income taxation (tax rents), ACE and similar measures reduce bias toward debt financing. - Human capital: increased and efficient spending in education and health raise long-term growth. - Total factor productivity (TFP): R&D incentives and efficient public infrastructure raise productivity and technology adoption. - When reforms require fiscal space: - Revenue: broaden tax base, close VAT gaps, use excises (tobacco, alcohol, sugar) where appropriate. - Expenditure: rationalize wages, subsidies, and untargeted benefits; protect/strengthen public investment management. ### Design, complementarities, implementation, and political economy - Complementarity and sequencing: - Reforms are more effective when revenue/expenditure measures reinforce each other and are complemented by structural reforms (trade, labor, product markets). - Social consensus and implementation: - Social dialogue, effective communication, and compensatory measures for losers increase sustainability. - Credible medium-term plans and fiscal rules (example: constitutional "debt brake") help lock in gains. - Composition considerations: - Expenditure-based consolidations often more durable in advanced economies; revenue-based adjustments found more durable in some LICs. - Large expenditure-based consolidations can increase inequality; balance and pragmatism required. ### Model simulations — endogenous growth model experiments (calibrated results) - Calibration (selected benchmark parameter values preserved exactly): - Capital income tax rate = 0.25 - Labor income tax rate = 0.25 - Consumption tax rate = 0.07 - Public investment ≈ 4 percent of final output on benchmark BGP - Discount factor = 0.98 - Labor supply parameter = 0.65 - Utility function parameter = 0.35 - Elasticity of human capital production to public capital = 0.09 - Elasticity of final output to public capital = 0.09 - Depreciation rates: human capital = 0.04; private physical capital = 0.04; public capital = 0.04 - Public investment share of revenue = 0.11 - s (Share of revenue spent on transfers) = 0.30 - Quantitative experiments (changes in long-run growth relative to benchmark; change in long-run level of sustainable government debt reported as ≈ 0): - Δ capital tax -5% → growth +0.2 percentage points; debt change ≈ 0 - Δ labor tax -5% → growth +0.2-0.3 percentage points; debt change ≈ 0 - Δ capital tax -5% & Δ labor tax -5% → growth +0.4-0.5 percentage points; debt change ≈ 0 - Δ public investment +1% of GDP & Δ unproductive spending -1% of GDP → growth +0.15-0.2 percentage points; debt change ≈ 0 - Additional model-level results cited: - A revenue-neutral labor tax simulation: reducing tax on labor income by 5 percentage points leads to higher long-run growth of about 0.2-0.3 percentage point. - Examples from literature: replacing distortionary capital and labor taxes with consumption taxes can raise growth by amounts ranging from 0.03 to 1.23 percentage points depending on model structure and labor supply endogeneity. ### Empirical evidence from country case studies (selected outcomes and channels) - Cross-country SCM quantitative results (post-reform 10-year averages): - Advanced countries (excluding Ireland): per capita growth about ¾ percentage points higher than counterfactual. - Emerging markets: divergence about 2¾ percentage points higher than counterfactual. - Low-income countries: divergence about 1¾ percentage points higher than counterfactual. - Relative drivers: advanced economies showed balanced capital/labor/TFP contributions; emerging and LICs dominated by capital accumulation. - Country highlights (selected exact figures and outcomes): - Australia: - Real GDP growth averaged 3.2 percent since 1980. - Pension assets: 1992 AUS$150 billion → By June 2014: $1.85 trillion. - Per capita growth differential opened after 1985 reform wave; private investment-to-GDP ratio more than doubled; annual growth averaged around 8 percent in episode cited. - Chile: - Fiscal consolidation 1974-79: primary fiscal deficit from 23 percent of GDP in 1973 to 5 percent surplus in 1979. - Growth peaked at 11 percent in 1989; average annual GDP growth: 1.6 percent pre-first episode → 3 percent during first episode → 5 percent during second episode. - Growth accounting (1974-1999 averages): Capital 2.3; Labor 1.8; TFP 0.4. - Germany (Agenda 2010): - Public spending dropped by almost 5 percent of GDP from its peak until 2007. - Overall fiscal deficit of 4 percent of GDP in 2003 to 0.2 percent of GDP surplus in 2007. - SCM indicates growth acceleration of about 0.7–1.5 percent depending on measure. - Unemployment fell substantially; labor and TFP were main drivers. - Ireland: - Ten years prior to reforms, GDP growth averaged 2.9 percent; ten years after reform averaged 7.1 percent. - Synthetic control: average real GDP growth during the ten-year post-reform period about 4.8 percentage points higher than synthetic control. - CIT reduced from 50 percent in 1987 to 12.5 percent in 2003 (timeline entries). - Malaysia: - Fiscal consolidation: government expenditure declined by 8.6 percent of GDP between 1986 and 1990. - Private investment surged from 14 percent in 1986 to 32 percent of GDP in 1997; growth averaged around 8 percent up to 1997. - Poland: - Corporate tax reduced progressively from 40 to 19 percent between 1998-2004. - SCM: fiscal reforms helped boost GDP growth by about 1.4 percentage points (absence of reforms would imply growth 1.4 percentage points lower in the second half of 2000s). - Real GDP per capita growth exceeded the synthetic control by 2¼ percentage points during the 5-year post-reform period. - Tanzania: - Real GDP growth: pre-reform ten-year average 4 percent → reform period 4.3 percent → subsequent ten years about 7 percent. - Synthetic control: actual growth about 1.7 percentage points higher than synthetic Tanzania on average; per-capita differential about 2.8 percentage points. - Uganda: - Real GDP growth averaged 6.5 percent from 1991 to 2013; real GDP per capita growth averaged 3.2 percent over same period. - Synthetic control: average real GDP growth during the five-year period following reform about 5.2 percentage points higher than synthetic control; per-capita growth exceeded synthetic by 4.3 percentage points in first five-year post-reform period. ### Empirical probabilities and reform types (technical annex I / event study) - Sample: 112 economies over 1975-2013; 146 growth acceleration episodes identified. - Conditional probabilities (selected exact figures): - Revenue reforms → growth acceleration: 26.0 percent. - Expenditure reforms → growth acceleration: 20.5 percent. - Combined revenue & expenditure reforms → growth acceleration: 60.0 percent. - By reform type (selected rows): - Corporate income taxes reduction → 31.0 percent. - Personal income taxes reduction → 40.0 percent. - Social security contributions reduction → 36.0 percent. - Indirect taxes increase → 37.1 percent. - Consumption taxes → 28.1 percent. - Property taxes → 6.7 percent. - Health spending increases → 39.5 percent. - Education spending increases → 26.2 percent. - Capital spending increases → 15.1 percent. - Transport & communication spending increases → 20.0 percent. - Robustness in conditional samples: - High-debt periods (debt above thresholds by income group): revenue reforms 22.7 percent; expenditure reforms 13.3 percent; combined reforms 27.3 percent. - Non-expansionary debt sample (no debt expansion): combined reforms P(accel|reform) = 71.4 percent. - Non-expansionary deficit sample (no deficit expansion): combined reforms P(accel|reform) = 63.6 percent. - Reforms followed by reduction in income inequality sample: combined reforms 61.5 percent. ### Policy menu and concrete recommendations (high-level) - Macroeconomic stability: - Reduce large fiscal deficits; pace and composition of consolidation should protect growth; gradual consolidation when not under market pressure; allow symmetric automatic stabilizers where appropriate. - Structural fiscal policies: - Labor supply: reduce labor taxes (esp. at low incomes), redesign unemployment benefits (eligibility, duration, conditionality on ALMPs), expand in-work benefits, target measures for women, older and low-skilled workers. - Investment in physical capital: tax excess returns (ACE), avoid open-ended tax holidays, use targeted incentives (accelerated depreciation, investment tax credits), protect/increase public capital stock, strengthen public investment management. - Human capital: increase spending at lower education levels, condition cash transfers on school enrollment, expand basic health coverage, reduce user charges for the poor. - TFP: R&D tax credits, increase public R&D spending, provide efficient public infrastructure. - Creating fiscal space least harmful to growth and equity: - Broaden tax base, shift toward less distortionary taxes (consumption), consider property/wealth/environmental taxes, improve revenue administration, rationalize public wage bill, improve targeting of social spending, phase out generalized energy subsidies. - Design and political economy: - Build social consensus via communication and compensating measures; complement fiscal reforms with structural reforms and consistent macro policies; use fiscal frameworks/rules for credibility. ### Methodology notes (SCM and event study) - Synthetic Control Method (SCM): - Constructs weighted synthetic comparator to match pre-reform outcomes; estimated impact is post-reform divergence. - Robustness assessed via in-space and in-time placebos, sequential exclusion of comparator countries, and sensitivity to reform start/end dates. - Event study approach for growth accelerations: - Uses 5-year windows (n=5) to calculate average growth rates; main results robust to 8-year window. - Identified 146 growth acceleration episodes in 112 countries (largest number in advanced economies: 62 episodes; emerging 42; low-income 42). *Italic: Source — IMF chapter "FISCAL POLICY AND LONG-TERM GROWTH" (excerpts provided).* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Purpose and approach - Explores how fiscal policy can affect medium- to long-term growth and identifies main channels and practical lessons for policymakers. - Draws on the Fund’s technical assistance and several analytical studies: - 9 country studies covering advanced, emerging market, and low-income countries (LICs), spanning 12 reform episodes. - A novel technique estimating post-reform impact using 10-year average growth rates following reforms. - A statistical analysis of the share of fiscal reform episodes followed by growth accelerations within the next 5 years. - Simulations of an endogenous growth model to isolate effects of fiscal reforms. - Notes limits: difficult to disentangle fiscal reform effects from other coterminous factors and to determine causality with certainty. ### Main findings on growth impacts - Fiscal policy is an effective tool for supporting growth. - Country studies suggest per capita growth is estimated at about ¾ percentage points higher following fiscal reforms in advanced countries; growth dividends could be even higher in emerging markets and LICs. - Endogenous growth model simulations: a budget-neutral tax reform package aimed at enhancing tax efficiency may lift long-term growth by as much as ½ percentage point. - Shifting spending composition toward infrastructure investment could add ¼ percentage point to long-term growth. - Statistical analysis indicates a relatively high likelihood that fiscal reforms are followed by growth accelerations. - Macroeconomic stability is a prerequisite for sustained growth. - Increasing the responsiveness of fiscal policy to output by one standard deviation could boost annual growth by about 0.3 percentage point in advanced economies; dividends appear much smaller in emerging markets and LICs. - High public debt tends to hamper growth through uncertainty over future taxation, crowding out private investment, and weakening resilience to shocks. - Empirical evidence suggests the debt-to-GDP ratio threshold at which growth is harmed varies with development level and other factors; for OECD countries, when public debt exceeds 85 percent of GDP it may become a drag on growth (further 10 percentage point increases cited as harmful in referenced literature). - The relationship between fiscal deficits and growth in developing economies is non-linear and depends on financing modalities: - Example threshold: the long-term growth dividend of cutting the deficit disappears or reverses below a threshold of around 1½ percent of GDP (Adam and Bevan, 2013). - In Uganda, public financial management reforms and strict expenditure controls reduced deficits and monetization, helped lower inflation, and paved the way for higher growth. ### Channels through which fiscal policy promotes growth - Macro channel: ensuring macroeconomic stability (reducing volatility, preserving price signals, maintaining investor confidence). - Micro channels via tax and expenditure design: - Lowering the tax wedge and improving design of labor taxes and social benefits can strengthen work incentives and induce positive labor supply responses. - Reforming capital income taxes to tax rents reduces distortions and encourages private investment. - Well-targeted tax incentives can stimulate private investment and enhance productivity through research and development (R&D). - Efficient public investment, especially in infrastructure, can raise the economy’s productive capacity. - More equitable access to education and health care contributes to human capital accumulation, a key factor for growth. - When growth-friendly reforms require fiscal space: - Revenue measures should focus on broadening the tax base and minimizing distortions. - Expenditure measures should aim at rationalizing spending and improving efficiency. ### Design, complementarities, and implementation - Effectiveness is enhanced when reforms reinforce each other and are complemented by structural reforms (e.g., liberalizing trade, labor, and product markets). - Policy design and social consensus matter for success and durability: - Reforms need internal consistency and complementarity with relevant structural reforms and supportive macroeconomic policies. - Balancing efficiency and equity objectives and fostering public support through social dialogue are critical. - Strategies to foster public support include effective communication and inclusion of compensatory measures for those expected to lose from reforms. ### Evidence from country experience and empirical patterns - Fiscal deficit reductions featured prominently in many country studies (example: Chile—large spending cuts and tax base broadening improved the primary balance by about 28 percentage points of GDP over five years in the 1970s; growth picked up subsequently). - Pace of fiscal consolidation matters: - In deep and lasting recessions with large negative output gaps and constrained monetary policy (zero lower bound and/or inoperative credit channels), fiscal consolidation can have negative short-term effects and possible hysteresis leading to lower long-term potential output. - Countries not under market pressure should proceed with gradual fiscal consolidation anchored in a credible medium-term plan. - Fund engagement and inputs: - The Fund fielded some 250 technical assistance missions from headquarters in revenue and expenditure areas in FY2015, and supported member countries through 9 regional technical assistance centers. ### Policy lessons (overview) - Use fiscal policy to secure macroeconomic stability while implementing micro-level tax and spending reforms that improve incentives, investment, and human capital. - Prioritize reforms that are growth-enhancing and minimize distortions (broadening tax bases, improving public investment management, reallocating spending toward infrastructure, education, and health). - Sequence and design reforms to build public support and ensure sustainability; complement fiscal reforms with structural reforms to magnify growth effects. *April 20, 2015 — EXECUTIVE SUMMARY* ### 13. The composition of adjustment matters as well. The appropriate mix of revenue and ### 13. The composition of adjustment matters as well. The appropriate mix of revenue and ### Composition of adjustment: durability, growth, and equity - The appropriate mix of revenue and expenditure measures depends on country-specific conditions, durability of measures, and impact on growth and equity. - Empirical findings: - For advanced economies, expenditure-based fiscal consolidations have been shown to be more durable (Alesina and Ardagna, 2012) and associated with growth in private investment (Alesina and others, 2002). - For LICs, Baldacci and others (2004) find that revenue-based adjustment leads to more durable consolidation episodes, with greater benefits for growth. - When private debt is high and credit supply is restricted, deficit reductions achieved through tax-base broadening while protecting public investment support medium-term growth in both advanced and emerging economies (Baldacci, Gupta, and Mulas-Granados, 2015). - Large expenditure-based consolidations tend to increase inequality, which can undermine long-term growth (Ball and others, 2013; Woo and others, 2013; Berg and Ostry, 2011). - Policy implication: pragmatism is required to balance revenue and spending measures to preserve durability, growth, and equity. ### Country examples and outcomes - Malaysia: - Faced sluggish growth and high fiscal deficits (10 percent of GDP in 1986). - Cut current spending and rationalized inefficient public investment. - Result: budget registered small surpluses and deficits during the 1990s; private investment-to-GDP ratio more than doubled; annual growth averaged around 8 percent. - Netherlands: - An expenditure cut of 15 percent of GDP between 1982 and 2000 created room for lower taxes and supported private investment and private sector job-creation. - Both Malaysia and the Netherlands managed to avert adverse consequences on income inequality (see Section D on Growth and Equity). ### Pension, health, and fiscal sustainability - Age-related spending shares in advanced and emerging market economies: public pensions account for 40 percent and health care for 30 percent of government spending (IMF, 2014f). - As populations age, pension and health spending pressures can undermine long-term fiscal sustainability; fiscal consolidation strategies need reforms in these areas. - Country reform examples: - Poland: shifted from a financially unsustainable defined-benefit system to an actuarially solvent defined-contribution system. - Germany: linked pension benefits to the old-age dependency ratio, tightened access to early retirement, and raised the statutory retirement age. - Health care reforms in Germany and the Netherlands included price controls on pharmaceuticals, higher co-payments and contributions, and budget caps. ### Institutions and fiscal frameworks - Strong and transparent institutions support macroeconomic stability and sustainability of fiscal policies. - Countries with stronger budget institutions tend to deliver more growth-friendly fiscal adjustments (IMF, 2014g). - The 12 budget institutions included in IMF (2014g) are: fiscal reporting; macro-fiscal forecasting; fiscal risk management; independent fiscal agency; fiscal objectives and rules; medium-term budget framework; performance orientation; intergovernmental financial arrangements; budget unity; top-down budgeting; parliamentary approval; and budget execution. ### Transmission channels of fiscal structural reforms - Four main channels through which tax and expenditure policy reforms affect medium- to long-term growth: - Labor supply - Tax-benefit systems influence labor market participation (extensive) and hours worked (intensive). - Particularly important for lower-income households, women, and older workers (IMF, 2014a; OECD, 2011). - Devereux and Love (1994) and Turnovsky (2000) show labor tax cuts can raise long-term growth via higher labor supply. - Physical capital - Capital income taxation affects private savings and investment; profit taxes and differential treatment of financing bias toward debt financing (De Mooij, 2011). - Efficient public investments can boost returns on private investment. - Human capital - Human capital drives long-term growth and promotes technical progress (Lucas, 1988; Barro, 2001). - Both tax and spending policies can raise human capital; investment in health and education featured in Ireland, Tanzania, and Uganda case studies. - Total factor productivity (TFP) - Government action on R&D (direct spending or tax incentives) and public infrastructure affects productivity and technology adoption. - Six country studies increased tax incentives for R&D or public R&D spending (Australia, Germany, Ireland, Malaysia, the Netherlands, and Poland). Public infrastructure improved in Chile, Malaysia, and Poland. ### Empirical evidence from country studies and SCM results - Using the Synthetic Control Method (SCM), country studies show a significant increase in average growth during the 10 years following fiscal reform episodes compared with the counterfactual, with caveats about attribution. - Key quantitative findings: - In advanced countries, excluding Ireland, per capita growth in the post-reform period is about ¾ percentage points higher than the counterfactual. - In developing economies, the estimated divergence in growth paths reaches almost 2½ percentage points, on average. - Relative contributions to growth varied: advanced economies experienced relatively balanced contributions from capital, labor, and TFP; emerging markets and LICs saw capital accumulation as the dominant growth driver. - SCM caveats: possible upward bias from concurrent reforms and downward bias if comparator countries also implemented growth-enhancing reforms. ### Growth accelerations and types of fiscal reforms - Analysis of 146 episodes of growth accelerations in 112 countries: - Revenue reforms are most likely to be followed by a growth acceleration in emerging market economies. - Expenditure reforms displayed the most potential in both advanced and emerging economies. - Quantitative probabilities: - 37 percent of episodes involving reductions in the share of income taxation matched by an increase in the share of indirect taxation are followed by a growth acceleration in the sample as a whole. - Increases in health, education and infrastructure spending are followed by higher growth in 20 to 40 percent of identified cases. - Combined revenue and expenditure fiscal reform packages have a higher likelihood (around 60 percent of reform cases) of being followed by growth acceleration. ### Model simulations and fiscal reform dividends - Budget-neutral reforms can yield growth dividends: - A budget-neutral tax reform package aimed at enhancing tax efficiency may lift long-term growth by about ½ percentage point. - Shifting the composition of spending toward infrastructure investment could add ¼ percentage point. - Revenue-neutral labor tax simulation: - Reducing tax on labor income by 5 percentage points leads to higher long-run economic growth of about 0.2-0.3 percentage point, via increased after-tax wages and labor supply. ### Policies to encourage labor supply and improve benefit design - Policies to boost labor supply: - Cut taxes on labor, redesign social benefits, and strengthen active labor market programs (ALMPs). - In low-income countries, prioritize equal access to education and dismantle legal obstacles to female labor force participation (FLFP). - Unemployment benefit design features to strengthen work incentives: - Eligibility criteria: condition eligibility on previous contributions or participation in ALMPs (example: Netherlands tightened access in mid-1980s and saw increased participation). - Benefit duration: lowering maximum duration and reducing replacement rates over time can expedite return to employment; about a third of OECD countries have maximum durations in excess of 12 months. - Individual unemployment savings accounts (ISAs): linking contributions to individual accounts can reduce distortionary effects and facilitate expansion of unemployment insurance in economies with large informal sectors; used in Brazil and Chile (Hijzen and Venn, 2011). *Italic: Source — IMF chapter "FISCAL POLICY AND LONG-TERM GROWTH" (excerpts provided).* ### 22. In particular, advanced economies could intensify the use of ALMPs and in-work ### 22. In particular, advanced economies could intensify the use of ALMPs and in-work ### Active Labor Market Policies (ALMPs) and In-work Benefits - Conditioning of means-tested transfers on participation in ALMPs (personal employment services, training, job placement, public employment schemes). - Activation intensity should increase with unemployment duration: initial period for job search, followed by job placement assistance and individually tailored training—especially important for youth unemployment and the long-term unemployed. - The use of ALMPs has increased over the last decade, but “there is still significant room for improvement in many countries (OECD, 2012b).” - Germany example: - Labor force participation increased from 66 percent to 74 percent between 2000 and 2013. - The unemployment rate fell to 5.2 percent in 2013, after reaching a peak of 11.2 percent in 2005 (OECD, 2014c). - Greater use of in-work benefits: - Systems allow gradual withdrawal of benefits as earnings or employment duration increase (examples: Germany, the Netherlands, and Sweden). - Reduces the net tax on additional earnings; can turn it negative for low-income groups with benefits for employment, equity, and poverty reduction (IMF, 2012). ### Targeted Tax and Spending Measures to Raise Labor Supply - Labor force participation of women and older workers remains low; gender gaps in participation rates: - 51 percentage points in the Middle East and North Africa, - 35 percentage points in South Asia and Central America, - 12 percentage points in OECD countries (Elborgh-Woytek and others, 2013; Cuberes and Teigner, 2014). - Women: - Female labor supply is more responsive to taxes than male labor supply; tax relief for women could elicit a positive net response. - Examples: India applies a higher tax exemption for women; many advanced economies replaced family taxation with individual taxation to reduce tax burden for secondary earners. - Expenditure-side interventions: closing gender gap in education (India, Turkey); well-designed family benefits including paid parental leave up to about two years (United States); more flexible work options (India and Japan); greater availability of child-care options (Germany, Japan, United States). - Policies with beneficial impact on FLFP: social benefit reforms (Germany, Netherlands); higher labor market flexibility (Germany, Netherlands); better education (Ireland); shift from family to individual taxation (Ireland). - Older workers: - More sensitive to financial incentives than younger workers (Blundell, 2014; IMF, 2014a). - Lower tax rates (including implicit taxes on continuing work) can increase incentives to remain in the labor force. - Examples of policies: specific earning tax credits for older workers (Australia, Denmark, Netherlands, Sweden); pension reform (increase effective retirement age; adjust benefits to actuarially fair levels). - Many countries enacted legislation to raise statutory retirement ages (including Australia, France, Germany, Poland). - Targeted measures should protect against old-age poverty, including expansion of social pension for low-income workers financed through general revenues rather than labor taxes (India, Indonesia, Thailand; Clements, Eich, Gupta, 2014). - Low-skilled workers: - Targeted tax credits yield positive net employment effects as low-skilled workers exhibit higher labor supply elasticities (OECD, 2011; IMF, 2014a). - Most advanced economies have introduced in-work tax credits. - More progressive tax schedules could be a revenue-neutral way of reducing tax wedges for low-skilled workers. - Hiring subsidies or targeted reductions in non-wage labor costs (such as social contributions) can stimulate demand for low-skilled labor. ### Policies to Enhance Investment in Physical Capital - Taxation of capital income influences private savings and investment; corporate taxes increase the user cost of capital and can adversely impact domestic investment and FDI (Abbas and Klemm, 2012; Vartia, 2008; Schwellnus and Arnold, 2008). - Revenue-neutral simulation: reducing tax on capital income by 5 percentage points (while increasing the consumption tax to keep fiscal revenue unchanged) adds about 0.2 percentage point to long-run economic growth. - Country examples: Malaysia streamlined and reduced corporate income tax (CIT) contributing to a surge in investment; similar responses in Germany, Ireland, the Netherlands, Uganda. - Reforming CIT to tax “excess returns” (rents) could reduce investment distortions while still generating revenue (Cottarelli and Keen, 2012). - Allowance for corporate equity (ACE) exempts investments that earn a “normal” return via deduction of an imputed return on equity and reduces bias toward debt-financing (Klemm, 2006; Mirrlees and others, 2011). - Countries using variants: Austria, Belgium, Brazil, Croatia, Italy. - Evidence of positive impact in Belgium (Aus dem Moore, 2014). - Tax incentives: - Well-targeted incentives that directly reduce cost of capital (accelerated depreciation, investment tax credits, super deductions) have had some success. - Open-ended profit-based tax holidays are less effective and can erode the tax base indefinitely. - Cost examples: CIT incentives in 15 Caribbean countries estimated at around 5½ percent of GDP, on average (Cubeddu and others, 2008); preferential treatments under income tax in Latin America estimated between ½-6 percentage points of GDP (Villela and others, 2010). - FDI is eight times stronger for countries with good investment climates (James, 2013). - Malaysia’s 1986 incentives stimulated domestic investment but foreign investors were primarily influenced by macroeconomic stability and infrastructure; incentives cost 2.2 percent of GDP (World Bank, 1991). - International cooperation: - Lack of cooperation can erode tax bases via cross-border spillovers and profit shifting by MNEs. - OECD/G20 Base Erosion and Profit Shifting project aims at protecting tax bases and ensuring predictability (OECD, 2014a). - Initial coordination steps could include promoting transparency (publishing data on tax expenditures and country-by-country reporting on transfer prices). - Public investment in infrastructure: - Positive relationship between public capital and growth; developing economies with large infrastructure gaps stand to reap high returns (Romp and de Haan, 2007; Bom and Ligthart, 2010). - In endogenous growth literature, public capital yields a direct permanent growth dividend (Futagami and others, 1993) and increases longevity of private capital (Agenor, 2010). - Higher infrastructure investment estimated to raise output by as much as three percent in advanced economies—assuming significant slack, accommodative monetary policies, and fully efficient public investment (IMF, 2014b). - Staff’s growth acceleration exercise: transportation and communication spending exhibits the highest likelihood of subsequent growth acceleration (20 percent). - Country examples: Poland (transport infrastructure expansion contributed to higher growth); Malaysia (1985–1995 accelerated infrastructure provision, more than doubling existing capacity; annual growth surged to close to 8 percent). - Public investment efficiency: - Not all public investment creates economically valuable capital; weak public investment management undermines translation into productive capital (Pritchett, 2000; Dabla-Norris and others, 2012). - Potential gains substantial: the average country loses about 30 percent of the value of its public investment to inefficiencies in the investment process (IMF, forthcoming). - Most efficient countries get twice the growth dividend from investment compared with the least efficient countries. - Improving institutional arrangements for allocating public investment projects is most important for enhancing efficiency. - Examples: Tanzania (medium-term planning, improved project selection/prioritization before scaling up); Malaysia (dismantled inefficient SOE projects and refocused public investment on critical infrastructure). ### Policies to Support Human Capital Development - Fiscal policies can promote investment in human capital due to positive externalities of education; deductibility of education expenses or tax credits can mitigate adverse impact of progressive taxation (Heckman and Klenow, 1997). - Public spending on education: - Baldacci and others (2008): spending on education has a significant impact on output growth in developing countries, with two-thirds of the effect realized within the first five years and the remainder over the following five-year span. - A sustained increase in the share of education spending is followed by a growth acceleration in about a quarter of reform cases. - Country examples: Tanzania (increased education spending, assistance to open new schools in less developed regions, decentralized management—boosted enrollment and sustained growth); Ireland (substantial investment in education from the 1960s helped create a skilled workforce, key for FDI inflows after comprehensive fiscal and structural reforms in 1987-89). - Education reform priorities: - Increase investment in lower levels of education: many developing economies allocate a large share to higher education while lower-income groups and girls have lower access to upper-secondary and tertiary education; less than 40 percent of spending reaches the poorest 40 percent of households in most developing economies. - Improve efficiency of education spending: inefficiencies are substantial, including in developing economies. - Increase cost recovery in tertiary education: strong case for tuition fees and income-contingent student loans to relieve financing constraints and provide insurance against inability to repay due to low future income (Barr, 2012). - Target conditional cash assistance: targeting and conditioning cash transfers on education outcomes can reduce income barriers and improve attainment (examples: PROGRESA in Mexico; programs in Brazil, Chile, Nicaragua, Peru, United Kingdom, United States). - Bolsa Familia in Brazil provides assistance to about 14 million families or about 50 million people and is credited with reducing inequality and halving extreme poverty. *Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_042015.pdf* ### introduction in 2003 (World Bank, 2013). The United Kingdom introduced means-tested ### _042015 - introduction in 2003 (World Bank, 2013). The United Kingdom introduced means-tested ### Conditional Cash Transfers and Human Capital - The United Kingdom introduced means-tested education stipends conditioned on education performance; and New York City provides targeted education and health subsidies (IMF, 2014e). - CCT programs are administratively demanding and may require complementary reforms, such as: - investment in quality health and education services; - targeted information campaigns to raise awareness amongst eligible populations (Grosh and others, 2008; Fiszbein and Schady, 2009). ### Health Investment and Growth - Investing in health care supports human capital accumulation; healthier individuals are likely to invest more in their own education and health (Aghion and others, 2010). - Empirical payoff examples: - Jamison and others (2013) estimate that the economic value of increases in life expectancy in developing economies between 2000 and 2011 was equivalent to a 1.8 percent annual increase in GDP. - Staff’s growth acceleration analysis suggests health spending is most likely to be followed by growth accelerations (40 percent). - Advanced economies: - Public health care spending accounted for about 17 percent of primary spending in advanced economies or 6 ½ percent of GDP in 2013. - Projected to rise on average by 3 percentage points of GDP between 2015 and 2030 (Clements, Coady, and Gupta, 2012; IMF, 2015a). - Reforms to curb spending growth may include increased co-payments or reducing the scope of public services; ensure the poor retain access by exempting them from co-payments. - Developing economies — recommended measures for fiscally sustainable progress toward universal basic health coverage: - Expanding health coverage to low-income households: - A fiscally sustainable, publicly financed basic health package covering essential health care would benefit the poor and enhance progressivity of public health spending (Lancet Commission, Jamison and others, 2013). - Poor households often forgo or delay care; many fall into poverty because of high out-of-pocket spending or catastrophic illnesses. - Reducing or eliminating user charges for low-income households: - Health services outside the basic package could be financed by public and private mechanisms (insurance contributions, fees, copayments). - Out-of-pocket spending under typical insurance plans may still be too high for low-income households. - Preventive care, such as immunizations, should be offered free of charge given their large social benefits. - Linking utilization of preventive care to eligibility for other social benefits (such as conditional cash transfers) could increase coverage. - Addressing supply side barriers in less developed areas: - Public provision as last resort or incentives for private providers may be necessary. - Country examples: - Tanzania increased public health spending almost threefold, from 1.3 percent of GDP in 1998, to a peak of 3.8 percent of GDP in 2006. - Uganda increased public spending from 0.1 percent of GDP in 1998 to 1.2 percent in 2003 after free primary health care was introduced. ### Policies to Increase Total Factor Productivity (TFP) - Public goods and infrastructure: - Public investment in physical infrastructure can improve productivity of private capital and raise its rate of return (Munnel, 1992; Easterly and Rebelo, 1993). - Public spending on education accelerates technology catch-up and enhances local productivity (Everaert and others, 2014; Dhont and Heylen, 2009). - R&D incentives: - Well-targeted R&D tax incentives can support lasting growth; two main forms: - tax credits that reduce the costs of R&D (geared toward encouraging innovation); - special intellectual property (IP) boxes that reduce the tax burden on profits earned from patents and trademarks (more likely used as a tool for tax competition). - In advanced economies, R&D tax provisions have a positive, albeit relatively small, impact on TFP; larger for R&D intensive industries (OECD, 2010a). - Country experiences: - Ireland: business expenditure on R&D grew by 80 percent between 2003—the year before the introduction of the tax credit regime—and 2012 (Hynes and O’Connor, 2014). - Poland: five-year growth in real R&D spending accelerated from 32 percent in the pre-reform period (1994-99) to 63 percent in the post-reform period (2005-10). - Netherlands: public spending on R&D increased by 8 percent during a substantial expenditure-based consolidation in the mid-1980s. - Cautions on R&D tax incentives: - They can be distortive and ineffective if not designed carefully. - Empirical evidence on positive effects of such incentives on innovation and growth remains relatively scant. - Where capacity for R&D is limited by human capital constraints, incentives are less compelling; alternatives like incentives for technology transfers may be better. ### Fiscal Space for Pro-Growth Reforms - Growth-friendly fiscal reforms may require fiscal space. Examples: - Revenue losses from lowering highly distortionary taxes (e.g., labor taxes) must be offset by other tax measures and/or spending cuts. - Increased spending on infrastructure, health, and education must be financed through additional revenue, spending reductions elsewhere, or borrowing if fiscal sustainability and rollover risk are not concerns. - Creating fiscal space through revenue measures — recommended approaches: - Shift revenue composition toward more growth-friendly taxes: - Corporate income taxes have the most negative effect on growth, followed by labor income taxes, then indirect taxes, and finally property taxes (IMF, 2013a). - Many countries rely heavily on direct tax revenue. - Closing VAT policy and compliance gaps would improve revenue and remove inefficiencies. - Increasing excise taxes on alcohol, tobacco and even sugar can be justified on health grounds. - Regressive impact of higher indirect taxes can be compensated by expanding spending on programs that benefit the poor. - Examples: Poland reduced the share of direct taxes in overall tax revenues from 45 percent to 36 percent, contributing to increased investment and employment; Chile’s broad-based VAT with limited exemptions reduced distortionary effects and yielded revenue gains. - Base-broadening measures: - Rationalizing tax exemptions and preferential regimes can yield higher revenue and improve horizontal equity. - Examples: Australia (1980s) cut tax rates and tightened exemptions; Malaysia (late 1980s) combined growth-friendly tax cuts with sales tax base broadening; Uganda made civil servants’ salaries taxable and curtailed tax exemptions. - Improvements in revenue administration: - Introduce risk management techniques and taxpayer segmentation (large taxpayer units). - Simplify laws and procedures to reduce compliance costs. - Examples: Chile simplified taxpayer forms; Tanzania and Uganda created unified revenue authorities. - Conditionality under Fund-supported programs: Crivelli and Gupta (2014) estimate that tax revenues increased by approximately ½ percentage point of GDP in a given year where such programs included conditionality on tax policy and administration. - Creating fiscal space through spending measures — recommended approaches: - Rationalizing spending: - Spending on wages, subsidies and social benefits accounts for around three-quarters of total spending in advanced and emerging economies. - Priority areas for rationalization include government wage bills and poorly targeted social spending. - Examples: Only one-fifth of total spending on family benefits was means-tested in 2011 in advanced economies; social assistance in low-income countries often has leakages and insufficient coverage (IMF, 2014f). - Country studies show public wage bill rationalization helped create fiscal space in the Netherlands, Ireland, Germany, and Malaysia; redesign of social transfers featured in adjustment packages in the Netherlands, Chile, Germany, and Poland. - Improving efficiency: - At least 20-40 percent of health spending is typically wasted (World Health Organization, 2010). - There is scope for substantial gains in health indicators at current spending levels (Grigoli and Kapsoli, 2013). - Education: implement per-student financing formulas (example: Netherlands) to align wage costs with student numbers and potentially free resources for school infrastructure and materials. - Reform of inefficient SOEs and privatizations provided fiscal space in Chile, Tanzania, and Malaysia. - Environmental taxation and subsidy reform: - Generalized energy subsidies distort consumption and production and are a poor instrument for income redistribution (Arze del Granado and others, 2012). - In 2015, spending on energy subsidies (on a post-tax basis) is projected to reach US$5.3 trillion (or 6½ percent of global GDP). - Carbon or congestion taxes aimed at reducing emissions and pollution could yield potential revenue gains amounting to 2.9 percent of global GDP (Gupta and Keen, forthcoming). ### Growth and Equity - Income inequality affects growth and policy assessment must reflect distributional consequences. - Evidence on inequality and growth: - At low income, some inequality can spur growth by raising savings and investment (Kaldor, 1957) and enabling business starts and education (Barro, 2000). - With rising inequality, the relationship may turn negative (Benhabib, 2003). - Recent studies suggest high levels of inequality are overall harmful for the pace and sustainability of growth (Berg, Ostry and Zettelmeyer, 2012; Ostry, Berg and Tsangarides, 2014). - Education and health outcomes for the poor tend to be better in more equal societies, aiding human capital accumulation (Perotti, 1996; Galor and Moav, 2004; Aghion, Caroli, and Garcia-Penalosa, 1999). - Higher income equality can expand domestic demand and support higher physical capital accumulation (Murphy, Shleifer and Vishny, 1989). - Trade-offs and examples: - Some efficiency-enhancing reforms can worsen distribution: - Shift from direct to indirect taxes can reduce progressivity and increase inequality. - Reductions in social transfers or public employment and pension freezes can increase unemployment and lower purchasing power of lower income groups. - Country cases: inequality worsened where current spending cuts involved reductions in social benefits, including in Chile and Germany. - Australia: reforms in the 1980s increased wage dispersion; the introduction of the GST in the early 2000s reduced tax progressivity (Singh and others, 1998; Greenville and others, 2013). *Source: IMF — "Fiscal Policy and Long-Term Growth" (excerpts).* ### 44. Appropriately designed, fiscal reform packages can serve both growth and equity ### 44. Appropriately designed, fiscal reform packages can serve both growth and equity objectives. ### Main findings on growth and inequality - Cross-country analysis finds that a reduction in inequality does not diminish the association between fiscal reforms and growth accelerations. - If the proceeds of a regressive, yet growth-enhancing tax reform are used to finance higher health and education spending, the overall outcome may be higher growth and lower inequality. - Providing conditional cash transfers tied to the schooling of young children, especially girls, can reduce inequality and boost human capital. - Reducing evasion and tax expenditures or loopholes that largely benefit the rich can simultaneously benefit growth and income equality. - A tax system that is perceived to be “fair” is associated with improved tax compliance. - Empirical examples: - Despite a sharp reduction in public spending, income inequality did not increase significantly after Ireland’s first reform episode in the late 1980s, reflecting the composition of adjustment (cuts in public sector wages and untargeted transfers were progressive) and a sharp increase in employment subsequent to reforms. - In Malaysia, when a 10 percent of GDP cut in primary spending was instituted during the second half of the 1980s, spending to reduce ethnic inequality was protected; measures included public provision of health and education in rural areas, targeted transfers, and education and technical training. ### The “how”: design and implementation matter - Critical determinants of reform success: social dialogue, policy complementarities, consistency with structural and macroeconomic policies, and policy credibility. - Social dialogue - Social dialogue enhances the likelihood that reforms are implemented and sustained. - Public sector employment reforms involving social dialogue resulted in deeper and more sustained reductions in the wage bill (examples: Netherlands, Ireland). - Examples: Netherlands’ Wassenaar agreement (1982) and Ireland’s tripartite agreement (1987) facilitated politically difficult measures. - Fostering public support - Effective communication that emphasizes intended benefits or the cost of maintaining the status quo can mitigate resistance (example: Germany in 2003). - Inclusion of compensatory measures for those expected to lose from reforms helps gain public support. - Ireland and the Netherlands: reductions in real wage growth were compensated with tax cuts to mitigate disposable income effects; cuts in social benefits were offset by promises of private-sector job creation. - Policy anchors (e.g., EU-accession prospect in Poland) can help overcome resistance to reforms. - Policy complementarities and supportive structural and macroeconomic policies - Fiscal policy complementarities: design should reinforce fiscal measures (examples: reduced benefits and income taxes to enhance work incentives in Netherlands, Ireland, Germany). - Combining expenditure and revenue reforms increases the likelihood of growth acceleration. - Supportive structural reforms (labor market, deregulation, privatizations) magnify fiscal reforms’ impact (examples: Netherlands, Ireland, Germany, Malaysia, Chile, Tanzania). - Consistent macroeconomic policies (the “two-handed approach”) can smooth implementation; transitory fiscal loosening can buy time to implement structural reforms; a slower pace of consolidation may be required to absorb structural reform costs. - Credibility - Credible medium-term adjustment paths matter more for market confidence than the initial fiscal adjustment effort; credibility allows even or back-loaded adjustment and can minimize negative hysteresis effects. ### Policy menu for medium- to long-term growth (high-level options from Table 1) - Macroeconomic stability - Reduce large fiscal deficits (examples: Chile, Ireland, Malaysia, Netherlands). - Adjust pace and composition of consolidation to protect growth (example: Ireland, Netherlands). - Contain increase in age-related expenditure (examples: Germany, Poland, Australia). - Structural fiscal policies - Policies to encourage labor supply: - Reduce labor taxes, especially at low income levels (examples: Ireland, Netherlands). - Redesign unemployment benefits: tighten eligibility, shorten duration, condition on ALMPs; increase use of in-work benefits (examples: Netherlands, Germany). - Stimulate participation of women, older workers, low-skilled via targeted measures and incentives (examples: Ireland, Australia, Germany, Netherlands). - Policies to enhance investment in physical capital: - Design systems that tax excess returns on capital (allowance for corporate equity) (example context: advanced economies). - Avoid open-ended tax holidays; use targeted incentives (accelerated depreciation, investment tax credits, super deductions) in developing economies. - Protect or increase public capital stock and strengthen public investment processes (examples: Poland, Tanzania, Malaysia). - Policies to support human capital: - Increase spending at lower education levels, condition cash transfers on school enrollment, expand access to basic healthcare (examples: Ireland, Tanzania, Uganda, Chile). - Reduce user charges for poor households; address supply-side barriers in less developed areas. - Policies to increase total factor productivity: - Grant tax credits/deductions for R&D; increase public R&D spending (examples: Ireland, Poland, Malaysia, Netherlands). - Provide more efficient public infrastructure (examples: Poland, Tanzania, Malaysia). - Fiscal space: revenue and expenditure measures - Revenue measures: - Use indirect, property/wealth and environmental taxes to raise revenue (examples: Chile, Poland). - Broaden tax base by reducing exemptions and preferential regimes (examples: Australia, Malaysia, Uganda). - Improve revenue administration and simplify procedures (examples: Chile, Malaysia, Tanzania, Uganda). - Expenditure measures: - Rationalize public wage bill (examples: Chile, Germany, Ireland, Netherlands, Malaysia). - Improve targeting of social spending (examples: Chile, Germany, Ireland, Netherlands, Poland). - Improve efficiency through sectoral reforms (example: Netherlands). - Eliminate generalized subsidies, especially for energy products; reform inefficient SOEs (examples: Chile, Malaysia, Tanzania). - Equity and growth - Include mitigating measures when implementing potentially regressive reforms (e.g., increasing indirect taxes) (examples: Ireland, Malaysia). - Growth-enhancing reforms that also help equity include closing tax loopholes used by the wealthy and targeted CCTs. - Policy design and complementarity - Build social consensus through effective communication and/or compensating losers (examples: Ireland, Netherlands). - Complement fiscal reforms with other structural reforms and consistent macroeconomic policies (examples: Chile, Germany, Ireland, Malaysia, Netherlands). ### Lessons and concrete policy recommendations - Macroeconomic stability is essential for sustained growth: - Large fiscal deficits reduce aggregate savings and may lead to inflation, high interest rates, and balance of payments pressures. - Fiscal frameworks that allow automatic stabilizers to work symmetrically can reduce volatility and foster growth. - Pace of fiscal consolidation should be carefully considered; gradual consolidation anchored in a credible medium-term plan is appropriate when not under market pressure. - Composition matters: expenditure-based consolidations are typically more durable and supportive of long-term growth, though revenue-based consolidations may be appropriate and equity-friendly in some cases. - Many low-income countries may have fiscal space for productive spending on infrastructure and critical social services. - Policy design and social consensus: - Structural reforms should be mutually reinforcing and accompanied by supportive macroeconomic policies. - Appropriately designed fiscal reform packages can serve both growth and equity objectives (example: using revenue from regressive tax reforms to finance health and education). - Social consensus (communication, compensatory measures) increases the likelihood reforms are implemented and sustained. - Specific tax and expenditure policies: - Increase labor supply by lowering labor tax wedge, redesigning unemployment benefits, expanding ALMPs, and targeted measures for women, older workers, and low-skilled. - Enhance investment by taxing excess returns, avoiding open-ended tax holidays, and prioritizing efficient public investment. - Support human capital via access to education and basic health services, including conditioning cash transfers on attendance and preventive health visits where appropriate. - Increase total factor productivity through R&D tax incentives and improved public infrastructure. - Creating fiscal space least harmful to growth and equity: - Broaden tax base by rationalizing exemptions and preferential regimes. - Shift toward less distortionary taxes (consumption) and consider property/wealth taxes to increase progressivity. - Improve revenue administration (risk management, taxpayer segmentation, simplified laws) to boost compliance. - Rationalize government wage bills where overly large, and improve targeting of social spending. - Phase out energy subsidies and introduce environmental taxation to create fiscal space while addressing externalities. - Where expanding fiscal space is difficult, focus on budget-neutral reforms. ### Issues for discussion (questions posed for Directors) - Do Directors agree that fiscal policy can be an effective tool for supporting medium- to long-run growth? - Do Directors agree that the mix of fiscal policy options should be tailored to country-specific conditions, administrative capacities and preferences? - Do Directors agree that the growth dividends of fiscal reforms depend to a large degree on complementary structural reforms and supportive macroeconomic policies? - Do Directors agree that strategies such as effective communication with stakeholders, and compensatory measures for those made worse off can help foster public support for fiscal reforms? - Do Directors agree that both growth and equity objectives can be achieved when fiscal reform packages are appropriately designed? - In cases where countries need to mobilize resources to create space for growth-friendly policies, do Directors agree that the tax and spending policies identified in the paper are the least harmful for growth? *Source: IMF staff calculations, SWIID 5.0; material summarized from the IMF chapter “FISCAL POLICY AND LONG-TERM GROWTH.”* ### References ### _042015 - References ### Key empirical findings (Technical Annex I) - Sample: 112 economies over 1975-2013. - Revenue reforms are followed by growth acceleration in 26 percent of reform cases. - Expenditure reforms are followed by growth acceleration in 21 percent of reform cases. - A combined package of both revenue and expenditure reforms is followed by growth acceleration in 60 percent of cases. - For comprehensive reform packages, the association with growth acceleration by country group: - Advanced countries: 80 percent. - Emerging countries: 67 percent. - Low-income countries: 38 percent. - Reforms aimed at reducing the share of income taxation and increasing the share of health and education spending are most likely to be followed by growth acceleration. - The conditional likelihood of growth acceleration is not significantly altered by: - the presence of high initial debt, - subsequent fiscal expansion, - reduction in income inequality. ### Major thematic literature represented in the references - Fiscal adjustment design, persistence, and macroeconomic effects - Alesina, A. and S. Ardagna, 1998, “Tales of Fiscal Adjustment”, Economic Policy, Vol. 13(27), pp. 487-545. - Alesina, A., Ardagna, S., Perotti, R. and F. Schiantarelli, 2002. "Fiscal Policy, Profits, and Investment", American Economic Review, 92(3), pp. 571-589. - Baldacci, E., B. Clements, S. Gupta, and C. Mulas-Granados, 2004, “Persistence of Fiscal Adjustments and Expenditure Composition in Low-Income Countries,” in Helping Countries Develop, The Role of Fiscal Policy. - Blanchard, O. and Cottarelli, C., 2010, “Ten Commandments for Fiscal Adjustment in Advanced Economies,” IMFdirect, Global Economy Forum. - Tax policy, composition, and growth - Acosta-Ormaechea, S., and J. Yoo, 2012, “Tax Composition and Growth: A Broad Cross-Country Perspective,” IMF Working Paper No. 12/257. - De Mooij, R. A., 2011, “Tax Biases to Debt Finance: Assessing the Problem, Finding Solutions”, IMF Staff Discussion Note SDN/11/11. - Arnold, J., B. Brys, Ch. Heady, Å. Johansson, C. Schwellnus and L. Vartia, 2011, “Tax Policy For Economic Recovery and Growth,” The Economic Journal, Vol. 121, pp. F59-F80. - Feldstein, 2014, “Raising Revenue by Limiting Tax Expenditures” NBER Working Paper No. 20672. - Public spending composition, public investment, and productivity - Clements, B., R. Bhattacharya, and T. Q. Nguyen, 2004, “External Debt, Public Investment, and Growth in Low Income Countries,” in Helping Countries Develop, The Role of Fiscal Policy. - Bom, P.R.D., J. E. Ligthart, 2009. "How Productive is Public Capital? A Meta-Regression Analysis," Working Paper No. 0912. - Dabla-Norris, E., J. Brumby, A. Kyobe, Z. Mills, and C. Papageorgiou, 2012, “Investing in public investment: an index of public investment efficiency,” Journal of Economic Growth, 17(3), pp. 235-266. - Gupta, S., Kangur, A., Papageorgiou, C. and A. Wane, 2014, “Efficiency-Adjusted Public Capital and Growth,” World Development Vol. 57, pp. 164–178. - Human capital, health, education, and growth - Aghion, P., P. Howitt, and F. Murtin, 2010, “The Relationship between Health and Growth: when Lucas Meets Nelson-Phelps,” NBER Working Paper No. 15813. - Hanushek, E., and L. Woessmann, 2011, “The Economics of International Differences in Educational Achievement,” in Handbook of the Economics of Education, Vol. 3. - Jamison, D., L. H. Summers, G. Alleyne, K. J. Arrow, S. Berkley, A Binagwaho, F. Bustreo, and others, 2013, “Global Health 2035: A World Converging within a Generation,” Lancet, Vol. 382, pp. 1898–1955. - Bastagli, F., D. Coady and S. Gupta, 2012, “Income Inequality and Fiscal Policy,” IMF Staff Discussion Note SDN/12/08. - Inequality, redistribution, and growth - Aghion, P., E. Caroli, and C. Garcia-Peñalosa, 1999, “Inequality and Economic Growth: The Perspective of the New Growth Theories,” Journal of Economic Literature, Vol. 37(4), pp. 1615–1660. - Ostry, J.D., Berg, A. and C.G. Tsangarides, 2014, “Redistribution, Inequality and Growth,” IMF Staff Discussion Note SDN/14/02. - Bourguignon-style references and regional studies on fiscal policy and income distribution (e.g., Lustig et al., 2011). - Debt, fiscal space, and growth interactions - Cecchetti, S. G., Mohanty, M. S. and F. Zampolli, 2011, “The Real Effects of Debt,” BIS Working Paper No. 352. - Kumar, M. and J. Woo, 2010, “Public Debt and Growth,” IMF Working Paper No. 10/174. - Pescatori, A., Sandri, D., and J. Simon, 2014, “Debt and growth: is there a magic threshold?” IMF Working Paper No. 14/34. - Heller, P, 2005, “Understanding Fiscal Space,” IMF Policy Discussion Paper No. PDP/05/4. - Labor markets, employment policies, and fiscal implications - Abbring, J., G. Berg and J. Ours, 2005, "The Effect of Unemployment Insurance Sanctions on the Transition Rate from Unemployment to Employment," Economic Journal, Vol. 115(505), pp 602-630. - Banerji, A., S. Saksonovs, L. Huidan, and R. Blavy, 2014, “Youth Unemployment in Advanced Economies in Europe: Searching for Solutions,” IMF Staff Discussion Note SDN/14/11. - Blundell, R., 2014, “How Responsive is the Labor Market to Tax Policy?” IZA World of Labor (May), pp. 1-10. - Methods and empirical approaches relevant to fiscal policy and growth - Abadie, A., A. Diamond and J. Hainmueller, 2010, “Synthetic Control Methods for Comparative Case Studies: Estimating the Effect of California’s Tobacco Control Program,” JASA, Vol. 105, No. 490, pp. 493-505. - Berg, A., Borensztein, E., and C. Pattillo, 2005, “Assessing Early Warning Systems: How Have They Worked in Practice?” IMF Staff Papers, Vol. 52(3), pp. 462–502. - Hausmann, R., Pritchett, L., and Rodrik, D., 2005, “Growth Accelerations,” Journal of Economic Growth, 10: pp. 303–29. ### Representative IMF institutional outputs cited - IMF policy and analytical reports: - IMF, 2010, “From Stimulus to Consolidation: Revenue and Expenditure Policies in Advanced and Emerging Economies”. - IMF, 2013a (October), Fiscal Monitor: Taxing Times. - IMF, 2014a (October), Fiscal Monitor: Back to Work, How Fiscal Policy Can Help. - IMF, 2015a, Fiscal Monitor: Now Is the Time: Fiscal Policies for Sustainable Growth. - IMF, June 2015, “Making Public Investment More Efficient”. - IMF Working Papers and Staff Discussion Notes on revenue mobilization, fiscal policy and employment, energy subsidy reform, tax compliance, and redistribution (multiple entries in the references list). *Source: _042015 - References (extracted content).* ### 1. The fiscal response to a rapid slowdown in economic growth has dominated the policy ### The fiscal response to a rapid slowdown in economic growth has dominated the policy agenda following the global crisis ### Overview - The global crisis left a lasting legacy of slow growth in most advanced and many emerging economies, posing risks to fiscal sustainability and compounding challenges associated with projected demographic and environmental trends. - With monetary policy options limited due to the zero-lower bound and fiscal expansion complicated by rapid debt build-up, attention has shifted to deficit-neutral fiscal reforms aiming at more growth-friendly composition of government revenue and expenditure. - The note analyzes the empirical relationship between fiscal reforms and long-run growth using an event study methodology on a sample of 112 countries over the period 1975-2013. - The methodology identifies 146 growth acceleration episodes in 112 countries over the period 1975-2013. ### Empirical methodology - Growth accelerations: - Event study approach (Hausmann and others, 2005) with a slightly less restrictive parameterization. - Uses 5-year windows (n=5) to calculate average growth rates. - Identified 146 growth acceleration episodes in 112 countries, with the largest number in advanced economies (62 episodes), followed by emerging (42) and low-income (42) countries. - Median growth rate: decelerated from 4 percent (five years before acceleration) to close to 1 percent (one year before acceleration); jumped to 4 percent in the first year of acceleration and peaked at 5 percent on the fifth year. - Average growth increased from 1.8 percent before acceleration to 4.5 percent during acceleration. - Main results are robust to using an 8-year window to identify growth accelerations. - Fiscal reforms (de-facto approach): - Protracted growth-friendly improvements in revenue and expenditure composition used to identify fiscal reforms. - Revenue-side growth-friendliness implies higher share of indirect taxes in total revenue; expenditure-side growth-friendliness implies higher share of capital, health, and education spending in total expenditure. - Methodology identifies 168 revenue reforms and 220 expenditure reforms in 112 countries over 1975-2013. - Improved revenue and expenditure composition persists through the fifth year into the reform. - Indicators approach: - Non-parametric indicators approach (Kaminsky and others, 1998) used to assess probability of growth accelerations conditional on fiscal reforms. - Classification table yields probability P(acceleration|reform) = D/(D+C), where D and C are counts from the 2x2 classification. ### Estimation results — main findings - Sample totals and conditional probabilities: - Total sample observations with entries for both growth accelerations and fiscal reforms: 3,419. - Number of growth accelerations in total sample: 143. - Number of revenue reforms in total sample: 131. - Number of expenditure reforms in total sample: 185. - Revenue reforms are followed by growth accelerations in 26.0 percent of reform cases. - Expenditure reforms are followed by growth accelerations in 20.5 percent of reform cases. - Reform packages implementing revenue and expenditure reforms jointly are followed by growth accelerations in 60.0 percent of cases. - By country group (P(accel|reform) for combined revenue and expenditure reforms): - Advanced economies: 80.0 percent (sample: 894 total obs., 62 growth accelerations, 5 fiscal reforms? — table entries list numbers; preserve numeric table values as presented). - Emerging economies: 66.7 percent (sample: 922 total obs., 42 growth accelerations, 12 fiscal reforms? — table entries list numbers; preserve numeric table values as presented). - Low-income countries: 37.5 percent (sample: 1,603 total obs., 39 growth accelerations, 8 fiscal reforms? — table entries list numbers; preserve numeric table values as presented). - Summary from Table 1 (selected rows preserved exactly as presented): - Revenue measures — Total sample — 3,419 total obs. — 143 # of growth accelerations — 131 # of fiscal reforms — 26.0 P(accel|reform) - Expenditure measures — Total sample — 3,419 total obs. — 143 # of growth accelerations — 185 # of fiscal reforms — 20.5 P(accel|reform) - Revenue and expenditure measures — Total sample — 3,419 total obs. — 143 # of growth accelerations — 256 # of fiscal reforms — 60.0 P(accel|reform) - (The table continues with country-group specific rows and conditional probabilities as reported in the source.) ### Types of reforms and their conditional probabilities - Revenue reforms (conditional probabilities of being followed by growth acceleration): - Measures reducing the share of income taxation (corporate, personal, and social security contributions): conditional probabilities range between 31-40 percent (specific table entries: Corporate income taxes 31.0; Personal income taxes 40.0; Social security contributions 36.0). - Consumption taxes: 28.1 percent. - Indirect taxes: 37.1 percent. - Property taxes: 6.7 percent. - Expenditure reforms (conditional probabilities): - Health spending reforms: 39.5 percent. - Education spending reforms: 26.2 percent. - Capital spending reforms: 15.1 percent. - Transport and communication spending reforms: 20.0 percent. - Interpretation: - Reductions in distortionary income taxation are most likely to be followed by growth accelerations, consistent with theoretical predictions about distortions on labor and capital. - Human capital–oriented spending (health and education) has relatively high conditional probabilities of growth accelerations. ### Other conditional factors assessed - High level of debt: - Sample restricted to periods when public debt exceeded 40 percent in low-income countries, 60 percent in emerging countries, and 90 percent in advanced countries. - Restricted sample: 1,774 total obs.; 55 growth accelerations; 44 revenue reforms; 90 expenditure reforms. - Conditional likelihoods in high-debt periods: revenue reforms 22.7 percent; expenditure reforms 13.3 percent; combined reforms 27.3 percent. - Fiscal expansion (no debt expansion / no deficit expansion): - Non-expansionary debt sample: 934 total obs.; 61 growth accelerations; 52 revenue reforms; 88 expenditure reforms. - Revenue measures — Debt reduction — P(accel|reform) = 34.6 percent. - Expenditure measures — Debt reduction — P(accel|reform) = 27.3 percent. - Revenue and expenditure measures — Debt reduction — P(accel|reform) = 71.4 percent. - Non-expansionary deficit sample: 3,024 total obs.; 121 growth accelerations; 114 revenue reforms; 150 expenditure reforms. - Revenue measures — Deficit reduction — P(accel|reform) = 27.2 percent. - Expenditure measures — Deficit reduction — P(accel|reform) = 20.7 percent. - Revenue and expenditure measures — Deficit reduction — P(accel|reform) = 63.6 percent. - Conclusion: Conditional probability of growth acceleration for combined revenue and expenditure reforms remains high in non-expansionary episodes (71 and 64 percent reported), suggesting fiscal expansion does not significantly alter the relationship. - Income inequality: - Sample restricted to periods when fiscal reforms were followed by a reduction in income inequality as measured by the GINI coefficient: 1,068 total obs.; 67 growth accelerations; 57 revenue reforms; 72 expenditure reforms. - Conditional likelihood in this restricted sample: revenue measures 33.3 percent; expenditure measures 29.2 percent; combined reforms 61.5 percent. - Suggests inclusiveness (reductions in inequality) does not undermine the success of fiscal reforms in terms of growth outcomes. ### Policy-relevant implications from empirical findings - Fiscal reform packages that combine revenue-side and expenditure-side composition improvements have markedly higher conditional probabilities of being followed by growth accelerations than standalone revenue or expenditure reforms (combined reforms: 60.0 percent in total sample). - Revenue-side reforms that shift away from distortionary income taxation (corporate, personal, social security contributions) toward less distortionary forms (indirect/consumption taxes) are associated with higher probabilities of growth acceleration (corporate income taxes 31.0; personal income taxes 40.0; social security contributions 36.0; indirect taxes 37.1; consumption taxes 28.1). - Expenditure-side reallocations toward health and education spending exhibit relatively high probabilities of being followed by growth accelerations (health 39.5; education 26.2), consistent with human capital channels. - The association between fiscal reforms and growth accelerations is robust: - In periods of high initial public debt (revenue reforms 22.7; expenditure reforms 13.3; combined reforms 27.3). - In non-expansionary fiscal reform episodes (revenue and expenditure combined: 71.4 percent when restricting to no debt expansion; 63.6 percent when restricting to no deficit expansion). - In episodes with reductions in income inequality (combined reforms 61.5 percent). - These findings support the feasibility of deficit-neutral fiscal reforms—reforming tax structure and expenditure composition—to boost long-run growth even when conventional fiscal expansion is constrained. ### Technical annex: endogenous growth model summary - The Technical Annex II describes an endogenous growth model with micro foundations to study effects of fiscal policy changes on long-run growth and government debt dynamics. - Model simulations indicate: - Fiscal reforms aimed at reducing rates of distortionary taxes on capital and labor income lead to significant increases in the long-run growth rate, even if offset by raising the rate of less distortionary consumption taxation. - Deficit-neutral reform that increases productive public investment offset by a reduction in unproductive government expenditure also raises the long-run growth rate. *Italic: IMF staff calculations, analysis based on sample of 112 countries, 1975-2013 (source content provided).* ### 1. The model is in the endogenous growth theory tradition. It is similar to models ### _042015 - 1. The model is in the endogenous growth theory tradition. It is similar to models ### Model overview and theoretical tradition - The model is in the endogenous growth theory tradition and is similar to models presented by King and Rebelo (1990), Rebelo (1991), and Devereux and Love (1994). The model also allows for productive public capital and government borrowing. - Endogenous growth arises because of non-decreasing returns to scale to reproducible factors of production (physical capital, human capital and public capital). Human capital accumulation can offset decreasing returns to physical capital accumulation, making the long-run growth rate endogenous and potentially influenced by fiscal policy. - The model contains two production sectors in a closed economy: - Final output good sector. - Human capital sector. - Both sectors require as inputs: stocks of public capital, private capital, and human-capital-adjusted (skilled) labor supply. The two-sector setup permits different relative factor importances across sectors and is formulated in discrete time. ### Agents and their roles - Representative consumer: - Chooses consumption and saving in up to three assets: (i) private capital, (ii) human capital, and (iii) government bonds. - Supplies labor and capital for production of both final output and human capital. - Maximizes discounted present value of utility over an infinite horizon subject to a long-run budget constraint. - Earns income from labor supply, returns on assets, and government transfers. - Notes: The total private capital stock comprises capital used by firms and for human capital production. - Representative firm: - Produces final output and rents private capital and skilled labor from consumers each period to maximize profit. - Benefits from access to the stock of public capital, which it takes as given each period. - Firms do not make forward-looking investment decisions; investment decisions are made by the representative consumer (consumer is the owner of the firm). - Human capital sector: - Produces human capital using private capital and skilled labor, with public capital also as an input. - Consumers purchase human capital; human capital is embodied in the consumer’s labor supply and is productive only when attached to an individual’s labor supply. - Government: - Engages in (i) investment in public capital stock, (ii) transfers to consumers, and (iii) unproductive spending. - Raises revenue via distortionary taxes on: private capital income, labor income, and consumption. - Borrows by issuing bonds to the representative consumer. - In the long run government sets spending by a rules-based approach: a fixed share of revenue every period is spent on each item, with shares differing across items. ### Mechanisms: how fiscal policy affects long-run growth - Channels through which fiscal policy affects growth: - Capital income tax rate (τ_k): changes affect the post-tax rate of return on private capital and influence incentives to invest. - Labor income tax rate (τ_l): changes affect the post-tax wage, the return to skilled labor, and incentives to acquire human capital. - Consumption tax rate (τ_c): changes affect labor supply decisions; consumption taxation is less distortionary in this model because it does not distort intertemporal savings decisions. - Share of revenue devoted to public investment: affects public capital stock available to firms and human capital production, influencing total factor productivity. - Specific model implications: - Reductions in distortionary capital and labor income tax rates raise long-run growth by increasing post-tax returns and inducing more private capital investment and human capital accumulation. - Deficit-neutral reforms that cut capital and labor taxes while increasing consumption tax can still raise long-run growth because consumption taxation is less distortionary than capital or labor taxation in the model. - Increasing public investment (financed by cutting unproductive spending so primary balance is unchanged) raises the public-to-private capital ratio, boosting productivity and long-run growth. - Implementing capital and labor tax cuts or public investment increases without compensating measures has similar long-run growth effects because consumption taxes have relatively small growth effects in this model; consumption tax changes mainly have level effects on consumption as a share of long-run output. ### Solution concept and balanced growth path (BGP) - The model admits a long-run steady state or balanced growth path (BGP) for particular combinations of tax rates and government spending rules. - On a BGP, non-stationary endogenous variables (consumption, final output, stocks of physical capital, human capital and public capital) all grow at a constant rate equal to the economy’s overall growth rate. - On a BGP: - The production function for final output exhibits constant returns to scale to reproducible factors. - Firms take the ratio of total public to private capital in the economy as given, so firms face constant returns to scale in private capital input and skilled labor input. This ratio is kept constant on a BGP because public investment is set proportional to revenue. - At the social level, there are constant returns to scale to public capital, total private capital stock and skilled labor; exponents of the aggregate production function sum to one. - The BGP growth rate is found by solving an approximate solution to the simultaneous system of nonlinear equations characterizing the BGP (first-order conditions of consumer and firm optimization problems and budget constraints). - The BGP growth rate depends on tax rates and government spending rules. ### Calibration and benchmark BGP - Benchmark distortionary tax rates: - Capital income tax rate = 0.25 (25 per cent). - Labor income tax rate = 0.25 (25 per cent). - Consumption tax rate = 0.07 (7 per cent). - Public investment is set to be approximately 4 per cent of final output on the benchmark BGP. - The complete calibration of fiscal policy settings and parameters is presented in Table 1 (selected parameter values from Table 1 preserved exactly): - Discount factor = 0.98 - Labor supply parameter = 0.65 - Utility function parameter = 0.35 - Parameter related to the elasticity of intertemporal substitution = 2 - Elasticity of human capital production to public capital = 0.09 - Elasticity of final output to public capital = 0.09 - s (Share of revenue spent on transfers) = 0.30 - Capital share in final output = 0.36 - Capital share in human capital production = 0.85 - Unproductive government spending share of revenue = 0.51 - Share of public capital in final output = 0.5 - Labor income tax rate = 0.25 - Capital tax rate = 0.25 - Consumption tax rate = 0.07 - Depreciation rate: human capital = 0.04 - Depreciation rate: private physical capital = 0.04 - Depreciation rate: public capital = 0.04 - Public investment share of revenue = 0.11 - Scale factors A = 0.43 and C = 0.43 ### Fiscal sustainability and government debt on the BGP - On any BGP, the government’s long-run budget constraint must be satisfied: government borrowing must grow at a slower rate than the real rate of interest on government bonds, which requires the government to run a primary surplus on any BGP. - Given the endogenous interest rate on government bonds and the primary surplus (as a ratio of final output), the government’s budget constraint reveals the maximum level of government debt (as a ratio of final output) that is sustainable in the long-run on a BGP. - Fiscal reforms that produce a lower long-run primary balance (relative to the benchmark BGP) imply only a lower long-run level of government debt is sustainable; the government must engineer a reduction in the level of debt (as a ratio of final output) during the transition to the post-reform BGP. ### Quantitative experiment results (Table 2: Impact of Revenue-Neutral Fiscal Reforms) - Policy experiments are presented relative to the benchmark BGP; consumption tax rate is raised permanently in these revenue-neutral experiments to keep the primary balance and government debt levels approximately unchanged on the new BGP. - Results (changes in long-run growth relative to the benchmark; change in long-run level of sustainable government debt): - Δ capital tax -5% → Increases in long-run growth relative to the benchmark: 0.2 percentage points; Change in long-run level of sustainable government debt: ≈ 0 - Δ labor tax -5% → Increases in long-run growth relative to the benchmark: 0.2-0.3 percentage points; Change in long-run level of sustainable government debt: ≈ 0 - Δ capital tax -5%, Δ labor tax -5% → Increases in long-run growth relative to the benchmark: 0.4-0.5 percentage points; Change in long-run level of sustainable government debt: ≈ 0 - Δ public investment +1% of GDP, Δ unproductive spending -1% of GDP → Increases in long-run growth relative to the benchmark: 0.15-0.2 percentage points; Change in long-run level of sustainable government debt: ≈ 0 - Note: The balanced growth paths achieved following all reforms imply higher consumer welfare than the benchmark balanced growth path. Small reductions in sustainable government debt can occur because the interest rate – growth differential may be higher than on the benchmark BGP. ### Literature context (select findings from Table 3) - Lucas (1990): Growth rate invariant to changes in capital tax rates when labor supply is fixed; small effects under elastic labor supply. Eliminating a 36 percent capital tax (while raising labor tax by 6 percentage points) raises growth by 0.03 percentage points. - Chen and Lu (2013): 1 percentage point increase in capital income tax lowers growth by 0.02 percentage points; 1 percentage point increase in labor income tax lowers growth by 0.22 percentage points. - King and Rebelo (1990): 10 percentage point increase in both labor and capital income tax (derived from final output) reduces growth by 0.5 percentage points; similar increase applied to income from both final output and human capital sectors reduces growth by 1.5 percentage points. - Jones, Manuelli and Rossi (1993): Elimination of all tax rates can raise growth by up to 8 percentage points depending on labor supply elasticity. - Turnovsky (2000): In an AK model with productive government expenditure and elastic labor supply calibrated to the US, an increase in capital income tax of 12 percentage points reduces growth by around 0.5 percentage points; a reduction of capital and labor tax rates each by 8 percentage points raises long-run growth (quantitative value truncated in source). *Source: IMF chapter text provided in the content unit.* ### 0.4 percentage points. ### _042015 - 0.4 percentage points. ### Fiscal policy experiments: effects on long-run growth - "0.4 percentage points." - "A reduction in the capital and labor income tax rates of 8 percentage points and an increase in the consumption tax rate of 13 percentage points raises long run growth by 0.36 percentage points." - "A 50 percent cut in productive government expenditure (as a percentage of national production) lowers growth by 0.2 percentage points." ### Results from selected endogenous growth models (paper-level findings) - Pecorino (1993) - Model: "A three-sector endogenous growth model. Physical and human capital are inputs into the production of new human capital. Labor supply is endogenous." - Calibration: "the tax rates on capital and labor income are 42 percent and 20 percent respectively." - Policy experiment: "Capital and labor income taxes replaced with a consumption tax (presumably sufficient to leave revenue unchanged)." - Effect: "This raises the growth rate by 1.23 percentage points when labor supply is endogenous (or around 1 percentage point when labor supply is exogenous)." - Kim (1998) - Model: "A one-sector endogenous growth model, with human capital in the production function. Labor supply is exogenous. The model has a rich financial and fiscal sector." - Taxes in model: "taxes imposed on labor income, interest income, dividend income and capital gains. There is also a corporate income tax rate, a value-added tax rate as well as certain other taxes on firms." - Calibration: "The model is calibrated to the US economy." - Effect: "The elimination of all taxation raises the growth rate by 0.85 of a percentage point." - Devereux and Love (1994) - Model: "A two-sector endogenous growth model similar to that of King and Rebelo (1990), but allowing for endogenous labor supply." - Benchmark: "The benchmark calibration involves 20 percent tax rates on capital and labor income, but zero consumption tax." - Effects: - "Eliminating all taxation raises growth by around 1 percentage point." - "Eliminating only capital taxation raises growth by around 0.3 percentage points." - "Eliminating only wage taxation raises growth by around 0.7 percentage points." - Turnovsky (2004) - Model: "A one-sector model with growing population but constant growth rate (i.e. without scale effects). Public capital is productive and labor supply endogenous. There is no human capital." - Effect: "The long-run growth rate is invariant to tax rates." - Baier and Glomm (2001) - Model: "A one-sector model with productive public capital, private capital and human capital in production. Government spending can take the form of investment in public capital, spending on useful goods (that enhance utility) and transfers to consumers." - Finding: "For given tax rates on company profits and consumer labor income, increases in the share of government spending directed to public investment raise the long run growth rate. The increase in public investment is financed by reducing lump sum transfers to consumers." ### Cross-cutting analytical insights - Replacing distortionary capital and labor taxes with consumption taxes can materially raise long-run growth; magnitude depends on labor supply endogeneity (examples: 1.23 percentage points with endogenous labor supply; around 1 percentage point with exogenous labor supply). - Full elimination of taxation in calibrated models can raise growth by between 0.85 and around 1 percentage point, depending on model structure and tax coverage. - Targeted elimination of specific taxes yields heterogeneous effects: eliminating capital taxation (~0.3 percentage points) vs eliminating wage taxation (~0.7 percentage points) in one calibration. - Cuts to productive government expenditure can lower long-run growth (example: 50 percent cut lowers growth by 0.2 percentage points). - Composition of government spending matters: reallocating spending toward public investment (financed by reduced lump-sum transfers) can raise long-run growth for given tax rates. *International Monetary Fund, Fiscal Policy and Long-Term Growth (excerpt).* ### 2. Real GDP Growth, 1970-2014 ________________________________________________________________ 142 ### FISCAL POLICY AND LONG-TERM GROWTH - CASE STUDIES ### Introduction - Sample covers Australia, Chile, Germany, Ireland, Malaysia, Netherlands, Poland, Tanzania, and Uganda. - Studies assess a wide variety of fiscal reforms: macroeconomic stabilization, tax policy, expenditure policy, and institutional reforms. - Transmission channels considered: human capital-adjusted labor supply, physical capital, and total factor productivity. - Annex I: sample selection; Annex II: Synthetic Control Method (SCM) methodology. ### Synthetic Control Method (SCM) and Limitations - SCM constructs a counterfactual (“synthetic” country) as a weighted average of many countries unaffected by the reform, then estimates impact as the difference in post-reform growth between the country and its synthetic counterpart. - Limitations noted: - Difficult to disentangle reform effects from other growth determinants. - Robustness checks are applied (Annex II), but differences may reflect non-fiscal factors. - Potential bias if comparator countries also underwent growth-enhancing reforms; such bias would tend to reduce estimated reform impacts, making estimates conservative. ### Cross-Country Findings: Impact and Transmission - Impact on long-term per-capita growth post-reform (Figure 1a): - Advanced economies (excluding Ireland): about ¾ percentage points higher than the counterfactual. - Emerging markets: 2¾ percentage points higher than the counterfactual. - Low-income countries: 1¾ percentage points higher than the counterfactual. - Transmission channels (Figure 1b): - Emerging market and low-income countries: capital accumulation was the most significant driver. - Advanced economies studied: relatively balanced contributions across channels. ### Lessons from Case Studies - Design matters: fiscal measures that reinforce each other are more successful (examples: Netherlands, Ireland, Germany — reductions in benefits and income taxes improved work incentives). - Complementary structural reforms amplify growth impact: fiscal reforms commonly implemented together with broader product and labor market reforms. - Social dialogue and consensus-building enhance implementation and sustainability: - Effective stakeholder communication (Germany). - Compensatory measures for losers from reforms (Ireland, Netherlands). - Common policy anchors (e.g., prospect of EU accession in Poland) can help forge consensus. ### AUSTRALIA: Background and Context - Long-running program of reforms beginning in the mid-1980s following a decade of poor growth, high unemployment, persistent inflation, deteriorating competitiveness, and fiscal/external imbalances. - Early reforms: tariff reduction, exchange rate and financial sector liberalization; followed by fiscal consolidation beginning in 1985, comprehensive tax reform, and credible fiscal rules. - 1990s: strengthened product market competition and liberalized wage bargaining. - 2000: introduction of the Goods and Services Tax (GST), allowing limited reductions in personal income tax rates and removal of inefficient wholesale sales tax. ### Australia: Macroeconomic Conditions and Reform Rationale - 1970s–early 1980s: severe macroeconomic imbalances; unemployment rose from less than 2 percent in 1971 to almost 10 percent in 1983. - Objectives of the comprehensive 1983 strategy: - Improve macroeconomic management: floating the Australian dollar; removal of capital controls; liberalized interest rates. - Restore macroeconomic stability: fiscal consolidation in 1985 and the ‘trilogy’ of fiscal rules in the 1986 budget (commitment not to increase taxes or expenditures as a ratio of GDP; reduce budget deficit both in absolute terms and as a ratio of GDP). - Strengthen supply side: four-year tax reform introducing taxes on capital gains and fringe benefits; streamlining wholesale sales tax; progressive lowering of corporate tax rate; income tax reductions to encourage labor force participation. - Tax burden on individuals: fell from 13.5 percent of GDP to 11.4 percent between 1987 and 1992. ### Australia: Pension Reform and Fiscal Transparency - 1992 pension reform ("Superannuation Guarantee"): three-pillar fully funded system (means-tested safety-net pension; compulsory employer-based contribution funding private pension schemes; voluntary pillar). - Pension assets growth: - 1992: AUS$150 billion. - By June 2014: $1.85 trillion (ASFA, 2014). - 1998 Charter of Budget Honesty: introduced transparent budget reporting, intergenerational accounting, medium-term fiscal planning, Pre-Election Economic and Fiscal Outlook, Intergenerational Report at least once every five years. - 2000 GST: replaced Federal wholesale sales tax and many State/Territory taxes and enabled a shift of tax burden away from direct taxation; average tax rates were reduced for all income levels in 2001. ### Australia: Reform Sequencing and Outcomes - 1991 recession triggered by global downturn and domestic asset-price collapse led to fiscal deterioration; subsequent consolidation returned budget to balance by the mid-1990s and surpluses for the following eight years. - Post-1991 reforms targeted the real economy: - 1993: inflation targeting introduced. - 1995: National Competition Policy and broader competition legislation reform. - 1996: Workplace Relations Act reduced centralized wage-setting and promoted decentralized wage bargaining—enterprise/individual contracts rose from one-third of workers in 1990 to almost 80 percent by 2002. - Late 1990s & 2000s: further fiscal transparency and tax reforms (Charter of Budget Honesty; GST); continued review of tax policy including natural resource taxation (Henry Review 2008–12; establishment of Minerals Resource Rent Tax noted in Table). *Source: IMF staff reports, IMF supplement "Fiscal Policy and Long-Term Growth - Case Studies".* ### 15. More recently, tax reform has again emerged as an important issue on the policy ### 15. More recently, tax reform has again emerged as an important issue on the policy agenda. ### B. Notable Design Features - 2008: government initiated a wide-ranging review of the tax system to identify a reform agenda for the next twenty years. The review led to the proposal to introduce an ambitious Resources Super Profit Tax. - A controversial Minerals Resource Rent Tax was subsequently established but was repealed in 2014. - Policies promoting social cohesiveness were decisive in the success of Australia’s reform strategy; highly decentralized political structure made sub-national entities important actors in policy dialogue, necessitating a “Collaborative Federalism” model with formal institutions to enhance cooperation between levels of government. - Council of Australian Governments (COAG) created in 1992; it replaced Premiers Conferences and took a leading role in developing a national reform agenda (example: 2009 role in developing a new Federal Financial Relations Framework). - Introduction of the consumption tax in 2000 (GST) exemplified successful intra-governmental cooperation: accompanied by reform of the State Government financing model, providing income that permitted abolition of many state-based fees and taxes and enabled a coalition of interests across government levels supporting the reform. - Strong civil and public institutions—think-tanks, trade unions, the financial press, universities, National Productivity Commission—actively contributed to policy dialogue and innovation. - Measures to enhance fiscal transparency helped ensure a more informed political debate over policy options. ### Impact on Long-Term Growth — Key Findings - Australia achieved several decades of strong growth, monetary stability, low inflation, and prudent macroeconomic management. Since 1980, real GDP growth averaged 3.2 percent per year. - Unemployment was consistently below the OECD average. - Since the early 1970s, Australia consistently maintained a general government gross debt below 35 percent of GDP. - Five periods (1970–2007) useful for assessing fiscal policy impact: - Pre-reform period 1970–84: inward-looking economy, high protection; limited fiscal reforms primarily focused on tariff reduction. - First wave of fiscal reforms 1985–92: began with major consolidation, tax cuts, and fiscal rules; concluded with creation of a fully funded pension system. - Real sector structural adjustment 1993–1997: reforms directed toward labor and product markets. - Second wave of fiscal reforms 1998–2001: greater fiscal transparency, GST introduction, new funding arrangement for States, and lower personal income tax rates. - Post-fiscal reform period 2002–07: interregnum between early-2000s reforms, last major review of the tax system and introduction of a new framework for natural resource taxation. - Comparative performance (Figure 3): Australia’s per capita growth improved after reforms; growth volatility and imbalances declined relative to peers (EU15 + Canada, United States, Japan, excluding Ireland). - Synthetic control counterfactual (Figures 4, Table 2): - Growth differential opened after 1985 when first fiscal reform wave started. - Mid-1990s: differential narrowed and briefly reversed as Australian growth decelerated during second fiscal reform wave while counterfactual picked up. - Post-reform (2002–07): small positive differential vis-à-vis peer group re-established. - Robustness checks of synthetic control: - Placebo test: post-reform growth in Australia higher relative to growth distribution of non-reformers. - Sequential exclusion of comparator countries: post-reform Australian growth remained higher than synthetic series in each exclusion case. - Alternative pre-reform sample size and identification of reform period: results robust; Australian growth out-turn higher than alternative synthetic control series in all cases. ### Growth Decomposition and Transmission Channels - Decomposition of growth into capital, labor, and total factor productivity (TFP) (Figure 5) highlights: - Gradually increasing contribution of capital to economic growth, emphasizing improved investment climate due to macroeconomic and fiscal stability. - Pension reform increased private sector savings, contributing to capital accumulation. - In the decade just prior to the first wave, capital accumulation contributed on average 30 percent towards GDP growth; during the first decade of the 2000s this contribution increased to almost 50 percent. Contribution rose notably after 1992, partly due to improved terms of trade and mining-related investment. - Between 1987 and 1992, labor contribution was the primary growth driver, reflecting tax changes reducing distortions such as lower personal income tax rates and increased labor force participation. - Mid-1990s: a more muted labor contribution increase associated with policies enhancing labor market flexibility. - No notable increase in labor contribution to growth after second wave of fiscal reforms from 2000 onwards. ### Fiscal Policy, Investment, and Labor Market Indicators (Figure 6 observations) - Trade and financial sector liberalization in the 1980s restructured the growth model. - Personal income tax rates have been reduced significantly over the last three decades; lower tax burden on individuals enhanced labor force participation. - After pension reform in 1992, private investment recovered and was less volatile. - Public investment has gradually declined over time. - Strong macro-fiscal management kept the debt ratio low. ### Lessons: Fiscal Reform as a Catalyst for Accelerating Growth - Structural and fiscal changes increased Australia’s flexibility and resilience to external shocks, e.g., global financial crisis. - Nonetheless, a gradual growth deceleration followed the first wave of fiscal reforms, prompting renewed debate on fiscal policy and growth; tax reform remains an important policy issue. - Fiscal reforms operated through four channels influencing long-run growth: - Macroeconomic stability: Two successful fiscal consolidations and fiscal rules contained debt and deficit levels. - Social cohesion: Building political consensus across government levels and civil society was essential to policy success. - Expenditure reforms: Fully funded pensions increased private savings and supported private investment recovery. - Tax reform: Lower personal income tax rates increased labor force participation and positively contributed to growth. - Developing a fiscal reform agenda in a diverse, decentralized polity requires cooperative institutions (formal and informal) to build social cohesiveness and political consensus; Australia created such institutions enabling policy innovation and honest assessment of challenges to underpin difficult policy measures. ### Selected Indicators (excerpted numerical highlights from Table 3) - Real GDP (period averages across episodes): 2.8; 2.6; 3.2; 4.0; 3.7; 3.6; 2.3 - Contributions to Growth — Capital: 0.9; 1.0; 1.1; 1.2; 1.3; 1.8; 1.9 - Contributions to Growth — Labor: 1.3; 0.9; 1.4; 1.4; 0.7; 1.6; 1.3 - Contributions to Growth — Total Factor Productivity: 0.7; 0.9; 0.5; 1.5; 1.6; 0.1; -1.0 - CPI Inflation (Average): 11.6; 9.0; 6.3; 2.2; 2.8; 2.8; 3.1 - Total Revenue (Percent of GDP): 22.5; 23.9; 24.4; 23.3; 25.1; 25.4; 22.2 - Total Expenditure (Percent of GDP): 24.1; 25.4; 25.2; 25.3; 24.3; 23.9; 25.2 - Fiscal Balance (Percent of GDP): -1.6; -1.5; -0.8; -2.0; 0.8; 1.4; -3.0 - Gross Debt (Percent of GDP): 22.4; 19.4; 23.3; 29.5; 20.7; 11.8; 18.4 - Long Term Bond Yield (Percent): 9.8; 13.8; 12.2; 7.7; 5.9; 5.6; 4.7 - Labor Force Participation Rate (selected periods): ...; 60.8; 62.5; 63.2; 63.2; 64.2; 65.5 - Unemployment Rate (Percent): 5.6; 7.6; 8.1; 9.2; 6.9; 5.3; 5.0 - Lower PIT tax rate (Percent): ...; 29.8; 22.4; 20.0; 18.5; 16.0; 15.0 - Upper PIT tax rate (Percent): ...; 60.0; 48.9; 46.4; 47.0; 46.7; 45.0 - Private Investment (Percent of GDP): 18.6; 19.8; 19.9; 19.2; 20.6; 22.5; 22.3 - Public Investment (Percent of GDP): 7.7; 7.5; 6.8; 5.2; 4.4; 4.5; 5.5 - Market Gini Coefficient: 35.6; 40.5; 43.7; 47.6; 48.9; 46.7; 49.3 - Net Gini Coefficient: 26.0; 28.1; 29.4; 30.8; 30.9; 30.4; 33.0 *International Monetary Fund — Fiscal Policy and Long-Term Growth: Case Study (Australia), extracted chapter content.* ### 1. Every country in the comparator group was alternatively chosen as the tested country ### _042015 - 1. Every country in the comparator group was alternatively chosen as the tested country ### A. Placebo Tests: Australia (1985 and 1998 reform waves) - Method: Each country in the comparator group was alternatively chosen as the tested country while in fact no fiscal reform took place in that country (Figure A1). - Finding: Post-reform growth in Australia was higher relative to the growth distribution of non-reformers (countries in the comparator group), in terms of both the size of growth gaps and ratios of post-reform and pre-reform root mean square prediction errors (RMSPEs). - Interpretation: If the estimated effect for Australia is significantly larger than the placebo countries, it strengthens the case that the growth gap estimate in the baseline can indeed be attributed to the fiscal reform. - Visual indicators (as presented): - A. GDP Growth Gap, 1985-1992 (Real minus synthetic) — time series spanning 1970 to 2010 showing deviations up to ±10 (axis labels present). - B. Ratio of Post-Reform RMSPE to Pre-Reform RMSPE, 1985-1992 — ranked ratios for countries including DEU, LUX, AUS, DNK, GBR, FIN, SWE, BEL, FRA, ESP, CAN, USA, GRC, ITA, AUT, JPN with ratio axis 0.0–2.0. - C. GDP Growth Gap, 1998-2001 (Real minus synthetic) — time series spanning 1970 to 2010 showing deviations up to ±10 (axis labels present). - D. Ratio of Post-Reform RMSPE to Pre-Reform RMSPE, 1998-2001 — ranked ratios for countries including IRL, AUS, ESP, SWE, DNK, BEL, NLD, GRC, LUX, USA, PRT, ITA, FRA, FIN, GBR, AUT, CAN, JPN with ratio axis 0.0–2.0. - Conclusion: The evidence indicates that the fiscal reform likely has made a positive difference in the growth performance in Australia. *Source: IMF staff calculations.* ### B. Sequential Exclusion Sensitivity (Australia, 1985 and 1998 reforms) - Method: Sensitivity tested by sequentially excluding each country in the comparator group that received a positive weight and re-estimating the model (Figure A2 and A3). - Finding: Post-reform GDP growth gaps are larger than pre-reform GDP growth gaps for almost all exclusion cases for both 1985 and 1998 reforms, confirming robustness of the baseline results. - Figures and exclusion sets: - Figure A2 (Australia, 1985): 10-year average annual GDP growth (real versus synthetic) plotted for periods 1975-1984, 1985-1992, 1993-2002 with panels: - A. Excluding Greece — Comparator group 1/ = United States, Sweden and Japan. - B. Excluding Spain — Comparator group 2/ = Sweden, United States, Greece and United Kingdom. - C. Excluding Sweden — Comparator group 3/ = United States, Italy, Denmark, Luxembourg and Greece. - D. Excluding United Kingdom — Comparator group 4/ = United States, Sweden and Greece. - E. Excluding United States — Comparator group 5/ = Canada, Sweden, Greece and United Kingdom. - Figure A3 (Australia, 1998): 10-year average annual GDP growth (real versus synthetic) plotted for periods 1988-1997, 1998-2001, 2002-2010 with panels: - A. Excluding Ireland — Comparator group 1/ = United States, Sweden, Japan. - B. Excluding Greece — Comparator group 2/ = United States, Sweden, Japan and Ireland. - C. Excluding Japan — Comparator group 3/ = United States, Ireland, Sweden, Italy and Finland. - D. Excluding Sweden — Comparator group 4/ = United States, Italy, Ireland, Japan and Spain. - E. Excluding United States — Comparator group 5/ = Canada, Ireland and Japan. - Interpretation: Results support robustness; exclusion of individual positive-weight comparators does not overturn the post-reform growth gap finding. *Source: IMF staff calculations.* ### C. Changes in Reform-Start Year (Australia) - Method: Synthetic series re-estimated for alternative start years: - First wave (1985 reform): 1980, 1984, 1986, 1990. - Second wave (1998 reform): 1993, 1997, 1999, 2003. - Rationale: If growth gap estimate in baseline changes substantially with slight variation of the starting year, it would cast doubt on existence/size of positive growth gap; if it does not change with large variation, it would undermine confidence that the positive growth gap is due to the fiscal reform. - Finding: Results show the conclusion for the baseline is not sensitive to small changes in starting periods, but large changes sometimes result in disappearance of growth effects. - Figures (A4 and A5) detail panels for alternative reform periods: - Figure A4 (Change in Reform Period-Start Year: Australia, 1985) panels: - A. Reform Period: 1980-1987 — Comparator group 1/ = United States, Sweden, Spain and Japan. - B. Reform Period: 1984-1991 — Comparator group 2/ = United States, Sweden and Greece. - C. Reform Period: 1986-1993 — Comparator group 3/ = United States, Sweden and Greece. - D. Reform Period: 1990-1997 — Comparator group 4/ = United States, Spain and Japan. - Figure A5 (Change in Reform Period-Start Year: Australia, 1998) panels: - A. Reform Period: 1993-1996 — Comparator group 1/ = United States, Sweden, Japan. - B. Reform Period: 1997-2000 — Comparator group 2/ = United States, Sweden, Japan and Ireland. - C. Reform Period: 1999-2002 — Comparator group 3/ = United States, Ireland, Sweden, Italy and Finland. - D. Reform Period: 2003-2010 — Comparator group 4/ = United States, Italy, Ireland, Japan and Spain. - Interpretation: Small variations in start year do not materially alter baseline conclusion; large shifts can eliminate measured growth effects, consistent with baseline conjecture attributing positive growth effect to the fiscal reform. *Source: IMF staff calculations.* ### D. Changes in Reform-End Year (Australia) - Method: Difference in average growth rates recalculated by setting end of the fiscal reform period to different years (Figure A6 and A7) to examine sensitivity given uncertainty about reform end timing. - Finding: - For the 1998 reform, results confirm the baseline conclusion holds when the end of the fiscal reform period changes. - For the 1985 reform, results do not confirm robustness to changes in the reform end year. - Figures and comparator sets: - Figure A6 (Change in Reform Period-End Year: Australia, 1985) panels: - A. Reform Period: 1985-1995 — Comparator group 1/ = Sweden, United States, Spain, Greece and United Kingdom. - B. Reform Period: 1985-1997 — Comparator group 1/ = Sweden, United States, Spain, Greece and United Kingdom. - Figure A7 (Change in Reform Period-End Year: Australia, 1998) panels: - A. Reform Period: 1998-2004 — Comparator group 1/ = United States, Greece and Denmark. - B. Reform Period: 1998-2006 — Comparator group 1/ = United States, Greece and Denmark. - Interpretation: Timing uncertainty affects confidence in measured effects for the 1985 reform but not for the 1998 reform. *Source: IMF staff calculations.* ### E. Chile: Background and Fiscal Reform Episodes - Background (pre-reform, 1964–1973): - Real GDP growth (1964-1970 average): about 4 percent. - Per-capita GDP growth (1964-1970 average): about 2 percent. - Inflation (end of period): around 28 percent per year (Table 1). - Fiscal balance (general government): after average deficits of about 5 percent per year in early 1960s, deficit shrunk to 0.8 percent of GDP by 1969. - By end-1973: GDP contracted by about 6 percent and end-year inflation exceeded 550 percent. - Table 1: Chile: Selected Indicators, 1964-1973 (Percent change unless otherwise indicated, annual) - Indicator values provided for 1964-1970, 1971, 1972, 1973: - GDP Growth (Constant Prices): 3.8, 9.0, -1.2, -5.6 - Per-Capita GDP Growth (Constant Prices): 1.6, 7.1, -2.9, -7.1 - Inflation (End of Period): 28.0, 19.4, 149.2, 558.6 - Fiscal Balance (Percent of GDP) 1/: -2.6, -9.5, -12.5, -24.0 - Trade Openness (Percent of GDP) 2/: 27.8, 23.1, 23.1, 29.1 - Copper Price Inflation: 14.3, -23.5, -0.9, 65.9 - Notes: 1/ General government. 2/ Exports of goods and services plus imports of goods and services divided by GDP. - Reform episodes: - Reform episode I: 1974–79 (late 1973 military takeover) - Objectives: drastically reduce state role; shift to deregulated and open market economy based on private ownership. - Cornerstones: sharp tightening of fiscal policy by cutting primary spending (wages, transfers, investment); radical structural reforms including introduction of value added tax (VAT) and privatization of a large number of state-owned enterprises (SOEs); removal of price controls; trade liberalization; financial markets deregulation. - Outcome note: Primary fiscal balance posted an unprecedented correction. - Reform episode II: 1983–89 - Context: late 1970s exchange rate-based anti-inflation program with full indexation led to real appreciation, large capital inflows, unsustainable trade deficits; 1982 external financing stop produced severe recession and banking crisis. - Measures: stabilization program in 1983 focused on fiscal retrenchment and structural measures—further privatizations, social security reform, labor market flexibility, financial system reform, adoption of flexible exchange rate regime, enhanced central bank independence. - Support: Financial arrangements with IMF, World Bank, and IDB during 1983-1990 (two Stand-by Arrangements 1983-85 and 1989-90; one Extended Fund Facility 1985-89). - Fiscal adjustment characteristics: - Both reform programs featured large fiscal adjustments mainly focused on primary spending cuts. - First episode (1974–79): unprecedented compression of primary spending; capital expenditure reduced from 8 percent of GDP in 1973 to 3 percent in 1979. - Second episode (1983–89): fiscal adjustment smaller; part of spending cuts used to reduce tax burden (particularly on business income) and increase public investment. - Initial spending reforms emphasized immediate and permanent savings with limited room for pro-growth measures; health and education expenditures were protected after initial severe cuts. - Tax policy reforms: - 1975: cascading sales tax replaced with broad-based VAT with general rate of 20 percent and initial exemptions for certain basic goods. - PIT reforms 1974-79: temporary one-year increase followed by reduction of the top rate from 60 to 58 percent; replacement of proportional tax on labor income by progressive tax. - Custom duties 1974-79: revision toward uniform import tariff of 10 percent by 1979 with some exceptions; elimination of quantitative restrictions. - Table 2. Chile: Major Fiscal Reforms (selected entries) - 1. Fiscal Consolidation (1974-79): Expenditure-based fiscal consolidation brought the primary fiscal deficit from 23 percent of GDP in 1973 to a 5 percent surplus in 1979. - 2. Tax Reform: - PIT (1974-79): Temporary one-year increase followed by a reduction of the top rate from 60 to 58 percent; replacement of proportional tax on labor income by progressive tax. - VAT (1975): Introduction of a broadly based VAT with general rate of 20 percent and initial exemptions for certain basic goods. - Custom Duties (1974-79): Revision to tariff structure to achieve by 1979 a uniform import tariff of 10 percent with some exceptions; quantitative restrictions eliminated. - 3. Spending Reform (1974-79): - Civil Service: Wage restraint and reduction of public employees. - Subsidies: Reduction facilitated by privatization of SOEs and reversal of previous expropriation of enterprises. - Public Investment: Reduction from 8 percent of GDP in 1973 to 3 percent in 1979; efforts to protect the most productive investment projects. - Education and Health: Increase in spending on primary and secondary education, and primary care expenditure. - 4. PFM and Revenue Administration: - Budget Process (1975): Adoption of single treasury account; strong coordination of macro framework and the budget. - Revenue Administration (1974-79): Improvement of enforcement and tax collection including by streamlining filing and payment procedures. - 5. Labor Market (1979): New labor plan for collective bargaining. - 6. Privatizations (1974-79): Sale of more than 500 SOEs. *Source: IMF staff calculations, WEO, Banco Central de Chile, DIPRES, WDI.* ### 1. Fiscal Consolidation1983-89Expenditure-based fiscal consolidation brought the primary fiscal balance from a ### 1. Fiscal Consolidation1983-89Expenditure-based fiscal consolidation brought the primary fiscal balance from a negligible deficit in 1982 to a 9 percent surplus in 1989. ### Fiscal consolidation summary - Expenditure-based fiscal consolidation brought the primary fiscal balance from a negligible deficit in 1982 to a 9 percent surplus in 1989. - During the second reform period (1983–89), the improvement in the primary balance was about 9 percentage points of GDP, with current primary spending falling by about 8.5 percentage points of GDP and the tax ratio lowered by about 3 percentage points. ### Tax Reform (1983-89) - CIT: Major revisions to rate structure; top rate reduced from 50 percent in 1983 to 35 percent in 1989; near elimination of the tax on retained profits. - PIT: Top rate reduced from 58 percent to 50 percent. - VAT: Reduction of general rate to 18 percent. - Note: "The corporate income tax was significantly reduced with the top rate declining from 49 percent in 1982 to 33 percent in 1989. During the 1990s, the corporate income tax was raised to 35 percent until 1994 and then lowered to 15 percent." (as reported in source footnote) ### Spending Reform (1983-89) - Primary current expenditure: Reduction in primary current spending from 25 percent of GDP in 1982 to 17 percent in 1989. - Public investment: Increase from about 2 percent of GDP in 1982 to about 3 percent in 1989. - Across reform episodes: Primary spending fell from 43 percent of GDP in 1973 to 23 percent in 1999 (contextual figure reported). ### Public Financial Management (PFM) - Copper Stabilization Fund: Adoption of the fund in 1985 to shield the budget from copper prices' volatility. - Continued improvement in revenue administration and PFM systems helped enact fiscal reforms swiftly: examples include greater taxpayer education, simplification of taxpayer forms, streamlined filing and payment procedures, tighter control over the budget preparation process, enhanced cash management system, adoption of a medium-term macroeconomic and planning framework for investment projects, ceilings set by the Ministry of Finance prior to preparation of ministry spending envelopes, and adoption of a single treasury account in 1975. ### Labor Market - End 1982: Removal of full wage indexation. - Consequences: Suspension of wage indexation at the end of 1982 and fiscal retrenchment between 1983 and 1989 were instrumental in translating nominal exchange rate depreciations into a real depreciation, which boosted non-copper exports. ### Privatizations - 1983-89: Sale of about 80 SOEs. - Longer-term: Number of state-owned enterprises reduced to 38 in 2000 from 595 in 1973 (reported outcome). ### Outcomes: Macroeconomic and social impacts - Growth: - GDP fell cumulatively by about 12 percent during 1974–75. - Economic activity contracted by about 16 percent in 1982–83. - Growth peaked at 11 percent in 1989 and hovered at around 6 percent in the following decade. - Average annual GDP growth: about 1.6 percent during five years preceding the first reform episode; increased to 3 percent during the first reform episode; increased to 5 percent during the second reform episode; in the first half of the 1990s, trend growth averaged 7 percent. - During 1980-89, Chile exceeded the average growth rate of emerging Latin American economies by about 1.7 percentage points. - During 1990-99, Chile outperformed its peers by about 3 percentage points. - Public finances: - First reform episode: primary fiscal balance moved from a deficit of about 23 percent of GDP in 1973 to a surplus of about 5 percent in 1979. - Two-thirds of the adjustment during the first episode came from a dramatic reduction in primary spending, with primary current expenditures and public investment falling by 20 and 4 percentage points of GDP, respectively. - Revenues increased by 4 percentage points of GDP following the introduction of a VAT. - Labor market and inequality: - Unemployment rate reached 20 percent in 1982 (4 percent in 1973) and remained in double digits until 1987. - Poverty rate fell to about 12 percent in 1992 from about 21 percent in 1970. - GINI coefficient increased from about 0.45 in 1973 to about 0.56 in 1987; inequality remained on average 20 percent higher than in 1970 during the 1990s. - Fiscal-structural linkages: - Fiscal retrenchment and privatizations reduced the state’s role, contributing to private-sector-led growth. - The 1981 pension reform included a shift to privatized savings plans and an increase in the retirement age. - Pension and labor reforms, along with removal of wage indexation, helped boost private savings, deepen capital markets, and increase private investment. ### Impact on long-term growth: sources and mechanisms - Growth accounting (1974-1999 period averages): - Capital contribution to growth: 2.3 percent (average). - Labor contribution to growth: 1.8 percent (average). - Total factor productivity (TFP) contribution: 0.4 percent (average). - Sub-period patterns: - First reform episode: capital accumulation explains half of average growth. - Years immediately following 1975 recession: TFP was the main contributor. - 1980-1982: capital accumulation was the only source of growth; TFP contribution negative. - Second reform period: labor accounted for almost two-thirds of growth. - 1990-1999: more than half of average GDP growth explained by capital accumulation driven by record high private investment rates. - Channels through which fiscal measures supported growth: - Fiscal retrenchment and privatizations improved borrowing conditions and market expectations, supporting private investment. - Reductions in corporate income tax rates and increased public infrastructure spending in the 1990s may have contributed to crowding in private investment. - Improved PFM systems likely raised productivity of public investment and crowded in foreign direct investment with knowledge transfers. - Efficiency gains from deregulation, price liberalization, privatization, labor and pension reforms, and significant reduction in inflation enhanced resource allocation and TFP. *Source: Corbo (1985), IMF, and Mackenzie and others (1997a).* ### 23. Also, the sharp increase in the contribution of labor in the late 1980s may have been ### _042015 - 23. Also, the sharp increase in the contribution of labor in the late 1980s may have been ### Drivers of the late-1980s rise in labor contribution - Macroeconomic and policy context: - Macro stability, pro-growth tax and spending policies, and labor reforms underpinned the sharp increase in the contribution of labor in the late 1980s. - Specific fiscal and labor measures: - Fiscal retrenchment reduced uncertainty associated with fiscal imbalances and improved financing conditions (Mackenzie and others, 1997a), supporting private sector activity and job creation. - Reduction in income tax rates (particularly on business income) and social security contributions in the context of the 1981 pension reform (Edwards and Edwards, 2000) benefited labor demand and supply. - Substantial restructuring of the civil service and removal of full wage indexation in 1982 increased real wage flexibility amid record high unemployment (Corbo, 1985; Corbo and Fischer, 1993). - Increased allocation of budgetary funds to the education system could have reduced labor mismatches by increasing workers’ skills. - Implementation of these measures appears to have been facilitated by well-functioning PFM systems (Mackenzie and others, 1997a). - Other supporting macro reforms (footnote 17): - Adoption of a flexible exchange rate regime and liberalizations in the trade and financial sectors likely supported employment growth during 1983-89. ### Role of fiscal policy in Chile’s post-1973 growth - Aggregate assessment: - Fiscal policy played an important role in boosting Chile’s growth performance after 1973 by promoting productive factor accumulation and some gains in TFP (Figure 6). - Mechanisms and sequencing: - Fiscal consolidation restored macroeconomic stability and created conditions for durable private sector development. - Consolidation enabled difficult tax and expenditure reforms supported by well-functioning fiscal institutions. - Ambitious labor and pension reforms and large-scale privatizations reduced the state’s role, improved resource allocation, and promoted private investment. - Caveat: - Fiscal policies were not the sole drivers; other external and internal factors also played a key role. ### Empirical evidence and indicators (figures and table highlights) - Figure 6 summary points (text from chart): - Growth following and reforms came mainly from higher capital and labor accumulation. - Reform measures primarily aimed at fiscal adjustment and macroeconomic stabilization. - Fiscal consolidation in both reform periods was significant and largely expenditure-based. - Some efforts were made to protect growth-enhancing spending after initial steep cuts. - This created room for tax cuts that, along with privatization, boosted private investment. - Strong growth and poverty reduction were not sufficient to lower inequality. - Table 4. Chile: Selected Indicators (period averages; selected entries preserved exactly): - Reform Episode columns: 1964-68; 1969-73; 1974-79; 1980-82; 1983-89; 1990-94; 1995-99 - Real GDP: 4.2 1.6 3.0 0.2 5.0 7.3 5.4 - Contributions to Growth (Percent) 1/: - Capital: 4.5 3.7 1.4 2.6 1.1 3.0 4.4 - Labor: 0.8 0.9 1.1 -0.1 2.9 1.6 2.2 - Total Factor Productivity: -1.1 -3.0 0.5 -2.3 1.1 2.7 -1.2 - CPI Inflation (End of Period): 26.2 158.4 170.6 21.0 20.8 16.1 5.6 - Total Revenue 2/: 18.8 20.4 23.4 26.4 26.7 23.9 22.7 - Total Expenditure: 21.8 30.3 26.0 25.6 29.7 22.4 21.6 - Fiscal Balance: -3.0 -9.9 -2.6 0.8 -3.1 1.6 1.1 - Primary Balance: -1.4 -8.3 1.6 2.8 3.0 4.3 2.5 - Gross Debt 5/: 13.5 17.8 22.1 17.2 67.8 38.5 15.4 - Real Wage Index (1970=100) 6/: ... 99.8 70.4 94.4 86.7 102.4 126.0 - Employment Ratio 7/: 30.2 29.2 29.2 27.0 30.7 34.5 35.1 - Unemployment Rate: 5.3 4.0 12.6 13.9 13.5 7.4 7.2 - Corporate Income Tax Top Rate (Percent): ... 49.2 50.0 20.0 15.0 15.0 15.0 - Private Investment: ... ... ... 16.5 21.6 22.3 - Foreign Direct Investment: ... 0.6 1.2 2.4 2.7 6.9 - Market Gini Coefficient 8/ 9/: 49.6 ... ... 52.8 54.1 53.3 54.3 - Net Gini Coefficient: 46.8 ... ... 49.9 51.1 50.2 51.2 - Poverty Rate (Percent) 10/: ... ... ... 18.8 10.7 6.3 - Notes accompanying the table: - 1/ Growth accounting estimates are calculated using Penn World Table 8.0. - 2/ From 1960-1990, figures are from Indicadores Económicos y Sociales de Chile. From 1991-2013, figures are from DIPRES. This is true for all revenue, expenditure, and resulting balance figures. - 3/ DIPRES data from 1991-present does not break out tax revenue into direct and indirect taxes. For these years, figures are estimated by applying the growth rate in indirect tax revenue (data from Central Bank authorities) to the split between direct and indirect tax revenue in 1990. - 4/ Estimates of current and capital expenditure are calculated using shares obtained from GFS. - 5/ Gross central government debt. - 6/ From 1970-1979, figures are from Edwards and Lustig (1997). From 1980-2012, figures are from CEPAL. - 7/ Percent of the entire population that is employed. - 8/ "Market" Gini measures the income distribution before taxes/transfers; "net" refers to after taxes/transfers. - 10/ Percent of the population living on less than $2 (PPP) per day. ### Lessons and policy recommendations (Sections 25–28) - Lesson 1: Large fiscal retrenchment and long-term growth - Large fiscal retrenchment for stabilization may impose short-term pain but can be compatible with higher long-term growth. - Comprehensive, growth-friendly tax and spending reforms can contain adjustment pain by making the tax structure more growth friendly (e.g., moving from direct to indirect taxation) and improving the quality of spending (e.g., reducing unproductive expenditures). - Reforms that take time to produce net fiscal savings (e.g., tax reform, civil service reform) should start early in the adjustment process. - Initial spending cuts can be partially restored once stabilization takes hold and revenue-raising measures start bearing fruit. - Lesson 2: Consistency with other macro policies - Inconsistencies with other macroeconomic policies, if unaddressed, can jeopardize benefits of growth-oriented fiscal adjustment. - Example: Chile’s 1978-82 performance was undermined when exchange rate stabilization coexisted with full wage indexation. - Lesson 3: Importance of fiscal institutions - Strong and effective fiscal institutions are critical to maximize benefits of fiscal reforms. - Well-functioning PFM and revenue administration systems permitted timely enforcement of substantial changes in spending and revenues; higher revenue collection helped create fiscal space for growth-enhancing policies. - Lesson 4: Distributional challenges - Fiscal adjustment strategies aimed at boosting growth can face major challenges regarding income inequality. - Chile’s experience shows that successful growth and poverty reduction do not necessarily lead to durable improvements in income inequality and may even worsen income distribution. - Policy implication: specific and well-targeted measures are needed to protect the most vulnerable and ensure equitable sharing of growth benefits. ### Robustness and sensitivity analysis for Chile - Placebo tests (Appendix A.1): - Each country in the input comparator group was alternately chosen as the tested country when no fiscal reform took place. - Post-reform growth in Chile was higher relative to the growth distribution of non-reformers in terms of the size of growth gaps. - Ratios of post-reform and pre-reform RMSPEs are not high, as the synthetic series for Chile were not able to reproduce the pre-intervention outcome variable very well; positive growth gap in the post-reform must be cautiously interpreted. - Sequential exclusion of comparator countries (Appendix B; Figures A2 and A3): - Sequential exclusion of countries with positive weights (Colombia, Peru, Uruguay) and re-estimation showed the post-reform growth gap is higher than the pre-reform growth gap in all cases, confirming the baseline. - Changes in reform timing (Appendix C): - Start-year sensitivity: - Synthetic series re-estimated for start years 1969, 1973, 1975, 1979 (first period) and 1978, 1982, 1984, 1988 (second period). - Growth effects in baseline are not sensitive to small changes in starting periods (1973 and 1975 for first period; 1982 and 1984 for second period). - Setting the start of reform in 1969 results in disappearance of the growth effects. - Positive growth effects were also observed for start years 1978, 1979, and 1988 in some exercises. - End-year sensitivity: - Recalculations setting end of fiscal reform to 1982 and 1984 (first period) and to 1992 and 1994 (second period) confirm the baseline conclusion for both 1974 and 1983 reforms when end-year is varied. ### Transition to Germany case study (opening background) - Germany context (beginning of next section): - By the late 1990s and early 2000s, Germany’s growth was weak relative to peers; between 1993 and 2002 growth was consistently below the EU average. - In 2002 and 2003, Germany’s growth trailed that of almost all other EU and OECD countries (Figure 1). - Unemployment rose from 5.5 percent in 1992 to 11.3 percent in 2005. - By 2003, the fiscal balance worsened from around 1 percent deficit in 2000 to a peak of over 4 percent of GDP in 2003; by 2005 the deficit had exceeded the 3 percent Stability and Growth Pact threshold for several years in a row. - Debt ratio rose from around 41 percent of GDP in 1991 to 68 percent of GDP in 2005; average fiscal deficit was around 2.5 percent of GDP during 1991–2005. - Key contributors to fiscal deterioration included large spending programs in Eastern Germany after reunification in 1990, persistently weak economic performance, and liabilities inherited from former Eastern Germany. *Source: IMF staff calculations and chapter content from the provided PDF.* ### 3. In 2003, Germany embarked on an ambitious and wide-ranging reform program ### _042015 - 3. In 2003, Germany embarked on an ambitious and wide-ranging reform program ### Overview of Agenda 2010 and objectives - Agenda 2010 (2003) aimed to fix structural problems underlying Germany’s weak long-term economic performance by: - introducing more flexible hiring and firing rules; - modernizing and reorganizing the labor office to facilitate job placements; - reducing the duration and eligibility of unemployment and welfare benefits; - slashing non-wage labor costs through reduced health insurance premiums. - Central motivation: reform and liberalize the labor market to boost both labor supply and labor demand. ### Fiscal dimension and major reform steps - Expenditure-based consolidation was an important objective given fiscal deterioration and breach of the Stability and Growth Pact. - Public spending dropped by almost 5 percent of GDP from its peak at around 47 percent of GDP until 2007, especially driven by declines in the wage bill and social spending (amounting to 3.7 percent of GDP). - Major reform areas and steps (as presented in source): - Fiscal Consolidation (2003): Expenditure-based fiscal consolidation led to overall fiscal deficit of 4 percent of GDP in 2003 to 0.2 percent of GDP surplus in 2007. - Tax Reform: - PIT (2005): Cut from 48 percent to 42 percent in 2005. - CIT (2008): Cut from 25 percent to 15 percent in 2008. - VAT (2007): Raised from 16 percent to 19 percent in 2007. - Spending Reform: - Health Care Reform (2004, 2007-09): Increase in copayment, limits on dental coverage (2004). - Pension Reform (2004, 2007): Linking benefit levels to the old-age dependency ratio (2004); raising statutory retirement age from 65 to 67 (2007). - Entitlement Reform (2005-06): Tightening of eligibility and maximum duration of unemployment benefit; merger of long-term unemployment and social assistance. - Labor Market Reform: - Reform of Active Labor Market Policy (2003-05): Deregulation of part-time work; streamlining of job protection regulation; and improvement in job intermediation. - Additional tax changes described in text: - Top marginal income tax rate cut from 48 percent to 42 percent in 2005 (partially reversed in 2007). - Marginal tax rate for low incomes cut from approximately 20 percent to 15 percent between 2003 and 2005. - Federal corporate tax rate reduced from 25 percent to 15 percent in 2008 as part of larger corporate tax reform that entailed base broadening. - Increase of the standard VAT rate from 16 percent to 19 percent (text references this increase as occurring in 2005; Table entry lists VAT change in 2007). - Savings on the expenditure side created fiscal space for tax cuts and helped contain social spending via reduced unemployment and stronger growth. ### Fiscal rule and consolidation durability - Germany introduced a "debt brake" fiscal rule: - Requires the structural deficit of the federal government not to exceed 0.35 percent of GDP. - Requires that the structural deficit of the German states remains at zero. - Phased in over the 2011–2020 period and becomes fully binding for the federal government from 2016 onwards. - The debt brake is included in the German constitution and is more binding than the Stability and Growth Pact and the previously included golden rule. - Fiscal outcomes cited: - Overall deficit of 4 percent of GDP in 2003 to 0.2 percent of GDP surplus in 2007 (Table entry). - Overall deficit of 4.2 percent in 2003 turned into a fiscal surplus of almost 0.2 percent by 2013, projected to persist in 2014 and 2015 (text). ### Design features and political economy - Reforms targeted key labor-market rigidities and non-wage labor costs, with immediate fiscal benefits from expenditure savings. - Prioritization rationale: - Structural reform dividends unfold slowly; boosting medium- and long-term growth is essential for successful fiscal consolidation. - Target the most important and politically difficult reforms early to preserve political capital. - Political support: - Reforms initiated by a coalition of the social democrats and the green party; opposition (conservative and liberal parties) were sympathetic to general reform impetus. - Cuts in personal income taxation in 2005 (agreed in 2000) may have helped safeguard voters’ support. - Favorable mid-2000s economic conditions—partly external—also helped maintain support. - Timing considerations: - Reforms may have been enabled by persisting stagnation despite global recovery and by freed political capital after reunification issues subsided. ### Economic performance after reform - Growth and macro indicators: - Strong growth of significantly above 3 percent in 2006 and 2007. - Average growth rates of 2.2 percent between 2010 and 2013. - Potential growth is estimated to be 1-1.5 percent. - Germany recorded a relatively deep recession in 2009. - Labor market outcomes: - Unemployment rate was almost halved between 2004 and 2013 and reached historically low levels. - Fiscal trajectory: - Notable consolidation despite temporary deterioration in 2009–2010 due to the global financial crisis. - Assessment of reform success: - After 10 years the program is widely believed to have been largely successful, especially in reducing unemployment. - Key measures believed important: more flexible labor contracts and stronger incentives for the unemployed to speed up job search. - Alternative and complementary explanations for outcomes: - Wage restraints (facilitated by a decentralized, consensus-based wage-bargaining system) played an important role in competitiveness gains. - Subsidized short-time work arrangements and firm-level working time accounts allowed firms to cut working hours rather than employment, aiding rapid response when demand rose (2010 onwards). ### Empirical evaluation and decomposition of growth gains - Comparative and counterfactual evidence: - Simple comparisons: Germany’s growth lagged peers by about 2 percentage points in the 10 years before the reform; post-reform it has been higher by about 0.5 percentage points. - Synthetic Control Method (SCM) counterfactual simulations indicate fiscal reform resulted in growth acceleration of about 0.7–1.5 percent (depending on GDP growth or per capita GDP growth). - Growth accounting and channels: - Labor and TFP were the main drivers of the post-reform growth performance. - Labor was the principal channel through which fiscal reform affected growth: - Spending reforms (streamlining unemployment benefits, pension reform) increased incentives for job search and contributed to higher labor supply. - Spending reform created fiscal space for tax reductions, contributing to increased labor supply. - Labor market reforms improved job matching, increasing job creation for given labor supply and demand. - TFP developments likely influenced by factors other than fiscal reform, including product market reform and the GFC. - Capital accumulation was subdued: - Capital contribution to growth showed a gradually decreasing trend. - Both public and private investment to GDP ratios remain lower than the euro area average. - No clear evidence that fiscal and labor market reform affected investment. ### Distributional and social effects - Income inequality and poverty: - Market Gini coefficient increased slightly until 2007 and stabilized afterwards. - Market Gini may have been affected by changes in capital income and greater labor income dispersion. - Net Gini was affected by weakening of tax and public transfer system due to top income tax cuts and replacement of public transfer by labor income amid rising employment. - Income inequality saw a slight increase until 2007 both before and after redistribution and largely stabilized afterwards. - Relative poverty rate trends are reported in Table 3. ### Key statistics and selected indicators (period averages and levels from source) - Growth and contributions (Table 3, period averages): - Real GDP: 1993-97 = 1.1; 1998-2002 = 1.7; 2003-05 = 0.5; 2006-10 = 1.4; 2011-13 = 3.0 - Contributions to Growth (Percent): - Capital: 1993-97 = 0.8; 1998-2002 = 0.7; 2003-05 = 0.4; 2006-10 = 0.5; 2011-13 = 0.5 - Labor: 1993-97 = 0.3; 1998-2002 = 1.0; 2003-05 = 1.4; 2006-10 = 0.4; 2011-13 = 0.9 - Total Factor Productivity: 1993-97 = 0.0; 1998-2002 = -0.1; 2003-05 = -1.3; 2006-10 = 0.6; 2011-13 = 1.7 - CPI Inflation (Period Average): 1993-97 = 2.3; 1998-2002 = 1.2; 2003-05 = 1.6; 2006-10 = 1.6; 2011-13 = 2.1 - Fiscal indicators (ESA 95 accounting, period averages): - Total Revenue (% of GDP): 1993-97 = 46.1; 1998-2002 = 45.8; 2003-05 = 43.8; 2006-10 = 44.2; 2011-13 = 44.7 - Total Expenditure (% of GDP): 1993-97 = 49.0; 1998-2002 = 48.2; 2003-05 = 47.6; 2006-10 = 45.9; 2011-13 = 44.8 - Fiscal Balance (Percent of GDP): 1993-97 = -2.9; 1998-2002 = -2.4; 2003-05 = -3.7; 2006-10 = -1.8; 2011-13 = -0.2 - Primary Balance (Percent of GDP): 1993-97 = 0.5; 1998-2002 = 0.7; 2003-05 = -0.8; 2006-10 = 1.0; 2011-13 = 2.1 - Gross Debt (Percent of GDP): 1993-97 = 53.6; 1998-2002 = 59.2; 2003-05 = 64.8; 2006-10 = 69.5; 2011-13 = 77.8 - Ten Year Bond Yield: 1993-97 = 6.5; 1998-2002 = 4.8; 2003-05 = 3.8; 2006-10 = 3.6; 2011-13 = 1.9 - Labor market and corporate sector indicators: - Real Wage Index (2013=100): 1993-97 = 91.1; 1998-2002 = 94.7; 2003-05 = 95.9; 2006-10 = 96.3; 2011-13 = 99.1 - Employment Ratio (Percent of population 15-64 employed): 1993-97 = 64.5; 1998-2002 = 65.3; 2003-05 = 65.0; 2006-10 = 69.6; 2011-13 = 72.9 - Unemployment Rate: 1993-97 = 8.6; 1998-2002 = 8.5; 2003-05 = 10.5; 2006-10 = 8.3; 2011-13 = 5.6 - Corporate Income Tax Top Rate (Percent): 1993-97 = 40.0; 1998-2002 = 30.0; 2003-05 = 25.5; 2006-10 = 19.0; 2011-13 = 15.0 - Private Investment (Percent of GDP): 1993-97 = 19.7; 1998-2002 = 19.0; 2003-05 = 16.1; 2006-10 = 16.5; 2011-13 = 15.9 - Income distribution and poverty: - Market Gini Coefficient: 1993-97 = 46.2; 1998-2002 = 47.3; 2003-05 = 49.7; 2006-10 = 50.7; 2011-13 = 49.4 - Net Gini Coefficient: 1993-97 = 27.0; 1998-2002 = 26.6; 2003-05 = 27.8; 2006-10 = 28.8; 2011-13 = 28.6 - Relative Poverty Rate (Percent): 1993-97 = 6.9; 1998-2002 = 7.3; 2003-05 = 8.5; 2006-10 = 8.7; 2011-13 = 8.7 ### Lessons and policy implications (as discussed in source) - Prioritize reforms that target major impediments and those that have the largest economic impact early, since political capital wanes over time. - Combining spending reforms that create fiscal space with tax cuts can help maintain political support while achieving consolidation. - Embedding fiscal limits in stronger institutions (constitutional debt brake) can help lock in consolidation gains and prevent reversals after shocks. - Structural reforms yield potential growth dividends slowly; short-term cyclical shocks (e.g., GFC) complicate the assessment of long-term effects. - Labor-market reforms, when combined with measures that preserve worker attachment (e.g., short-time work subsidies), can improve employment resilience during downturns. *Source: IMF, "FISCAL POLICY AND LONG-TERM GROWTH - CASE STUDIES" (Germany section), as provided in the supplied content.* ### 25. Reforms that aimed at promotion of long-run growth were helpful in sustained ### _042015 - 25. Reforms that aimed at promotion of long-run growth were helpful in sustained ### Germany: main findings on reforms, growth, and distribution - Reforms targeted key rigidities of the labor market and entailed cuts in unemployment benefits. - Central lesson: consolidation measures should ideally result in spending cuts and in the promotion of long-run growth. - Rationale highlighted: in a prolonged recession, improving the fiscal position is very difficult because debt as a share of GDP increases if the economy shrinks even in the absence of deficits, and lowering deficits is considerably harder with automatic increases in social spending and automatic decreases in tax revenue in recessions. - Political reversals and recent measures: - Recent measures facilitated early retirement in some cases and resulted in higher pensions for specific population groups. - Recently introduced child care-benefits have been shown to be a powerful incentive for labor participation by the parents, but can be economically costly. - A uniform minimum is set to become effective which will result in significant wage increases in some regions. - Distributional effects: - Dustmann and others (2014) report that real wages at the 15th percentile fell significantly, in particular between 2003 and 2008, whereas wages at the 85th percentile still increased over the same time horizon. The reforms may have contributed to the slight increase in income inequality. ### Germany: robustness tests (Appendix A) - A. Placebo Tests - Every country in the comparator group (European Union-15) was alternatively chosen as the tested country when in fact no fiscal reform took place in that country. - Result: Post-reform growth in Germany was not demonstratively higher relative to the growth gap distribution of non-reformers, in terms of either the size of growth gaps or ratios of post-reform and pre-reform RMSPEs. - Interpretation caveat: results cannot rule out the possibility that the baseline growth estimate could be due to factors other than the fiscal reform; pre-reform match was poor for some comparator countries. - B. Sequential Exclusion of a Comparator Country - Sensitivity tested by sequentially excluding comparator countries that received positive weight: Austria, Belgium, France, Netherlands and United Kingdom. - Result: The post-reform growth gap is higher than the pre-reform growth gap in all exclusion cases, confirming the baseline. - C. Changes in the Reform Periods - Synthetic series re-estimated for start years 1998, 2002, 2004 and 2008. - Result: Growth effects in the baseline are not sensitive to small changes in starting periods (2002 and 2004), but setting the start of reform in 1998 results in disappearance of the growth effects. - Interpretation: These results support that the fiscal reform is the likely reason for the positive growth effect in the baseline. ### Ireland: background and macro-fiscal outcomes - Historical performance and crisis: - 1967–1986: Real GDP growth averaged 3.8 percent; GDP per capita averaged 62 percent of the level in the EU; budgetary deficits averaged 7.6 percent of GDP; debt-to-GDP ratio doubled to 123 percent by 1987 from 53.6 percent in 1970. - 1987–2005 (post-reform expansion): Over the near 18-year period post 1989, real GDP growth averaged 6 percent and GDP per capita caught up to and eclipsed the EU average; primary deficits turned to surplus in 1987; balanced budgets achieved in 1997; debt-to-GDP declined to 24 percent by 2007. - 2006–07 property peak: housing construction was contributing 15 percent to national income compared to 4–6 percent in the 1990s (estimates in Kelly (2009)). - 2007–2013 crisis: Over the period 2007 to 2013, GDP growth averaged 1.1 percent; the overall deficit excluding financial sector support averaged 11 percent of GDP; the overall deficit including financial sector support averaged 19 percent; debt-to-GDP ratio increased to 116 percent in 2013 from 24 percent of GDP in 2007. - IMF/EU program and financing: Ireland participated in a $67.5 billion International Monetary Fund (IMF) and European Union (EU) supported program; Ireland contributed €17.5 billion and the external commitment consisted of €22.5 billion from the IMF, and €45 billion (EFSM €22.5 billion, EFSF €17.7 billion and bilateral loans of €4.8 billion) from the EU. - Factors supporting the ‘Celtic Tiger’: - Fiscal consolidation reduced economic uncertainty and, with support of social partners, created a virtuous cycle of low taxes and increased labor competitiveness. - Low labor costs, high trade openness, an underutilized but better-educated labor force, and favorable tax rates supported FDI. - Improved external environment: wider exchange rate bands in ERM (second half of 1993), EU structural funds, Maastricht Treaty (1992), and U.S. recovery from recession in 1991. ### Ireland: fiscal policy reforms and mechanisms - Overview of reform timing and areas: - Early reform period: 1987–89; reforms built on earlier education and investment measures and included labor market reforms, expenditure-based fiscal consolidation and tax reductions. - Key reform areas and steps (Table summary): - 1. Fiscal Consolidation - 1987: Substantial cuts in public-sector spending. - 2008: Tax increases and base broadening (1/3) and expenditure cuts (2/3). - 2. Tax Reform - PIT: 1987 onward — PIT rate reduced from 65 percent in 1985 to 42 percent in 2001. - CIT: 1987 onward — CIT rate reduced from 50 percent in 1987 to 12.5 percent in 2003. - Capital Gains Taxes: 1987 onward — Capital gains tax reduced from 60 percent in 1985 to 20 percent in 2001. - 3. Labor Market Reform - 1987: Debut of the Social Partnership agreements which continued until they collapsed in 2009. - 4. Public pension - 2009: Pension levy; changes to the retirement age; and reduction in benefits. - 5. Education - 1967: Expansion of the education system. - 6. Economic Openness - 1958 onward: Industrial Development Agency created; import levies removed; and tax concession for manufacturing exporters. - Reform Area details: - Spending reforms (1987): hiring freeze in the public sector, early retirement scheme, deferral of special pay awards, postponement and reduction of infrastructure spending — expenditure-based consolidation contributed to improved macroeconomic stability. - Labor market reforms: tripartite social partnership agreements encouraged wage and strike moderation; partnership agreements helped moderate wage growth in exchange for reduced personal income taxes, supporting competitiveness and FDI; later, these agreements may have exacerbated procyclical policies in the 2000s. - Tax reforms: high marginal tax rates in 1970s–1980s were reversed from 1987 onwards (marginal income tax as high as 85 percent in 1975 and 65 percent in 1985); a special manufacturing tax rate of 10 percent introduced in 1981 remained and encouraged FDI. - Education reforms: significant reforms beginning in the late 1960s, including removal of fees for secondary education. ### Ireland: crisis response and assessment - Crisis impact and policy response: - Property-related tax revenues became an ever-increasing share of total revenues in the 1990s and accelerated in the mid-2000s; authorities treated these revenues as structural, increasing public spending as a result. - Crash in the property market and bailouts for an over-extended banking sector precipitated a sovereign debt crisis and the IMF/EU-supported program. - Assessment of post-crisis reforms: - Recent IMF Staff Reports suggest the reforms have been effective at achieving a major fiscal consolidation while preserving social cohesion and protecting key public services and the most vulnerable. - It is difficult to assess at this stage the long-run impact on growth of the post-crisis reforms. *Source: IMF staff calculations and IMF staff reports as presented in the source PDF.* ### 1967. The minimum school leaving age was raised from 14 to 15 in 1972. A means-tested grant ### _042015 - 1967. The minimum school leaving age was raised from 14 to 15 in 1972. A means-tested grant ### Financial crisis reform period - Fiscal crisis began in 2008; Irish government instituted reforms beginning in 2009 and as part of the 2010 IMF/EU supported program. - Program three main elements: - Stabilize Irish banking sector by publicly financed recapitalizations. - Fiscal consolidation to place public finances on a sustainable path. - Structural reforms to restore competitiveness and improve potential growth. - Fiscal measures implemented under the IMF/EU program totaled EUR 13 billion (8 percent of GDP). - Two-thirds of the EUR 13 billion were due to expenditure cuts; the other third from tax increases. - Banking crisis resulted in cumulative public support costs of about 40 percent of GDP. - Expenditure-based fiscal consolidation expected to reduce uncertainty and encourage investment. ### Reform area 2: Broadening the tax base and increasing rates - Personal income tax base broadened by: - Reducing the income tax bands (10-percent reduction). - Introducing the universal social charge. - Eliminating Pay-Related Social Insurance reliefs and exemptions. - Other revenue measures: - Taxes increased on capital and savings. - VAT standard rate increased from 21 percent to 23 percent in 2012. - Excise taxes on both fuel and tobacco were increased. - An additional tax on property was introduced. ### Reform area 3: Spending reforms - Majority of consolidation occurred on the expenditure side: - Public wages were cut by 14 percent and salary progression for public servants was halted for a period of three years. - Welfare rates were reduced by 8 percent. - Public service was reduced by 10 percent relative to its size in 2008. - Non-pay current and capital budgets were reduced by 17 and 63 percent, respectively. ### Reform Area 4: Pension Reforms - State and public sector pensions substantially reformed: - Portion of the state pension related to living expenses was reduced substantially in the 2013 budget. - Retirement ages were increased and pension benefits frozen at 2009 levels. - Beginning in January 2011, a Public Service Pension Reduction applied resulting in average reduction of 4 percent of gross benefits. - 2013: Creation of the Single Public Service Pension Scheme: - New-hires pensions based on career-average earnings. - Retirement age linked to the State pension and will rise progressively over time. - Pension payments will increase with CPI rather than average earnings. - Expected secondary effect: reduced pension benefits will likely encourage older workers to remain in the labor force longer. ### Reform Area 5: Structural Fiscal Reforms - Fiscal Responsibility Act came into effect in December 2012. - Established a budgetary rule, a debt rule, and a medium-term budgetary objective. - Established the Irish Fiscal Advisory Council (IFAC) as a statutory body to endorse macroeconomic forecasts produced by the Government and to monitor and assess compliance with the budgetary rule beginning in 2016. - Fiscal rule and monitoring by IFAC expected to encourage fiscal discipline and lock-in consolidation efforts. ### Notable design features - Unwavering commitment to policies encouraging FDI shaped fiscal policy for 50 years; trade openness and FDI seen as economic backbones. - During 1980s consolidation, favorable tax rates for (largely foreign) manufacturers were left untouched. - In 2000, when special treatment of manufacturing exporters was set to expire, government lowered some corporate tax rates rather than increase taxes for that sector. - Footnote: The favorable rate for manufacturers was 10 percent, but the headline corporate tax rate was set to 12.5 percent to comply with EU rules. The headline corporate tax rate was 20 percent. - Labor reform pursued through consultative social partnership agreements involving government and labor partners. ### Outcomes - GDP growth: - Ten years prior to reforms, GDP growth averaged 2.9 percent. - Ten years after the reform, GDP growth averaged 7.1 percent. - GDP-per-capita growth: averaged 2 percent in the ten years leading up to reforms and 6.2 percent in the ten years afterwards. - Ireland surpassed the EU average level of GDP per capita in 1999; Irish GDP per capita was 70 percent of the EU average in 1986. - Fiscal balances: - Budgetary deficits peaked at 13.1 percent of GDP in 1982. - Deficit remained 10.5 percent of GDP in 1986. - First primary surplus recorded in 1987. - Deficit reduced by nearly 8 percentage points to 2.8 percent of GDP by 1990. - Budget surpluses began in 1997 and continued largely uninterrupted until 2008 (with a small deficit in 2002). - Labor market and strikes: - Hourly compensation growth in manufacturing declined from an average of 13.6 percent over 1977–1986 to an average of 4.5 percent over 1987–1996. - Number of strikes declined from 192 in 1984 to 38 in 1987. - Average number of work days lost to strike in the 1980s was 317,078 while in 1994 it was 25,500. - Employment and participation: - Unemployment peaked at 18.1 percent in 1987, declined to 3.7 percent by 2001. - Female participation: From 1987 to 1997, female participation rates increased by approximately 8 percentage points. - Education attainment (1967–1994): - Proportion taking Junior-cycle examinations rose from about 40 percent in 1967 to close to 100 percent in 1994. - Proportion taking senior-cycle examinations rose from about 21 percent to 82 percent. - 1996 Census: 30 percent of the 55–64 age group had completed at least upper secondary education; 66 percent of the 25–34 age group had done so. - As of 1996, nearly 28 percent of the Irish labor force had a tertiary education compared with the OECD average of 26 percent. ### Recent fiscal consolidation (post-2008) - Recent consolidation reduced the budget deficit considerably, with two-thirds of the consolidation coming from expenditure cuts. - After peaking at 11.5 percent of GDP in 2009, overall budget deficits excluding bank support are estimated to be around percent of GDP in 2014—the point at which primary surpluses are expected to begin. (text as provided) ### Impact on long-term growth — Evidence and decomposition - Growth turnaround: - Output growth exhibited a clear turnaround beginning in 1987; growth averaged 2.9 percent before reforms and 7.1 percent after. - Average growth in the 10 years following reform (1990–99) was 4.4 percentage points higher than the EU-15 average. - Gap between Irish growth and EU-15 narrowed over 2000–2007 but remained 2.9 percentage points higher than EU-15. - Synthetic control results: - Average real GDP growth during the ten-year period following the reform was about 4.8 percentage points higher than the synthetic control group. - Growth exceeded the synthetic country by 4.1 percentage points beyond the 10-year reform period. - Placebo and robustness tests indicate the impact for Ireland is significantly larger than placebo countries and not sensitive to comparator selection. - Decomposition of GDP per capita growth (1990–2007): - Capital deepening, TFP and labor utilization all contributed significantly; human capital contribution was more muted. - Labor utilization was the most consistent contributor over 1990–2007. - Capital deepening contributed significantly over 2000–07; limited role over 1990–99. - TFP contribution was large from 1990–1999 but subtracted from growth when investment shifted to less productive industries during the property boom. - Human capital contribution appears smaller; measurement issues may understate the effect of targeted education investments (Regional Technical Colleges and technical training valuable to IT, software and pharmaceutical firms). - Labor utilization drivers: - Employment rate increases (share of labor employed). - Labor force participation increases (notably female participation). - Demographic shift: delayed baby boom increased share of working-age population. - Consecutive labor market agreements kept wage growth moderate, stimulating labor demand. - Human capital measurement notes: - Human capital index from Penn World Tables constructed using Barro and Lee (2010) years of education and Psacharopoulos (1994) returns to education may understate quality improvements. - Alternate indices suggest larger effects; Bergin and Kearney (2004) estimate GNP per capita would have been 20 percentage points lower if education attainment had remained at 1980 levels. *International Monetary Fund — FISCAL POLICY AND LONG-TERM GROWTH - CASE STUDIES (excerpt as provided).* ### 33. Reduced corporate taxes and a high degree of trade openness increased investment by ### _042015 - 33. Reduced corporate taxes and a high degree of trade openness increased investment by ### Investment, productivity, and growth (Ireland, 1987–1997) - Sustained fiscal consolidation supported by positive external conditions enabled large reductions in taxes, creating an environment conducive to investment. - Foreign direct investment (FDI) increased from 0.2 percent of GDP in 1989 to 3.4 percent of GDP in 1997. - FDI occurred in industries with high productivity including ICT and health. - Trade openness may have enhanced productivity via partner-country productivity spillovers (Helpman, 2006). ### Change in investment composition and growth contribution (post-2000) - Beginning in 2000, a sectoral shift in investment occurred from manufacturing and other high-productivity industries into construction, which was considerably less productive (Crafts, 2014). - This shift may explain: - A relatively large contribution to growth from capital deepening (including capital used in the property sector) after 2000. - A negative contribution to growth from TFP over the same period. ### Role of 1987–89 reforms in long-run growth - The 1987–89 expenditure-based fiscal consolidation and subsequent tax cuts helped create conditions for private-sector investment, especially from foreign-owned corporations. - Complementary factors that supported the growth take-off: - Education reform producing a more educated workforce. - Moderate wage growth and labor stability from labor partnership agreements. - Favorable demographics and increased labor participation supplying labor. - Supportive external environment providing strong demand. - Signals of fiscal commitment from signing the Maastricht Treaty. - EU structural funds helped offset some fiscal consolidation with additional public capital spending (Honohan and Walsh, 2002). ### Recent reforms (post-crisis) and prospects - Substantial fiscal consolidation occurred since the onset of the crisis, with most consolidation coming from reductions in expenditures. - Measures are likely to be “locked in” with monitoring by the IFAC. - Significant cuts to the public sector wage bill have occurred while protecting public services; the progressive nature of consolidation helped protect the most vulnerable. - It is too early to assess the impact of recent reforms on long-run growth, but they appear to be of high quality and likely to operate through similar channels as earlier reforms. ### Lessons - Fiscal policy can hinder growth as well as encourage it; growth-enhancing policies (increased education spending, openness to FDI) were in place long before the 1990s surge, but poorly designed fiscal policy in the 1970s–1980s impeded convergence. - A demonstrable commitment to macroeconomic stability and fiscal sustainability appears crucial in both reform periods. - Political will and buy-in from social partners is essential for durable reforms; collaboration across governing and opposition parties and labor leaders underpinned the early reform partnership. - External fiscal enforcement mechanisms increase the credibility of reforms; Maastricht Treaty membership and later EU fiscal frameworks and IFAC helped ‘lock-in’ fiscal savings and boost investor confidence. ### Key statistics and growth-accounting outcomes (Table 3: Ireland — Period averages by reform episode) - Real GDP (percent): - 1975-79: 4.5 - 1980-86: 1.7 - 1987-89: 4.1 - 1990-94: 4.2 - 1995-99: 10.1 - 2000-04: 6.0 - 2005-09: 1.8 - Contributions to Growth — Capital (percent): 3.3; 2.1; 1.2; 1.4; 3.2; 5.2; 4.0 (by period left-to-right as in table) - Contributions to Growth — Labor (percent): 1.1; 1.2; 1.2; 0.8; 0.6; -0.1; -0.1 - Contributions to Growth — Total Factor Productivity (percent): 0.0; -0.4; 2.7; 2.0; 4.1; -0.9; -2.4 - CPI Inflation (Average): 14.7; 11.9; 3.1; 2.7; 2.1; 4.1; 1.8 - General Government — Total Revenue (percent of GDP): 38.5; 42.9; 42.1; 41.5; 38.0; 34.3; 35.9 - General Government — Total Expenditure (percent of GDP): 47.1; 54.1; 47.4; 44.1; 37.2; 32.8; 39.3 - Fiscal Balance (percent of GDP): -8.6; -11.2; -5.2; -2.6; 0.8; 1.4; -3.4 - Primary Balance (percent of GDP): -4.1; -3.2; 3.2; 4.4; 4.7; 2.9; -2.1 - Gross Debt (percent of GDP): 51.0; 69.7; 83.1; 92.4; 64.4; 33.2; 37.2 - Wage Growth (hourly compensation in manufacturing, percent): 18.3; 12.9; 5.3; 4.7; 4.0; 5.9; 4.4 - Labor Force Participation Rate (percent): 73.0; 73.2; 73.1; 73.2; 75.4; 80.6; 83.9 - Employment Rate (percent): 91.9; 86.6; 81.6; 83.1; 90.2; 95.7; 93.6 - Unemployment Rate (percent): 8.1; 13.4; 18.4; 16.9; 9.8; 4.3; 6.4 - Corporate Income Tax Rate (percent): ...; 47.9; 49.0; 41.2; 36.0; 17.0; 12.5 - Market Gini Coefficient: 45.4; 47.3; 49.9; 49.3; 48.0; 46.6; 49.9 - Net Gini Coefficient: 33.9; 33.7; 32.9; 33.5; 32.9; 31.1; 29.7 ### Robustness and sensitivity checks (Ireland) - Placebo tests: Post-reform growth in Ireland was clearly higher relative to the distribution of non-reformers in the comparator group, in terms of growth gaps and ratios of post-reform and pre-reform RMSPEs. - Sequential exclusion: Sequentially excluding each comparator country that received positive weight still yields a post-reform growth gap higher than the pre-reform gap. - Changes in reform timing — start year: Re-estimating synthetic series with start years 1982, 1986, 1988, and 1992 shows baseline growth effects are not sensitive to small changes (1986 and 1988). Setting start in 1982 results in disappearance of growth effects. - Changes in reform timing — end year: Recalculating differences with end years 1992 and 1994 confirms the conclusion holds when the end of the fiscal reform period changes. *Source: IMF staff calculations and cited IMF chapter content.* ### 5. Tax reforms also sought to lower the tax burden and incentivize private investment. ### 5. Tax reforms also sought to lower the tax burden and incentivize private investment. ### Tax reforms and investment incentives - The excess profit tax was abolished. - The corporate income tax rate was reduced to a level comparable to that of other South East Asian countries. - Tax cuts were coupled with liberal tax incentives for investment. - The Promotion of Investment Act of 1986 provided added tax incentives such as tax holidays and targeted allowances. - Import duties on manufacturing sectors that had enjoyed extensive tariff protection over the previous ten years were dismantled. - Potential revenue losses were to be partially offset by: - closing tax loopholes, - improving revenue administration, and - widening of the sales tax base. - Additional tax changes noted: - Development tax phased out. - Broadening of the sales tax base. - Reduction in CIT and PIT rates. - Abolished excess profit tax rate. ### Privatization, SOE reform, and liberalization - A wide-spread privatization program and economic liberalization complemented fiscal reforms. - Measures included restructuring or liquidation of SOEs; privatization receipts were earmarked to pay down public debt. - Deregulation policies in the Investment Act and Industrial Coordination Act of 1986 relaxed foreign ownership requirements and liberalized the regulatory framework to attract foreign direct investments. - By 1994, large corporations in transportation, telecommunications, electricity and steel had been privatized. - SOE reform and privatization improved efficiency and reduced the administrative and financial burden on the central government. ### Labor market and employment measures - Government measures to address high unemployment included: - Revising labor legislation to lower fringe benefits, - Ensuring faster and smoother arbitration processes, - Phasing out accelerated depreciation to remove biases in favor of capital-intensive production. - Labor market rigidities identified: cumbersome wage-setting and arbitrage systems, high retrenchment costs, and tax biases favoring capital-intensive production. ### Fiscal consolidation, spending prioritization, and revenue trends - Government expenditure declined by 8.6 percent of GDP between 1986 and 1990. - The overall budget deficit of 10.5 percent of GDP in 1986 was eliminated; small budget surpluses and deficits were maintained during the 1990s. - Expenditure was focused on priority areas such as infrastructure investments, health and education; their level as a share of GDP was kept relatively unchanged despite consolidation. - Revenue followed a downward trend: 27 percent of GDP in the first half of the 80s to 23 percent of GDP in 1997. - Cuts in spending created fiscal space for reductions in direct taxes and import duties, only partially offset by tightening exemptions and broadening the sales tax base. ### Outcomes: investment, growth, employment, and poverty - Private investment surged from 14 percent in 1986 to 32 percent of GDP in 1997. - Growth averaged around 8 percent over the period up until the onset of the Asian Crisis in 1997. - Real per capita income nearly doubled. - Unemployment declined by 5 percentage points from its 1986 level, to below 3 percent in 1997. - Poverty declined from 19 percent in 1986 to 6 percent by 1997. - Foreign direct investment increased from an annual flow of 4 percent of GDP in the first half of the 1980s, to an annual average of 6 percent during the decade following the reform period. - Deregulation and tax incentives contributed to attracting FDI and improving SOE efficiency. ### Growth accounting and transmission channels - Capital accumulation contributed primarily to the rebound in growth, with smaller contributions from labor and TFP. - The sharp pick up in private investment resulted in fast accumulation of capital and improved investment efficiency; capital contribution rose until the Asian crisis of 1997. - TFP’s contribution rose sharply during the reform but declined thereafter. - Labor contribution was positive and rising, driven by expansion of labor-intensive manufacturing. - Identified transmission channels from fiscal policy to growth: - Tax reform and expenditure prioritization enabled a shift from public to private investment, increasing capital accumulation and investment efficiency. - SOE restructuring and privatization opened formerly monopolized sectors to competition, improving efficiency and profitability. - Improved domestic policy environment plus FDI inflows to labor-intensive manufacturing supported job creation and labor contribution to growth. ### Empirical comparisons and counterfactuals - Average growth in the 7 years following the reform period and preceding the Asian Crisis (1991–97) was 3 percentage points higher than average growth in the decade prior to the reform period (1975–85). - Compared with peers, average growth in the 10 years following the reform period (1991–2000) was about 1.6 percentage points higher than the average growth in emerging Asia. - Synthetic control results: - Average growth during the 10-year period following the reform period was about 2.3 percentage points higher than average growth generated by the synthetic control group. - Per capita GDP growth in the post-reform decade was about 2.3 percentage points faster on average than its synthetic counterpart. - Results reverse in the following decade (2001–10), with growth broadly similar to or below the synthetic counterpart. ### Selected indicators and exact figures (period averages, Table 3 highlights) - Real GDP (period averages): 1976-80: 8.6; 1981-85: 5.2; 1986-90: 6.7; 1991-95: 9.5; 1996-2000: 5.0; 2001-05: 4.8; 2006-10: 4.5. - Contributions to Growth (Capital, Labor, TFP) for selected episodes (percent): - Capital: 1976-80: 4.3; 1981-85: 5.0; 1986-90: 2.8; 1991-95: 5.7; 1996-2000: 3.4; 2001-05: 2.0; 2006-10: 2.4. - Labor: 1976-80: 3.1; 1981-85: 2.8; 1986-90: 2.4; 1991-95: 2.9; 1996-2000: 2.5; 2001-05: 1.2; 2006-10: 2.1. - Total Factor Productivity: 1976-80: 1.2; 1981-85: -2.7; 1986-90: 1.5; 1991-95: 0.9; 1996-2000: -1.0; 2001-05: 1.5; 2006-10: 0.0. - CPI Inflation (Average): 4.5; 5.1; 1.4; 4.0; 3.1; 1.8; 2.7 (by episode). - Total Revenue (% of GDP): 23.6; 26.8; 24.4; 24.7; 20.6; 21.4; 21.0. - Of Which Tax Revenue (% of GDP): 20.2; 21.2; 17.1; 18.9; 16.4; 16.1; 14.4. - Total Expenditure (% of GDP): 29.8; 38.0; 31.4; 25.4; 22.7; 26.3; 25.8. - Fiscal Balance (Percent of GDP): -6.0; -10.8; -5.6; 0.1; -1.5; -4.6; -4.6. - Gross Debt (% of GDP): 46.7; 69.9; 93.3; 56.4; 35.2; 43.4; 44.5. - Unemployment Rate (by episode): ...; 4.5; 6.4; 3.6; 3.0; 3.6; 3.4. - Corporate Income Tax Top Rate (Percent) by episode: 40.0; 40.0; 38.0; 33.2; 28.8; 27.4; 26.2. - Private Investment (% of GDP) by episode: 16.2; 17.3; 16.8; 26.3; 20.7; 10.7; 11.7. - Foreign Direct Investment (Percent of GDP) by episode: 3.1; 3.7; 2.9; 7.0; 4.4; 2.5; 3.4. - Poverty Rate (Percent) by episode: 37.6; 20.7; 18.0; 10.6; 7.3; 5.9; 3.7. - Market Gini Coefficient and Net Gini Coefficient (selected episodes): Market Gini: 49.3; 48.8; 46.5; 46.6; 47.6; 46.1; 44.4. Net Gini: 45.7; 45.2; 42.5; 43.3; 44.4; 41.2; 41.4. ### Key lessons - High growth rates can disguise growing structural weaknesses, delaying adjustment and adding to the cost of reforms. - Malaysian authorities waited until 1983 onwards to address weaknesses of the state-run model; rapid external and domestic demand and debt-financed public spending masked vulnerabilities. - The reform package implied a significant shift from a state-led to a private sector driven growth model; fiscal reforms reduced the government’s share in GDP, raised spending efficiency, and provided investment incentives while broadening the sales tax base. - Given concurrent industrial deregulation and liberalization of foreign investment, it is difficult to quantify the contribution of each reform; the positive growth impact is attributed to the reform package as a whole. *Source: IMF staff analysis in "FISCAL POLICY AND LONG-TERM GROWTH - CASE STUDIES" (Malaysia).* ### 23. Complementing fiscal reforms with structural reforms - in particular deregulation was ### Complementing fiscal reforms with structural reforms - in particular deregulation was ### Malaysia: reform complementarities and social outcomes - Downsizing of the government sector via the SOE reform and tax reform created space and incentives for private investment growth. - Industrial policies included relaxing administratively cumbersome regulations and ownership requirements to attract domestic and foreign private investors. - Safeguarding spending on basic public services such as health and education enabled the full benefits of the rebound on growth to be reflected in a reduction in poverty. - Broad-based productivity increases and sustained growth resulted in a steady decline in unemployment and were reflected by more than a 15 percentage point decline in the incidence of poverty. - Expenditures on health and education were maintained at a steady level of 1.5 and 5 percent of GDP respectively, above ASEAN neighbors. ### Malaysia: robustness tests for synthetic control baseline - Tests performed (broadly in line with Abadie (2014)): (i) placebo test; (ii) sequential exclusion of each comparator country from the synthetic series; and (iii) changes in the reform period. Placebo tests - Each country in the input group was alternately chosen as the tested country when in fact no fiscal reform took place. - Post-reform growth in Malaysia was not particularly higher relative to the growth distribution of non-reformers, in terms of either the size of growth gaps or ratios of post-reform and pre-reform RMSPEs. - The tests cannot rule out the possibility that the baseline growth estimate could be due to factors other than the fiscal reform; interpret cautiously because pre-reform match was poor for some comparator countries. Sequential exclusion of a comparator country - Countries sequentially excluded from the synthetic control group: Indonesia, Korea and The Philippines. - The post-reform growth gap is higher than the pre-reform growth gap in all exclusion cases, confirming the baseline. Changes in reform timing - Start year sensitivity: synthetic series re-estimated for 1981, 1985, 1987 and 1991. - Growth effects in the baseline are not sensitive to small changes in starting periods (1985 and 1987). - Setting the start of reform in 1981 results in disappearance of the growth effects. - Conclusion: results support that the fiscal reform is the likely reason for the positive growth effect in the baseline. - End year sensitivity: end of fiscal reform period set to 1993 and 1995 respectively. - Results confirm that the conclusion holds when the end of the fiscal reform period changes. *Source: IMF staff calculations and related robustness exercises.* ### Netherlands: background to reforms - Pre-1980s deterioration: GDP growth rates fell increasingly below those of other European countries. - Wage developments (price-indexation) drove rapid wage growth despite external shocks in the 1970s, reducing corporate profitability and stagnating private investment and job creation. - Collapse in housing prices in 1978 and falling participation rates led to unemployment reaching 12 percent in 1982. - Fiscal position deteriorated with high public expenditure; overall deficit of 6 percent of GDP by 1982. ### Netherlands: fiscal policy reforms (expenditure-based consolidation and labor market reforms) Overview of major reform features - Expenditure-based fiscal consolidation aimed to secure macroeconomic stability. - Spending cuts reached approximately 2.5 percent of GDP between 1983 and 1986. - Consolidation was gradual and anchored by a fiscal rule. - Major fiscal reforms (selected items and dates as presented): - Fiscal Consolidation (1982): expenditure-based consolidation led to overall fiscal deficit of 6 percent of GDP in 1982 to 2 percent of GDP surplus in 2000. - Tax Reform: - Social Contributions: cut in employer social security contributions, in particular for low-skilled workers and long-term unemployed. - PIT: cut from 72 to 60 percent in 1990 and to 52 percent in 2001. - CIT: cut from 50 to 42 percent between 1982 and 1986 and to 32 percent in 2005. - Spending Reform: - Wage Bill: 1983—reduced from 13.6 percent of GDP in 1982 to 9.5 percent in 2000. - Entitlements: 1984—reduction in unemployment and disability benefit replacement rates in real terms; tightened access criteria. - Labor Market Reform: - Wage Bargaining: 1982—wage bargaining was decentralized, consensus around wage moderation. - Minimum Wages: 1984—frozen in nominal terms for most of the 1980s, decreased in real terms. - Wage Indexation: 1982—automatic price indexation virtually disappeared by mid-1980s. - Fiscal Institutions: 1983—overall balance rule in 1983, amended to expenditure rule in 1994. Notable design features - Reforms were coordinated and complementary: taxes cuts, expenditure reductions, and labor market reforms reinforced each other to boost employment and growth while consolidating finances. - Continued consultations with labor unions enhanced ownership and credibility; concessions to unions included tax reductions and employment-boosting measures to compensate for wage moderation. ### Netherlands: outcomes - Growth recovery: - Real GDP growth recovered from an average of about 1 percent during 1978-82, to 2½ percent during the reform period (1983-86), and continued to exceed 2½ percent, on average, throughout the 1980s and 1990s. - Inflation moderated substantially from the high levels of the 1970s. - Fiscal consolidation: - Overall fiscal balance moved from a deficit of 6 percent of GDP in 1982 to a surplus of 2 percent of GDP in 2000. - Total expenditure reduced from 59 percent to 44 percent of GDP. - Total revenue decreased from 53 percent to 46 percent of GDP, driven by decreases in PIT, CIT and social security contributions. - Labor market and employment: - Private sector employment grew significantly, with a high incidence of part-time jobs; government employment decreased. - Labor force participation increased, driven principally by higher female labor participation and favorable demographic developments. - Employment rate grew from around 45 percent in 1982, to around 60 percent by 2000. - Fiscal rule evolution: - The overall fiscal deficit rule was found to be too pro-cyclical and was replaced by an expenditure target in 1994 to enable a more strategic approach to expenditure management in 4-year fiscal frameworks. - Distributional and social impacts: - Reforms disproportionately affected low–income groups; employment by the low-skilled remained stagnant and many long-term unemployed did not return to work. - Over time, acceptance of the reform package increased as growth and employment gains were delivered to a large part of the population. ### Netherlands: impact on long-term growth - Trend output growth exhibited a turnaround in the early 1980s after a decline during the previous decade; higher growth was sustained through the 1990s before weakening in 2001-02 amidst a global slow-down. - To attribute growth to fiscal reforms requires comparison with appropriate comparators; the analysis emphasizes evaluating growth against such comparators to assess whether growth was higher than it would have been absent reforms. *International Monetary Fund (excerpts from chapter on fiscal policy and long-term growth case studies).* ### 18. Simple comparisons of growth post-reform with EU peers indicates that long-term ### _042015 - 18. Simple comparisons of growth post-reform with EU peers indicates that long-term ### Growth-comparison findings - Average growth in the 10 years following the reform period (1987-96) was 0.6 percentage points higher than average growth in the 10 years before the reform period (1973-82). - Compared with EU-15, average growth in the 10 years following the reform period (1987-96) was about ¼ percentage points higher than the average growth in the EU-15; the Netherlands underperformed against its EU peers in the following decade. - Synthetic control method results: average growth during the 10-year period following the reform period was about 0.15 percentage points higher than average growth generated by the “control group.” - Per capita GDP growth synthetic control robustness: per capita GDP growth also shows a small advantage of 0.15 percentage points, on average, to the actual Netherlands vs. its “synthetic” counterpart. - Placebo and sensitivity checks indicate the post-reform growth gap for the Netherlands is higher than for non-reformers in the comparator group and is robust to sequential exclusion of comparator countries and to reasonable variations in reform start year. ### Synthetic control and robustness evidence - The synthetic control exercise used EU-15 (excluding Ireland and Portugal) as the donor pool. - Robustness checks: - Results are robust to changes in the starting year of the reform, enlargement or reduction of the pre and post estimation sample period, and to the exclusion of any particular country from the initial sample in the input group. - Placebo tests: post-reform growth in the Netherlands was higher relative to the growth distribution of non-reformers in both the size of growth gaps and ratios of post-reform and pre-reform RMSPEs. - Sequential exclusion of comparator countries (Austria, Belgium, Germany, Sweden) preserves a higher post-reform than pre-reform growth gap. - Changing reform start year: growth effects in the baseline are not sensitive to small changes in starting periods (1982 and 1984); setting the start in 1978 results in disappearance of growth effects; effects are observed when start is set in 1988. ### Drivers of post-reform growth - Labor and private investment were the main contributors: - Labor: the labor share in growth increased significantly throughout the 1980s and 1990s; surge in private sector employment is identified as the main driver of the sustained pickup in growth. - Private investment: picked up after 1983; capital accumulation contribution remained moderate, possibly due to offsetting reduction in public capital spending. - Policy and environment contributions: - Fiscal consolidation, fiscal rules, and entitlement reform enhanced fiscal sustainability and macroeconomic stability, supporting medium-term investment decisions. - Reduction in wage and non-wage labor costs, cuts in corporate taxation, and return to corporate profitability supported higher private investment through reinvested earnings. - Policy package elements that stimulated labor demand and supply: - Reductions in labor costs and taxes; benefit reform; structural labor market reform (notably sharp reductions in the minimum wage and suspension of price-indexation); tripartite Wassenaar agreement emphasizing wage moderation. - Introduction of affordable childcare policy supported female labor participation. ### Growth transmission channels (policy measures and links to outcomes) - Fiscal consolidation and control over expenditure created space for lowering tax burdens (PIT, CIT) and reduced labor tax wedge. - Tax reform, spending reform, labor market reform, introduction of fiscal rules, social consensus building → macroeconomic stability → conducive environment for capital accumulation and employment growth. - Noted linkage: wage moderation and significant reduction in the tax wedge boosted employment; fiscal consolidation improved policy credibility and borrowing conditions; lower corporate taxes and lower non-wage labor costs supported private investment and FDI. ### Quantitative snapshots and select indicators (period averages and levels from source tables) - Synthetic-control predictor means before fiscal reform (Reform Period 1983 1/): - GDP Growth (Percent): Real 3.3, Synthetic 3.8 - GDP Per Capita (2005 I$/Person): Real 22074.7, Synthetic 19453.6 - Trade Openness (Percent): Real 59.8, Synthetic 66.3 - Terms of Trade (Percent): Real 109.3, Synthetic 105.8 - Inflation Rate (Percent): Real 6.4, Synthetic 7.1 - Human Capital Index: Real 2.7, Synthetic 2.5 - GDP Growth Per Capita (Percent): Real 2.4, Synthetic 2.9 - GDP Per Capita (2005 I$/Person) for per-capita set: Real 22074.7, Synthetic 19894.6 - Trade Openness (Percent) for per-capita set: Real 59.8, Synthetic 59.9 - Terms of Trade (Percent) for per-capita set: Real 109.3, Synthetic 107.8 - Inflation Rate (Percent) for per-capita set: Real 6.4, Synthetic 7.0 - Human Capital Index for per-capita set: Real 2.7, Synthetic 2.4 - Source: IMF staff calculations. (Notes: All variables except GDP growth and GDP growth per capita are averaged for the 1970-1982 period. The average for GDP growth and GDP growth per capita is calculated using the years 1970, 1976 and 1982.) - Select indicators, Reform Episode period averages (table excerpts): - Real GDP: 1973-77 = 3.4; 1978-82 = 1.1; 1983-86 = 2.6; 1987-91 = 3.3; 1992-96 = 2.5; 1997-2001 = 3.8; 2002-2006 = 1.6 - Contributions to Growth (Percent) — Capital: 1.3; 0.9; 0.8; 0.9; 0.8; 1.1; 0.7 - Contributions to Growth (Percent) — Labor: -0.2; 0.2; 0.1; 1.4; 0.9; 1.4; 0.1 - Total Factor Productivity: 2.3; 0.0; 1.7; 0.9; 0.8; 1.3; 0.9 - CPI Inflation (Average): 8.7; 5.5; 2.1; 1.3; 2.5; 2.6; 1.9 - Total Revenue (Percent of GDP): 47.6; 51.5; 53.2; 51.3; 49.8; 45.9; 44.6 - Of which Tax Revenue (Percent of GDP): 40.4; 42.5; 42.9; 44.4; 43.0; 39.5; 37.8 - Total Expenditure (Percent of GDP): 48.7; 55.4; 57.9; 55.8; 53.2; 46.0; 45.9 - Capital Expenditure (Percent of GDP): ...; 3.3; 3.0; 2.6; 2.8; 2.9; 3.4 - Fiscal Balance (Percent of GDP): 2/-1.1; -3.9; -4.7; -4.5; -3.3; 0.0; -1.4 - Primary Balance (Percent of GDP): 1.8; 0.0; 1.2; 1.4; 1.4; 4.1; 1.1 - Gross Debt (Percent of GDP): 39.5; 46.7; 66.4; 75.1; 75.5; 59.9; 51.3 - Long Term Bond Yield (Percent): ...; 10.6; 7.6; 7.5; 6.9; 5.0; 4.1 - Labor Tax Wedge (Percent): 3/...; 40.1; 42.1; 39.8; 35.5; 31.7; 28.9 - Real Wage Index (100 = 2000): 98.0; 104.2; 96.4; 93.9; 96.6; 97.8; 102.7 - Employment Ratio (Proportion of working-age population employed): 4/...; 45.4; 45.9; 51.7; 55.0; 60.3; 62.4 - Unemployment Rate: 5/4.3; 7.5; 11.3; 8.6; 6.5; 3.7; 3.9 - Corporate Income Tax Top Rate (Percent): ...; 48.0; 44.0; 37.8; 35.0; 35.0; 32.9 - Private Investment (Percent of GDP): ...; 15.0; 15.4; 16.5; 15.9; 18.0; 15.9 - FDI Net Inflows (Percent of GDP) (RHS): 1.1; 1.0; 1.3; 2.5; 2.5; 10.3; 4.1 - Market Gini Coefficient: 6/ 7/46.1; 46.9; 48.2; 46.3; 46.6; 42.8; 45.9 - Net Gini Coefficient: 25.1; 24.4; 24.4; 25.4; 25.9; 23.1; 26.6 - Poverty Rate (Percent): 2.7; 2.9; 3.4; 5.2; 6.6; 6.7; 7.3 - Source for table: Eurostat, Haver Analytics, IFS, OECD, Penn World Table, Statistics Netherlands, SWIID 5.0, WEO, and WDI. ### Lessons and policy implications - Design and complementarity: The Dutch reform package stands out for its well thought-out and complementary design; consistency and mutual reinforcement of policy measures are important. - Social consensus and wage moderation: The consensual approach to achieve wage moderation contributed to the success and durability of the reform episode and reduced the risk of reform reversals. - Distributional trade-offs: Challenges remain on income distribution—poverty worsened and inequality did not fall—highlighting that growth alone is not sufficient for inclusiveness and that targeted measures are required. *Source: IMF staff calculations.* ### 4. The difference in average growth rates was recalculated by setting the end of the fiscal ### _042015 - 4. The difference in average growth rates was recalculated by setting the end of the fiscal ### Change in Reform Period-End Year: Netherlands (sensitivity check) - Exercise: end of fiscal reform period was set to 1989 and 1991 to examine sensitivity of baseline conclusion to timing of reform end. - Result: "Results confirm that the conclusion holds when the end of the fiscal reform period changes." - Visuals referenced: Figure A4 compares annual GDP growth (real) versus annual GDP growth synthetic, 10-year average, for multiple reform-period specifications (Reform Period: 1978-1981; 1982-1985; 1984-1987; 1988-1991; 1983-1989; 1983-1991). *Source: IMF staff calculations.* ### Poland — Background - Poland was an early mover in transition to a market economy among Central and Eastern European (CEE) peers; reform of public finances was central to transition from a socialist central planning fiscal system. - Pre-transition fiscal characteristics: subsidized provision through state-owned enterprises under soft budget constraint; highly opaque and non-parametric levies determined by price and wage controls. - Transition objectives: encourage efficient resource allocation in product, capital and labor markets; ensure sustainability of social security programs; improve budgeting efficiency and public governance in line with EU standards. - Growth dynamics: output growth declined from an average of "5 percent in 1992–99" to "slightly more than 1 percent in 2001–02". - External and domestic shocks contributing to slowdown: enterprise restructuring, investment collapse from spillovers of the Russian crisis, cyclical downturn in Germany, sharp monetary policy tightening. - Unemployment: rapid increase in unemployment rate peaking "close to 20 percent" during the reform period. - Public finance reform pace: accelerated in the late 1990s. ### Fiscal Policy Reforms: Overview - Key reform areas targeted at improving growth performance: pension system and tax system reforms initiated in 1999 (Table 1). - Selected reform years reflect application of selection criteria and "does not necessarily include all significant fiscal reforms". - Structural reforms accompanying fiscal package (1999): - Health care reform: regional health insurance companies financed through national health insurance surcharge and private payments; decentralization to provincial level; independence of health care providers. - Administrative reform: introduced three levels of state administration (regional, provincial, community); reduced number of regions; strengthened self-administration bodies. - Education reform: new pre-tertiary education established; resulted in "substantial improvement of PISA test scores above OECD average in 2009." ### Reform Area 1: Pension System — Issues and reform design Findings / issues: - Pension system unsustainable in late 1990s due to population aging (falling fertility, increased life expectancy, post-war demographic boom), generous early retirement provisions, lax disability eligibility, generous pensions and indexation rules. - Decline in employment led to rising economic dependency ratio relative to demographic dependency ratio. - Impediments to long-run growth via: - Fiscal sustainability concerns and business uncertainty. - Political influence over public pension management leading to short-run benefit increases passed to future generations. - Weak contribution–benefit links and incentives for early retirement reducing labor supply. - Defined benefit system not encouraging higher savings or development of local capital markets. Reform design features: - 1999 pension reform: move from defined benefit to defined contribution; creation of a three-pillar system: - First pillar: notional defined contribution pay-as-you-go operated by state social security administration; universally compulsory. - Second pillar: individual accounts managed by private pension funds; compulsory for individuals under age 30 at reform; voluntary for ages 30–49; not available to those aged 50 or more at reform. - Third pillar: voluntary individual accounts. - Social protection adjustments: more targeted means-testing; consolidation of social benefits starting in 2004 into two groups (social assistance benefits with minimum amount equal to "30 percent of poverty gap"; family benefits introducing a single income criterion); transfer of allocation responsibility from central to local governments; changes to unemployment benefit design linked to minimum wage and local labor market conditions. Fiscal and transition costs: - Transition fiscal costs associated with pre-funding of future pension liabilities were "1–2 percent of GDP over the last decade." - Pension contributions were maintained at "19.52 percent of the wage bill" with "7.3 percentage points transferred to the second pillar" and the remainder to the first pillar. - Financing of transition costs was mainly via issuance of public debt, partially offsetting net private savings growth. - Expected long-run benefits: improved long-run sustainability, higher national savings rates, increased labor participation. Recent reversals and impact: - Global financial crisis led to large fiscal costs from pre-funding and a reversal of some reform components. - Overall deficit rose by "1.5–2 percent of GDP per year" during the downturn. - Starting May 2011, contributions to the second pillar were reduced from "7.3 to 2.3 percent of the wage bill" with the remaining "5 percentage points redirected to the first pillar." - In 2014, the second pillar was scaled back with the transfer of "about half of the pension fund assets and corresponding liabilities to the first pillar"; contributions were redirected to the first pillar. - Short-run effect: sharp one-off decline in public debt and improvement in the government deficit. - Long-run assessment: reversals did not affect the defined contribution characteristic of the pension system and its long-run sustainability; growth gains from previous reform efforts could be protected. - Note: "The plan was to raise it back to 3.5 percent of the wage bill by 2017." ### Reform Area 2: Tax System — Issues and reform design Findings / issues: - Pre-transition tax system: complex and inefficient, two parallel systems (public bodies/cooperatives vs. private sector/individuals), large share of lump-sum payments, generous exemptions and loopholes. - Some taxes outdated (e.g., turnover tax predecessor to VAT). - High initial top marginal tax rates: corporate and personal income tax rates "stood at 40 percent", and social insurance contribution rates were "43 percent" with burden largely on employers. - Harms to long-run growth via: - High labor taxes discouraging employment; combined impact of social security contributions and personal income taxes "42 percent average and 45 percent marginal tax rates, respectively" creating a large wedge between labor costs and workers’ disposable income. - Complexity (many small taxes, exemptions, returns even for small liabilities) discouraging entrepreneurship. - Preferential tax regimes for private investment poorly targeted, giving rise to tax avoidance. - System heavily tilted toward distortionary direct taxation, discouraging labor and capital accumulation. Reform design features: - Post-transition reforms aimed at efficiency, transparency, and preserving incentives. - Specific objectives: make consumption taxes the major revenue source; reform social security for future fiscal autonomy; unify taxation of income into a single income tax; harmonize tax system with EU members. - Tax policy changes: initial high rates were later lowered and the base widened through subsequent modifications. - Reform timeline for tax system modernization: "1999-2004" (Modernization of the tax system; reduction of marginal tax rates; expansion of the tax base; and shift in revenue composition away from direct to indirect taxation). *Source: IMF staff calculations and IMF staff reports.* ### 13. The speed of tax reforms picked up in September 1998, when the Polish Ministry of ### _042015 - 13. The speed of tax reforms picked up in September 1998, when the Polish Ministry of ### Tax reforms and tax-system changes (1998–2009) - The Polish Ministry of Finance issued a white book on taxes in September 1998 calling for fundamental changes in the tax system. - Corporate tax rate: - Progressively reduced from 40 to 19 percent between 1998-2004. - Successive cuts brought Poland into the club of EU states with low statutory taxes on corporate profit; "well below the German and most other European Member States’ rates." - Corporate Income Tax Top Rate timeline (Table 3): 40.0, 31.2, 20.6, 19.0 (periods as in table). - Personal income tax system: - Remained progressive with three brackets at 19, 30, and 40 percent, respectively (as of the white book and 1999 reform period). - Subsequent change: rates were changed to a two-year brackets schedule of 18 and 32 percent in 2009; current system characterized as close to flat with only two tax brackets with marginal tax rates of 18 and 32 percent and 97.5 percent of taxpayers falling into the first bracket. - 1999 corporate-taxation reform measures included: - Abolition of several investment allowances. - Change in depreciation allowances. - Introduction of thin capitalization rules disallowing deductibility of interest payments on debt exceeding three times the size of equity. - Social security reform in 1999: - Burden of social contributions more equally split between employers and employees. - Major contribution to a shift in the composition of tax receipts. ### Fiscal outcomes and tax-revenue composition - Overall tax to GDP ratio: - Decreased from 37 percent in 1995 to 31 percent in 2004 (Eurostat, 2014). - Composition shifts: - Substantial decrease of direct taxation (personal income and corporate income taxes). - Partial compensation through a parallel increase in employees’ social contributions and in VAT receipts. - Social security contributions and indirect taxes are now the two main sources of revenues. - Indirect taxes comprise 40 percent of total tax receipts versus EU average of 33 percent. - Share of direct taxes in overall tax revenues declined from 45 to 36 percent (paragraph 21). - Government size and public finances (paragraph 21 and Table 3): - Government size reduced from 50 to 44 percent of GDP. - Room created for a reduced tax burden from 25 to 20 percent of GDP. - Level of debt maintained at a sustainable level below 60 percent of GDP. - Government’s long-run borrowing costs reduced from 12 to 4 percent. ### Impact on long-term growth and growth accounting - GDP growth dynamics: - 5-year moving average growth rate at 6 percent in late 1990s rebound (Figure 2 text). - Late 1990s growth decelerated to slightly above 1 percent after enterprise restructuring and investment collapse. - Post-reform moving average growth rate rebounded to 5 percent and remained robust during the global financial crisis. - Comparison with CEE peers: - During the global financial crisis, output growth in Poland outperformed the CEE average by 1 percentage point and approached the highest 5th quantile of the CEE distribution. - Synthetic control method (counterfactual) results: - Fiscal reforms helped to boost GDP growth by about 1.4 percentage points (paragraph 17). "In the absence of pension and tax reforms, the growth in Poland would have been 1.4 percentage points lower than what was actually observed in the second half of 2000s." - Real GDP per capita growth in Poland exceeded growth in the synthetic control group by 2¼ percentage points during the 5-year post-reform period (paragraph 18). - Results robust to choice of dependent variable, length of pre-reform period, and selection of comparator countries; validated by robustness checks in the appendix. - Growth-accounting decomposition (paragraphs 19–21; Figure 5): - Post-reform rebound in average growth to 5 percent from 1 percent lows in early 2000s. - Initial pick-up driven by rebound in TFP contribution, followed by increased capital accumulation and labor activity. - Contribution of labor, capital, and TFP all remained robustly positive during the global financial crisis. - Specific quantitative growth-accounting and labor-market changes (Table 3): - Real GDP (period averages): Reform Episode columns show Real GDP: -2.4 (1989-1993), 6.1 (1994-98), 3.1 (1999-2003), 5.4 (2004-08), 3.3 (2009-2013). - Contributions to Growth (Percent, 1/): Capital: 0.2, 0.7, 1.3, 1.4, 1.9; Labor: -2.7, 1.4, 0.2, 1.1, 0.9; Total Factor Productivity: -0.3, 3.5, 2.0, 2.4, 1.0. - CPI Inflation (Average): 197.1, 21.3, 5.1, 2.7, 3.0. - Employment Ratio (period averages): ...0.6, -2.0, 3.0, -0.3 (Table 3 formatting). - Unemployment Rate (period averages): ...11.8, 17.6, 13.5, 9.6. - R&D spending growth: accelerated from 32 percent in the pre-reform period (1994–99) to 63 percent in the post-reform period (2005–10) (paragraph 21). - Survey: 77 percent of Polish companies responded that simplified tax regime and introduction of the tax credit for R&D activities were instrumental in decision to expand R&D spending (Deloitte, 2014) (paragraph 21). ### Mechanisms: labor, inequality, investment, credibility - Labor-market and incentive effects (paragraph 20): - Pension reforms: moving away from defined benefit system, reduction of early retirement privileges, and stricter fiscal discipline contributed to increased work incentives. - Demand side: reduction of labor tax wedge and cuts in capital income taxation increased hiring by private sector. - Unemployment rate fell from 20 to 7 percent (paragraph 20). - Income distribution: - Market Gini declined from 38 to 30 percent (paragraph 20). - Table 3 shows Market Gini Coefficient: 40.0, 50.6, 47.5, 50.1, 47.2 (period averages); Net Gini Coefficient: 26.3, 30.6, 28.5, 31.1, 30.7. - Progressive income taxation and shift to indirect taxation plus means-tested social assistance contributed to reduced income inequality. - Investment and capital accumulation: - Reduction in government size and improved expenditure composition created space for productive capital projects and lower tax burden. - Increased investment incentives, positive impetus to foreign investment after EU accession in 2004, and rapid increase in R&D spending. - Change in expenditure composition: share of current spending in total expenditure declined from 93 to 91.5 percent (paragraph 21). - Credibility and borrowing costs: - Enhanced macroeconomic stability and pension reform reduced residual risks to pension system sustainability. - Government long-run borrowing costs reduced from 12 to 4 percent (paragraph 21). - Long Term Bond Yield (Percent) in Table 3: ......9.1, 5.8, 5.4 (period columns). ### Lessons and policy implications - Political economy and sequencing (paragraph 22): - Buildup of political consensus and external anchor (EU accession prospects) were essential for success. - Declining growth in late 1990s intensified reform efforts; EU accession prospects served as external anchor. - Satellite social protection reforms (expansion of active labor market policies and means-testing for social assistance benefits) supported political success by reducing income inequality. - Concentration and durability (paragraph 23): - Concentration of major pension and tax changes in a short period contributed to durability of reform impact. - Reduction in inefficient current expenditure allowed expansion of productive capital projects and reduction in tax burden. - Despite need to pre-finance future spending liabilities, fiscal position did not improve markedly but debt remained below 60 percent of GDP. - Poland was the only EU country that did not experience negative growth rates during the global financial crisis (paragraph 23). - Cautions on causality (paragraph 24): - Difficulties separating fiscal reform effects from contemporaneous policies (labor market, governance, property rights) and EU accession effects. - Possible reverse causality: rebound in growth may have enabled spending and tax reductions and improvements in labor conditions and inequality. ### Robustness and sensitivity checks (Appendix) - Placebo tests (Appendix A): - Each country in the input group was alternatively chosen as the tested country when no fiscal reform took place. - Post-reform growth in Poland was higher relative to growth distribution of non-reformers, in size of growth gaps and ratios of post-reform and pre-reform RMSPEs; pre-reform match was poor for some comparator countries. - Sequential exclusion of comparator countries (Appendix B): - Sequential exclusion of comparator countries that received positive weight: Albania, Croatia, Turkey. - Results show sensitivity: post-reform growth gap is similar to pre-reform growth gap when Albania and Croatia are excluded. - Change in reform period start year (Appendix C): - Synthetic series re-estimated for start years 1998, 2000, and 2004. - Growth effects in baseline not sensitive to small changes in starting periods (1998 and 2000). - Setting start of reform in 2004 results in sizeable growth effects. *Source: IMF staff calculations and content from the provided IMF chapter/section.* ### 4. Omitted as there are not enough post-reform observations. ### TANZANIA: FISCAL POLICY AND LONG-TERM GROWTH ### Background - During the 1970s and 1980s, unsustainable fiscal policies coincided with low and volatile growth; the Ujamaa socialism period from 1970 to 1985 featured pervasive interventionism and state ownership, centrally determined prices, inefficient public marketing boards, an oversized and inefficient public sector, large deficits financed by money creation, inflation rates of over 30 percent, and foreign exchange shortages. - The 1986 Economic Recovery Program began adjustments in exchange rate and trade regimes, agricultural markets, and domestic prices; by 1988, around 400 SOEs generated 20 percent of GDP and assumedly provided about two-thirds of total employment. - Continued weak budget management, accumulation of arrears, and monetization of fiscal deficits led to recognition that deeper reforms were needed to enhance macroeconomic stability and attract donor assistance. ### Fiscal Policy Reforms: From Fiscal Dominance to a Strong Fiscal Framework (Overview) - Major fiscal reforms were initiated in the mid-1990s; key milestones and reform steps included: - 1996: Introduction of a cash budget system; start of the Tanzania Revenue Authority (TRA). - 1998: Introduction of the VAT; Mining Act establishing a fiscal regime for natural resources; PFMRP; TRA strategic plan. - 1998: Introduction of a Medium Term Expenditure Framework (MTEF). - 2000: Poverty Reduction Strategy Paper; Public Services Reform Program (PSRP). - 1996 onward: Privatization and reform of parastatals accelerated. - ESAF/PRGF-supported program lasted from November 1996 to February 2000; IMF provided program support to Tanzania almost continuously since 1975. ### Notable Design Features - Fiscal institutional strengthening: - Cash budget system and single treasury account enhanced payment controls; cash releases to line ministries limited to availability and centrally controlled by the Ministry of Finance. - Public Financial Management Reform Program (PFMRP) improved budget processes and introduced the computerized Integrated Financial Management System (IFMS) in 1998. - TRA consolidated Income Tax, Sales Tax, and Customs departments and followed a five-year strategic plan to improve revenue collection. - Expenditure reforms and public service delivery: - MTEF (1998) and Poverty Reduction Strategy Paper (2000) directed spending to priority areas and introduced public annual expenditure reviews. - PSRP (2000) focused on public service delivery and salary adjustments to attract and retain staff. - Tax policy and SOE reforms: - 1998 VAT replaced sales tax (previous multiple rates ranging from 5 to 30 percent), hotel levy, and stamp duty; VAT intended to become the single most important revenue source. - 1998 Mining Act provided a transparent fiscal regime for natural resources. - Parastatal Sector Reform Commission (PSRC) established in 1993; by 2000 the vast majority of manufacturing and commercial parastatals were privatized, liquidated, or put under direct budgetary control. - External support: - 2001 HIPC relief: external debt service relief of about US$3 billion (US$2 billion in net present value terms). - 2006 MDRI cancellation further reduced external debt service as a percentage of GDP from about 2.4 percent in 2001 (before HIPC assistance) to about 1.3 percent in 2008 after HIPC and MDRI relief. ### Outcomes - Growth and volatility: - Real GDP growth increased from 4 percent in the ten years before the reform period, to 4.3 percent during the reform period, and reached about 7 percent in the subsequent ten years. - High volatility of GDP growth largely disappeared after reforms. - Inflation: - Average inflation declined from about 29 percent in the ten years before the reform period, to 7 percent on average during the ten years following the reforms. - Public spending composition: - Public education expenditure rose from 1.8 percent of GDP in 1998 to 3.5 percent of GDP in 2005. - Public health spending increased from 1.1 percent of GDP in 1998 to a peak of 3 percent of GDP in 2006. - After privatization of most parastatals, public investment moved under central government control and refocused to infrastructure, health, and education. - Challenges remained in investment planning and PFM systems, resulting in accumulation of domestic payment arrears. - Tax revenue: - Tax revenue declined from 9.1 percent in 1996 to 7.2 percent in 1999 during transition, then rebounded strongly; by 2006 the VAT accounted for almost 40 percent of total revenue collected. - Tanzania’s tax revenues remain low by regional and international standards; VAT regime weakened over time by numerous exemptions and reliefs—including zero-rating of domestic supplies—and a weak refund system. - Fiscal sustainability and FDI: - Fiscal imbalances reduced by increased tax revenue and increased budget support. - Net FDI inflows increased from 0.5 percent of GDP in the ten years prior to the reform period, to 4 percent of GDP in the ten years after the reforms. - Poverty and inequality: - Poverty rate fell from about 39 percent in 1991-95 to about 34 percent in 2006-10. - Net Gini coefficient increased modestly over the same period; growth was stronger in industrial and service sectors than in agriculture, which is the dominant income source for most of the poor. ### Impact on Long-Term Growth - Aggregate growth performance: - GDP growth during 2001 to 2010 (post-reform period) was about 3 percentage points higher than average growth in the 10 years preceding the reform period. - Tanzania’s average growth after the reforms until the onset of the Great Recession was about 2½ percentage points higher than that of its Sub-Saharan peers (low-income and low middle-income Sub-Sahara Africa excluding oil producers and Uganda). - Synthetic control analysis: - Following the reform period until 2008, actual growth was about 1.7 percentage points higher than that of the “synthetic” Tanzania, on average. - On a per-capita basis, the corresponding growth differential was about 2.8 percentage points. - The divergence between actual and synthetic series was largest immediately after the reform period and converged from the mid-2000s. - Predictor means before fiscal reform (selected figures, 1980-1995 averages unless noted): - Real GDP Growth (Percent): 3.8 (Real) vs. 2.2 (Synthetic) - GDP Per Capita (2005 I$/Person): 649.2 (Real) vs. 842.5 (Synthetic) - Trade Openness (Percent): 17.8 (Real) vs. 51.2 (Synthetic) - Terms of Trade (Percent): 58.3 (Real) vs. 58.3 (Synthetic) - Inflation Rate (Percent): 29.3 (Real) vs. 2.5 (Synthetic) - Human Capital Index: 1.7 (Real) vs. 1.7 (Synthetic) - GDP Growth Per Capita (Percent): 1.4 (Real) vs. 0.0 (Synthetic) - GDP Per Capita (2005 I$/Person) for GDP Growth Per Capita set: 649.2 (Real) vs. 899.5 (Synthetic) - Trade Openness (Percent) for GDP Growth Per Capita set: 17.8 (Real) vs. 30.5 (Synthetic) - Inflation Rate (Percent) for GDP Growth Per Capita set: 29.3 (Real) vs. 29.3 (Synthetic) ### Transmission Channels from Fiscal Reform to Growth - Growth accounting insights: - Main drivers of GDP growth were total factor productivity (TFP) in the earlier years after the reform period and capital accumulation in the later years. - Contribution of labor did not exhibit major changes and declined somewhat during the reform period. - Potential channels identified: - Capital accumulation: - Privatization, liquidation, or absorption of a large number of SOEs. - Introduction of cash budget system and TRA strategic plan. - PFMRP, introduction of VAT, enactment of the Mining Act. - Reversal of fiscal dominance and macroeconomic stability. - MTEF, Poverty Reduction Strategy Paper, PSRP redirecting public investment to priority areas. - These measures likely stimulated private and foreign direct investment, crowding in capital—particularly in mining after a transparent fiscal regime for natural resources was introduced in 1998. - TFP improvements: - Structural reforms improving efficiency across sectors contributed to aggregate TFP growth. - Caution: - Effects of fiscal policies on growth are difficult to disentangle from external shocks and other domestic policy changes; results should be interpreted with caution. - The exercise faces additional challenges due to poor quality of labor statistics and data on the capital stock in Tanzania. *Source: IMF staff calculations.* ### 20. Similarly, TFP may have been influenced by an increase in efficiency brought forward ### Similarly, TFP may have been influenced by an increase in efficiency brought forward ### TFP and drivers of post-reform growth in Tanzania - Improvements in the fiscal institutional framework, such as PFM and revenue administration reforms, may have positively impacted TFP by reducing allocative distortions. - SOE reform and privatization potentially increased overall productivity through much improved governance and incentive structures. - The public spending shift towards education may have helped boost the quality of workers’ productive skills and stimulated the creation of new technologies, with ensuing benefits for TFP. - Reforms may have contributed to a more FDI-friendly environment with potential benefits in terms of international technology transfers. - On balance, fiscal policy may have contributed to Tanzania’s strong growth performance after the reform period: - Following the reforms, Tanzania’s growth was higher than that of its peers and that of a synthetic control group. - The main drivers of GDP growth were TFP and capital accumulation. - Other macroeconomic reforms, such as financial sector liberalization and trade reforms, as well as external factors, also contributed significantly to overall growth performance. ### Lessons from Tanzania’s reform episode - Swift implementation of a wide range of reform measures has the potential to yield strong outcomes. - The comprehensiveness of the reform package and the interaction of key policies signaled a strong commitment, which ultimately led to a buy-in of donors and the private sector. - Close coordination and continued engagement with the international community promoted large aid inflows that further supported growth and continuation of reform efforts, eventually leading to comprehensive debt relief under the HIPC and MDRI initiatives. - Growth cannot be seen as the sole driver to reduce poverty or inequality. - Higher long-term growth can make a key contribution to lowering poverty, but it is not sufficient in itself. - This underscores the potential role that fiscal policies can play in supporting inclusive growth. ### Key statistics and indicators for Tanzania (from Table 3: Selected Indicators; period averages by reform episode) - Reform Episode periods: 1986-1990; 1991-95; 1996-2000; 2001-05; 2006-10 - Real Economy - Real GDP: 3.9, 4.0, 4.3, 7.0, 6.2 - Contributions to Growth (Percent) 1/ - Capital: 0.7, 1.5, 0.6, 2.3, 4.7 - Labor: 2.0, 2.2, 1.8, 1.6, 1.8 - Total Factor Productivity: 1.2, 0.3, 1.9, 3.1, -0.3 - CPI Inflation (Average): 31.3, 26.9, 12.5, 4.5, 8.8 - General Government 2/ - Total Revenue: 13.0, 12.0, 11.8, 13.6, 15.8 - Total Expenditure: 16.5, 14.2, 11.8, 15.3, 19.0 - Fiscal Balance: -3.5, -2.2, -0.1, -1.7, -3.2 - Gross Debt 3/: 119.3, 126.8, 73.2, 51.3, 20.0 - Labor Market - Employment Ratio 4/: 49.2, 49.4, 50.2, 49.7, 49.6 - Corporate Sector - Private Investment: 16.6, 19.4, 13.2, 16.5, 24.2 - Foreign Direct Investment (Net Inflows): 0.1, 0.8, 3.2, 3.8, 4.4 - Income Distribution - Market Gini Coefficient 5/: 40.3, 37.8, 38.3, 38.3, 38.8 - Net Gini Coefficient: ...37.1, 35.9, 36.6, 37.5 - Poverty Rate (Percent) 6/: ...38.6, ...35.7, 33.6 - Notes attached in source: - 1/ Growth accounting estimates are calculated using Penn World Table 8.0. - 2/ The revenue, expenditure, and balance figures for 1986-1990 reflect central government. - 3/ Includes publicly guaranteed debt. - 4/ Percent of the total population that is employed. - 5/ "Market" Gini measures the income distribution before taxes/transfers; "net" refers to after taxes/transfers. - 6/ Percent of the population falling below the nationally defined "basic needs poverty line". ### Tanzania robustness tests (summary) - Robustness checks performed (broadly in line with Abadie (2014)): - (i) placebo tests; - (ii) sequential exclusion of each comparator country from the synthetic series; - (iii) changes in the reform period. - A. Placebo tests: - Each country in the input group was alternatively chosen as the tested country where no fiscal reform took place. - Post-reform growth in Tanzania was not demonstratively higher relative to the growth distribution of non-reformers, in terms of either the size of growth gaps and ratios of post-reform and pre-reform RMSPEs. - Results should be interpreted with caution because pre-reform match was poor for some comparator countries. - B. Sequential exclusion of comparator countries: - Sequential exclusion of countries with positive weights (Ghana, Burundi, Mozambique, Lesotho, Malawi, Zambia) produced post-reform growth gaps that are higher than pre-reform gaps in most cases, indicating that baseline results are broadly robust. - C. Changes in reform timing: - Re-estimating synthetic series with start years 1991, 1995, 1997 and 2001 shows growth effects in the baseline are not sensitive to small changes in starting periods (1995 and 1997). - Setting the start of reform in 2001 results in disappearance of the growth effects, supporting interpretation that the fiscal reform timing is likely the cause of the positive growth effect in the baseline. - Changing the end year of the reform period to 2003 and 2005 confirms the baseline conclusion holds when the end date changes. ### Additional contextual points (Uganda case excerpt) - Fiscal policy played an active role in Uganda’s economic development especially after peace was established in 1986. - Real GDP per capita growth averaged 1.8 percent between 1964 and Idi Amin’s coup in 1971. - During 1971–1986, real GDP per capita declined by 35 percent, or an average of 2.6 percent per year. - By FY1987/88, revenues were only about 5 percent of GDP. - Reforms in Uganda included: - Floating exchange rate (1990) — gradual move to floating exchange rate. - Privatization of SOEs (1991) — Coffee Marketing Board monopoly ended. - Non-tariff barriers reduced (1991-95). - Spending reductions (1992) — large reduction in deficits through cuts in expenditures. - Budget planning (1997/98) — medium term expenditure framework. - Expenditure prioritization (1997) — PEAP and PAF created. - Revenue administration (1991) — Uganda Revenue Authority (URA) created. - PFM reforms (1992) — cash management begins; merger of Ministry of Finance and Ministry of Economic Development. - Recent trends for Uganda: - GDP growth over 2009–2014 averaged 5.2 percent compared to 7 percent over 1991–2008. - A tax GDP ratio that has remained essentially flat around 12 percent since 2008, with a VAT compliance gap of an estimated 60 percent. - Public investment in infrastructure has not kept pace with other sub-Saharan countries. *Source: IMF staff calculations and case study text as provided in the supplied content.* ### 4. Tax Reform ### 4. Tax Reform ### Tax Reform Measures - Trade Taxes1991-Export taxes eliminated and import duties reduced. - VAT1996-VAT replaced distortionary Commercial Transaction Levy (CTL) and Sales Tax. - PIT1997-Exemptions removed and base widened. - Source: IMF staff reports, Kuteesa and others (2010). ### Institutional Reforms and Expenditure Management - Ministry of Planning and Economic Development (MoPED) merged with the Ministry of Finance (MoF) in 1992 to rein in deficits and maintain budget discipline. - Cash management introduced as the main tool to ensure adherence to planned spending targets; tax revenues, donor contributions, and inflation tracked monthly by a Cash Management Committee. - Uganda Revenue Authority (URA) created in 1991 to consolidate tax and customs collection; URA given clear objective of increasing the tax-to-GDP ratio by 1 percent per year. - PEAP (Poverty Eradication Action Plan) and PAF (Poverty Alleviation Fund) created; process incorporated into the Medium-Term Economic Framework (MTEF) to increase spending efficiency and monitoring. ### Notable Design Features of Tax Reforms - VAT introduced in 1996 at 17 percent to keep the new tax revenue neutral in the short-term and ease transition. - 1997 Income Tax Act repealed non-taxable allowances, redefined gross income to worldwide concept, eliminated tax holidays granted under the Investment Code, made public-sector incomes taxable, and removed discretionary powers of the Minister of Finance to grant exemptions. - Design issues: - VAT thresholds initially set so low that the number of traders in the VAT register exceeded URA capacity. - Many small traders captured by the threshold were unable to meet accounting requirements. - Cap on VAT refunds (originally part of cash rationing) persists, creating uncertainty for legitimate refunds, straining private-sector cash flow, undermining system credibility, and potentially increasing corruption. ### Outcomes and Fiscal Indicators - Real GDP growth averaged 6.5 percent from 1991 to 2013. - Real GDP per capita growth averaged 3.2 percent over the same period. - Overall budget deficit, excluding grants, peaked in FY1991/92 at 14.7 percent of GDP; by FY1995/96 the deficit was just over 6 percent of GDP and since that time it has averaged about 7 percent. In FY2013/14 it was 5.4 percent of GDP. - Inflation (GDP deflator): nearly 200 percent in 1987 and 1988; averaged 38 percent per year over 1964 to 1986; since 1989 averaged around 16 percent; since 1999 averaged 7.1 percent. - Real effective exchange rate declined by about a third from 1982 to 2010; trade (exports + imports) increased from around 10 percent to around 60 percent of GDP over the same period. - Total tax-to-GDP ratio increased from 5 percent in FY1997/98 to 12.5 percent in FY 2012/13. - Income taxes contributed 4 percent of the 7.5 percent increase. - VAT contributed 2.7 percent. - Excise taxes contributed 2 percent. - Trade taxes declined as a share of GDP by 1.1 percent. - Recent tax revenue has been flat: total tax revenue in FY2013/14 was the same, in percent of GDP, as in 2007/08. - Note: Uganda underwent a GDP rebasing exercise resulting in a 17 percent increase in the level of GDP and a reduction in the tax-to-GDP ratio. Over FY2009/10 to FY2013/14 the tax-to-GDP ratio was 10.6 percent compared to 12.3 percent prior to rebasing. - Spending on education, health, water quality, and agriculture increased from 1.6 percent of GDP in 1998 to 5.3 percent in 2011, then slowed to 4.3 percent of GDP in 2013. - Poverty: proportion below the poverty line fell from 56.4 percent in 1992 to 19.7 percent in 2013. - External debt as a share of GDP declined from nearly 100 percent in 1991 to less than 20 percent in 2014; between 2004 and 2007 the external debt-to-GDP ratio was reduced by 50 percent of GDP. Over FY1995/96 to FY2006/07 Uganda saved around $1 billion in external debt service payments. ### Impact on Long-Term Growth and Transmission Channels - Real GDP per capita growth turnaround began in 1987; growth increased through the 1990s and moderated in the last five years of the sample. - Comparative performance: - Real GDP growth in Uganda averaged 4.2 percent in the ten years leading up to the reform period, and averaged 7 percent over both five-year periods after the reforms. - Average growth over 1997–2001 was 2.5 percentage points higher than the sub-Saharan comparator. - The gap increased to 2.9 percentage points over 2002–2006. - Synthetic control estimates: - Average real GDP growth during the five-year period following the reform was about 5.2 percentage points higher than the synthetic control. - The superior performance narrowed to 2.5 percentage points over the second five-year period. - Real GDP per capita growth exceeded the synthetic control by 4.3 percentage points during the first five-year post-reform period; in 2002–06 Uganda’s growth was 1.8 percentage points lower than the synthetic control. - Growth accounting indicates: - Main driver of growth in the years directly following reform was Total Factor Productivity (TFP). - Human capital and capital deepening contributed a larger share in the latter period. - Labor utilization did not contribute to GDP per capita growth over the reform period. - Transmission channels highlighted: - Macroeconomic stability and a more favorable tax regime fostered private investment and trade. - Reduction in taxes and non-tariff barriers created an environment conducive to investment and trade. - Improved public-sector institutions and reform of state-owned enterprises contributed to TFP. - Increased public spending on education in the mid-1990s may have enhanced worker productivity and technological advancement, supporting TFP. - Labor utilization constrained by strong population growth; demographic circumstances (lack of fertility decline) prevented realization of a demographic dividend. ### Lessons - Stability and confidence in government are pre-conditions for growth; macroeconomic stability was prioritized before structural reforms and private-sector involvement. - Political will and broad buy-in were essential to enact reforms; the president and policymakers incorporated views of academics, politicians, and policy makers and restructured ministries when fiscal institutions hindered reform. *Source: IMF staff reports, Kuteesa and others (2010).* ### 29. Creating an explicit link between priority spending and poverty reduction increased ### 29. Creating an explicit link between priority spending and poverty reduction increased ### Priority spending, donor involvement, and debt relief - Creating the PEAP and PAF provided a transparent way to track spending in priority areas and allowed donors to see the impact of their contributions. - The commitment to spend the savings from debt service on poverty reduction in a transparent manner helped convince the international community that Uganda was a good candidate for debt relief. - The PEAP became the blueprint for Poverty Reduction Strategic Plans (PRSPs) that were a condition of debt relief to all countries that received it. - This sequence—explicit link between priority spending and poverty reduction → increased donor involvement → debt relief—is highlighted as an important lesson for other low income countries seeking similar relief. ### Tax reform: achievements and limitations - Tax reform increased revenues, but weaknesses in design and poor implementation hindered significant improvement in revenue mobilization. - Tariff policy volatility: import duties were alternately abolished and reinstated at different rates from one year to the next, increasing uncertainty and preventing the tax authority from achieving a firm tax base. - VAT introduction challenges: poor dissemination of VAT objectives, tax thresholds that were too low, and insufficient capacity of the revenue authority limited effectiveness. - Widespread ad-hoc tax exemptions had dual harms: direct revenue losses and indirect erosion of tax morale. - After initial increases during the early years of reform, the tax-to-GDP ratio has been essentially flat, at around 12 percent of GDP, over the last six years—significantly lower than Uganda’s east African peers. ### Key quantitative indicators and fiscal context (selected figures from Table 3) - Real GDP growth (period averages by reform episode): 2.2; 5.8; 7.3; 7.0; 7.2; 6.6 - Contributions to growth (Percent): Capital: 0.4; 2.5; 2.7; 2.8; 3.4; 3.7 - Contributions to growth (Percent): Labor: 3.1; 2.2; 2.0; 1.9; 1.7; 2.3 - Total Factor Productivity (TFP): -1.3; 1.1; 2.6; 2.3; 2.2; 0.5 - CPI Inflation (Average): 93.3; 140.4; 21.8; 4.0; 5.6; 10.8 - Total Revenue (percent of GDP, selected episodes): 18.3; 18.5; 15.6 - Tax Revenue (percent of GDP, selected episodes): 10.1; 10.9; 11.8 - Total Expenditure (percent of GDP, selected episodes): 17.9; 19.4; 18.8 - Current Expenditure (percent of GDP, selected episodes): 9.7; 12.2; 12.5 - Capital Expenditure (percent of GDP, selected episodes): 8.8; 7.2; 6.3 - Fiscal Balance (percent of GDP, selected episodes): -5.8; -9.3; -8.4; -8.6; -6.0 - External Debt (percent of GDP, selected episodes): 79.3; 57.8; 55.9; 13.7 - Employment Ratio (percent, selected episodes): 80.1; 79.5; 77.7; 75.2 - Private Investment (percent of GDP, selected episodes): 5.3; 5.6; 9.7; 12.9; 15.7; 17.6 - Foreign Direct Investment (percent of GDP, selected episodes): 0.00; 0.0; 1.4; 2.7; 4.1; 5.3 - Market Gini Coefficient (selected episodes): 45.6; 39.3; 44.1; 43.8; 45.8 - Net Gini Coefficient (selected episodes): 42.9; 37.2; 40.8; 41.0; 43.3 - Poverty Rate (selected episodes): 50.4; 37.5; 33.9; 24.8 ### Robustness tests for the estimated growth effect of fiscal reform in Uganda - Placebo test: - Post-reform growth in Uganda was higher relative to the growth distribution of non-reformers (countries in the comparator group), in terms of both the size of growth gaps and ratios of post-reform and pre-reform RMSPEs. This indicates the fiscal reform likely made a positive difference in Uganda’s growth performance. - Sequential exclusion of comparator countries: - Sequentially excluding Zambia, Sierra Leone and Burundi from the synthetic control and re-estimating the model still produced a post-reform growth gap higher than the pre-reform growth gap in all cases, confirming the baseline result. - Changes in reform timing (start year): - Re-estimating synthetic series with start years 1986, 1990, 1992, and 1996 shows growth effects are not sensitive to small changes in starting periods (1990 and 1992). - Setting the start of reform in 1996 results in disappearance of the growth effects, supporting the baseline that the earlier fiscal reform timing explains the positive growth effect. - Changes in reform timing (end year): - Recalculating average growth rates with end of fiscal reform set to 1999 and to 2001 confirms the baseline conclusion holds when the end of the fiscal reform period changes. ### Sample selection criteria and final country sample (Annex I) - Country-case selection criteria: - Quantitative indicators: changes in main tax and spending categories and overall fiscal balance; durability required change over at least two consecutive five-year periods; five-year non-overlapping averages starting in 1975 used. - Qualitative indicators: reforms affecting fiscal institutions, revenue administration, pension systems, and labor market. - Candidate pool excluded oil exporting countries and required at least 20 years of data for relevant indicators. - Minimum frequency: at least 4 reform episodes per country (all reforms given equal weight). - Income and regional diversity constraints: targeted 5 HICs; 2 MICs; 2 LICs and regional spread (4 EUR; 2 AFR; 2 APD; 1 WHD). - Final country sample selected: - Germany, Ireland, Netherlands, Poland, Australia, Malaysia, Tanzania, Uganda and Chile. *Source: IMF staff calculations; figures and tables as presented in the source content.* ### Annex II. Methodology: The Synthetic Control Method ### Annex II. Methodology: The Synthetic Control Method ### A. Brief Description - The synthetic control method (SCM) provides a data-driven method to quantify the effect of an event in comparative case studies or event study analysis by creating an artificial counterfactual (or control group) that closely matches the economic characteristics of the unit of interest prior to an event and comparing post-event outcomes. - The method was first introduced in Abadie and Gardeazabal (2003). Notable applications include Abadie and others (2010), Abadie and others, (2014), Billmeier and Nannicini (2013), and Cavallo and others (2013). - SCM constructs the counterfactual as a weighted average of comparison units using an iterative optimization algorithm that minimizes the distance between the unit of interest and its counterfactual in terms of both the outcome variable and its predictors. Comparison units are chosen to be similar to the unit of interest but unaffected by the event. - The estimated impact of the event is the difference between the outcome series for the unit of interest and the synthetic counterfactual after the event. - SCM controls for both observable and unobservable predictors provided the pre-event sample period is sufficiently long (Abadie and others (2010)). Potential sources of bias include events after the studied event that affect the unit of interest and comparators differently (example: Cavallo and others (2013) on catastrophic natural disasters and ensuing political revolutions). In these case studies, reforms outside fiscal policy and heterogeneous effects of the global financial crisis are identified as potential biases. ### A. Robustness Checks - Standard large-sample statistical inference is not the preferred approach for SCM; instead, robustness is assessed with placebo analysis. - Two placebo approaches: - In-time placebo: apply SCM to alternative points in time when the event did not take place. - In-space placebo: apply SCM to each comparator unit that did not experience the event by construction. - Validation rule: if the baseline estimate is substantially larger than estimates from the in-time and in-space placebos, this supports the baseline estimate. - Placebo analysis intuition: demonstrate SCM does not generate large differences in outcomes unless applied to the actual event/time. - Additional sensitivity test: repeatedly exclude one-by-one countries from the comparison units that received positive weights in the baseline (Abadie and others (2014)). ### B. Implementation Steps - Step 1: Choose potential comparator countries and explanatory variables. - Comparator countries: those as similar as possible to the country of interest but did not experience the same event within the sample period. - Predictor variables: those considered good predictors of the outcome variable of interest (economic growth in these case studies). - Table 1. Model and Comparators (country, period, initial input group) - Australia 1971-2007 — EU15 (excluding Ireland, Netherlands and Portugal), Canada, United States, and Japan - Chile 1960-2010 — Emerging market and middle-income Latin America (excluding oil producers) - Germany 1990-2010 — EU 15 - Ireland 1971-2007 — EU15 (excluding Netherlands and Portugal) - Malaysia 1970-2010 — Emerging market and middle-income Asia - Netherlands 1970-2010 — EU 15 (excluding Ireland and Portugal) - Poland 1995-2010 — Emerging market and Middle income Europe - Tanzania 1980-2010 — LIC and LMIC Sub-Sahara Africa (excluding oil producers and Uganda) - Uganda 1982-2007 — LIC and LMIC Sub-Sahara Africa (excluding oil producers and Tanzania) - Country group selection notes: - Start with the country’s respective country group (as defined in the Fiscal Monitor), and adjust for economic similarity and data availability. - Exclude countries that implemented substantial fiscal reforms in periods similar to the country of interest to the extent possible. - Predictor variables used: - GDP per capita - Trade openness - Inflation rate - Terms of trade - Index of human capital (per person) - Sources used: - World Economic Outlook, World Development Indicators and Penn World table (Versions 7.1 and 8.0). - Variable of interest: - GDP, GDP per capita (percent change) - Step 2: Calculate a synthetic series given comparator countries and outcome/predictor variables. - Procedure calculates weights of predictor variables and comparator countries to reproduce as closely as possible the values of the outcome variable pre-event. Not all comparator countries must receive a positive weight. - Iterative optimization algorithm summary: - Start from an initial vector of weights of the predictor variables V. - Choose the vector W^* of country weights to minimize a distance ‖X_1-X_0 W‖ where X_1 and X_0 are matrices of predictor variables for the unit of interest and its comparator units, respectively, subject to weight constraints (weights between zero and one). - Once country weights are chosen, variable weight V^* is chosen among all positive definite and diagonal matrices such that the mean square prediction error (MSPE) of the outcome variable is minimized over pre-event periods. - Z_1 and Z_0 are matrices of the outcome variable for the unit of interest and its comparator units, respectively. - The resulting V^* is used as input to the country-weight optimization; the process iterates until V^* and W^* converge. - The synthetic series is constructed by solving this nested optimization problem (Abadie and others, 2011). - Use the obtained weights to create the synthetic comparator and a counterfactual path of the outcome variable post-event. - Step 3: Compare actual post-event outcome series with the synthetic comparator. - The difference between the two series is the estimated impact of the event (assuming other factors have been successfully controlled). *Annex II. 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