IMF Survey : Strong and Equitable Growth: Fiscal Policy Can Make a Difference
IMF News, June 30, 2015
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Bibliographic details
- Published: June 30, 2015
Overview
- Publication: IMF Survey ; authors Jeff Danforth, Eva Jenkner, and Rossen Rozenov; IMF Fiscal Affairs Department; June 30, 2015.
- Central finding: Fiscal policy can lift potential growth, especially when complemented by supportive structural reforms and attention to equity.
- Evidence base: Nine country case studies (Australia, Chile, Germany, Ireland, Malaysia, the Netherlands, Poland, Tanzania, and Uganda) and an analysis of growth accelerations (defined as increases of at least 1 percentage point in five-year average growth following fiscal reforms) across 112 countries.
Key empirical findings
- Average growth increased substantially during the decade following reforms in most countries studied: by about ¾ percentage point on average in advanced economies (excluding Ireland) and by even more in emerging markets and low-income countries.
- Analysis of growth acceleration episodes in 112 countries finds that such accelerations occurred significantly more often when countries had implemented fiscal reforms.
- Examples from country cases:
- Germany increased its labor force participation by 8 percentage points between 2000 and 2013 through active labor market programs and other labor market reforms.
- Between 1985 and 1995, Malaysia more than doubled its existing infrastructure capacity in most sectors—and annual growth surged to close to 8 percent.
- Tanzania increased its education spending significantly over 1998–2005, from 1.8 percent of GDP to 3.5 percent of GDP, including measures targeted to less-developed regions; the reforms helped boost enrollment rates and spur sustained economic growth.
- Ireland saw investment surge after it streamlined and reduced its corporate income tax structure.
Anatomy of successful fiscal reforms (four main channels)
- Employment
- Cutting labor taxes, especially when they are high, increases take-home pay and incentives to work.
- Improving design of social benefit programs and active labor market programs can strengthen work incentives and assist job seekers.
- Targeted measures to support labor market participation for women, youth, older workers, and low-skilled workers are important (example: India applies a lower effective tax rate on women’s labor income; most advanced economies subsidize hiring of unemployed youth).
- Investment
- Tax policies influence private investment decisions; taxing all capital income can jeopardize investment by reducing returns.
- Focusing capital income taxation on returns beyond a normal, risk-free rate of return can stimulate private investment and reduce debt-financing bias.
- Favor incentives that directly reduce cost of capital (investment tax credits) over open-ended profit-based incentives (tax holidays) which erode the tax base.
- Public investment in infrastructure can yield significant returns; attention to quality and efficiency is critical.
- Human capital
- Fiscal policy ensures access to education and health, especially for disadvantaged groups, accelerating accumulation of human capital.
- Priority measures: increase investment in primary education, provide a basic health care package, reduce user charges for poor households.
- Innovation
- Targeted tax incentives (tax credits and deductions) can promote R&D investment and productivity, especially in R&D-intensive industries such as pharmaceuticals and telecommunications.
How to pay for growth-friendly reforms
- Revenue-side measures (preferred):
- Broaden the tax base by eliminating tax exemptions and preferential tax rates for certain types of income.
- Shift tax composition from direct taxes to indirect and property taxes.
- Improve revenue administration.
- Introduce environmental taxes to price negative externalities (can generate fiscal resources while boosting environmentally sustainable growth).
- Examples: Poland reduced the share of direct taxes in overall revenue and generated increased investment and employment; Chile simplified taxpayer forms and streamlined filing and payment procedures to improve enforcement and tax collection.
- Expenditure-side measures:
- Improve targeting and increase efficiency of spending.
- Lower the government wage bill while protecting quality of public services (examples: Germany, Ireland, Malaysia, and the Netherlands).
- Eliminate generalized subsidies (such as energy subsidies) that disproportionately benefit higher-income groups in favor of targeted measures.
- Budget-neutral options:
- Countries with little room to increase revenue or trim expenditure can change the composition of taxes and spending to boost growth.
Design and implementation: the “how” matters
- Packaged reforms: Inclusion of fiscal measures in a package with complementary structural reforms increases the likelihood of success; in most studied countries, fiscal reforms were implemented together with structural reforms and macroeconomic policies.
- Example complementarities: strengthened work incentives combined with labor market reforms (streamlined hiring and firing procedures, changes in wage bargaining, minimum wage cuts); reducing government debt and deficits to create room for corporate tax decreases combined with deregulation and privatization.
- Social dialogue and public support:
- Social dialogue with stakeholders enhances implementation and sustainability of politically difficult reforms (examples: the Wassenaar agreement in the Netherlands in 1982; the tripartite agreement in Ireland in 1987).
- Strategies to foster support include effective communication emphasizing benefits or costs of the status quo, and inclusion of compensatory measures for those expected to be worse off.
- Balancing efficiency and equity:
- Reforms that increase efficiency may have adverse distributional consequences; trade-offs can be avoided by pairing measures.
- Example: Increasing the share of consumption taxes may hurt lower-income households, but if proceeds finance higher health and education spending from which these households benefit, they may be better off overall.
IMF Survey : Strong and Equitable Growth: Fiscal Policy Can Make a Difference, June 30, 2015.