1. Fiscal Policies and Growth: Constraints and Opportunities Carlo Cottarelli and Michael Keen Ascent after Decline: Workshop World Bank, Nove mber 19, 2010 1

2. THE MACROECONOMIC DIMENSION 2

3. The state of the worlds public finances 3

4. 4 Advanced economies entered crisis with worst (non-war) fiscal outlook General Government Gross Debt for G-7 Economies, 1950-2007 (In percent of GDP)

5. 5 Old Age Dependency Ratio With pressures from aging on top of that Pension reforms contain cost to 1 percent of GDP Health care costs increase by average 3.5 points by 2030

6. 6 Pre-crisis outlook for emerging economies better General Government Debt in Emerging Economies, 1998-2007 (In percent of GDP)

7. 7 Fiscal legacy of crisis most marked in advanced economies---reflecting lasting impact on GDP General Government Debt General Government Balance

8. Deficits, debt and growth 8

9. 9 In advanced economies, fiscal positions are unsustainable

10. What debt target for stabilization? Higher public debt associated with: Higher real interest ratesperhaps 1.75 percentage points over 2008-15 for advanced economies Higher real interest ratesperhaps 1.75 percentage points over 2008-15 for advanced economies Lower growth (through reduced investment and labor productivity)perhaps 0.5 points per year Lower growth (through reduced investment and labor productivity)perhaps 0.5 points per year 10

11. 11 So need to do more than return to pre-crisis -10 -8 -6 -4 -2 0 2 4 6 2007200920112013201520172019202120232025202720292030 Cyclically Adjusted Primary Balance Primary Balance Overall Balance Required adjustment is roughly: 8.5 percent GDP in advanced economies 3 percent in emerging

12. Impact of fiscal adjustment on growth Prospects for expansionary contractions limited: Prospects for expansionary contractions limited: Recent WEO work Recent WEO work Low interest rates Low interest rates Evidence that adjustment on spending side is: Evidence that adjustment on spending side is: Associated with more durable consolidation Associated with more durable consolidation Less contractionary Less contractionary 12

13. THE MICROECONOMIC DIMENSION 13

14. Spending better 14

15. Welfare reform PensionsArgue for raising retirement age by 2 years: stabilizes spending at 2010; best for growth PensionsArgue for raising retirement age by 2 years: stabilizes spending at 2010; best for growth Health caresupply and demand side measures Health caresupply and demand side measures Better targeting? Better targeting? Incentive effects of means-testing Incentive effects of means-testing Wage subsidies Wage subsidies Tagging by correlates with participation responsiveness; increase UK workforce by 1 percent. Tagging by correlates with participation responsiveness; increase UK workforce by 1 percent. 15

16. Infrastructure and innovation Literature gives good reason to suppose strong positive output effect from public capital.... Literature gives good reason to suppose strong positive output effect from public capital.......but little guidance on specifics...but little guidance on specifics Institutions matter Institutions matter Likely needs: Likely needs: Climate changeadaptation not costly in most advanced, but likely to be in some emerging Climate changeadaptation not costly in most advanced, but likely to be in some emerging Fundamental R&Denergy research, geoengineering? Fundamental R&Denergy research, geoengineering? 16

17. Eliminating wasteful subsidies Petroleum subsidiescost around 0.3 percent global GDP in 2010 Petroleum subsidiescost around 0.3 percent global GDP in 2010 Exemptions and special treatmentimportance of tax expenditure analysis Exemptions and special treatmentimportance of tax expenditure analysis Subsidies to renewablesdont let spending substitute for proper carbon pricing Subsidies to renewablesdont let spending substitute for proper carbon pricing 17

18. Taxing smarter 18

19. In search of immobile tax bases VAT: VAT: Potential in Japan (and US?) Potential in Japan (and US?) Large scope in most advanced economies to eliminate exemptions and reduced ratescould raise £11 bn in UK even after compensation Large scope in most advanced economies to eliminate exemptions and reduced ratescould raise £11 bn in UK even after compensation Property tax Property tax 19

20. Green taxes Revenue potential is: Revenue potential is: Significant but not transformational in advancedabout $100 bn per year in U.S Significant but not transformational in advancedabout $100 bn per year in U.S More in some emergingIf internationally traded More in some emergingIf internationally traded But requires that permits not be given away But requires that permits not be given away Not much money in other environmental taxes Not much money in other environmental taxes Though potential in congestion pricing Though potential in congestion pricing 20

21. Investment and finance Giving an allowance for notional cost of equity (an ACE) would Giving an allowance for notional cost of equity (an ACE) would Eliminate corporate-level disincentives to invest Eliminate corporate-level disincentives to invest Reduce debt bias Reduce debt bias Financial sector Financial sector Pre-financing resolution/Corrective tax Pre-financing resolution/Corrective tax Financial Activities Taxa fix for the VAT Financial Activities Taxa fix for the VAT Gains from enhanced international cooperation Gains from enhanced international cooperation 21