1. POLICY STRATEGIES FOR GROWTH- AND EQUITY- FRIENDLY FISCAL CONSOLIDATION Jan Stráský With input from Boris Cournède, André Goujard and Álvaro Pina Prague, 20 April 2015

2. The opinions expressed and arguments employed in this document are the authors’ and do not necessarily reflect the official views of the Organisation or of the governments of its member countries. This document and any map included therein are without prejudice to the status of or sovereignity over any territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or area. The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law. Remarks 2

3. Cournède, Goujard and Pina (2013): How to achieve growth- and equity-friendly fiscal consolidation? A proposed methodology for instrument choice with an illustrative application to OECD countries, OECD ECO Working Paper 1088. Available at http://www.oecd- ilibrary.org/economics/how-to-achieve-growth-and- equity-friendly-fiscal-consolidation_5k407lwvzkkh-enhttp://www.oecd- ilibrary.org/economics/how-to-achieve-growth-and- equity-friendly-fiscal-consolidation_5k407lwvzkkh-en 3 Source

4. Outline 1.Consolidation needs 2.Ranking consolidation instruments 3.How much consolidation can rely on benign instruments? 4

5. CONSOLIDATION NEEDS 5

6. Consolidation needs (short and long term): – Bring gross debt to 60% of GDP and keep it there Choice of instruments driven by other objectives: – Output – Equity – Global rebalancing 6 Fiscal consolidation and other objectives

7. 7 Defining short- to medium-term and long-term consolidation needs

8. Further consolidation is needed over the outcomes achieved as of end-2012 Difference between debt-control and baseline underlying primary surplus % of potential GDP 8 Source: Cournède, Goujard and Pina (2013).

9. RANKING CONSOLIDATION INSTRUMENTS 9

10. The instruments of fiscal consolidation: spending side Public consumption: Education Public consumption: Health Public consumption: Other (except family policy) Cash transfers: Pensions Cash transfers: Unemployment benefits Cash transfers: Sickness and disability Public consumption and cash transfers: Family policy Subsidies Public investment 10

11. The instruments of fiscal consolidation: revenue side Personal income taxes Social security contributions Corporate income taxes Environmental taxes Consumption taxes (non-environmental) Recurrent taxes on immovable property Other property taxes Sales of goods and services 11

12. Rough assessment (--, -, +, ++) is given to the effects of each instrument on: – Short- and long-term growth – Short- and long-term equity – Global rebalancing This is based on the following sources: – Previous work of WP1 on the sources of growth – OECD Going for Growth – Wider literature – New econometric estimates Growth and equity effects of fiscal consolidation instruments 12

13. Consolidation instruments harmful for growth Public investment and consumption vs. transfers and taxes (direct vs. indirect effect on AD) ALSO: Scope for monetary policy response to offset fiscal consolidation is important 13 Short-term growth effects

14. Smaller government and better allocation – Distortions through subsidies – Better pricing (also of environmental services) Cuts in public spending –  pensions  labour utilisation  –  unemployment benefits  employment  14 Positive long-term growth effects

15. Tax burden on mobile and adjustable factors of production (ALL in the long run) – Personal income taxes, social security contributions and corporate income taxes particularly harmful – Value-added and consumption taxes less bad Lower spending on public goods – Cuts in education and health care  labour supply and productivity  – Cuts in childcare  labour force participation  – Cuts in family benefits ambiguous (  labour market participation,  child poverty,  fertility rates) 15 Negative long-term growth effects

16. Many instruments aggravate income inequality – cuts in benefits, cuts in public services – Many taxes fall disproportionately more on lower- income households BUT: some taxes can reduce inequality – Inheritance and capital gain taxes (here as “other property taxes”) – Personal income tax (i.e. progressive) – Corporate income tax (i.e. on capital income) 16 Effects on equity

17. Assessing the instruments Notes: (a) current account effects refer to a deficit country and would switch signs for a surplus country (b) this + sign relates to welfare effects as the GDP impact may be ambiguous. GrowthEquity Current account (a) STLTSTLTST Spending cuts Education-- - + Health services provided in kind-----++ Other government consumption--+-+ Pensions++ Sickness and disability payments-+---++ Unemployment insurance-+-++ Family---- + Subsidies-+++++ Public investment-- ++ Revenue increases Personal income taxes---+++ Social security contributions----- Corporate income taxes---++++ Environmental taxes-+ (b) -+ Consumption taxes---++ Recurrent taxes on immovable property-+ Other property taxes-++++ Sales of goods and services-+--+ 17 Source: Cournède, Goujard and Pina (2013).

18. A possible generic hierarchy of consolidation instruments Ranking from most (highest score) to least (lowest score) desirable instrument of consolidation 18 Source: Cournède, Goujard and Pina (2013).

19. 1.Consolidation needs 2.Hierarchy of instruments - Instruments used one by one until consolidation needs are met 3.Room for manoeuvre in each instrument – Move until reaching the median (OECD benchmark) – No more than one st.dev. (national preferences) – Reduced margins for pensions (esp. in the short term) – Adjustment for pensions and education and for unemployment benefits 19 The optimal use of instruments depends on:

20. HOW MUCH CONSOLIDATION CAN RELY ON BENIGN INSTRUMENTS? 20

21. Short- to medium-term simulations – Short- to medium-term consolidation needs Long-term simulations – Long-term consolidation needs – Considering only long-term growth and equity effects 21 Two sets of simulations for each country

22. Results from short- to medium-term simulations Consolidating more in general implies using more unfavourable marginal instruments (but there are exceptions) 22 Source: Cournède, Goujard and Pina (2013).

23. Simulated short- to medium-term consolidation packages: Top-half instruments only in 16 countries (e.g. AUS, CAN, NLD) Top-half instruments mainly in 6 countries (e.g. FIN, FRA) Bottom-half instruments mainly: JAP, the UK, and the US 23 How far down the hierarchy of instruments do countries need to go?

24. Results from long-term simulations Consolidating more in general implies using more unfavourable marginal instruments (but there are exceptions) Marginal instrument rank 24 Source: Cournède, Goujard and Pina (2013).

25. Simulated long-term consolidation packages: Top-half instruments only in 20 countries Top-half instruments mainly in 6 countries Bottom-half instruments mainly: AUS, NZL, and the US 25 How far down the hierarchy of instruments do countries need to go?

26. On average across countries, spending reductions account for: 41% of short- to medium-term simulated packages 65% of long-term simulated packages with considerable variation across countries. Examples: In JPN and USA, the simulations give a large role to tax increases (70% of consolidation over the medium term). FRA has a very strong potential for spending cuts which make up 73% of the simulated medium-term package. Spending vs. taxes in simulated packages 26

27. 27 A medium-term increase in the tax share Source: Economics Department Policy Note No. 20.

28. No room for complacency CZE situation good in the short-/medium term, less so in the long term Structural reforms to ease trade-offs between fiscal consolidation and other objectives 28 Conclusions

29. OECD Economic Policy Papers No. 07, “Choosing Fiscal Consolidation Instruments Compatible With Growth and Equity”, A Going for Growth Report, July 2013. Cournède, B., A. Pina and A. Goujard (2013), “How to Achieve Growth- and Equity-Friendly Fiscal Consolidation? A Proposed Methodology for Instrument Choice With an Illustrative Application to OECD Countries”, OECD Economics Department Working Papers, No. 1088. Barbiero, O. and Cournède (2013), “New Econometric Estimates of Long-Term Growth Effects of Different Areas of Public Spending”, OECD Economics Department Working Papers, forthcoming. Goujard, A. (2013), “Cross-Country Spillovers from Fiscal Consolidation”, OECD Economics Department Working Papers, forthcoming. The full results are available in: 29