Fiscal Policies and Growth: Constraints and Opportunities

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

2. The Macroeconomic Dimension

3. The state of the world’s public finances

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

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

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

8. Deficits, debt and growth

9. In advanced economies, fiscal positions are unsustainable

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

11. So needtodo more thanreturnto pre-crisis 6 4 2 0 Cyclically Adjusted Primary Balance Primary Balance - 2 - 4 - 6 OverallBalance - 8 - 10 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2030 • 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: • Recent WEO work • Low interest rates • Evidence that adjustment on spending side is: • Associated with more durable consolidation • Less contractionary

13. THE MICROECONOMIC DIMENSION

14. Spending better

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

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

17. Eliminating wasteful subsidies • Petroleum subsidies—cost around 0.3 percent global GDP in 2010 • Exemptions and special treatment—importance of tax expenditure analysis • Subsidies to renewables—don’t let spending substitute for proper carbon pricing

18. Taxing smarter

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

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

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