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Should fiscal consolidation rank high on the policy agenda?
The target of balancing the general government budget was reached in 2001, one year earlier than originally scheduled. This was achieved mainly via revenue increases, without much spending restraint. In 2002 a small deficit re-emerged, totalling 0.2 per cent of GDP on account of slower growth. Other factors affecting the outturn were largely offsetting. Expenditures were driven up by extra spending on account of the 2002 summer flooding and new demands, notably a substantial increase in family benefits, rising outlays on account of subsidised part-time employment for older people, and an investment stimulus package. On the other hand, ongoing administrative reform curbed spending. This is mainly reflected in flat outlays for active personnel. Largely reflecting the impact of past decisions, the deficit is set to rise in 2003. Public sector reform, including further reform of the social security system, continues to rank high on the government’s policy agenda and will be needed to move on to a sustainable path of fiscal consolidation.
The new government, which came into office in March 2003, has widened priorities to include substantial income tax reductions that are planned to be phased in from 2004 onwards. As the tax cuts are not scheduled to be balanced soon by corresponding reductions in spending, they would entail higher deficit levels for some years, before fiscal consolidation would resume. Austria’s tax to GDP ratio is high by international comparison, and so are tax wedges on labour. While this reinforces the case for tax reductions, policies need to take into consideration the trade off between the beneficial effects of lower taxes on the one hand and maintaining the momentum of fiscal consolidation on the other hand. With a number of risks surrounding the evolution of the general government balance in the medium term, adverse shocks might easily push the deficit to much higher levels than foreseen in Austria’s Stability Programme. Moreover, future spending pressure is looming, notably on account of the rapidly ageing population. Hence, cuts in government expenditure are necessary to create room for the planned tax reductions.
How should public sector reform progress?
Reductions in personnel play a large role in the government’s fiscal consolidation policies, and have been significant over the last couple of years. But a large share of the cuts has been introduced by an early retirement package under very generous conditions. This is costly and at variance with the need to raise labour force participation. Instead, public sector employment rules should be made more flexible so as to support the reallocation of staff. This entails in particular:
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Current definitions of admissible reassignments of civil servants with respect to their function and pay should be revisited to assess whether they are broad enough.
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Abolishing special tenure for civil servants and associated rigid pay schemes should be considered.
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Full harmonisation of the pension schemes for civil servants with the general public scheme is necessary to abolish a significant hurdle to mobility between the two sectors. This would be facilitated by establishing individual pension accounts that are governed by the same standards across the different schemes.
The authorities have made progress with respect to aligning the provision of certain administrative and judicial services at the regional level. To fully reap the benefits of this reform it should be followed up within the states by concentrating related tasks in the hands of one and the same regional administration so as to further promote the implementation of the one-stop-shop principle for regional services as well as administrative permissions necessary for the establishment and operation of industrial plants. This requires adjusting the allocation of funds in accordance with the redistribution of tasks. However, more fundamental reform of federal fiscal relations is necessary. The following areas deserve particular attention:
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While the intergovernmental revenue redistribution system has succeeded in achieving a high degree of income equalization across regions, it appears complex and opaque. Redistribution mechanisms were found to produce effective tax rates for marginal revenues generated at the level of the communities of close to or above 100 per cent, providing disincentives for local policies designed to enhance growth.
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Spending and financing responsibilities in several areas are mixed between the federal government and the states or between various authorities. Examples are, inter alia, the provision of means-tested income replacement benefits for the unemployed, the funding of teachers and the financing of waste water purification facilities and networks. This can cause significant inefficiency in resource allocation, making fiscal consolidation policies more difficult and reducing policy effectiveness in areas such as labour market or educational reform.
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Reform of the federal fiscal system should therefore strengthen the congruence between spending and revenue responsibilities. To this end, choices need to be made both in terms of what services can be better provided by the private sector rather than the government, and which level of government is best suited to deliver public sector services. Local governments could be given more scope to generate own tax revenues, and the volume of co-funding should be scaled back correspondingly to reduce the adverse incentives generated by the present system. In addition, efforts should be made to internalise spill-over effects of local services to other localities via co-operation of local governments or public institutions or by merging local utilities.
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