Key policy messages
- Many countries face enormous fiscal consolidation challenges. Even if debt-to-GDP ratios stabilise over the medium term, they would remain at dangerous levels.
- Countries should reduce debt levels to around 50% of GDP or lower to provide a safety margin against future adverse shocks.
- Some countries – including Greece, Iceland, Ireland, Portugal and Spain – have started fiscal consolidations of between 5% and 12% of GDP, which are very large by historical comparison.
- Other countries, notably, Japan, the United Kingdom and the United States require a fiscal tightening that would exceed 5% of GDP in order to bring their debt back to 50% of GDP by around mid-century.
- Spending pressures, principally from health and long-term care will continue to mount, and could require an additional permanent fiscal tightening of several percentage points of GDP to help keep debt down in the future.
- Due to the scale of consolidation needs, most countries will need a sustained period of fiscal tightening, acting on both the revenue and spending side.
- The extent to which revenue or spending bears the brunt of consolidation will depend on whether spending is already high.
- Given the current state of the economy and the already exhausted monetary stimulus, implementing a large degree of fiscal tightening could be particularly costly.
- Using instruments with low multipliers initially may help minimise the trade-off with growth in the short run, but could involve other trade-offs, such as with credibility of the effort.
- Given the scale of ageing and other spending pressures, reforms to entitlement programmes need to be an important part of any longer-term sustainability strategy.
- Potential budgetary savings have been identified, which are either growth-friendly or have little adverse effect on economic activity. For most countries they amount to between 4% and 10% of GDP. More specifically:
- Efficiency gains in public spending on health and education could yield savings of 0.5% to 4.5% of GDP in the longer term.
- There is scope to broaden tax bases by eliminating tax expenditures (such as tax credits or deductions). These can be costly, with individual large items accounting for 1% of GDP or even more in many countries.
- Environmental taxes, user fees for government services, taxes on immovable property and well designed financial sector levies could support fiscal consolidation while minimising welfare costs.
- Fiscal institutions and fiscal rules may be helpful in buttressing credibility. In the longer run, better institutional frameworks can help ensure that fiscal policy stays on track.