What is being done to put public finances on a sustainable path?
The second main policy challenge is to put public finances on a sustainable path. The general government budget balance has deteriorated markedly, from a surplus of 1.5 per cent of GDP in 2000 to an estimated deficit of 3.2 per cent of GDP in 2003. Some 2.7 percentage points of this 4.7 percentage point deterioration appear to be cyclical, with the structural balance having declined from broad balance in 2000 to a deficit of2.2 per cent of GDP in 2003. In order to get public finances back on a sustainable path – defined as one on which the future costs of government programmes can be financed at constant tax rates the government has announced four large consolidation packages since July 2002 with a cumulative effect of € 20 billion (3.8 per cent of GDP) by 2007, of which about € 15½ billion relate to expenditure reductions. The budget deficit is projected to fall to 0.6 per cent of GDP in 2007. This budget consolidation should also raise medium-term growth prospects as it focuses on expenditure reductions that strengthen work incentives. To guard against the recurrence of any fiscal deterioration in future years, the government has also announced a strengthening in the medium-term budget framework with windfalls being earmarked for debt reduction (unless otherwise decided by the council of ministers in the case of expenditure windfalls) and revenue shortfalls for new debt as long as there is no risk of breaching the limits imposed by the Stability and Growth Pact.
General government finances
Per cent of GDP
Source: CPB Netherlands Bureau for Economic Policy Analysis; OECD.
These measures are projected to raise the underlying EMU balance to 1.1 per cent of GDP in 2007, which is judged by the Netherlands Bureau of Economic Policy Analysis (CPB) to be sufficient to put public finances on a sustainable path. The difference between the actual budget balance and the underlying EMU balance of 1.7 percentage points of GDP is attributable to the future beneficial impact of economic policies on potential growth and the cyclical component of the balance (together amounting to 1.2 per cent of GDP) and to pension fund contributions temporarily being above their cost-covering level (0.5 per cent of GDP). There are, however, considerable uncertainties surrounding estimates of the structural balance needed for public finances to be on a sustainable path. On the one hand, a higher surplus could be required as the net fiscal costs of second-pillar pension schemes may have been underestimated by assuming unrealistically high real rates of return. On the other hand, the level of disability beneficiaries in the projections does not take into account the effect of recent reforms, resulting in an overestimate of the balance required for fiscal sustainability. These and other factors will be taken into account when the CPB updates its fiscal sustainability projections in 2006. Careful monitoring will be required to ensure that the fiscal targets set in the next coalition agreement, starting in 2007, are compatible with sustainable public finances. In the meantime, the government needs to ensure that its consolidation measures are fully implemented.
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