The following OECD assessment and recommendations summarise Chapter 2 of the Economic Survey of Portugal 2006 published on 20 April 2006.
The 2002-04 fiscal consolidation efforts were insufficient
Consolidation efforts in 2002 04 failed to durably reduce the fiscal deficit below the Stability and Growth Pact threshold of 3% of GDP, and Portugal was again submitted to the excessive deficit procedure with a deficit of close to 6% of GDP in 2005. New efforts are required and in an even more depressed economic environment than four years ago. The strategy followed between 2002 and 2004 combined a rise in the indirect tax rate, emergency spending cuts or freezes and one-off measures with more in-depth medium-term measures on the spending side. This strategy was appropriate to deal with the urgency of the situation while addressing Portugal’s weak expenditure control with measures that typically take time to show results. However, the reliance on one-off-measures may have reduced the sense of emergency and commitment to undertake the painful structural reforms required. Implementation was too slow, in particular as concerned the much needed public administration reform. Emergency measures were able to control the wage bill over the short term but other expenditure items, especially pensions, continued to increase strongly. Taxes were lowered rapidly once the deficit was below 3%, even though the underlying situation had not improved. Despite some consolidation measures the deficit increased to close to 6% of GDP in 2005, partly because of the decision to stop one off measures. The government that came to office in early 2005 is committed to bringing the deficit to below 3% of GDP by 2008. The strategy combines short-term measures to control the wage bill with tax hikes and more in-depth spending reforms. In addition, the control of budget execution is being strengthened. A major difference with the 2002 04 programme is the decision to stop relying on one-off measures in a context where Portugal has been granted more time to get its deficit under 3% of GDP.
Fiscal balances in Portugal
As per cent of GDP
Source: OECD, Economic Outlook No. 78.
A strong commitment to proceed with in-depth reforms
on the spending side is required
Success in achieving the consolidation targets will depend heavily on progress in spending reforms. A fundamental reform of the civil servants pension system brings it gradually in line with the general pension system. Further positive steps have been taken to continue the ambitious health reform initiated under the previous administration. The government has also reengaged a reform of public administration that includes many commendable measures, such as alignment of legal conditions of employment, career and remuneration in the public administration with the private sector and a major restructuring of central administration. The reforms already approved or under preparation are going in the right direction and, if fully implemented, are likely to succeed in bringing the deficit below 3% of GDP over the next few years. Although fiscal consolidation could have a short-term cost in terms of activity, experience elsewhere shows that this cost can be minimized if consolidation is credible, which implies resolute and consistent action that delivers solid results. Therefore it is important that the authorities remain committed to achieving the projected fiscal consolidation without slippage and that the planned structural reforms on the spending side are launched quickly and implemented forcefully. Ongoing steps to improve statistical information on spending at all levels should continue. Consideration should also be given to improving the fiscal framework drawing from successful experiences in other OECD countries, in particular adopting medium term expenditure ceilings that are consistent with the desired consolidation path and strengthening the role of independent economic advisors councils in the preparation of the budget and the assessment of final outcomes.
Further steps are necessary to ensure long term fiscal sustainability…
The consolidation programme nevertheless needs to be complemented by additional reforms to strengthen expenditure control. A key pending reform is the reform of the general pension system to ensure its viability. The system is under strong pressures arising not only from the ageing population but also from its maturation and the high replacement rates granted to pensioners. Updated official simulations show that the system will likely be in deficit by 2007, and could be financed thereafter for only 7 years by the pension trust fund. Therefore action is urgent. A working group has been appointed and some of its proposals are being considered, such as introducing incentives to increase the effective retirement age. It is important that action in this area is not delayed. More radical changes should be envisaged, such as adjusting replacement rates and/or the retirement age for changes in life expectancy and limiting the costs of transition by a relatively rapid phasing in.
… and on the revenue side, the priority should be to make the tax system
simpler and more stable
On the revenue side, there is no room to lower taxes before the public finances have been put on a sustainable path. Nevertheless, there is ample room for further simplification of the tax regime, which is as important for competitiveness as lowering tax rates and can help to improve the efficiency of tax collection. Already, the tax administration has started to deliver results in terms of tax collection over the past two years. The abolition of some tax benefits and exemptions in the 2006 budget is also an appropriate step. However the creation of a new personal income tax bracket, with a higher marginal tax rate, complicates the system and creates additional disincentives to work. A tax reform that really simplifies the tax system is needed. In the meantime, refraining from revising the tax legislation from one year to the next, as has happened in recent years, would make the tax system easier to manage and would facilitate long-term decision-making by economic agents. Indeed, re-establishing macroeconomic stability will be the key to ensuring that the necessary structural reforms to improve education, the labour market and the business environment can be successfully pursued.
The Policy Brief (pdf format) can be downloaded. It contains the OECD assessment and recommendations, but not all of the charts included on the above pages.
The complete edition of the Economic Survey of Portugal 2006 is available from:
For further information please contact the Portugal Desk at the OECD Economics Department at email@example.com. The OECD Secretariat's report was prepared by Bénédicte Larre, Stéphanie Guichard and David Haugh under the supervision of Wilhelm Leibfritz.