Economic survey of Spain 2007: Medium and long-term fiscal issues

 

Contents | Executive Summary | How to obtain this publication | Additional information

The following OECD assessment and recommendations summarise Chapter 3 of the Economic survey of Spain published on 23 January 2007.

Contents                                                                                                                           

Fiscal policy still has medium-term challenges to face

The fiscal consolidation achieved over the past decade in a context of strong growth and substantial decentralisation has been remarkable, and the authorities have clearly indicated their intention to continue to pursue a prudent fiscal policy in the medium term. Reforms have been introduced with the object of improving the efficiency of budgetary management in terms of both resources and expenditure. In this regard, the spending caps, which in practice have consisted in limiting the growth of central government expenditure to below the projected rise in nominal GDP, have been an effective way to pursue a counter-cyclical fiscal policy and to use buoyant tax revenues to reduce indebtedness. However, further efforts are necessary, bearing in mind the pressures that will weigh on the public accounts in the medium term as a result, for example, of the gradual decrease in EU transfers and the ambitious public investment programme.

Budget efficiency can still be improved

Recent measures to simplify and reduce tax rates on households and businesses and bolster efforts to combat tax evasion will improve the effectiveness, equity and neutrality of the tax system. Furthermore, by increasing the regions’ control over the taxes levied on their territory and limiting their dependence on central government transfers, the ongoing revision of fiscal federalism will better align their revenue-raising powers with their spending responsibilities, thereby enhancing accountability. However, unless the regions are allocated more expenditure responsibilities, this revision of fiscal federalism must not entail any further reduction in central government resources. With decentralisation leading to fragmentation and loss of information, setting up an agency to evaluate the quality of public policies is a promising idea for comparing the management methods of the various government agencies and boosting efficiency. For this reform to succeed, however, the agency in question must be sufficiently independent and make its assessments widely available to the public so as to promote best practices. Publication of the results of comparative analyses, in particular, must not be hindered by opposition from the regions, as happened in the case of hospital waiting lists.

A stabilising fiscal role with prudent economic assumptions is key

To ensure continuing sound fiscal management in a decentralised framework, while maintaining the stabilising role of public finance, the government has reformed the 2003 Fiscal Stability Law, which obliged each level of government to keep its accounts permanently in balance. The new rule retains its predecessor’s simplicity and has fairly broad support from the regions because of its increased flexibility. More significantly, the law has improved fiscal policy’s stabilising function by evaluating the cyclical position of the economy and taking into account its expected growth rate relative to potential. However, care should be taken when implementing this new budgetary rule to avoid a procyclical budgetary outcome. Equally important, the authorities’ use of prudent macroeconomic assumptions should continue  and incorporate the risks of a slowdown in potential growth in the medium term, given the persisting sluggishness of productivity growth and the uncertain trend in immigration. In this respect, according to OECD estimates, an assumption for potential growth averaging above 3% for the next few years may be optimistic. While the new law takes account of the economic cycle, it may exceptionally exclude increases in public investment (including for R&D and innovation) up to 0.5% of GDP. That said, an unjustified bias in favour of tangible over other forms of investment resulting from this exclusion should be avoided. Moreover, any exclusion should be treated very cautiously so as not to weaken the rule itself. Hence, they should be granted only exceptionally -- as foreseen by the law -- and kept strictly under the ceiling, which should not be raised in the future.

It is time to confront the budgetary implications of ageing

The time has come to develop a more far-sighted long-term strategy to deal with fiscal management in the context of population ageing. The social partners now broadly recognize the scale of the financial problems resulting from ageing: something on the order of 7% of GDP by 2050 merely for public pension spending, which is more than in most other EU members because of the larger, albeit later, demographic shock and the insufficient actuarial fairness   of the old-age pension system. Indeed, its parameters provide pensions whose discounted value on average exceeds the sum of corresponding contributions. Also, according to OECD estimates, the rise in health spending by mid-century could exceed an additional 4 percentage points of GDP, while the average annual budgetary cost of the infrastructure needed to provide long-term care for the elderly – to be gradually developed between 2007 and 2015 – may ultimately reach as much as 1% of GDP. Confronting these cost increases will be difficult. Although the massive recent increase in immigration has improved short-term pension finances, it has reduced the public’s awareness of how urgent it is to deal with the problem so as to minimise adjustment costs. As the present average level of pensions is low and is expected to rise only slowly, reducing the replacement rate may not be the right approach. Rather, the appropriate strategy might be to gradually extend the contribution period required to qualify for a full pension. Incentives to take early retirement should also be removed and working lives prolonged. Relying heavily on increased contributions to contend with growing expenditure would mean shifting more of the adjustment burden onto younger generations and would have negative effects on employment. Substantial debt reduction and building up the reserve pension fund before the demographic shock occurs is an appropriate part of the Spanish authorities’ answer to the budgetary problems flowing from ageing; indeed, public debt has been reduced by about 20 percentage points of GDP since 2000. It should, however, be linked to the implementation of an ambitious reform of the parameters of the pension system. Some modest reforms have been recently undertaken but further progress is necessary. It follows that drawing up alternative, model-based scenarios, for example in the framework of the Toledo Pact monitoring commission, would have a useful educational role to play as regards building a consensus on the socially preferred strategy.

How to obtain this publication                                                                                      

The Policy Brief (pdf format) can be downloaded (also available in Spanish). 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 Spain 2007 is available from:

Additional information                                                                                                  

For further information please contact the Spain Desk at the OECD Economics Department at eco.survey@oecd.org. The OECD Secretariat's report was prepared by Claude Giorno and Eduardo Camero under the supervision of Peter Jarrett.

 

 

 

 

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