Public finance and fiscal policy

Choosing fiscal consolidation instruments compatible with growth and equity


Choosing fiscal consolidation instruments compatible with growth and equity
Main Paper, Economic Policy Paper no. 7

How much scope for growth and equity-friendly fiscal consolidation?
Short Paper, Economics Department Policy Note no. 20

Put your own weights on growth, equity and current-account objectives and see the resulting ranking of fiscal consolidation instruments


This study proposes a structured approach to selecting instruments of fiscal consolidation that are consistent with growth, equity and global-rebalancing objectives, which is then illustrated with a particular application.
In most OECD countries, compared with what had been achieved by end 2012, additional consolidation is needed in the short to medium term to put government debt on a trajectory toward more prudent levels (defined for simplicity as gross debt at 60% of GDP) and even more to keep debt stable in the very long run, i.e. in 2060.    

Consolidation instruments (increases in particular taxes and cuts in specific spending areas) can be ranked according to their effects on short- and long-term growth, income distribution and current accounts, with the rankings taking into account country circumstances. Based on these rankings, illustrative consolidation packages to optimise the side-effects of consolidation on other policy objectives can be drawn up for each country. The packages are based on using instruments sequentially, and within reasonable limits, starting from the most desirable and moving down the ranking until consolidation needs are satisfied. Based on this approach, half of OECD countries appear to be in a position to fulfil their short- to medium-term consolidation needs entirely through instruments that are well ranked (that is to say ranked in the top half). This suggests that, in these countries, well-designed consolidation packages can avoid severe adverse side effects on growth, equity and current account imbalances.

In the simulations, eight countries use some poorly-ranked instruments but achieve more than half their short- to medium-term consolidation through well-ranked instruments.    

In the illustrative simulations, three countries (Japan, United Kingdom and the United States) implement more than 50% of their short-to-medium-term consolidation packages through instruments that have low rankings meaning that they are likely to involve substantial adverse side-effects.

Despite the generally stronger consolidation requirements in the long term, twenty countries would manage to keep debt durably stable at 60% of GDP by relying only on well-ranked instruments. In the simulated very long-term packages, six countries use some poorly ranked instruments but can nonetheless achieve more than 50% of their adjustment with well-ranked instruments.A few countries would have to implement most of their simulated very long-term consolidation packages relying on poorly-ranked instruments (that have more adverse effects on long-term growth and equity objectives).

On average across countries, spending reductions would account for 41% of short- to medium-term and 65% of long-term consolidation packages, the rest being achieved through tax hikes. The difference mostly reflects the greater concern for demand effects in the short term.
In the many cases where countries have to use fiscal instruments that are detrimental for growth or equity on their own, they can ease the potential trade-off between consolidation and other policy objectives by exploiting the scope for efficiency gains through structural reforms.