An Economic Outlook Report, OECD Economics Policy Paper No. 1, 12 April 2012
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.