With population ageing, fiscal consolidation has become of paramount importance for euro area
countries. Consolidation can be pursued in various ways, with different effects on potential growth, which
itself will be dragged down by ageing. A dynamic general equilibrium model with overlapping generations
and a public finance block (including a pay-as-you-go pension regime, a health care system, non ageingrelated
public spending and a stock of debt to be repaid) is used to compare the macroeconomic impact of
four scenarios: a) increasing taxes to finance unchanged pensions and repay public debt, b) lowering future
pension replacement rates and repaying public debt through a lower ratio of non ageing-related outlays to
GDP, c) raising the retirement age by 1.25 years per decade and increasing taxes only to pay off debt, and
d) increasing the retirement age by 1.25 years per decade and paying off debt through a lower ratio of non
ageing-related expenditure to GDP. This last scenario is the one where growth is strongest: with gradual
increases in the retirement age and spending restraint, average GDP growth in the 2010s would be
0.34 percentage point stronger than in a scenario where fiscal consolidation is achieved exclusively
through tax hikes. The appropriate conclusion from the model is not that public spending is bad per se, but
that cuts to lower-priority spending items can deliver surprisingly large income gains compared with the
alternative of raising taxes.
Restoring Fiscal Sustainability in the Euro Area
Raise Taxes or Curb Spending?
Working paper
OECD Economics Department Working Papers
Share
Facebook
Twitter
LinkedIn
Abstract
In the same series
-
Working paper20 September 2024
-
5 September 2024
-
5 September 2024
Related publications
-
16 October 2024
-
Working paper20 September 2024