April 2017 IMF Fiscal Monitor: Achieving More with Less

Tuesday, May 9

Victor Lledo, Senior Economist, Fiscal Affairs Department, International Monetary Fund

Major transformations in the global economy have increased the importance of fiscal policy in fostering sustainable and inclusive growth and smoothing the economic cycle. Yet fiscal policy also must achieve more in a more constrained and riskier environment. The April 2017 issue of the Fiscal Monitor explores how the difficult task of achieving more and better might be accomplished using fewer resources.

Mr. Lledo started his presentation by reviewing recent fiscal developments in advanced, emerging market and middle-income economies as well as in low-income developing countries (LIDCs), underscoring the risks to the outlook. In the rest of the presentation, he concentrated on how the role of fiscal policy can be elevated by adopting growth-friendly, inclusive, and countercyclical measures and discussed how the resources necessary to finance such measures could be generated.

In 2016 advanced economies (AEs) marginally eased their fiscal stance, breaking a five-year trend of fiscal consolidation. The fiscal stance of AEs as a group is expected to stay fairly neutral over the medium term. By contrast, in emerging markets (EMs) deficits increased for the fourth year in a row, from about 1 percent of GDP in 2012 to about 5 percent in 2016. However, their fiscal position is expected to improve in the near term, largely driven by improvements in oil exporting countries as oil prices recover. In LIDCs, the average deficit went up for the third consecutive year, reaching 4.4 percent of GDP. However, deficits are now projected to stabilize as a percentage of GDP, halting the recent trend.

Fiscal risks remain elevated and on the downside, although some upside risks have also increased recently. In general, the fiscal outlook may differ from the baseline projections for two main reasons: (1) In the past year, uncertainties about both the scope and the design of fiscal policies have risen. Here Mr. Lledo highlighted the example of the United Kingdom after Brexit; (2) Government balance sheets continue to be vulnerable to a wide range of such risks as high levels of nonfinancial (largely private) sector debt, a growth slowdown, tighter financial conditions, weaker currencies, lower commodity prices, and the materialization of contingent liabilities.

In this challenging environment countries must make selective and difficult budgetary choices. To guide their decisions, sound fiscal policy objectives should include being countercyclical, growth-friendly, and inclusive. A countercyclical fiscal response should rely mostly on automatic stabilizers and be symmetrical, expanding in bad times and tightening in good times. Countries that have run out of policy options can turn to procyclical fiscal policies but should calibrate their pace and composition to reduce short-term drag on economic activity. Using the United States as an example, Mr. Lledo illustrated how procyclical policies in good times can be a major factor in ratchetting up debt-to-GDP ratios. While countercyclical fiscal policy is used to smooth output fluctuations around a trend, growth-friendly fiscal policies are meant to affect the trend itself. Options include direct policies in the form of structural tax or spending policies that directly boost employment, accumulation of physical and human capital, and productivity. Meanwhile, indirect policies could be used to enhance the effectiveness and progress of structural reforms in labor and product markets. The widespread perception of increasing income inequality worldwide shows that what matters is the national dimension of the problem. Here inclusive fiscal policy, in particular, can do a great deal to ensure that the poor and the middle class share in the growth dividend. 

Achieving any of the three objectives often requires additional resources—to be made available in ways least harmful to growth. If fiscal space permits, some countries can finance their policies through additional borrowing—but debt should be used wisely. Countries that do not have the necessary fiscal space must create room within their budgets: they can raise more revenue or reduce spending to implement desired policies in a budget-neutral way. For revenue, the priority is to identify the least distortionary measures available—the measures that least reduce incentives to work, save, and invest. Options include broadening the tax base and raising indirect and property taxes. As for spending, savings can be generated by better targeting expenditures and increasing their efficiency, preferably as part of comprehensive spending reviews.

Risks to public balance sheets are high today, Mr. Lledo pointed out, stressing the importance of countries better understanding their fiscal exposures and putting in place risk management strategies.

After his presentation, Mr. Lledo answered a number of questions, among them: Should labor and capital be taxed differently considering that the latter is becoming an increasingly important factor in production? What should be the composition of LIDC current and capital spending?

Mr. Lledo responded that the IMF is currently reassessing its view on taxing labor vs capital and sees scope for reducing elements of regressivity in taxation. Here, he emphasized that there is considerable room for changes in corporate taxation; for instance, favoring debt over equity puts new and innovative firms at a disadvantage. Mr. Lledo also reiterated the importance of constructing fiscal policies in ways that best meet the unique needs of a given country and support its growth.

Maria Arakelyan, Senior Research Officer, JVI


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