Volume Article Contents Abstract. Literature Review. Empirical Methodology. Conclusions and Further Work. Annex 2. Annex 3. Jarmila Botev , Jarmila Botev. Oxford Academic. Google Scholar. Annabelle Mourougane. Select Format Select format. Permissions Icon Permissions. Abstract This article derives time-varying threshold multipliers for G7 countries and the euro area, above which consolidation will be self-defeating that is, leading to an increase rather than a decrease in the debt-to-GDP ratio.
Issue Section:. You do not currently have access to this article. After a decade of strong growth performance, economic activity in Ireland decelerated markedly in and remained subdued in Despite the relatively low public debt, around 35 percent of GDP, and a near-balanced budget, the country undertook fiscal consolidation.
Revenue measures, including increases in VAT and excises, and changes in capital gains taxation accounted for more than 90 percent of the 2. On the expenditure side, capital expenditure was reduced, while the wage agreement moderated wages. Structural reforms included the introduction of rolling multiyear capital expenditure budgeting and preparation of long-term fiscal projections.
The central government traditionally held tight administrative control over subnational governments, although no specific adjustment measures were introduced at that level during the period. The coalition government had enjoyed a strong parliamentary majority since , despite some differences of views within the coalition. Public support for fiscal consolidation was partial, with strong opposition from the trade unions.
The government responded to a rapid fall in its popularity by substantially reshuffling the cabinet in September , which revitalized the reform agenda. Fiscal consolidation in Italy was preceded by electoral reforms at both the central and regional levels, which resulted in political stability. The fiscal consolidation occurred at a time when growth turned negative after a strong performance in Inflation was declining, but unemployment remained high.
The debt was very high, over percent of GDP in , and had been rising in spite of fiscal consolidation efforts since the early s. A public consensus emerged that fiscal consolidation was necessary to achieve EMU membership. Expenditure and revenue measures, approximately equally, contributed to the improvement in the CAPB by about 2 percent in and by a cumulative 3. A number of temporary and permanent measures, including a personal income surtax, a levy on severance payment funds, and an increase in VAT rates in , boosted revenues to a record high of over To lower expenditure, the government curtailed capital spending, reduced transfers to subnational governments, and halted the persistent increases in pension and health care outlays.
Other reforms included tighter control over intergovernmental transfers since , clearer delineation of expenditure responsibilities between the tiers of government, and electoral reform, which increased accountability.
However, a decade of high fiscal deficits about 8 percent of GDP in led to a rapid accumulation of public debt, which reached percent of GDP in while social security spending kept rising. The cyclically adjusted primary fiscal balance improved by about 1.
Revenue measures included a rollback of past income tax cuts, while the higher-than-expected tax revenues were saved. A gradual reduction in capital spending, containment in the growth of social security expenditures, and across-the-board cuts in discretionary spending programs were helpful.
A devolution of tax and spending responsibilities to the subnational governments led to a cut in subsidies and a modest net savings. The Dutch economy had experienced a significant downturn in activity since , accompanied by a sharp deterioration in its fiscal position as the 3 percent Maastricht deficit ceiling was breached in The challenge was to nurture the emerging recovery while ensuring fiscal sustainability. Against this background, fiscal consolidation was initiated by a new government and consisted mainly of expenditure measures, which accounted for more than 75 percent of the improvement in the structural deficit-to-GDP ratio.
As a result, the structural deficit narrowed by about 2. There were modest base-broadening tax policies, while natural gas revenues increased.
Expenditure measures included a significant cut in civil service employment, a general cut in subsidies, a freeze of public sector wages and social security benefits, and a reduction in the coverage of the basic public health care package. Earlier reforms in the s had established a strong institutional framework for medium-term budgeting, which incorporated long-term projections of pension and social welfare spending.
At the subnational level, there were more explicit constraints on the operation of the local governments, including limitations on how much they could borrow and a strong emphasis on closer cooperation between the central and local governments. Local governments supported the consolidation effort by improving their balances in — The government was determined to comply with the 3 percent deficit limit.
To this end, debt and deficit reduction objectives were put into multiyear perspective using a medium-term fiscal framework. The role of the Bureau for Economic Policy Analysis was seen to be important in bringing consensus on the needed measures. The political environment was competitive, with the opposition calling on the ruling Labor Party to introduce more tax cuts and improve the quality of health and education services.
Nevertheless, following the September elections there was no significant relaxation of fiscal policy, and the incumbent party was re-elected with a confirmed mandate for continued fiscal consolidation. Fiscal adjustment measures were mixed. Tax revenues and surpluses of public enterprises turned out to be higher than expected.
Expenditure restraint accounted for approximately 40 percent of the improvement in the cyclically adjusted primary fiscal balance of about 1. Caps on current expenditure led to a gradual reduction in the expenditure-to-GDP ratio. The government reiterated the importance of its commitment to the principles of medium-term budgeting established earlier including the need to achieve an average surplus over the cycle and emphasized the need for higher savings in the light of future pension and health care obligations.
The economy experienced a relatively rapid recovery after the recession, which had culminated in negative GDP growth in However, while economic activity was on the rise and inflation gradually subsided, high unemployment at above 20 percent of the labor force persisted. Public finances deteriorated gradually after , with the fiscal deficit exceeding 7 percent of GDP in and public debt rising rapidly to over 70 percent of GDP.
The focus of fiscal consolidation was on expenditure reduction, complemented by some revenue measures. Expenditure cuts accounted for about 60 percent of the improvement in the cyclically adjusted primary fiscal balance of about 2. Reductions in current expenditure included cuts in social transfers, the wage bill, and health care spending.
Tax reforms aimed at simplifying the tax code and reducing the burden on small businesses, coupled with strengthened tax administration, resulted in a significant improvement in tax buoyancy.
Structural reforms included gradual improvements in budgeting and monitoring, privatization, a reorganization of public enterprises, and the strengthening of tax administration. In , Spain adopted a cooperative approach to regulating subnational public finances, whereby subnational fiscal targets were negotiated between the central and regional governments. The fiscal consolidation enjoyed only partial support at the regional level, although there was public consensus that it was necessary to achieve EMU membership.
The Swedish economy had witnessed the deepest recession since the s, accompanied with high inflation, rising unemployment, and exchange rate depreciation. The fiscal deficit exploded to over 12 percent of GDP, as a result of the cyclical downturn and the underfinanced tax reform of —91, with public debt reaching 80 percent of GDP. Fiscal consolidation was largely expenditure-based, complemented with significant revenue measures.
Expenditure cuts accounted for approximately 75 percent of the improvement in the cyclically adjusted primary fiscal balance of about 11 percent of GDP over — There were reductions in pension and welfare spending, including unemployment benefits and cuts across a broad range of spending programs.
The country saw increases in social security fees, full taxation of dividends and capital gains, and increases in personal income tax rates. The unemployment benefits were reformed, with emphasis on shifting from cash payments to training.
In , the mechanism of distributing relief grants to municipalities was revised, which alleviated the problem of soft budget constraint. The consolidation was supported at the local level in and — Fiscal consolidation was unpopular, as reflected in the outcome of the September elections in which the ruling party suffered major losses, despite retaining the majority in parliament. After 18 years of being in opposition, the Labor Party won elections in the United Kingdom in May with an overwhelming majority in Parliament.
The new government confirmed the course of fiscal consolidation and introduced a number of new policy reforms, including transferring the responsibility for setting interest rates from the Treasury to the Bank of England. The economy had experienced three successive years of solid economic growth, led by private consumption.
Unemployment was falling rapidly, while inflation remained relatively low. The public sector fiscal deficit had increased to over 7 percent of GDP by , the debt-to-GDP ratio was on the rise and already exceeded the target level of 40 percent by about 8 percentage points. Adjustment efforts in the period —98 were focused on expenditure restraint, which accounted for about 75 percent of the improvement in the cyclically adjusted primary fiscal balance of 6. Expenditure measures included containing increases in health care and education spending.
On the other hand, revenue measures covered increases in indirect taxes and some duties, while for equity reasons the VAT on some items was lowered. Advanced corporation tax rebate was abolished, accompanied by a small reduction in the corporate tax rate. There was a one-off windfall levy on profits earned by privatized utilities. However, the central government maintained its traditional tight administrative control over subnational government spending.
A new government in reiterated its preelection commitment to the golden rule and its intention to reduce the general government fiscal deficit of 4 percent of GDP in fiscal year —97, while at the same time implementing tax reform to encourage investment. Economic activity in the United States had been weak, and unemployment was rising. In nominal terms, federal debt had quadrupled over the —92 period, and the debt ratio was projected to continue rising at a high rate.
Measures included increases in income tax rates on the top 1. There were virtually no expenditure measures. In particular, there were no cuts in social and health care spending. The adjustment was carried out entirely at the federal government level. Consolidation was accompanied with intensive discussions regarding health care reform, as the costs were rising at a very fast pace and taking up sizable part of the budget. Right from the beginning, President Clinton emphasized the need to reduce the deficit, in spite of the concerns that it could further depress still weak economic activity.
However, there was a recognition that an adjustment could lead to a decline in interest rates that could outweigh the contractionary effect of the deficit reduction. The deficit reduction package was passed with an extremely narrow vote in the Congress. When the Democratic majority was lost in the mid-term elections, the President demonstrated a strong commitment to his original position of continued fiscal discipline, opposed plans by some to provide a stimulus through a large tax cut, and withstood a budget crisis in Congress in November Following a default on its external debt in the s, Chile has since implemented strong and sustained fiscal and other economic reforms.
The government reduced its debt from 54 percent of GDP in to 21 percent in , owing to expenditure restraint, improvement in revenue collection, and reform of loss-making state enterprises. Privatization proceeds helped reduce debt, while real exchange rate appreciation reduced the external-debt-to-GDP ratio. Structural reform since the return of democracy in was enhanced by a high degree of political cohesiveness.
In the absence of fiscal rules, other institutional factors were useful in maintaining fiscal discipline. They included allocating more powers to the Finance Ministry than other ministries or the legislature, including over subnational finances, prohibiting the central bank from extending credit to the government, and preventing lower-level governments from borrowing.
The degree of central government control over subnational finances contrasted sharply with the cases of Argentina, Brazil, and Mexico. The ban on revenue earmarking rendered fiscal policy more flexible. The central government adopted a structural balance rule, targeting an annual surplus of 1 percent of GDP. These sustained fiscal policy actions improved financial market confidence, resulting in significantly lower interest rate spreads below the regional norm.
Over the period, Chile enjoyed uninterrupted access to capital markets, reinforcing confidence in its economic management and avoiding forced pro-cyclical policies observed in other countries in the region. There was broad consensus for fiscal consolidation in Brazil, bolstered by new governments elected in and The platform for fiscal consolidation was provided by external and fiscal crises stemming from contagion from Asia, a rising current account deficit, loose fiscal policy, sharp exchange rate devaluation in early , and the adoption of a flexible exchange rate.
The economy also experienced low growth, inflation, increasing primary fiscal deficits at all levels of government, and a rise in public debt. Other economic weaknesses included fiscal indiscipline at the subnational level, loss-making public enterprises, labor market rigidities, a somewhat restricted trade system, a cumbersome tax system, generous pensions, and significant budget rigidities. Fiscal adjustment was essentially revenue based, targeting increases in the primary surplus of 3 percent of GDP in and gradually to 4.
At the same time, total expenditure in the nonfinancial public sector increased by 7 percent of GDP, despite measures to contain entitlement spending. The public sector primary balance improved from a 1 percent of GDP deficit in to a 4. Expenditure measures included efforts to strengthen the social safety net and pension reform to reduce generous benefits.
The primary balance targets were consistently met throughout the period. Furthermore, there was a well-established framework for developing, implementing, and monitoring the annual budget law. The fiscal framework was anchored in the Fiscal Responsibility Law, the constitutional provisions on public financial management, and the budget guidelines, which set targets for three years ahead on a rolling basis.
All levels of government contributed to the turnaround in fiscal outcomes. There was a debt restructuring agreement between the federal and the subnational governments and legislation limiting personnel expenditures and debt levels at all government levels. The economy experienced high inflation and stagnant output in the early s, a financial crisis in —97, and a high current account deficit amidst exchange stability and lower inflation. Fiscal balances worsened by 8 percent in —97, partly reflecting support for troubled financial institutions.
Public debt rose to percent of GDP in The interest bill was high, while wage bill pressures mounted. Other issues included a large and growing informal sector, high crime rates, vulnerability to tourism receipts, and volatility in bauxite prices. The targeted improvement in the public sector primary balance was 7. Expenditure measures targeted cuts in capital expenditure equivalent to 2. The Staff Monitored Program targeted cost recovery in health and education and a rationalization of safety nets, while the Staff Monitored Program focused on enterprise reforms.
The fiscal impact was an overall improvement of central government and public sector primary balances by 6. However, while public sector primary surpluses averaged The adjustment effort was derailed by revenue weaknesses, wage increases, and security and tourism spending in — Real exchange rate appreciation and lack of structural reforms affected competitiveness and export growth.
These were compounded by a narrow tax base 15 percent of GDP , high spending on rebuilding the economy 9 percent of GDP per year during —97 , a high wage bill 11 percent of GDP , and debt service obligations. Earlier adjustment had been undermined by weak support, high oil prices, and civil conflict in the south of the country. A new government in supported fiscal adjustment focused on expenditure, targeting an 11 percent of GDP reduction in the primary balance in and a 14 percent reduction over five years.
Revenue measures included higher customs tariffs, a new tax on hotel and restaurant services, higher receipts from cellular contracts, and increases in fees and excises. On the expenditure side, a 7 percent cut in non-interest spending was envisaged based on reducing public investment, transfers, and the number of teachers and contractual employees, as well as a wage freeze bill.
Following the adjustment measures, the primary balance improved by Revenue increased by 5. Non-interest expenditure fell by 8. Structural reforms included improved expenditure forecasting and tax and customs administration reforms. The Lithuanian economy experienced a deep recession following the financial crisis in Russia, with growing unemployment, a high current account deficit, and low inflation.
Its currency was pegged to the U. Its fiscal deficit worsened in —99, reflecting this recession as well as increased household transfers and lending to the state oil company. Other economic problems included poor expenditure management, a large stock of payment arrears, high debt burdens, labor market rigidities, energy tariffs below cost recovery, trade restrictions, and excessive agriculture subsidies. Fiscal adjustment was expenditure based, targeting reduction of the overall deficit by 5.
Revenue measures targeted 1. Expenditure reductions amounted to 4. The deficit was reduced by 6. Important structural reforms included strengthened treasury and commitment controls and the consolidation of extra budgetary funds, while the Fiscal Reserve Fund, an organic budget law, and a medium-term framework facilitated the adjustment. Low wage growth and labor market reforms improved competitiveness.
In —94, it experienced severe contraction and hyperinflation, with the inflation rate exceeding percent in and output declining by The fiscal deficit increased from 6.
Following violence in October , the political landscape was characterized by a succession of prime ministers and, eventually, the resignation of President Yeltsin in The country had a severe financial crisis in , defaulting on its debt, while the domestic currency depreciated.
Central government tax revenues declined through the mids, reaching 9 percent of GDP in due in part to depressed oil prices. The targeted adjustment in was 2. Tax collection from oil companies was strengthened, boosted by the introduction of new oil taxes, a rationalization of the tax structure, and high oil prices. Transfers to subnational governments were cut by 1. The interest bill declined sharply as a result of the default, while the primary balance improved by 8 percent of GDP to a surplus of over 5 percent in — The economy of South Africa experienced recession during —92 with high inflation, capital flight, and concerns over the transition from apartheid to majority rule.
The fiscal deficit had worsened during that period by 5 percentage points, due to revenue weakness and high social spending. Public debt increased, although it remained moderate at 40 percent of GDP. There were calls for structural reforms in the labor market, trade, public enterprises, and public administration. The international trade and financial sanctions of the apartheid era were lifted in October Fiscal adjustment adopted an expenditure focus, targeting a 4 percent of GDP deficit reduction over five years—2 percent in the first year and 0.
Subsequent efforts announced in targeted a further deficit reduction by 2 percent of GDP from the —96 out-turn. Revenue measures were neutral from —95, with the elimination of exemptions, an extension of the tax base, and lower tax rates. The VAT rate was raised from 10 to 14 percent in —94, while tax policy and administration reform continued. Expenditure measures targeted cuts in the wage bill and in subsidies and transfers, as well as a 1 percent of GDP increase in capital expenditures.
Following fiscal adjustment, the overall deficit was reduced by 6. Revenue gains accounted for 3 percentage points, while spending reductions amounted to 3. The primary balance was strengthened by 6. Following the decline in the interest bill, social and capital spending were increased.
Key structural reforms included base broadening and lower rates for income taxes, revenue administration reforms, a medium-term budget framework, improved expenditure planning, and management accounting. Nigeria witnessed many years of military rule prior to its democratic transition.
There were numerous allegations of corruption, fraud, and theft during the Abacha regime — GDP growth slowed from nearly 9 percent per year in —90 to 1.
Inflation increased over the same period, exceeding 70 percent in The overall balance weakened from a surplus of 2. The non-oil primary deficit was in excess of 40 percent of GDP. A dual exchange rate system, a large informal sector, corruption and weak governance, oil dependency, and subsidies were all major issues of concern.
Fiscal consolidation, which began in was revenue based. The introduction of VAT in and oil price increases during the period improved government revenue, while the removal of a fertilizer subsidy and a reduction in the wage bill moderated the rising government spending. Unfortunately, higher wages in offset the earlier reduction. The primary balance improved by 9 percent of GDP during — Similarly, the non-oil primary balance as a percentage of non-oil GDP improved by 20 percentage points.
In , Barbados faced severe balance of payment difficulties caused by a bunching of external debt obligations, loosened financial policies, and a steep drop in tourism receipts. High expenditure outlays in the face of weak revenue growth further widened the fiscal deficit to an unsustainable level in , while public debt remained at about 31 per cent of GDP.
The country undertook fiscal adjustment and economic reforms to restore financial stability and foster conditions for economic growth. Under an IMF Stand-By Arrangement, Barbados undertook broad-ranging economic policy measures, including major increases in taxes and charges for public sector goods and services, as well as a large scale-back in expenditures.
Among other revenue measures, the consumption tax was raised three times, increasing from 10 to 17 percent; a stabilization tax of 4—5 percent was imposed; and public utility tariffs and charges were raised by as much as 75 percent. The expenditure and income policies included an 8 percent wage cut for public employees, an 11 percent cut in the public workforce, cuts in transfers to public corporations, and wage freezes.
Although initially the economy contracted more sharply than expected, the fiscal deficit narrowed from 7. Growth had stagnated during —93, partly due to strong currency and a high and increasing public debt of more than percent of GDP in The fiscal deficit was equally high at 12 percent of GDP in — Tax revenues had declined from 20—22 percent of GDP in the late s to less than 15 percent, wages were 11 percent of GDP in —93, and interest bills were 9.
Within the context of an IMF program, fiscal adjustment was revenue focused, with the primary balance targeted to improve by 5 percent of GDP in , by 1. Another three-year IMF program — targeted 1. There was a maximum tariff cut from to 35 percent and a VAT rate cut from 25 to 20 percent, while export taxes on coffee and cocoa were reintroduced. Tax exemptions were eliminated, a minimum 5 percent import tax was introduced, and property tax was extended.
Expenditure measures comprised reductions in the real wages of civil servants, a 1. The general government primary balance improved by 10 percent of GDP, 7.
The public debt ratio decreased from nearly percent of GDP in to just over percent during —, reflecting lower interest payments and a lower wage bill. Key structural reforms included the creation of a large taxpayer unit and improved customs administration.
Zambia had high inflation and external arrears, while the fiscal deficit averaged over 11 percent of GDP during —89 due to poor revenues and increasing expenditures. Structural issues included price controls, agricultural subsidies, and a large informal sector.
The fiscal adjustment was revenue-based, covering measures such as removal of import tax exemptions, adjustment of personal income tax brackets, reduction of the top marginal rate, extension of sales tax, introduction of a copper windfall levy, increased fees, and mandatory dividends from state-owned enterprises.
Furthermore, a sales tax on fuel was introduced, while the collection of tax arrears from parastatals improved. Expenditure measures included reducing maize and fertilizer subsidies and reorienting spending from investment to spending on operation and maintenance and on essential goods and services.
The overall balance improved by 9. Tax revenue improved by 4. Nevertheless, little progress was made in privatization, in reducing maize subsidies, or in civil service reform, and there was overspending on the wage bill. Also, a substantial exchange rate depreciation led to a sharp increase in the public debt ratio in , and the adjustment was further undermined by drought in It is easier to build broad consensus about the need for fiscal consolidation in difficult times.
Fiscal consolidations were initiated during periods of economic recession or at the early stages of a recovery—periods often characterized by macroeconomic imbalances in the form of worsening fiscal deficits, high debt levels, current account deficits, high unemployment, and high inflation. More than 75 percent of the episodes in the 14 advanced countries were initiated against the background of weak growth, except in the cases of United Kingdom and New Zealand. Significant fiscal consolidations were initiated by new governments.
In particular, about three-quarters of the episodes in advanced countries were started by new governments, many with an explicit mandate for fiscal consolidation. In emerging economies, a sizable number of the fiscal consolidation episodes were started by new governments. In Brazil, for example, consensus on the need for fiscal consolidation was bolstered by new governments elected in and In South Africa, consolidation coincided with the transition to majority rule that marked the end of the apartheid era.
New governments are favored to undertake fiscal adjustment because for them it comes at a low political cost, they are expected to propose new approaches in addressing existing problems, and they have scope to develop a medium-term strategy for fiscal adjustment with maximum ownership.
Fiscal consolidation based on expenditure reductions have tended to be more effective than tax-based consolidations.
A probable reason is that expenditure measures reflect greater commitment, make substantial consolidation more feasible, and can lead to efficiency gains Price, The composition of the adjustments was generally a mixture of revenue and expenditure measures, with many countries leaning toward expenditure-based reductions.
Expenditure measures accounted for an 85 percent improvement in fiscal balances in Canada and Finland and 75 percent improvements in the Netherlands, Sweden, and the United Kingdom. In New Zealand, the adjustment was a combination of revenue 60 percent and expenditure 40 percent measures. In the wider sample considered by Tsibouris and others , findings indicate that expenditure cuts made up three-quarters of the total effort in the sustained large adjustments.
In several successful episodes, spending cuts adopted to reduce deficits were associated with economic expansions rather than recessions. The more successful expenditure-based consolidations focused on cuts in transfers and wages, the so-called politically sensitive budget items. Country experiences show that expenditure-based adjustments, especially focusing on current expenditure—such as reductions in the wage bill and social spending—were more sustainable.
Expenditure cuts were spread across multiple spending categories and institutions. Sizable reductions in the wage bill and social security spending and in transfers, healthcare, and unemployment benefits made important contributions to fiscal adjustment, especially in Canada, Finland, Spain, and the Netherlands. Frontloaded adjustments emphasized revenue measures, while gradual adjustments relied on lowering primary current spending.
Gradual adjustments were more successful in advanced countries and sometimes extended up to a decade, for example in Finland, Sweden, and Spain. This approach reflects efforts to anchor policy objectives within a medium-term framework with a credible commitment to adopted strategies. However, in a wider sample, including emerging markets and developing economies, frontloaded and gradual adjustments were equally likely to succeed, with enduring frontloaded cases emphasizing revenues more than the gradual cases did, particularly trade taxes and non-tax revenues.
Successful revenue measures focused on broadening the tax base and making reforms to simplify tax administration and reduce the tax burden. Base broadening measures were common in countries with more developed revenue administrations and longer periods of implementation, including Brazil, Canada, Finland, New Zealand, and South Africa.
In some cases, tax reforms resulted in tax buoyancy and higher revenues over the medium term. Revenue-based adjustment was sustained when the revenue-to-GDP ratio was low. Tax measures focused on higher fees, excise taxes, and commodity taxes—as in Barbados, Jamaica, and Russia—which appear to be relatively easy to evade. Measures that relied on a narrow tax base and weak administration were unsuccessful. Adjustment efforts were also enhanced by broad political consensus and public support.
The presence of an external political or economic anchor influenced fiscal adjustments, especially in Europe in the s where the need to achieve membership in the EMU was the motivating factor. In that context, the introduction of a broad medium-term strategy was important in mobilizing public support.
Strong political leadership was needed to ensure continuity to fiscal consolidation, as the experiences of the United States and Japan illustrate. Structural reforms included the introduction of medium-term fiscal policy frameworks, organic budget laws, and tax and institutional reforms.
They also included reforms of healthcare, pensions, and unemployment benefits. A medium-term expenditure framework helped countries set and meet multiyear priorities and build credibility. Expenditure management and treasury operations were strengthened in Lebanon, Lithuania, Russia, and South Africa.
Some countries incorporated long term fiscal sustainability analyses into their medium-term policy frameworks. Tax reforms were also very common: Canada, Finland, and New Zealand reduced personal and corporate tax rates, eliminated exemptions, and taxed previously non-taxed income sources. Value-added taxes were introduced as well, for example in Nigeria and Russia. The size of the initial adjustment may determine the success of fiscal consolidation.
The empirical literature finds that there appears to be a size effect in successful fiscal consolidations. The larger the initial adjustment, measured by the change in primary fiscal balance, the larger is the likelihood of success Ardagna, In addition, initial conditions, particularly large initial deficits and high interest rates, have boosted the size and duration of fiscal adjustments Guichard and others, Higher GDP growth matters as well, but it does not drive the success of consolidation Ardagna, The findings of Kumar, Leigh, and Plekhanov suggest that a supportive domestic and international growth environment facilitates adjustment efforts.
Heylen and Everaert also note that the chances of a consolidation being successful rise with a favorable external environment, high economic growth, and low interest rates. The chance of success for consolidation also differs according to political arrangements, with a coalition government being much less likely to succeed than a single-party government. Song and D. Sutherland , Case studies of large fiscal consolidation episodes.
Molnar, M. Hagemann, R. In many countries, just stabilising debt, let alone bringing it down to a sustainable level, will be a major challenge. The poor state of public finances will require wide-ranging fiscal consolidation in most countries, particularly in those whose pre-existing imbalances have been aggravated by the crisis, as well as in those facing rapidly rising spending on health and long-term care.
In the short term, the pace of consolidation needs to be balanced with the effects of fiscal retrenchment on growth. The trade-off will depend on the choice of fiscal instrument, the size of the multiplier which is highly uncertain and whether monetary policy can offset the adverse demand effect. Even so, other things being equal, slower consolidation will ultimately require more effort to meet a given debt target.
Given the currently high level of taxation in many OECD countries, which adversely affects economic performance, and the future spending pressures due to population ageing, a large part of consolidation should probably focus on cutting public spending and addressing the drivers of future spending pressures.
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