Transcript of a Press Briefing on the International Monetary Fund’s Fiscal MonitorBy Carlo Cottarelli, Director, Fiscal Affairs Department, and Senior Advisors Philip Gerson and Gerd Schwartz
Friday, May 14, 2010 (...)
And finally, the third and final element of an adjustment strategy is on the revenue side. We think that for the countries that need to adjust, most of the effort has to come on the spending side because advanced countries have spending levels that are already high. Given the magnitude of the adjustment, though, it may be necessary to take measures also on the revenue side.
Nobody likes paying taxes, and taxes are also distortionary. We made an effort to identify tax measures that were relatively better in terms of economic efficiency. Some of them actually reduce distortions with respect to the current situation. We start from a tax system that in many countries was already quite distortionary. By eliminating some of these distortions it should be possible to improve revenues also.
And here are some numbers that talk about package for the average of the advanced countries, on the order of 3 percentage points to GDP. Many countries apply VAT rates on some sectors at the lower-than-standard level. By eliminating half of this gap between the standard level and the below-standard level, it would be possible to save more than 1 percentage point of GDP. Here we reduce the VAT policy gap. As I said, this refers to eliminating at least half of the below-standard VAT rates.
Second, excises for tobacco and alcohol are still fairly low in some countries. If they were raised to the 2006 average it would be possible to save 0.3 percent of GDP, to increase revenue by 0.3 percent of GDP on average.
A third: in some countries, gasoline and diesel taxes, fuel taxes are still low. By raising them a bit it would be possible to save something like 0.4 percent of GDP, 10 cents more per liter in each case. Of course, in the U.S. where they are lower, perhaps, a large increase would be possible.
Fourth, real estate. Real estate is, from a tax point of view, something that should be taxed because it is always better to tax immovable property.
Some countries already have a fairly high taxation of real estate, like the United States and the UK, but other countries have a low tax rate for real estate.
If it were possible for a country where property taxation is relatively low to bring it to the average level in the U.S., Canada, and the UK, the saving would be 0.4 percent of GDP. Now, of course, at the moment, the real estate market is still weak, so this is not something that could be implemented now, but here, remember, we have a measure that could be implemented over a number of years.
And finally, carbon taxation, carbon pricing, this goes beyond the taxation of fuel. Putting a tax on carbon emissions, or the auctioning of emission rights, it would be possible to save 0.6 percent of GDP. Altogether, this yields 2.8 percent of GDP and this does not include a few other things that may be important for specific countries.
For example, introducing VAT in the United States at the rate of 10 percent, a fairly modest rate, would yield 4.5 percentage points of U.S. GDP. Japan has a very low VAT rate, 5 percent. If it were possible to double it to 10 percent the saving would be 2.6 percent of GDP.
And, last but not least, tax evasion. Tax evasion is significant. The Monitor and the background board paper present calculations of country-by-country of tax evasion for VAT and that is sizable. It’s 0.7 percent of GDP for the average advanced economy, but for some countries, of course, it’s much more than this. Fighting tax evasion is something that remains a priority in many countries.
This brings me to the end of my presentation. The last point I want to make really is on the timing of the implementation of these measures, and here we have to distinguish across countries and across types of actions.
Let me start from actions that go directly into the reduction of the deficit. As you know, some countries are already implementing fiscal tightening this year. There are two groups of such countries: on the one hand, you have countries where fiscal accounts are weaker and where countries are already in a way under the pressure of markets; on the other hand, some countries are also tightening, like in the case of Korea, because economic recovery is stronger than expected. The same applies for various emerging market countries-- These countries should tighten fiscal policy already in 2010. Other countries can wait until 2011. This, however, does not mean inaction for any of these countries. For all countries there is a need to clarify the fiscal exit strategy and there is also a need to take steps under these strategies that do not risk jeopardizing the economic recovery.
There is the broad area of entitlement reform. All countries that are facing fiscal pressures, and particularly those that are aging faster, should implement entitlement reform as soon as possible. Increasing the retirement age is a very important step and does not risk weakening aggregate demand. There is no need to delay this to the future.
Strengthening fiscal institutions is also something that could be implemented now and we know that it is being implemented now by a number of countries including in Europe.
So, with this I will close. As I said, some action should take place in 2010, some action could be delayed to 2011. What is most important in any case is a clarification of the fiscal strategies to reduce deficit and public debt.
So, thank you very much for your attention. Sorry if I took a bit longer than I expected, but now we are ready to take any questions that you may have. Thank you.
MR. THOMSON: Thank you, Carlo. And if I can reiterate, the journalists participating online can submit questions via the Online Media Briefing Center. Journalists in the room, if you could identify yourselves and your affiliation and use the microphones please.
QUESTIONER: Hi. One, I have a basic math question I’m trying to understand and then a sort of broader question.
So, you’re saying overall for the advanced G-20 countries, by 2030 the debt increases by 40 percentage points or thereabouts. And so to get it to a safe level they have to reduce the deficit by 8.5 percentage points over 10 years -- 8.75, sorry. How does that math work? Why does 8-3/4 get you 40 percentage points?
And then secondly, a sort of broader philosophical question, so you have a variety of tax increases and spending cuts, why don’t you have built in there, since you’re saying growth is so important, growth measures that you would score in the same way you’re scoring this?
MR. COTTARELLI: Let me start from the second one. Of course, there is a recovering growth in the projections, but there is no major increase in potential growth. The reason why we have not done this is to be, in a way, on the cautious side because these reforms in this area are extremely important but it’s difficult to calculate when they will yield benefits.
So, I think that while all countries facing fiscal adjustment should implement the measures to boost potential growth, I think it would be a bit risky to assume from the beginning that potential growth would pick up more strongly than expected, than before the crisis.
What countries, in our view, should do is to base fiscal adjustment on relatively conservative projections on output growth and then hope, to have the strong expectation, that through reforms it would be possible to improve potential growth and there would be upside surprises.
But in terms of measuring risk, I think it would be better not to base fiscal adjustment plans on the expectation that potential growth will be higher than before the crisis. Actually, it is better to be cautious.
On your specific question, the difference is between flows and stock. The improvement in the primary balance is an improvement in the flow and that of course is not from the first tier. It’s a gradual improvement, but it’s an improvement in the flow, in the primary position every year. As a result of this, at the end, you get a decline in the debt ratio by about -- with respect to the baseline and to the starting point, by about 35, 40 percentage points. We can perhaps go through separately to do the math later on at the end.
MR. THOMSON: Thank you, Carlo, we’ll take a question online and then come back to the room. We have a question: “What’s your opinion about the fiscal consolidation plans announced by Spanish and Portuguese governments? Could they delay recovery?”
MR. COTTARELLI: Clearly, the steps that have been taken by these countries, as well as by other countries, to strengthen the fiscal accounts, go definitely in the right direction and are important steps. The question also related to the effects that this would have on growth, and I want to give a broader answer here. There is a fear that fiscal tightening could slow down the growth process over the next few years. Now, this -- the extent to which this may happen depends on two factors, one is the credibility of the adjustment. There is some work on this in the last few pages, as you will see, of the Fiscal Monitor. There is a discussion and there is evidence of the difference, with respect to growth, between credible and non-credible adjustment.
This comes from work that has been done by our colleagues of the Research Department which we just reproduced. The basic result is that if the fiscal adjustment is credible, there could even be a boost to economic activity because people start expecting lower interest rates in the future, and they expect less volatility in the future.
This may not happen, so there may be some costs, in terms of output, but in general, the more credible the fiscal adjustment is, the lower the effect on growth, and this underscores not only a need to prepare clear and transparent plan, but also the role that the strength of fiscal institutions can play.
The second point relates to the timing of the adjustment. There is nothing wrong in expanding fiscal policy -- actually, it’s appropriate to expand fiscal policy when economic activity is weak and then to tighten it when there is a recovery in economic activity. This is part of how fiscal policy should be managed from a countercyclical point of view. So, in other words, in the next few years we should expect a recovery of private sector demand. It’s perfectly normal that public sector demand steps back.
One last point, sorry, if you allow me, this -- if fiscal tightening takes place, indeed we should expect over the next few years a lower increase in interest rates than we would normally see during the exit from an economic recession.
QUESTIONER: On the tax measures, the less distortionary tax measures, you know, these are the bad excise taxes. Could you talk, though, about the role of other taxes potentially -- income taxes, payroll taxes -- to help countries return to balance, and what are the challenges of that and what are the benefits of that?
MR. COTTARELLI: I don’t know whether my colleagues want to add something, but our work and the work of the OECD indicate that indirect taxation is in general better with respect to growth, with respect to direct taxation. That’s why we have focused primarily on indirect taxes and real estate taxes.
This said, I think, there may be a need in some countries, depending on countries’ circumstances, of favoring also some increase in direct taxation. But as a general policy we believe that indirect taxes, without being dogmatic at the same time, are better than direct taxation.
MR. GERSON: The only thing I would add is that even with direct taxation, there may be cases where base broadening can help remove some distortions and so it could be that in fact by broadening bases you can both increase efficiency and increase revenues at the same time.
QUESTIONER: My reading of your report, which is very long and very complete, is that, bottom line, governments in advanced economies are spending too much and cannot continue on this path which is unsustainable because they are borrowing too much. You are touching very politically sensitive issues there. We can take a few examples like in the U.S., the housing sector is highly subsidized. In France, the age of retirement is too low. In Japan, VAT is too low, but consumption has been seen as very depressed for the last decades. So, how politically realistic do you think it is to touch with very sensitive issues which are the biggest sources of potential revenues?
MR. COTTARELLI: It’s clear that the adjustment is not going to be easy. Nobody can deny this. At the same time we have seen a number of countries, and I gave you some examples before of countries that did manage to implement a very large fiscal adjustment and they did manage to do this without actually killing growth.
More generally we have seen, in the last 10 or 20 years, very important reforms undertaken, for example, in the pension area. Those are not easy reforms and yet they’ve been implemented. I think that there will have to be sufficient political consensus, of course, to implement these difficult measures, but as I said, this is already happening, it’s happened in the past.
QUESTIONER: Two questions: You talked about fiscal adjustment in some way potentially encouraging growth. You are also including in that fiscal adjustment the increase in taxes that you were referring to, correct?
And secondly you talked about that growth coming, if the fiscal adjustments are credible, and I think the question was relating to Spain and Portugal, do you think their fiscal reform measures are credible?
MR. COTTARELLI: Well, as I said, I mean, the announcements have been important for these countries. I don’t want to discuss too much about these specific countries because, as you know, there is an Article IV consultation that is ongoing on Spain, so these things are being discussed with the authorities.
So, what I was making was a general point about the importance of credibility of the fiscal adjustment. I don’t want also to be seen as too optimistic. I would not bet on the fact that fiscal tightening is going to boost growth. What I’m saying is that there is a possibility that fiscal tightening, if appropriately implemented, will actually help growth, and if the adjustment is credible and it comes at the right time, the loss in terms of output can be quite modest as our evidence in the Monitor shows.
QUESTIONER: Actually, in the light of that question I have a question on Spain and one on a broader issue.
I mean, the issue, I think, in Spain people fear is that the economy is really weak right now. I mean, the economy is not recovering fast at all and there is this fear that these new measures are just going to stall recovery and I wonder if you could comment on that.
And the broader question is, if you can comment on the recovery -- on the world recovery. I mean, you know, like three months ago I think people had a different idea of how things were going to play out. I mean, there was an expectation there would be an increase in interest rates and all that, and sort of the European crisis has changed a little bit that. It seems that countries are going to have to have a fiscal adjustment earlier than expected and I wonder if you had -- you know, if you can comment on how the world recovery is going to change a little bit because of this?
MR. COTTARELLI: I think that one should not exaggerate developments, the implications of developments. It’s clear that there are some countries that are implementing fiscal tightening earlier than perhaps had been expected, but we need to keep in mind that the largest European countries are still in a position to wait until 2011 and what matters for world growth is the behavior of the largest countries. So that needs to be taken into account in terms of the effects of these recent developments on world growth.
On the specific case of Spain, again, there is an Article IV consultation in progress, so I would take away the job of my colleagues if I said too much at this juncture. But as I said, the measures that have been taken are important. They go in the right direction and improve the credibility of fiscal adjustment in that country.
QUESTIONER: If I just may politely push a little bit more. There is no Article IV mission in Portugal, so perhaps you could comment on that credibility.
MR. COTTARELLI: Yes, I mean, as I said, I don’t have the alibi on the Article IV consultation in Portugal, but again, the point I want to make again, it goes in the right direction in increasing the credibility of the adjustment. Of course, all the European countries have more general challenges and those are particularly important in the area of health spending and pension spending. This, of course, does not apply particularly to Portugal, but is a point that I wanted to reiterate. I think the Europeans, as a group, are underestimating the challenges coming from health care spending. It’s a point that we make clearly in our report. We have a sort of differences of views with respect to the European Commission’s in the projections over the next 20 years of health care spending. You could find the details in the Fiscal Monitor.
QUESTIONER: Can I ask about another European country? If you look at it a different way, what’s the lesson from Greece on the message that you’re trying to enunciate today?
MR. COTTARELLI: Yeah. I mean, the lesson is that there are some countries where the fiscal accounts are weaker and that are potentially more exposed to a loss of confidence, including because they have, for example--and I’m not referring specifically to Greece, but as a general point --for example, because they have weaker fiscal accounts, because they have weaker fiscal institutions. And the message is that those countries -- some of these countries cannot afford waiting until 2011, they will have to tighten earlier. This is already happening.
So, that’s basically the lesson that I would draw from the recent developments.
MR. THOMSON: If that’s all the questions we have, then we’ll wrap up this briefing. Thanks very much for taking part, both journalists in the room and those who participated online.
Just to reiterate, the contents of this briefing and all the documents that we posted are under embargo until 11:00 a.m. D.C. time. That’s 1500 GMT today.
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