Restoring Fiscal Sustainability in the Euro Area: Raise Taxes or Curb Spending?

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Restoring Fiscal Sustainability in the Euro Area: Raise Taxes or Curb Spending?

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Boris Cournède
Frédéric Gonand

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Abstract

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.

Rétablir la soutenabilité des finances publiques dans la zone euro : Augmenter les impôts ou maïtriser les dépenses ?
Le vieillissement démographique renforce la nécessité d'un redressement des finances publiques dans la zone euro. Ce redressement peut emprunter plusieurs voies dont les effets sur la croissance potentielle sont variables, et dans un contexte où le vieillissement lui-même pèse sur l'activité à long terme. Un modèle d'équilibre général dynamique avec générations imbriquées, intégrant une modélisation des finances publiques avec un régime de retraites par répartition, un système d'assurance-maladie, des dépenses publiques non liées à l'âge et un stock de dette publique à rembourser, permet d'étudier l'impact macroéconomique de quatre scénarios de consolidation: a) hausse généralisée des prélèvements obligatoires pour financer l'accélération des dépenses sociales et rembourser la dette, b) baisse des taux de remplacement pour les futurs retraités et maîtrise des dépenses publiques non liées à l'âge pour rembourser la dette, c) augmentation de l'âge moyen de départ à la retraite de 1.25 année par décade et augmentation des impôts limitée au remboursement de la dette, d) augmentation de l'âge de départ à la retraite de 1.25 année par décade et remboursement de la dette par maîtrise des dépenses publiques. C'est ce dernier scénario qui aboutit au taux de croissance le plus élevé: une augmentation graduelle de l'âge de la retraite et une maîtrise des dépenses non liées à l'âge permettrait de relever le taux moyen de croissance potentielle pendant la décennie 2010 de 1/3 de point de PIB dans la zone euro, par rapport à une consolidation procédant par hausses générales d'impôts. La conclusion de cet exercice ne consiste pas à prétendre que les dépenses publiques seraient mauvaises en soi pour l'économie, mais qu'une baisse des dépenses dans des secteurs non prioritaires permettrait de dégager des gains significatifs en matière de croissance par comparaison à un recours massif aux prélèvements obligatoires.

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Paper provided by OECD, Economics Department in its series OECD Economics Department Working Papers with number 520.

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Date of creation: 30 Oct 2006
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Handle: RePEc:oec:ecoaaa:520-en

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Find related papers by JEL classification:
D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
E27 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation
E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management
J11 - Labor and Demographic Economics - - Demographic Economics - - - Demographic Trends and Forecasts

This paper has been announced in the following NEP Reports:

NEP-ALL-2006-11-12 (All new papers)
NEP-CBA-2006-11-12 (Central Banking)
NEP-EEC-2006-11-12 (European Economics)
NEP-MAC-2006-11-12 (Macroeconomics)
NEP-PBE-2006-11-12 (Public Economics)

Cited by:
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Frédéric Gonand, 2006. "Une politique budgétaire keynésienne neutralisant les stabilisateurs automatiques en haut de cycle : le cas de la France en 2000-2001," Working Papers hal-00243039_v1, HAL. [Downloadable!]
Other versions:
- Frédéric Gonand, 2006. "Une politique budgétaire keynésienne neutralisant les stabilisateurs automatiques en haut de cycle : le cas de la France en 2000-2001," Working Papers hal-00243038_v1, HAL. [Downloadable!]
Rob Euwals & Marike Knoef & Daniel van Vuuren, 2007. "The Trend in Female Labour Force Participation: What Can Be Expected for the Future?," IZA Discussion Papers 3225, Institute for the Study of Labor (IZA). [Downloadable!]
Rob Euwals & Marike Knoef & Daniel van Vuuren, 2007. "The trend in female labour force participation," CPB Discussion Papers 93, CPB Netherlands Bureau for Economic Policy Analysis. [Downloadable!]

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