Lesson 5: Fiscal Policy in Spain

Transcription

1 Lesson 5: Fiscal Policy in Spain 1 The Public Sector Accounts 2 The Impact of Economic Activity on the Public Sector Balance 3 The Impact of Fiscal Policy on Economic Activity 4 Sustainability of Public Debt 5 Evaluation of Public Interventions 1

2 Why is it important to analyse the Public Sector? 1. Fiscal policy (taxes/expenditure) has an influence on the business cycle, economic efficiency, and income distribution 2. Objective: Sustainable growth by means of "quality public finances": efficiency of public services public expenditure aimed at increasing productivity and global economic efficiency study effects of the tax system and social benefits on labour supply and demand 2

3 1 The Public Sector Accounts Effects of fiscal policy on the economy: direct: via public investment and consumption indirect: via the effect of taxes and income transfers on disposable income Under ESA-95, Administraciones Públicas (AAPP) include: national, regional, and local authorities, plus the Social Security administration. The Non-financial account from the AAPP summarizes their activity. 3

4 Non-financial account from AAPP 2003 % PIB Structure % Revenues 40,4 100,0 Taxes on Production and Imports 12,0 29,6 State and Income Tax 10,6 26,2 Social Contributions 13,7 33,8 Other current 3,4 8,3 Capital Resources (of which: Taxes) 0,8 (0,4) 2,1 (1,0) Expenditures 40,1 100,0 Final Consumption (of which: Compensations) 18,0 (10,4) 45,0 (26,0) Social Benefits 12,2 30,4 Paid Interests 2,5 6,3 Subsidies and other current transfers 2,5 6,3 Capital uses (of which: Gross Capital Formation) 4,9 (3,7) 12,1 (9,1) Net Lending/ Borrowing 0,3 National government -0,3 Social Security 1,0 Regional government -0,3 Local authorities -0,1 Source: Servicio de Estudios del BE (2005) 4

5 Forecasting economic trends requires the prediction of these operations. Two types of fiscal variables to predict: 1. Exogenous: public investment, income from EU. Its estimation is made from aproved budget and official norms. 2. Endogenous: income taxes, unemployment benefits. Its estimation is obtained considering the elasticity of the operation with respect to macroeconomic variables by an iterative procedure: Step 1: forecast of macro variables Step 2: forecast of endogenous variables given macro and exogenous variables Step 3: Repeat 1-2 until convergente Elasticities for several fiscal operations Operation Macro Variables Elasticity Labour Income Tax (private sector) Employment, private sector 1,0 Compensations of Employees, private sector 1,5 Unemployment-related expenditures Number of unemployed 1,0 Source: Servicio de Estudios del BE (2005) 5

6 2 The Impact of Economic Activity on the Public Sector Balance The public balance (revenues expenditures) in part reflects fiscal policy: To analyze the consolidation of public finances, two adjustments seem necessary: structural balance: public balance discounting the effect of the cycle in the public balance. primary structural balance: structural balance excluding interest. Neither the cyclical component nor the payment of interest is related to the adoption of fiscal measures by the government. 6

7 How to estimate the cyclical component of the balance? Whit a two-stage procedure: 1. Estimation of the cycle (actual product - potential product) 2. The impact of the economic cycle on the components of the public deficit is computed by using previously estimated elasticities Operation Variable Macro Elasticity (estimate) Total Public Balance: Cyclical Component Output gap* 0.4 *Output gap = (GDP potential GDP) / potential GDP (%) in real terms. Source: Servicio de Estudios del BE (2005) An increase of GDP of 1% over potential GDP is associated with an improvement of the public balance of 0.4%. 7

8 The Public Sector Balance Decomposition PUBLIC BALANCE CHANGE ( (R-U)) 0,1 1,9 0,3 0,4 0,2 0,6-0,6 2,7 Due to in primary struct. Balance (a) -0,8 0,7-0,3 0,3 0,2 0,4-0,8 * 0,7 Due to changes in Revenues -0,7 0,4-0,2 0,2 0,8 0,1 0,2 2,5 Due to changes in Expenditures -0,1 0,4-0,1 0,1-0,6 0,3-1,0 * -0,8 Due to changes in Interest Payments 0,5 0,7 0,2 0,2 0,3 0,3 0,3 2,1 Due to Cycle Effects 0,5 0,4 0,3-0,1-0,3-0,1-0,2 0,0 Balance (revenues-expenditures) -3,0-1,2-0,9-0,5-0,3 0,3-0,3 Cyclical Component of Balance -0,1 0,3 0,6 0,5 0,2 0,0-0,1 Structural Balance -3,0-1,5-1,5-1,0-0,5 0,3-0,2 Primary Structural Balance 1,3 2,1 1,8 2,1 2,4 2,8 2,0 Annual Changes Primary Balance 1,2 2,4 2,4 2,6 2,6 2,8 1,9 Interest Payments 4,3 3,5 3,3 3,2 2,9 2,5 2,2 Real GDP 4,3 4,2 4,4 2,8 2,2 2,5 2,7 Output gap (b) -0,2 0,6 1,7 1,3 0,5 0,1 0,1 Source: Banco de España. a. A positive sign reflects a contractionary fiscal policy and an improvement of the primary structural balance. b. Output gap = (GDP potential GDP) / potential GDP (%) in real terms. * It includes the acceptance of RENFE s debt by the government (0.7% GDP) 8

9 From 1998 to 2004 the accumulated increase in the public balance was 2.7 percentage points of GDP. It was mostly the result of the financial load and of the variation of the primary structural balance. This implies a structural improvement in public finances. Revenues and expenditures had a similar impact. The cycle s contribution (initial expansion and soon contraction) was neutral. Therefore, since 2002, Spanish public finances fulfill the requirement of the Growth and Stability Pact: structural balances with a maximum deficit of 0.5% of the GDP. 9

10 Are these estimates consistent with the budgetary measures for the period? Resources: negative effects on resources from income tax reductions and freezing of special taxes; positive effects from no-indexation to inflation of tax brackets and income tax deductions. Uses: after an initial cut of primary current expenditure, increases in minimum wages and pensions. The decrease in income tax was compensated with a large increase in indirect taxes and social security contributions. Note that if these increases were fully the product of the decrease in the size of the underground economy, then they should not affect the structural balance. In this case, fiscal adjustment as reported here would be overstated. 10

11 3 The Impact of Fiscal Policy on Economic Activity Computation of synthetic indicators allows us to evaluate the direction of fiscal policy. o Fiscal Impulse: it is obtained as the difference between: current budgetary deficit budgetary deficit if ratio of fiscal income to GDP and ratio of fiscal expenses to potential GDP were those of a base year (a positive value is interpreted as an expansion of discretionary fiscal policy) o Change in the primary deficit adjusted to the business cycle: A positive value when GDP is below potential GDP reflects a countercyclical fiscal policy. Model simulations allow us to quantify the impact of fiscal policy. Predicted results with fiscal policy change are compared with predicted results without policy change. Results depend on model assumptions. 11

12 2003 income tax reform: a 1.5% reduction of the ex-ante income tax rate. At the same time: Public consumption and investment grew at high rates. Rates for indirect taxes and social contributions also increased. Conclusions drawn from synthetic indicators suggest a contractionary fiscal policy but, what was the real effect of the income tax reform? 12

13 The 2003 Income Tax Reform INDICATOR %PIB (2004) Fiscal Impulse -0,5 SIMULATION ( Accumulated Deviation from base scenario) Real Gross Disposable Income (households) 0,9 Final Consumption Expenditure (households) 0,8 Fixed Gross Capital Formation 0,5 Imports of Goods and Services 0,8 Exports of Goods and Services -0,0 Gross Domestic Output 0,4 Source: Servicio de Estudios del Banco de España (2005) The econometric model indicates that the reform caused positive indirect effects on economic activity in spite of the overall restrictive direction for the fiscal policy. 13

14 Let 4 Public Debt Sustainibility B t : Public Debt; PD t : Primary Deficit (Expenditure-Revenue-Interest Payments); IP t : Interest Payments Then: Bt = Bt 1 + ( PDt + IPt ) If r t is the real interest rate and π t is inflation then [(1 )(1 π ) 1 ] [(1 )(1 π )] Bt = Bt 1 + PDt + + rt + t Bt 1 = PDt + + rt + t Bt 1 Dividing both sides of the equation by nominal GDP: Bt PDt B = + + r t t + π t GDPt GDPt GDPt [(1 )(1 ) 1 ] 14

15 On the other hand: GDPt = [(1 + gt )(1 + πt )] GDPt 1 where g t is the GDP real growth rate. Substitution for this expression yields: Bt PDt (1 rt ) Bt 1 = + + GDPt GDPt (1 + gt ) GDPt 1 Defining: Bt PD b ; t t dt GDPt GDPt and after substracting b t-1 at both sides of the equation, we get the dynamic equation of debt: ( rt gt ) bt = dt + bt 1 (1 + g t ) 15

16 Public Debt Change (% GDP) 1992: : PUBLIC DEBT 59,9 61,3 56,2 48,9 Change in public debt: 5,2 2,2-2,5-2,5 b t Of which: Primary Deficit: d t 0,9 1,5-2,3-1,3 Interest-growth differential ( rt gt ) 1,7 1,9-1,0-1,9 b t 1 (1 + g t ) Ajustment 2,6-1,1 0,8 0,7 Source: Servicio de Estudios del Banco de España (2005) (The adjustment includes financial transactions and adjustments of valuation between the public deficit and the national debt) 16

17 Main features: During debt grows fast, mainly (80%) as a result of, first, differences between growth and interests rates and, second, positive growth in the value of financial assets in public sector balances. During national debt decreases as a consequence of the budgetary adjustment to fulfill the criteria for convergence (not shown) During national debt decreases mainly because of the decrease in the primary deficit and, to a lesser extent, by differences between growth and interest rates. 17

18 Is current national debt sustainable considering the aging of the population? It is not: Debt b t 50,8 81,5 Actual Primary Deficit d t -2,9 3,6 Real Interest Rate r t 1,7 2,6 Real Growth Rate g t 3,3 3,3 Sustainable Primary Deficit d 0,8* 2,5** Sustainabily Gap*** Spain d- d t 3,7-1,1 France d- d t -2,1 -- Germany d- d t -2,8 -- g * t r d = t b t g t ** Ratio of public balance on GDP that, if maintained constant with an aging population, it guarantees the long-term intertemporal budget constraint. *** A positive value reflects sustainable fiscal policy. Source: Servicio de Estudios del Banco de España (2005) 18

19 5 Evaluation of Public Interventions There are not many studies on the quality of public policies! Evidence of positive impact on growth of public investment in physical capital (mainly from infrastructure investment, although with decreasing marginal returns), expenditure on education, and R&D. Productivity of public companies smaller than that of private companies in the manufacturing sector (highly competitive), but not in the energy sector (highly regulated). Unemployment benefits decrease by half the rates of exit from unemployment. 19