Fiscal Consolidation: Taking Stock of Success Factors, Impact, and Design

FiscalConsolidation: TakingStockofSuccessFactors,Impact,andDesign VybhaviBalasundharam,OlivierBasdevant,DalmacioBenicio,AndrewCeber,YujinKim,LucaMazzone,HodaSelim,andYongzhengYang WP/23/63 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate. TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. 2023 MAR ©2023InternationalMonetaryFundWP/23/63 IMFWorkingPaper FiscalAffairsDepartment FiscalConsolidation:TakingStockofSuccessFactors,Impact,andDesign PreparedbyVybhaviBalasundharam,OlivierBasdevant,DalmacioBenicio,AndrewCeber,YujinKim,LucaMazzone,HodaSelim,andYongzhengZhang AuthorizedfordistributionbyJamesDanielMarch2023 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. ABSTRACT:SurgesinpublicdebtinmanycountriessincetheCOVID-19pandemichaverekindledinterestinfiscalconsolidations,whichoftenentaildifficultpolicychoicesinthefaceofeconomicandpoliticalconstraints.Thispaperpresentsfindingsfromasurveyoftheliteratureonfiscalconsolidations,focusingonthepre-existingconditions,impactanddesignaspectsofpastconsolidationepisodes.Thesefindingsprovideinsightintofactorsthatinfluencethechanceofsuccessfulconsolidations,theirgrowthanddistributionalimpact,thepace,phasing,durationandpolicymixofreformstomitigatetheimpact,andtheroleoffiscalinstitutionsandcapacitydevelopmentinsuccessfulconsolidations. JELClassificationNumbers: E62,H2,H5,H6 Keywords: FiscalConsolidation;taxation;governmentspending;institutions Authors’E-MailAddresses: VBalasundharam@imf.org,OBasdevant@imf.org,DBenicio@imf.org,ACeber@imf.org,YKim9@imf.org,LMazzone@imf.org,HSelim@imf.org,YYang@imf.org *TheauthorswouldliketothankIMFcolleagueswhocommentedonearlierversionsofthepaperandthosewhoparticipatedinFundseminarsinSeptember2022andJanuary2023.SpecialthankstoJamesDanielandPaoloMauroforextensivecomments WORKINGPAPERS FiscalConsolidations:TakingStockoftheSuccessFactors,Impact,andDesign PreparedbyVybhaviBalasundharam,OlivierBasdevant,DalmacioBenicio,AndrewCeber,YujinKim,LucaMazzone,HodaSelim,andYongzhengYang Contents Introduction4 Pre-ExistingConditionsforSuccessfulFiscalConsolidations7 GrowthandDistributionalImpactsofFiscalConsolidations9 ApproachestoFiscalConsolidations18 PolicyImplications26 References28 BOXES 1.Self-DefeatingFiscalConsolidations10 2.Portugal:CushioningtheDistributionalandSocialImpactof2011-14FiscalConsolidation13 3.MethodologiesforEstimatingFiscalMultipliers17 4.RoleofClimatePoliciesinSupportingFiscalConsolidation22 5.ImpactofInflationonFiscalConsolidation23 TABLES 1.SummaryofKeyLiteratureFindingsonFiscalConsolidations5 2.SelectedMultiplierEstimates16 Glossary AEs AdvancedEconomies CD CapacityDevelopment IMF InternationalMonetaryFund FTE FiscalTransparencyEvaluation ECB EuropeanCentralBank EMs EmergingMarketEconomies ERM ExchangeRateMechanism IEO IndependentEvaluationOfficeoftheInternationalMonetaryFund LIDCs Low-IncomeDevelopingCountries OECD OrganisationforEconomicCo-operationandDevelopment PFM PublicFinancialManagement PEFA PublicExpenditureandFinancialAccountability PIMA PublicInvestmentManagementAssessment SDGs SustainableDevelopmentGoals TADAT TaxAdministrationDiagnosticAssessmentTool ZLB Zero-LowerBound Introduction UnprecedentedsurgesinpublicdebtinmanycountriessincetheCOVID-19pandemichaverekindledinterestinfiscalconsolidation.Althoughdebt-to-GDPratioshavedeclinedsomewhatinmanycountriesinthewakeofeconomicrecoveryandhigherthanexpectedinflationin2022,theyremainelevatedandabovepre-pandemiclevelsinmostcountries.Inthecomingyears,manycountrieswillneedtobringdownfiscaldeficitstorebuildfiscalspace,andforsome,thistaskisurgentastheircurrentpublicdebtlevelshavebecomeunsustainable.Infact,about60percentoflow-incomecountriesand30percentofemergingmarketeconomiesareathighriskoforalreadyindebtdistress(IMF,2022a).Moreover,manycountrieswillhavetoaddressmountingspendingpressuresoverthecomingyears,includingthosefrominfrastructureinvestment,climatechangemitigationandadaption,andageingpopulation,whichwillincreasespendingonpensionandhealthcare,especiallyinadvancedeconomies(AEs)andemergingmarketeconomies(EMs)(IMF,2022b).1Formanylow-incomedevelopingcountries(LIDCs),itisdauntingchallengetomeettheirsustainabledevelopmentgoals(SDGs)inthefaceofeconomicscarringcausedbythepandemicwhilekeepingtheirdebtatasustainablelevel. Fiscalconsolidationisacomplexundertakingandoftenentailsdifficultpolicychoicestoachievepolicyobjectives. Thefiscalconsolidationdebateisnotnewandhasinitiallyfocusedontheshort-termoutputimpact.Overtime,however,ithasevolvedtounderstandmorespecificaspectsofconsolidationdesign.Forexample,policymakershavetodecidehowmuchtheyhavetoreducethefiscaldeficit,whetherthedeficitreductionshouldcomefromraisingadditionalrevenueorcuttingexpenditur