The Costs of Delaying fiscal Consolidation

Abstract

Since 2004, the fiscal deficit has been brought down by over 5% of GDP to below the 3% limit in 2006, which is a major achievement. The government plans a more gradual reduction over coming years so that overall balance or surplus is reached no later than 2010. However, fiscal consolidation should continue, possibly at a more rapid pace than planned, given the high level of government debt, favourable outlook for output growth, and long-term fiscal costs of ageing which are estimated to be among the largest in the OECD. There are as yet no specific proposals to reform pensions, which account for most of the prospective ageing-related increase in public expenditure, although the government is expected to announce reforms following the publication of a report from a Committee of Experts. Delaying fiscal consolidation, particularly the urgently needed pension reform, would have substantial longer-term costs in terms of higher taxes and additional debt service costs, including an increase in the risk premium paid on government debt. In addition, this would heavily skew the tax burden towards future generations. Consolidation should focus on reducing primary spending and on enhancing tax revenues. This can be achieved particularly through increased efficiency of public administration and by measures to tackle tax evasion and further broaden the tax base. Ensuring long-run fiscal sustainability will also require the implementation of wide-ranging reforms in the key area of health care, as well as an early decision to introduce a comprehensive reform of the pension system.