ASSESSING FISCAL RISKS THROUGH
LONG-TERM BUDGET PROJECTIONS
Paal Ulla
Budgeting & Public Expenditures Division
Public Governance & Territorial Development
Directorate (GOV)
Sydney, Australia, June 2006
1
Why long-term projections?
Reasons for stronger emphasis on long-term
projections:
 Macroeconomic stability; stabilization supported by
monetary policy
 Planning on the core functions of the public sector
 Efficient use of public resources
 Transparency is needed in a globalized financial
market
 Fiscal sustainability
2
Is there a need for worry…
Income will be doubled in the next 40 years, so?
Yes, there is a need for worry:
 It is the demographic structure not the income level,
that creates the problems.
 Higher tax rates may reduce the incentives to work
even with higher income.
 It will take time to adapt to the demographic changes,
which give a need for lower public employment.
 These challenges will appear in 5-10 years.
3
Alternatives for growth in total factor
productivity
A. Real income per capita, 1000 NOK
1200
1000
1200
Reference
High growth
Low growth
1000
800
600
600
400
400
200
0
0
2010 2020 2030 2040 2050 2060
Source: Ministry of Finance, Norway
18
15
12
800
200
A. Net lending public sector
9
18
15
Ref. 1.44%
High 1.90 %
12
Low 1.00 %
9
6
6
3
3
0
0
-3
-3
-6
-6
2010 2020 2030 2040 2050 2060
4
Issues Addressed
How to produce long-term
projections?
 What are the uncertainties?
 What to learn from long-term
projections to secure sustainability
and avoid fiscal risks?

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Sustainability


Debt sustainability: when a borrower is
expected to be able to continue servicing
debt without large changes to the revenues
and/or spending
However, economic theory does not indicate
the maximum level of debt (or taxation)
– You do not know if you are in an unsustainable position until
you are there.

Fiscal risks are best met by fiscal
sustainability
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Long-term revenues projections



Purpose: to get a realistic view of available resources
Growth in taxation based on GDP
Growth adjusted for
– Income tax on transfers from public sector to households
such as pensions
– Capital income rise at the expense of labour income, fringe
benefits, tax exemptions
– Wealth-based taxation, quantity-based excises
7
Long-term expenditure projections


Discretionary spending
Mandatory spending

Reserves for new programmes
One-off expenditures

Interest payments

8
Projecting present expenditures
Demographic forecasts
Discretionary spending
 Mandatory spending

9
Unknown future expenditures
Reserves for new programmes
 One-off expenditures

10
Sources of uncertainty
Economic assumptions






Macroeconomic long-term modelling
Demographic assumptions
Labour market participation
Productivity
Specification of programmes for public revenues and
expenditures
Interest rates
11
Macroeconomic long-term modelling
Equilibrium in the long run
 When will we reach equilibrium?

12
Demographic assumptions
Fertility rates
 Immigration
 Life expectancy

13
Labour market participation

Labour market participation depends
on:
– Age and gender
– Cultural factors
– Future income

Pension reforms as a solution?
14
Productivity

Little gain in nominal spending because real
wages increase in the public sector

There may be some gain for the public
sector:
– Productivity in the public sector may reduce public
employment
– Productivity in the private sector may reduce the
prices on goods and services
15
Main uncertainties in the projections
Main
 Demographics, life expectancy
 Labour market participation rates
 Productivity, pension reforms
 Interest rates
 Fertility rates in the even longer run
16
Time horizon



Cover the problems and the solution; baby
boomers indicate at least a time horizon of
40-50 years
Will there be a constant increase in
expenditure?
The uncertainties in the demographics
increase because accumulated increased
longevity and projections include fertility rates
not yet observed
17
Projections in some countries
United Kingdom
50-year projection included in the yearly pre-budget
documents in December
United States
75-year projection in the yearly budget proposal
Australia
Productivity Commission Research Report gives
projections to 2044-45
New Zealand
Will present their first report in June 2006
Norway
Special report in 2004 with projections to 2060
Germany
First report in June 2005 gives projections to 2050
European Union
European Commission and Economic Policy
Committee’s report in February 2006 gives projections
up to 2050
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What do long-term projections tell us so
far?




Many countries will have to raise taxes even if
they reduce spending
The growth in the total expenditure must be
curbed: pension and health care reforms
There will be a shortage of labour, capital
deepening of public sector may be needed
Debt has to be reduced in some countries
otherwise they will need a primary surplus to
avoid rising debt
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How to avoid fiscal risks in the future
Handling uncertainty
 Incorporating long-term considerations into
the yearly budget process
 Specifying public expenditure programmes
 Shifting uncertainty to the private sector
 Reducing the debt (interest payments)
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Important documents





Projecting OECD Health and Long-Term Care Expenditures: What are
the Main Drivers (OECD 2006, ECO/WKP(2006)5)
Joaquim Oliveira Martins, Frederic Gonand, Pablo Antolin, Christine de
la Maisonneuve, Kwang-Yeol Yoo: The Impact of Aging on Demand,
Factor Markets and Growth (OECD Economic Working Papers No.
420, ECO/WKP(2005)7)
Jean-Marc Burniaux, Romain Duval and Florence Jaumotte; Coping
with Ageing : A Dynamic Approach to Quantify the Impact of Alternative
Policy Options on Future Labour Supply in OECD Countries, ( OECD
Economic Department Working Papers No 371, 21. June 2004)
Working Party No. 1 on Macroeconomic and Structural Policy Analysis,
Labour Force Participation of Groups at the Margin of the Labour
Market: Past and Future Trends and Policy Challenges, (OECD
ECO/CPE/WP1(2003)8, 22. September 2003) (Includes 3 annex.)
Economic Policy Committee, European Commission; The impact of
aging on public expenditure: projections for the EU25 Member States
on pensions, health care, long-term care, education and unemployment
transfers (2004-2050) (Special Report No 1/2006, DG ECFIN, Brussels,
14 February 2006)
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