The IMF’s Fiscal Monitor released on Friday should be troubling to us Americans for what it says about the required adjustments we’ll have to make to get to sustainable levels of public debt–because it puts us in the same category as Greece. From page 32 in the report:
26. The extent of fiscal adjustment required to achieve certain debt targets varies significantly across advanced economies.
The adjustment is highest—close to or above 10 percent of GDP in the baseline scenario described above—in countries with high initial CA primary deficit and debt levels (Greece, Ireland, Japan, Spain, the United Kingdom, and the United States) (Figure 13 and Appendix 2).
…and yet the report also explains why the U.S. will find such a large adjustment especially difficult to achieve given our projected age-related spending needs. From page 36, where Figure 14 shows the U.S. as the top-rightmost data point in a graph that plots the required fiscal adjustment against projected age-related spending increases:
29. The fiscal adjustment described above will be made more challenging by the spending pressures that will arise in the decades ahead, particularly in advanced economies.
The adjustments discussed above do not take into account those needed to offset the spending pressures already in train due to population aging and other spending trend increases. In particular, for several countries, total adjustment required goes well beyond the net improvement needed in the primary balance, as measures will also be required to offset higher health and pension spending (let alone pressures arising from global warming). On average, spending increases in health and pensions are projected at 4 to 5 percentage points of GDP in advanced economies over the next 20 years (see IMF 2010c). The relative position across countries along these two dimensions—the needed change in the primary balance to lower public debt below 60 percent of GDP for advanced economies, and the increase in spending pressures for pensions and health—is illustrated in Figure 14. Countries with adjustment requirements clearly above the (simple) averages in both dimensions—those located far in the upper right quadrant—include the United States, Spain, the United Kingdom, France, and the Netherlands.
That’s why the IMF report also explains that although the challenges are created by pressures on the spending side of the federal budget, “achieving large fiscal adjustments will require a variety of measures”–and they examine a variety of specific revenue measures (VAT, excise tax increases, and carbon fees/taxes–as shown in Table 11 on page 47) that for the U.S. could contribute a total of over 6 percent of GDP, or just about half the 12 percent of GDP adjustment needed over the next couple decades to stabilize debt/GDP to around 60 percent. That doesn’t even include any possible base broadening of the current federal income tax.
Their point being that age-related spending may be driving most of the longer-term problem but it can’t be all of the solution, because it’s doubtful we could damp down such spending enough, and even if we theoretically could, would we really want to (as a compassionate society)? On the other hand, there are a lot of ways to raise revenue in a socially-optimal, economically-efficient way–by as they put it “strengthening broad-based taxes on relatively immobile bases and increasing externality-reducing taxes” (pg. 45).
And if we don’t take advantage of the luxury of having adjustments like these available for us to make gradually over the next couple decades, we may be forced instead to make that huge adjustment suddenly. And then suddenly we may look a lot more like Greece.
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