The risk governments face nowadays is clear enough: absent a profound reengineering, inertial spending – owing to entitlements and civil-service wages – is bound to crowd out spending on new priorities and new policies. Fortunately, there are a few things governments can do to mitigate the effects.
PARIS – Since the financial crisis erupted in 2008, governments in advanced countries have been under significant pressure. In many countries, tax receipts abruptly collapsed when the economy contracted, income dwindled, and real-estate transactions came to a halt. The fall in tax revenues was in most cases sudden, deep, and lasting. Governments had no choice but to raise taxes or to adjust to leaner times.
In some countries, the magnitude of the shock was such that a large tax increase could not fill the gap. In Spain, despite tax hikes worth more than 4% of GDP since 2010, the tax-to-GDP ratio was only 38% in 2014, compared to 41% in 2007. In Greece, tax increases amounted to 13% of GDP during the same period, but the tax ratio increased by only six percentage points. Elsewhere, political limits to tax increases were reached before the gap could be filled. Willingly or not, priority is being given to spending cuts.
Disillusion about future growth adds to the pressure. The productivity record has generally been weak over the last few years, and this suggests that growth in the years ahead could be slower than previously expected. Revenue growth thus looks insufficient to match the surge in age-related public spending on health and pensions.