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1
Long-Term Budget Projections:
Can They Help GovernmentsAddress The Ageing Problem?
Presentation byBarry Anderson
At the2006 Meeting of the
OECD Asia Senior Budget Officials Network
Bangkok, Thailand December 14-15, 2006
2
Outline
Goals of Presentation Why do long-term projections? How are long-term projections prepared? How can long-term projections be used? An example of the use of long-term
projections
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Goals of Presentation
Increase your awareness of long-term budget projections as a mechanism to assess fiscal risks
Describe how long-term projections are made Describe how long-term projections can be
used Provide and discuss an example of their use
This presentation is based on OECD’s recent paper: “Assessing Fiscal Risks Through Long-Term Budget Projections” by Paal Ulla, which was presented at the 27th Annual Meeting of Senior Budget Officials held in June 2006 in Sydney.
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Why Do Long-Term Projections?
Addresses fiscal sustainability by identifying the long-term fiscal consequences of near-term political decisions
Promotes transparency by forcing the estimation of the costs and consequences of policy actions
Better quantifies significant fiscal risks—and thus helps plan for funding core functions—through use of sensitivity analysis
Allows for analyses of contingent liabilities and the potential costs of natural disasters
Most of all, unlike generational accounting & balance sheet analysis, it is relatively easy to understand & use
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How are long-term projections prepared?
Demographics Economics Current policy baseline
– Spending
• Age related
• Other mandatory
• Discretionary
• Contingent liabilities
– Revenues
– Debt service
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Demographic Projections
The most important are:– Life expectancy– Fertility rates– Net immigration
But demographic factors usually don’t change quickly, and immigration changes have to be huge to have much of an influence
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Economic Projections
The most important are:– Productivity– Labour market participation– Interest rates
As the future is unknowable, sensitivity analysis is particularly valuable
Use of past trends as possible indicators of the future can also be instructive
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Current Policy Baseline
A good starting point in that it permits displaying the potential costs of proposed legislation
Assumes current policies/laws are in place until/unless they expire under law
The major exception to this unchanged policy baseline is revenues—see below
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Age Related Spending
Public pensionsHealthLong-term careEducationUnemployment
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Other Spending Categories
Other mandatory– Usually done as a percentage of GDP
Discretionary– Usually done as a percentage of GDP
Contingent liabilities– Credit, especially insurance & loan guarantees– Government-owned enterprises– Public-Private Partnerships– Fiscal consequences of natural disasters
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Revenues
The unchanged policy scenario can be unrealistic here.– Even if kept constant in real terms, real
growth over the long run would eventually push the entire population to paying income taxes at the highest marginal rate.
So, an option is to keep the overall tax rate constant on household income.
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Debt Service
Base is determined by above calculations
Strongly influenced by interest rates
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How can long-term projections be used?
Sensitivity analyses on, for example:– Life expectancy– Immigration rates– Productivity growth– Size if the labour force– Pension reforms– Health care expenditures– Interest rates– Medium-term objectives
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Examples of the Time Frames Covered in Long-Term Projections
Projection Time Frame Covered
Australia 40 years
Canada 10 years
Denmark 10 years
Germany 45 years
New Zealand 45 years
Norway 55 years
United Kingdom 50 years
United States 75 years
European Commission 45 years
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An Example of the Use of Long-Term Projections
Based on a Special Policy Briefing before the Lisbon Council on the “Sustainability of Public Finances” by Joaquin Almunia, EC Commissioner for Economic and Monetary Affairs, Brussels, October 9, 2006. (http://www.lisboncouncil.net/index.php?option=com_content&task=view&id=32&Itemid=&lang=en)
See also “The Long-Term Sustainability of Public Finance in the European Union”, a report by the European Commission Services, October, 2006. (http://ec.europa.eu/economy_finance/publications/european_economy/2006/ee0406sustainability_en.htm)
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Population Pyramids for EU25
2004 2050
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Population Pyramid Summary for the UNITED STATES, 2004 & 2050
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Population Pyramid Summary for AUSTRALIA, 2004 & 2050
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Population Pyramid Summary for JAPAN, 2004 & 2050
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Population Pyramid Summary for THAILAND, 2004 & 2050
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Population Pyramid Summary for KOREA, 2004 & 2050
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Population Pyramid Summary for SINGAPORE, 2004 & 2050
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Population Pyramid Summary for INDIA, 2004 & 2050
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Population Pyramid Summary for CHINA, 2004 & 2050
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The EU Sustainability Gap* = 2¼% of GDP (*the gap between the structural budgetary position in 2005 and the 60% reference value used by the EC)
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Impact of Changes in Assumptions on the Sustainability Gap for the EUDemographic & Economic Assumptions % of GDP
Higher life expectancy, of which: .5
-pensions .2
-health care .2
-long-term care .1
Higher labour productivity -.3
Higher employment of older workers -.2
Higher employment if due to:
-an increase in the labour supply -.1
-a decrease in the NAIRU -.3
Higher interest rates .2
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Employment Rates Projected to Increase in the EU
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The Cost of Delay in Implementing Structural Government Balance by 2010
Selected Countries % of GDP
Portugal 1.4
Hungary 1.3
Germany .7
Italy .7
Luxembourg .7
France .6
Greece .6
United Kingdom .6
Czech Republic .4
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Average Exit Age from the Labour Market in 2004
Luxembourg 57.7
Poland 57.7
Slovak Republic 58.5
Austria 59.2
France 58.9
Belgium 59.4
Greece 59.5
Czech Republic 60.0
Finland 60.5
Hungary 60.5
Italy 61.0
Netherlands 61.1
Germany 61.3
Denmark 62.1
United Kingdom 62.1
Portugal 62.2
Spain 62.2
Ireland 62.8
Sweden 62.8
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The Benefits of Implementing Balance Budgets (MTO Scenario) by 2010
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Commissioner Almunia’s 3-prongedStrategy to Ensure Sustainability
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Commissioner Almunia’s Conclusions “The status quo is not sustainable and therefore not an option.” More movement towards structural balance in needed. “Growth potential needs to be improved by raising productivity and
employment and this means that Europe’s social models have to be adapted.”
“Structural reforms, notably in pensions, should improve government finances over the long-term and make Europe’s social models more sustainable.”
“Implementing the Lisbon strategy by fostering productivity, employment creation and adaptability of the economies is paramount, as it is the best way to increase economic growth and prosperity and contributes to fiscal sustainability.”
The “challenge is considerable, but manageable.” This is supported by the progress towards sustainability made by countries who have cut deficits and reformed pension systems.
“Our future is in our hands.”
33
My Observations There are no easy answers.
– Higher growth alone is not sufficient.– Higher productivity alone is not sufficient.– Higher population or labour force growth alone is not
sufficient—and mechanisms to induce greater labour force participation are not cheap or easy.
Higher taxes and/or higher debt can have serious detrimental effects.
Thus, benefit cuts must be part of a solution. The sooner a country begins, the easier it will be. For example,
the best way to prevent firing public employees in the future is not to hire them today.
Incorporating long-term projections into the annual budget process is worthwhile.