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Restoring Fiscal Sustainability in the Euro Area Raise Taxes or Curb Spending?

Cournède, Boris; Gonand, Frédéric (2006-10), Restoring Fiscal Sustainability in the Euro Area Raise Taxes or Curb Spending?. https://basepub.dauphine.fr/handle/123456789/11047

Type
Document de travail / Working paper
External document link
http://dx.doi.org/10.1787/414711615127
Date
2006-10
Publisher
OCDE
Series title
OECD Economics Department Working Papers
Series number
520
Published in
Paris
Pages
39
Metadata
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Author(s)
Cournède, Boris
Gonand, Frédéric
Abstract (EN)
With population ageing, fiscal consolidation has become of paramount importance for euro area countries. Consolidation can be pursued in various ways, with different effects on potential growth, which itself will be dragged down by ageing. A dynamic general equilibrium model with overlapping generations and a public finance block (including a pay-as-you-go pension regime, a health care system, non ageingrelated public spending and a stock of debt to be repaid) is used to compare the macroeconomic impact of four scenarios: a) increasing taxes to finance unchanged pensions and repay public debt, b) lowering future pension replacement rates and repaying public debt through a lower ratio of non ageing-related outlays to GDP, c) raising the retirement age by 1.25 years per decade and increasing taxes only to pay off debt, and d) increasing the retirement age by 1.25 years per decade and paying off debt through a lower ratio of non ageing-related expenditure to GDP. This last scenario is the one where growth is strongest: with gradual increases in the retirement age and spending restraint, average GDP growth in the 2010s would be 0.34 percentage point stronger than in a scenario where fiscal consolidation is achieved exclusively through tax hikes. The appropriate conclusion from the model is not that public spending is bad per se, but that cuts to lower-priority spending items can deliver surprisingly large income gains compared with the alternative of raising taxes.
Subjects / Keywords
Public debt; potential growth; fiscal consolidation; ageing; general equilibrium; euro area; fiscal sustainability; public expenditure
JEL
D58 - Computable and Other Applied General Equilibrium Models
E27 - Forecasting and Simulation: Models and Applications
E60 - General
H55 - Social Security and Public Pensions
H63 - Debt; Debt Management; Sovereign Debt
J11 - Demographic Trends, Macroeconomic Effects, and Forecasts

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