Fiscal Consolidation Policies Research Articles

Regulating local government debt in China: Intended and unintended consequences

This study integrates institutional and empirical analyses to investigate the intricate policies that regulate local government debt in China. It finds that, within a remarkably short period, China has skilfully incorporated local government debt into the local budget management system, thereby transforming it from a mere transaction between local governments and credit agencies to an intergovernmental fiscal relations framework. The study also establishes that the pivotal debt-regulating policies are more geared towards prioritizing the cost of debt over its scale. Official documents, statistical data, and in-depth interviews provide evidence to support these findings. Drawing on an analysis of county-level panel data in Sichuan Province, this study identifies two main effects of these policies. Primarily, the cost of local general debt may trigger the notorious soft budget constraint, thereby incentivizing county-level governments to depend more heavily on superior transfer payments. Additionally, the fiscal consolidation policy, which focuses on the cost of local special debt, may lower the debt ratio. However, it also has the unintended consequence of bolstering the local government’s reliance on land finance.

Regulating local government debt within growth trade-offs: a case study of China’s fiscal consolidation policy

ABSTRACT Local government debt is integral to China’s fiscal framework. Faced with mounting debt risks, China’s central government launched an expansive fiscal consolidation in 2016. Drawing on in-depth interviews and a case study, our research reveals that this measure signifies China’s introduction of de facto fiscal regulations. These regulations have prompted local governments to navigate the complexities of growth objectives and fiscal mandates. Our findings suggest that traditional consolidation strategies are not always effective in the distinct local context of China. As a result, local budgets are increasingly dependent on revenues from land-transfer fees. Notably, the consolidation plan incorporates provisions that allow potential ‘loopholes’ for local authorities, potentially compromising its overall effectiveness. This study sheds light on the intricate dynamics of local debt management, the Plan’s stipulated measures, and the overarching economic context, offering insights into the fiscal challenges faced by China.

Fiscal Consolidation and Firm Growth in Developing Countries: Evidence from Firm-Level Data

Despite a longstanding debate around the economic effects of fiscal consolidation policies, relatively few studies have focused on developing countries, and even fewer have paid attention to the growth implications at firm level. Using a unique narrative dataset based on contemporaneous policy documents to identify changes in fiscal policy aimed at reducing the accumulation of public debt, we investigate the effects of fiscal consolidation on the growth of 118,279 firms in 98 developing countries from 2006 to 2018. The results indicate that a one percentage point increase in fiscal consolidation as a share of GDP leads, on average, to a decline in firm growth of 3.97 percentage points. This decline is reduced when consolidation is large. We also find that debt-driven consolidation based on tax hikes is more contractionary than that based on spending cuts, though this contractionary effect is mitigated when spending cuts exceed 1.5 percent of GDP. While the negative effect of fiscal consolidation on firm performance is more pronounced in large and non-exporting firms, the effect is not statistically important in low-debt-risk developing countries.

Business politicians and fiscal consolidation

AbstractWhat explains the variation in countries’ propensity to engage in austerity policy? Economic and political country-level factors are the paramount explanations in the literature. Nevertheless, variation in fiscal preferences at the executive level remains underexplored, except for ideology. Moreover, budget decisions are endogenous to the state of the economy, thus casting doubt on standard measures based on the debt and/or deficit ratio. This article contributes to the literature in two ways. First, I turn to the individual level of analysis and suggest that leaders with business experience are more likely to pursue a balanced budget and tend to implement fiscal consolidation policies based on spending cuts. Second, I ease concerns about individuals’ self-selection into office by relying on fiscal adjustments that are weakly orthogonal to the economic cycle. The statistical analysis of a panel of 17 OECD countries between 1978 and 2014 confirms the theoretical expectations. The results are robust to a variety of specification and statistical methodologies and hold for a subset of as-if random leadership transitions following close elections. A case study of Brian Mulroney's governments in Canada (1984–93) further illustrates the argument.

Fiscal Consolidation Strategy: Phased vs. Direct, Which is Better?

This research aims to examine the impact of fiscal consolidation on the US economy. Since COVID-19 caused the government to cut expenditures due to higher health and business incentive expenditures, fiscal consolidation is required. The analysis is divided into three parts. First, we assume that the decrease in government expenditure is accomplished in the first year. Second, we suppose that government expenditure is progressively reduced, by 0.25% in the first year, 0.50% in the second year, 0.75% in the third year, and 1% in the fourth year. The last scenario predicts that the rest of the globe will follow fiscal consolidation. Following the investigation, we can conclude that fiscal consolidation has a significant long-term influence on the economy. Even while real GDP is declining in the near term, reductions in government expenditure may enhance real GDP in the long run. Based on the comparison of the first and second scenarios, we can conclude that gradual fiscal consolidation is preferable since real GDP does not fall immediately in the first year. Furthermore, we know that the impact of fiscal consolidation in the third scenario is not as favourable as in the first and second scenarios regarding real GDP. As a result, we may assume that the fiscal consolidation policy will be less successful if other nations follow it.

Differential impacts of fiscal consolidation policies under alternative monetary regimes: evidence from Indian economy

The study tried to examine the effects of fiscal consolidation policies under alternative monetary stances in Indian economy. Using structurally adjusted vector autoregression (SVAR) we found that both Monetary and Fiscal-policies interact in cooperative as well as competing manner depending on the type and timing of shocks. Although fiscal policy enjoys a certain degree of superiority, the potency of monetary policy has not waned away. In terms of effectiveness, the study found that the fiscal policy is a better tool of economic stabilisation in the short run but in long and medium run it may harm growth. A consolidation program aimed at infusing fiscal prudence was found to have differential impacts on economic growth depending on whether such a policy is undertaken in an expansionary or contractionary monetary regime. Ironically the fiscal-policy was found to have more influence on inflation than monetary policy pointing towards the fiscal theory of price level; FTPL.

Differential impacts of fiscal consolidation policies under alternative monetary regimes: evidence from Indian economy

Differential impacts of fiscal consolidation policies under alternative monetary regimes: evidence from Indian economy

Threshold effects of public debt on economic growth in South Africa: an application of a regression kink with an unknown threshold

PurposeSouth African public debt has recently increased significantly and has reached worrying levels. This study aims to examine the debt threshold effects on economic growth in South Africa, with an objective of suggesting a debt threshold as South African policymakers will seek to reduce debt to a sustainable level in the coming years.Design/methodology/approachThe study applies a recent novel methodology advanced by Hansen (2017) that allows modelling a regression kink with an unknown threshold.FindingsThe findings of this study indicate a robust debt threshold of 37% of gross domestic product (GDP). Below this threshold, debt is growth-enhancing, but above 37% of GDP, debt is harmful to growth in South Africa.Practical implicationsAmong other things, to reduce the debt-to-GDP ratio, South Africa will need a fiscal consolidation policy by undertaking reforms to state-owned companies to reduce their reliance on public funds, as well as putting in place economic measures to boost long-term growth. The country should also improve tax collection in order to realize additional tax revenue through enhancing compliance and other revenue collection measures.Originality/valueMost of the existing studies on debt threshold effects in Africa are panel data studies, which assume parameter homogeneity, by determining a single debt threshold value applicable to all countries. This can be misleading as the debt-growth nexus is country-specific, being conditional on several factors, such as institutional quality. The present study applies a recent novel methodology, which allows to model a regression kink with an unknown threshold, for the case of South Africa. The methodology endogenously determines the debt threshold while also allowing a country-specific analysis.

The contribution of tax expenditure in fiscal consolidation in post-crisis economies: a case study of the context in Portugal

In this research, we analyse the use of fiscal expenditure as an instrument of fiscal consolidation policy. Portugal was subject to the financial assistance programme (PAEF) articulated with the IMF, the European Commission and the European Central Bank between 2010 and 2014. The objective is to analyse the evolution of fiscal expenditure in the following four years, after the end of that term programme, that is, between 2015-2018. The outcome is to know if the policy of reducing fiscal expenditure implemented in the years in which the programme was in force (2010-2014), continued into the following four years. We compared this evolution with the evolution of direct expenditure, based on two main axes: economic expenditure and social expenditure. The data collection technique is used through document research, and the data obtained was from information provided by national, European statistical authorities and secondary sources of information. It is concluded that, in the 2014-2018 period, the increase in public revenue, due to the decrease in tax expenditure, did not evolve consistently. In 2014-2018, direct public expenditure did not follow the same pattern as in the previous years of 2011-2014, given the functional equivalence of the two types of expenditure. Finally, to observe the relationship between the level of fiscal consolidation, carried out between the years 2010 and 2018, and the behaviour of tax revenue and expenditure, the Scheffé test was performed on the averages of the variables Total Revenue and Expenditure, and Tax Revenue and Expenditure. This was applied in order to observe if the averages of the variables are significantly relevant for the level of fiscal consolidation or if there are other variables, equally important, that were not taken into account in the study, but that had a preponderant role (such as the economic context). We have to statistically conclude that both the revenue and expenditure averages and the percentage averages are not all equal, as they are, in fact, all different between the groups analysed. In order to clarify if the differences in revenue and expenditure and in the respective percentages are statistically significant or if, on the contrary, they are merely eventual, we previously verified their applicability through the assumptions of normality and homoscedasticity of each of the data sets, using the ANOVA test (Fisher, 1918). We observed that for both the amounts of revenue and expenditure, as well as the percentages, the p-value observed in the ANOVA test was equal to 0.000 (i.e. less than 0.050), implying the rejection of the null hypotheses and the acceptance of the alternative hypotheses, according to which the average values of the amounts of revenue and expenditure, and the average values of the percentages are not all equal. The general conclusion is that there was budget consolidation, but this must have been due to other factors, such as the economic environment, since there is no direct relationship between revenue, fiscal expenditure and budget consolidation in any of the periods studied.

Austerity in the midst of a pandemic: Pursuing accountability through the socio-economic rights doctrine of non-retrogression

This article examines the potential of the socio-economic rights doctrine of non-retrogression to hold the state accountable for policies of fiscal consolidation (‘austerity measures’) in South Africa. These policies threaten to erode many programmes and institutions critical to the delivery of the socio-economic rights recognised in the Constitution. The article provides a contextual analysis of fiscal consolidation policies in South Africa both in the lead up to and during the Covid-19 pandemic. It examines the nature of the doctrine of non-retrogression in international human rights law, and considers how the doctrine could be translated into South Africa’s existing jurisprudential framework on socio-economic rights. It concludes by considering how the procedural and participatory dimensions of the non-retrogression doctrine can play an important role in alleviating the institutional tensions involved in the judicial review of retrogressive measures. Ultimately, the article seeks to demonstrate that the doctrine of non-retrogression provides a framework and set of principles that can advance greater accountability for rights-eroding budgetary decisions.

Public debt, sovereign spreads and the unpleasant arithmetic of fiscal consolidations

AbstractIn response to severe fiscal consolidation policies implemented after the Great Recession and the euro area sovereign debt crisis, many have questioned the effectiveness of fiscal consolidations in reducing the burden of public debt. This paper revisits this fundamental policy debate qualitatively and quantitatively, studying conditions under which primary budget balance changes can successfully reduce government debt‐to‐GDP ratios. We first illustrate these conditions through a partial equilibrium setting. We then investigate the conditions quantitatively using a medium‐scale New Keynesian DSGE model calibrated on periphery countries of the euro area. The analysis highlights the critical role of sovereign spreads in driving the debt‐to‐GDP dynamics following a restrictive primary balance shock. Fiscal consolidations turn out to successfully reduce the debt‐to‐GDP even for fairly low elasticities of spreads to fiscal variables. However, their effectiveness is quantitatively moderate and varies crucially with the initial spread level, with the degree of monetary policy accommodation, and with the responsiveness of market investors to economic fundamentals.

Are EU Policies Effective to Tackle the Covid-19 Crisis? The Case of Italy

ABSTRACT In response to the economic crisis unleashed by the Covid-19 pandemic, the EU authorities have launched extraordinary fiscal and monetary measures in support of member states. The impact of these measures is of great significance for Italy, the EU third-largest economy, which as a result of the pandemic has suffered a dramatic decline in GDP, and a further rise in the government debt to GDP ratio. Building on a stock-flow consistent, structural macro-econometric model, this paper shows that the currently planned EU measures are insufficient to boost the recovery of the Italian economy, and to ensure the sustainability of its government debt. The paper also assesses two potential alternative policies. A fiscal consolidation (i.e. austerity) policy would exacerbate the decline in GDP and further deteriorate the government debt to GDP ratio. By contrast, a money-financed fiscal stimulus policy could lead the Italian economy on a path of sustainable growth, with positive outcomes for employment and government finances.

Introducing a Safety Net: The Effects of Neoliberal Policy on Welfare, Poverty, and the Net Social Wage during the Greek Crisis

The combined effects of internal devaluation and fiscal consolidation policies implemented in Greece between 2010 and 2019 are reflected in substantial levels of income contraction and unequal distribution of the financial burden. Neoliberal policy responses are examined through a safety net that allocates scarce fiscal resources to persons in extreme need, subject to high primary budget surplus targets. The safety net operates in this manner when social pressure upon the worker class intensifies. Further, the essay explores two supplementary aspects. First, a modified measure of poverty using the conventional approach of differentiated income poverty lines is considered. Second, net social wage variations are examined. Results indicate Greek workers have suffered substantially and that neoliberal policies have placed disproportionate burdens on persons most in need.

Fiscal Consolidation Programs and Income Inequality

Following the Great Recession, many European countries implemented fiscal consolidation policies aimed at reducing government debt. Using three independent data sources and three different empirical approaches, we document a strong positive relationship between higher income inequality and stronger recessive impacts of fiscal consolidation programs across time and place. To explain this finding, we develop a life-cycle, overlapping generations economy with uninsurable labor market risk. We calibrate our model to match key characteristics of a number of European economies, including the distribution of wages and wealth, social security, taxes and debt, and study the effects of fiscal consolidation programs. We find that higher income risk induces precautionary savings behavior, which decreases the proportion of credit-constrained agents in the economy. Credit-constrained agents have less elastic labor supply responses to fiscal consolidation achieved through either tax hikes or public spending cuts, and this explains the relationship between income inequality and the impact of fiscal consolidation programs. Combining micro- and macro data, we find evidence of the mechanism.

The Impact of Globalization and International Tax Competition on Tax Policies

The aim of the paper is to determine to what extent the strengthening of the transparency of the Ukrainian economy and its incorporation in international tax competition affects the tax policy of the country and the peculiarities of its tax system. In the study, the logical analysis of the direct and inverse relationship of changes in taxation with such manifestations of globalization, as the movement of capital and labor resources from Ukraine and to the country, is combined with an empirical (regression) analysis of the relationship between globalization and the main characteristics of the Ukrainian tax system. It is proved that the increase of incorporation of Ukraine in globalization processes, despite the reduction of taxes on the main factors of production, is accompanied by an increase in the general level of tax burden on the economy (tax rate). The above mentioned is a consequence of increase of other taxes, including excise, caused both by internal needs of Ukraine (conducting the policy of fiscal consolidation caused by large public debt, and increasing defense expenditures) and its international obligations (EU Association Agreement). The tax system in Ukraine is much stronger (about 25%) influenced by the general index of globalization in comparison with its subindex characterizing the economic component of globalization. Obviously, this is owing to the greater influence on taxation in Ukraine of other components of globalization such as political and social one. The results show that the growth of the globalization index is accompanied by rather expected effects such as reduction of corporate profit tax rates and personal income tax, transferring the tax burden from capital to labor and, to a greater extent, on consumption, improving business conditions in the context of tax payments, and specific increase in the general level of tax burden on the economy, significant losses of the state that is not so much from the reduction of tax rates as from the erosion of the tax base on income, which is the result of a combination of negative effects of external and internal factors; the threat of escalating the policy of low tax rates. It is recommended to the Ukrainian Government to focus increasingly on the tax evolution trends in post-socialist EU countries to strengthen Ukraine`s position in tax competition with this group of countries.

Air pollution and public finance: evidence for European countries

PurposeThe purpose of this paper is to investigate whether a statistically significant relationship exists between environmental quality, as measured by consumption-related air pollution, and public debt in Europe. In addition, since the debt burden is one of the most important indicators of fiscal soundness within the European Union (EU) Treaty and the subsequent fiscal compact, the authors propose a simple test to determine whether participation in EU Treaties has shaped the empirical relationship between fiscal policy/public debt and environmental performance.Design/methodology/approachTo this end, the authors built a panel data set that covers 24 European countries over the period 1996–2015.FindingsThe aspect that the authors want to underline is a possible trade off, which is confirmed in the empirical analysis, between the public finance equilibrium and the maintenance of a public good such as air quality. However, there are important non-linearities that shape the interaction between public debt and environmental pollution. Similarly, threshold effects arise when the authors examine the interaction between EU regulation and public debt and when the authors separately examine high debt and low debt countries. When the authors account for the stabilization rules introduced by EU Treaties, a negative effect on pollution is evident; in this way, fiscal consolidation limits the positive effect of fiscal policy.Practical implicationsThe results point out the existence of a potential trade-off between the role of EU as a regulator aiming to mitigate environmental pollution, and its role within the Stability and Growth Pact. The analysis highlights that fiscal consolidation policies, while facilitating the achievement of macroeconomic stability within EU, might have a negative side effect on the environment quality, which spreads beyond the borders of one single country.Originality/valueWhile a number of studies have suggested that fiscal spending might contribute to the level of pollution in European countries, there is scant evidence of the effect of public debt on environmental performance. This lack of scientific knowledge is a serious shortcoming, since it may allow for an underrepresentation of the wide-ranging consequences of stabilization programmes targeting the debt-to-GDP ratio, which could affect environmental quality.

Public Debt Consolidation and its Distributional Effects

We build a dynamic general equilibrium model with heterogeneous households, namely Rich and Poor, and capital–skill complementarity structure in the production function, to study aggregate and distributional implications of fiscal consolidation policies when the government uses a rich set of spending and tax instruments. Fiscal policy is conducted through constrained optimized fiscal rules. Our results show that, in the long run, fiscal consolidation enhances both aggregate efficiency and equity; however, it may hurt Rich households depending on which fiscal instrument takes advantage of the fiscal space created. Along the transition, wage inequality significantly increases due to the capital–skill complementarity structure of the production function. Specifically, this happens because debt consolidation crowds in capital and this favors Rich (skilled) households. On the other hand, the reduction in interest rates and government bonds lead to a decrease in Rich households’ income coming from capital and government bonds which eventually decrease income inequality. Finally, a rather novel finding is that the combination of asset and skill heterogeneity amplifies the increase in wage inequality in the early phase of fiscal consolidation.

THE POLICY OF FINANCIAL CONSOLIDATION AND ECONOMIC DEVELOPMENT IN THE FACE OF EXTERNAL SHOCKS

Topic . The article discusses the policy of progressive fiscal consolidation carried out in developed countries and in Russia. There is also a characteristic of fiscal policy in Russia. Purpose. We aim to identify the actual effects of the policy of financial consolidation in terms of a tight dependence on the cyclical development of the world economy. Methodology. We used the methodology of macroeconomic analysis, systemic approach, statistical methods (cluster analysis), and methods of mathematical statistics and econometrics. Results . The rising debt of the developed countries in conditions of chronic budget deficit actualized the task of fiscal consolidation. Initially, the idea of fiscal consolidation was to implement a progressive consolidation, i. e. the reduction of budget expenditures, which would contribute to the formation of the financial potential. In turn, the financial potential is realized in the form of a budget surplus that could be used to reduce the tax burden and rise of spending in the future. Literature indicates on the effect of reproduction of the austerity measures due to changes in budget institutions; it limits the ability to stimulate the economy through measures of fiscal policy. Thus, the approach to the implementation of fiscal policy is offset, in the direction of tightening. The analysis of fiscal policy in Russia since the late 1990s does not allow concluding that its character corresponds to the ideas of progressive fiscal consolidation. Despite the creation of a significant budget surplus in times of boom, it practically was not used for the task of stimulating economic development. Conclusions . The policy of fiscal consolidation, ongoing in Russia, primarily aimed at solving a narrow range of budget issues and is not intended for the future to stimulate the economy.

The (Intertemporal) Equity-Efficiency Trade-Off of Fiscal Consolidation

We build a dynamic general equilibrium model with heterogeneous households and capital-skill complementarity in the production function to study aggregate and distributional effects of fiscal consolidation policies when government uses a rich set of productivity-enhancing spending instruments along with utility-enhancing spending and tax fiscal instruments. Fiscal policy is conducted through simple fiscal rules. We study both ad-hoc and optimized fiscal rules. Our main results indicate that ad-hoc fiscal consolidation policies, either through spending cuts or tax increases, are recessionary and entail an equity-efficiency trade-off in the short- and medium-run. That is spending-based consolidation policies are less recessionary but come at a higher distributional cost; whereas tax-based consolidation policies result in sharper output losses but have smoother distributional effects. In addition, fiscal consolidation policies through optimized fiscal rules can be expansionary and social welfare enhancing while at the same time balance the equity-efficiency trade-off.

Fiscal Policy Effects in Ukraine

This paper empirically analyses fiscal policy effects in Ukraine using different identification strategies within the framework of a vector error correction model (VECM). For quarterly data from 2001 to 2016, we find a robust positive impact of both government expenditure and net revenue upon output in Ukraine, which closely corresponds with the predictions of the Mankiw-Summers model in the case of high demand for money in relation to consumption expenditure combined with significant investment elasticity in relation to the interest rate. In other respects, the fiscal policy transmission mechanism exhibits several standard features (such as an increase in government expenditure after a positive shock to revenue or a widening of the budget deficit following an interest rate hike). The results suggest the feasibility of revenue-based fiscal consolidation policies in Ukraine, as better tax collection may contribute to economic growth even in the short run. Since there is a robust conventional inverse relationship between interest rate and output, one of the puzzling results is that government expenditure puts downward pressure on the former, with net revenues being neutral in this respect. Real exchange rate (RER) depreciation is behind the decrease in output in the baseline model, but alternative identification schemes suggest that it is likely to be contractionary in the short run while turning expansionary in the long run.