Long-Term Fiscal Sustainability

On 8 July 2015, Alan J. Auerbach, Robert D. Burch Professor of Economics and Law and Director of the Burch Center for Tax Policy and Public Finance, gave a SAFE Policy Center Lecture on “Long-Term Fiscal Sustainability in Advanced Economies”. The lecture was moderated by Alexander Ludwig, SAFE Professor of Public Finance and Debt Management.

At the start of his lecture, Auerbach stated that, after the global financial crisis, many leading economies were struggling to regain adequate levels of economic growth and that large budget deficits left them with much larger overall debt levels. He went on to argue, that fiscal pressures, however, do not only result from higher debt-to-GDP ratios, but also from demographic change and the rising costs of age-related social insurance. The focus on how to manage the short-term debt burden may help to avoid crises like the one being played out in Greece at the moment. However, attention and policy actions must eventually turn to the longer-term fiscal problems.

According to Auerbach, key long-term fiscal problems in many societies stem from unfunded pension and health care commitments. Auerbach showed old-age dependency ratios for different countries for the years 2015 and 2050. For 2050, the projected ratios are much higher compared to 2015 which means that the burden on the productive part of the population, to pay for the pensions of those retired, will increase dramatically. This is particularly the case for Japan, where birth rates are very low and life expectancy is high. Other countries, such as the U.S., are better off because of higher immigration rates. Furthermore, the U.S. benefit from the fact that the U.S. Dollar is used as the global reserve currency.

In order to assess the long-term fiscal sustainability of a country, Auerbach uses measures of a country’s fiscal gap which determines how much primary deficits have to be reduced annually to achieve some target debt-to-GDP ratio at the end of a period. The fiscal gap is composed of past, current and future deficits, with the future deficits being subject to certain assumptions about economic growth, interest rates, government revenues and primary spending. Auerbach presented fiscal gap calculations for different countries until 2060. According to these, the country which is the most sustainable, in terms of long-term fiscal health, is Norway whose fiscal gap is even negative which means that the country will not have any problem with budget deficits until 2060 but rather has room for more government spending. In contrast, the U.S. have a very high fiscal gap for which Auerbach blames the massive health care costs.

Auerbach conceded that fiscal gap analyses are highly sensitive to underlying assumptions. He argues for communicating the uncertainties involved, while, nevertheless, making use of this essential tool to understand long term societal challenges and frame policy answers to these.