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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

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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.”

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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.