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IP/00/1537
Brussels, 21 December 2000
Commission calls on Member States to improve
quality and sustainability of their public finances
In preparation for the Stockholm European Council the Commission
approved today a Communication on the contribution of public finances to
growth and employment. Accounting for between 40% and 50% of GDP in the
Union, public finances play a key role in the realisation of the Lisbon
strategic objectives. According to Pedro Solbes, EU Commissioner for
Economic and Monetary Affairs, “improving the quality and sustainability of
our public finances while at the same time maintaining tight fiscal discipline
is the natural way forward now that fiscal consolidation in the Union is on the
right track”. The Communication identifies four main challenges: (i) the need
to maintain strong fiscal discipline; (ii) the need to accelerate progress
towards more employment friendly tax and benefit systems; (iii) the need to
re-orient public expenditure to areas promoting a knowledge-driven economy
and (iv) the need to ensure healthy public finances over the long term and
take account of the implications of ageing.
The Lisbon European Council last March established as a strategic goal for the EU
“to become the most competitive and dynamic knowledge-based economy in the
world”. Accounting for between 40% and 50% of GDP, public finances have a critical
role to play in the realisation of this goal. The Lisbon European Council called up the
Commission and Council to present a report to the Spring 2001 European Council
assessing the contribution of public finances to growth and employment. In particular
the report should assess whether, on the basis of comparable data and indicators,
adequate concrete measures are being taken in order to:
- alleviate the tax pressure on labour, especially on the relatively unskilled and
low-paidand improve the employment and training incentive effects of tax and
benefit systems;
- redirect public expenditure towards actions increasing the relative importance of
capital accumulation – both physical and human – and support research and
development, innovation and information technologies;
- ensure the long-term sustainability of public financesby examining the different
dimensions involved, including the impact of ageing populations.
The Commission Communication will serve as the basis for the joint CommissionCouncil (Ecofin) report on the same subject to be established early next year. While
recognising that the impact of public finances on the real economy is multiple and
complex, public finances enhance potential growth and employment via the
accumulation of productive factors (e.g. investment in physical and human capital),
by providing the right incentives through tax and benefit systems, and by ensuring a
stable macroeconomic environment.
The Communication identifies four main challenges to ensure that public finances
maximise their contribution to growth and employment.
A first key challenge is to maintain strong fiscal discipline in EMU. Recent
budgetary developments indicate that the EU is on the right track. The Stability and
Growth Pact (SGP) goal of “close to balance or in surplus” is within reach and public
debt is on a steady downward path. At the same time, reforms are being introduced
to lower the tax burden from historically high levels. However, the picture is not
altogether favourable, as there is emerging evidence of a pro-cyclical loosening of
the budgetary stance at a time when the output gap is turning positive in most
Member States. The Communication outlines four criteria for assessing whether tax
cuts can achieve a sustainable reduction in the tax burden and at the same time
contribute to growth and employment. They are: (1) Member States must meet or
make progress to the medium-term budget target of ‘close-to-balance or in surplus’;
(2) reforms should take into account the cyclical position and must not be procyclical; (3) account must be taken of the level of government debt and long-term
budget sustainability; and (4) tax reductions should form part of a comprehensive
reform package. On the basis of these four criteria, it appears that recent tax cuts in
many countries should be matched with further reductions in government
expenditure so as to achieve a sustainable reduction in the tax burden. The
Commission invites Member States to examine the merits of the criteria for
assessing tax cuts and asks for their implementation as part of the budgetary
surveillance process at EU level.
A second challenge is to accelerate progress towards more employment-friendly
tax and benefit systems. Tax reforms in recent years have focussed on the need to
reduce the burden on labour, which increased by one-third in the past 30 years.
Overall, progress has been made towards making tax systems more employmentfriendly, by lowering the fiscal burden on labour. However, unequal progress has
been made across Member States, and overall labour taxation in many Member
States remains very high by international standards. Insufficient progress has also
been made towards reforming benefit systems. Changes in net replacement rates
have been relatively small, while only few Member States have developed in-work
benefits to boost earnings of low-paid workers. Progress has been made in the shift
from passive to active measures but, according to the Commission, significant further
efforts are needed.
Assessing the contribution of public finances to a knowledge-driven economy
is timely given the ongoing debate on the “new economy”. However, only limited
information was available about concrete measures taken by Member States, and
consequently, the Communication only partly responds to the mandate of the Lisbon
Council. Despite the lack of information, some tentative policy conclusions can be
drawn. Some progress has been made towards increasing investment necessary to
facilitate the development of the information society, but greater efforts are required.
Governments must also put more emphasis on education and training in order to
equip European citizens with the necessary skills for an information society, while
promoting the involvement of the private sector on innovation and R&D activities.
Such efforts have to be made in a framework of sound fiscal policies with the
increase in capital accumulation being financed through expenditure restructuring
and not via an increase in overall public spending. Furthermore, restructuring of
public spending should be complemented by institutional and structural reforms that
enhance the role of market mechanisms and introduce adequate incentive systems
to promote private accumulation of physical and human capital. What counts in the
end for economic growth is not public accumulation of productive factors per se but
total (public and private) factor accumulation.
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An increase in public investment will have limited or even negative effects on growth
if it crowds out private investment. Further analysis as well as better information will
be required in this area and Member States should increase the information
available.
A final challenge is to ensure the long-term sustainability of public finances. The
old age dependency ratio for the EU (population over 65 as a percentage of working
age population aged between 20 and 64) will rapidly increase from 27% in 2000 to
over 50% in 2050. Projections provided by a recent study conducted by the
Economic Policy Committee where the European Commission is a member show
that ageing populations could lead to increased pension expenditure of between 3
and 5 percentage points of GDP in most Member States. Given that spending on
health care is also expected to rise substantially due to ageing populations, the EU is
facing a major challenge as regards the sustainability of public finances, which will
be most acute in countries having a large stock of public debt and that finance their
pension systems on pay-as-you-go (PAYG) basis.
A comprehensive approach is needed to address the budgetary implications of
ageing. Firstly, Member States should pursue fiscal consolidation and reduce public
debt levels at a faster pace: this will lower the future interest burden, and thus partly
offset increased public spending on pension and health care. Secondly, labour
market reforms are needed to increase employment rates, especially amongst
women and older workers. In addition to limiting access to early retirement schemes,
the tax and benefit provide positive incentives for older workers to stay in the labour
market. Thirdly, in many Member States further reforms to public pensions systems
are needed to ensure greater actuarial fairness between contribution and
entitlements, and funded pension provision will be expected to play a greater role.
The EU can play a constructive role in helping Member States address the
budgetary consequences of ageing populations. The Commission will support efforts
to extend long-term expenditure projections to cover health care and long-term care
for the elderly. Member States should fully incorporate long-term budgetary
sustainability aspects into their stability and convergence programmes. Finally, the
Commission will examine the possibility of establishing, in cooperation with Member
States, a European Longitudinal Ageing Survey, with a view to assisting countries in
the design of public policies that cater for the changing needs of an ageing
population.
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