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CESifo / LBI Conference on
Sustainability of Public Debt
22 - 23 October 2004
Evangelische Akademie Tutzing
Policy Adjustments and Sustainability of
Public Finances in the Netherlands
Jan-Egbert Sturm and Jakob de Haan
CESifo
Poschingerstr. 5, 81679 Munich, Germany
Phone: +49 (89) 9224-1410 - Fax: +49 (89) 9224-1409
E-mail: [email protected]
Internet: http://www.cesifo.de
Policy Adjustments and Sustainability of Public Finances in the
Netherlands
Jakob de Haana , Jan-Egbert Sturmb and Olaf de Grootc
a
b
University of Groningen, The Netherlands and CESifo, Munich, Germany
Thurgau Institute of Economics, Switzerland, University of Konstanz, Germany and CESifo
Munich, Germany
c
University of Groningen, The Netherlands
This version, 19 October 2004
Abstract
This paper analyses fiscal policy in the Netherlands over the period 1970-2004 from three
perspectives. First, we analyse fiscal policy in some detail, examining to what extent the
Dutch experience has been in line with policy recommendations coming from the so-called
fiscal adjustment literature. We conclude that successful fiscal adjustments in the Netherlands
are quite different from successful adjustments in other countries. Second, we draw on the
fiscal sustainability literature, which tests whether the intertemporal budget constraint of the
public sector would be satisfied had fiscal policy in the sample been pursued indefinitely and
were the relevant macro and structural features of the economy stable over time. These tests
suggest that fiscal policy in the Netherlands is sustainable. Since, however, the demographic
structure will not remain stable, we also discuss recent literature on generational accounting.
Key words: fiscal adjustments, sustainability, public finance, Stability and Growth Pact
JEL code:
Address of corresponding author: Jakob de Haan, Faculty of Economics, University of
Groningen. PO Box 800, 9700 AV Groningen, The Netherlands, tel. 31-50-3633706, fax 3150-3633720, email: [email protected].
1. Introduction
Following the oil shocks of the 1970s many OECD countries had large and persistent deficits,
which in turn resulted in an unprecedented peacetime rise in the public debt-to-GDP ratio.
The Netherlands was no exception. In 1982 the general government budget deficit in the
Netherlands amounted to 6.2 per cent of GDP, the highest level since decades. The general
government debt-to-GDP ratio increased from a post-war low of 39 per cent in 1976 to 78 per
cent in 1993.
Various coalition governments – that differed substantially in terms of the parties
participating – aimed at reducing the budget deficit in the 1980s and 1990s as fiscal policy at
the time was generally perceived as unsustainable. Over time, the financial position of the
public sector improved substantially. In 2000 the Dutch government even had a surplus of 2.2
per cent of GDP. However, in more recent years the fiscal situation deteriorated rapidly, even
to such an extent that the ECOFIN Council in its meeting of 2 June 2004 decided that the
Netherlands had an excessive deficit according to the rules of the Stability and Growth Pact.
This paper analyses fiscal policy in the Netherlands over the period 1970-2004 from
three perspectives. First, we analyse fiscal policy in some detail, examining to what extent the
Dutch experience has been in line with policy recommendations coming from the so-called
fiscal adjustment literature. According to this line of research, that started with the seminal
paper by Alesina and Perotti (1995), successful fiscal policy adjustments are characterised by
spending cuts. Notably spending on government wages and transfers ought to be cut in order
to permanently improve the government’s financial position. In contrast, fiscal adjustments
which rely primarily on tax increases and cuts in public investment tend not to last. We find
that successful fiscal adjustments in the Netherlands were often not in line with these
prescriptions.
Second, we draw on the fiscal sustainability literature, which tests whether the
intertemporal budget constraint of the public sector would be satisfied had fiscal policy in the
sample been pursued indefinitely and were the relevant macro and structural features of the
economy stable over time. Previous studies come to rather diverging conclusions with respect
to the sustainability of fiscal policy in the Netherlands. We perform various tests and find no
clear evidence that fiscal policy in the Netherlands is sustainable.
A crucial assumption of the sustainability literature is that the structural features will
remain the same. Since, however, the demographic structure of the Netherlands will not
remain stable, we finally discuss recent literature on ageing and generational accounting. This
2
literature suggests that a sustainable fiscal policy requires that tax revenues have to be
permanently increased with 0.7% of GDP.
The remainder of this paper is organized as follows. Section 2 outlines fiscal policy in
the Netherlands during the period 1970-2004. In section 3 the policy adjustments are analysed
in some detail, following the fiscal adjustment literature. In section 4 the sustainability of
fiscal policy in the Netherlands is examined. Section 5 reviews recent studies on generational
accounting. The final section offers our conclusions.
2. Fiscal policy in the Netherlands, 1970-2003
Figure 1 shows the general debt-to-GDP ratio (right-hand side) and the general government
financial balance. The decline in national economic performance since the late 1970s and
early 1980s triggered a financial crisis of the Dutch welfare state. As follows from figure 1,
annual budget deficits were quite high as from 1975, which was reflected in a subsequent
upsweep of the debt ratio, which reached a peak in 1993. Afterwards a steep decline of the
debt ratio set in, which in more recent years levelled of.
Figure 1. Government debt (right-hand side) and government financial balance (left-hand
side), 1969-2003 (% GDP)
3
80
2
1
70
0
-1
60
-2
-3
50
-4
-5
40
-6
2003
2001
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
1971
30
1969
-7
3
After the second oil shock had hit the Netherlands unemployment shot up from 4.1 to 11.2
percent. Since transfers to strongly rising numbers of benefit recipients were at the time fully
linked to contractual wages, general government spending was in fact out of control. In 1978,
the government presented a blueprint of medium term objectives and policies (‘Blueprint 81’)
which aimed at improving competitiveness of the Dutch economy, halting the growth of
public sector revenues as a proportion of GDP, and reducing the public sector deficit. The
aims of Blueprint 1981 have not been met. Despite improved competitiveness, output and
employment growth fell also well short of expectations. Rising interest payments and
increasing unemployment put upward pressure on government spending. Despite increasing
gas revenues, the general government deficit exceeded policy targets previously set, due to
lower tax revenues than envisaged and higher spending levels.
The economic programme of the incoming centre-left government aimed at a slight
reduction of the general government budget. However, revenues soon turned out to be lower
than assumed and various revenue boosting measures were taken; both factors resulted in a
public sector borrowing requirement of over percent of GDP. Disaccord on the allocation of
unavoidable spending cuts brought the government down in May 1982.
The new centre-right government that - after elections - came into office late in 1982
was clearly faced with unsustainable budget conditions. Continuation of public borrowing at
prevailing levels would have led to an explosion of government debt and interest payments.
The government announced objectives for the reduction of the deficit by the end of its
four-year term in office (in 1986). By now, the authorities shared the view that the size of the
public sector itself was an impediment to balanced long-term growth. High tax and social
security levels were thought to create potential welfare losses, distorting work, saving and
spending decisions in the private sector. Various spending cuts were introduced, along with
with certain tax increases (e.g. in the 1984 Budget the standard VAT rate was raised by 1
point to 19% and excise taxes were also increased) as well as tax decreases (e.g. the corporate
income tax rate was reduced by five percent points, down from 48%). The 1985 Budget also
introduced spending cuts (Gld 9.3 billion), including a Gld 2.5 billion cut in social security
benefits, while the corporate income tax rate was cut further by one point, to 42%. In 1985
and 1986 the level of minimum wages, social insurance benefits and child allowances was
‘frozen’. In its 1986 Budget, the government concluded that the objectives set in the 1982
programme (i.e. a reduction of the borrowing requirement of central and local government,
with no increase in the so-called ‘collective burden’, consisting of total of taxes, social
security contributions and certain non-tax revenues of government as a percentage of income)
4
had largely been attained. Indeed, public spending had fallen, while the objective for the
central and local government deficit had been broadly achieved. Although in itself this was a
remarkable achievement, some critical sounds might be voiced. First, the decline in the deficit
is much less impressive once the social security system is taken into account. Second, by 1986
expenditures were substantially higher than foreseen at the start of the plan. Part of this
overspending occurred because certain programmes were expanded; part of it was due to
slippage in a number of ‘open-ended’ income related programmes.
After the 1986 elections the centre-right coalition remained in power until mid 1989.
The coalition Agreement for the 1987-1990 period, drawn up around mid-1986, aimed at
reducing the central government budget deficit to 5.25 percent of net national income (NNI)
by 1990. Deficit reduction was to be accompanied by at least a stabilisation of the ‘collective
burden’ and without loss of real net income for families at the minimum income level. It can
be concluded that these objectives have been met. Reduction of the deficit was hampered,
however, by a marked drop in natural gas revenues accruing to the government. Especially in
1987 gas revenues decreased sharply. As a consequence, the 1987 target for the central
government deficit was missed, as the fall in gas revenues could only partly be offset by
additional spending cuts and tax increases (one percent point higher VAT rate, higher excise
taxes on energy, reduced income tax facilities for enterprises). During the 1987-89 period
spending overruns even exceeded those in 1984-86, but buoyant tax revenues ensured that
nonetheless deficit targets were met. Using these windfall revenues to finance spending
overruns implied that the pace of consolidation was slower than what could have been
achieved.
In May 1989 the government fell on disagreement over financing the National
Environmental Policy Plan. According to the coalition Agreement of the centre-left
government that came into office in November 1989 the central government budget deficit
would be brought down further by 0.5 percent points of NNI annually in the period
1990-1994, taking it to 3.25 percent, with the ‘collective burden’ not exceeding 53.6 percent.
In February 1991 the Government published its Midterm Review, which confirmed that on
unchanged policies the budget deficit was likely to exceed its target by a considerable margin
as a result of a number of unforeseen developments (shortfall of revenues, rise in interest rate,
higher than expected wage increases in the private sector). The Midterm Review contained
proposals for additional expenditure cuts and revenue increases amounting to around Gld 17.5
billion in 1994, to keep the budget deficit in line with the medium term target. The proposals
include cuts in subsidies (Gld 3.4 billion in 1994), reduction of disability and sickness
5
benefits (Gld 4.8 billion) and the number of public sector workers (Gld 1.1 billion), and cuts
in expenditure on defense and social welfare (Gld 3.8 billion). However, at that time a
considerable part of the spending cuts was not specified. The 1991 and 1992 Budget presented
more detailed proposals on spending cuts as announced in the Midterm Review. Additional
spending cuts were announced as well.
In most the years of the coalition of social democrats and the left-of-centre and
conservative liberals (the so-called Purple Coalition), the Dutch economy experienced
economic growth rates which were substantially above the EU average. As a consequence,
government’s financial position improved substantially.
It is quite interesting that various coalition governments all aimed at reducing budget
deficits, independent of their composition. Much of the improvement of the financial position
was realised by reducing government spending. Figure 2 shows total government spending as
share of GDP, as well as government transfers and government wages. The latter are also
shown since the fiscal adjustment literature suggests that especially reductions in these
categories of spending are needed for a permanent improvement in the government’s financial
position. Figure 2 indicates that indeed the time pattern shows by total government spending
and government transfers are much a like (correlation coefficient of 0.96). The degree of
concordance between government spending and wages is much less (correlation coefficient of
0.25).
6
Figure 2. Total government spending, government transfers to households and government
wages, 1969-2003 (% GDP)
60
50
40
30
20
10
Spending/GDP
Transfers/GDP
2003
2001
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
1971
1969
0
Wages/GDP
However, in the more recent period, the general government budget balance deteriorated
markedly, from a surplus of 2.2 per cent of GDP in 2000 to an estimated deficit of 3.3 per
cent of GDP in 2004. Part of this increase reflected the soaring state of the economy, but
structural effects also played a role, amounting to roughly 2 percentage points of GDP
(included the 2001 tax reform). Temporary expenditure windfalls were used to fund
permanent increases in spending, notably on health care and education. Moreover, after years
of running close to balance, the local governments surprisingly recorded a deficit of 0.6
percent of GDP in 2003, contributing to the breach of the 3 percent Maastricht ceiling.
3. Fiscal policy adjustment
When a policymaker must redress a fiscally unbalanced position, he can raise taxes and/or cut
expenditures. Which should be used in order to permanently improve the fiscal position? And
which type of expenditure or tax should be changed? A large literature has addressed the
question whether the composition of the fiscal adjustment matters for it to be long lasting.
Alesina and Perotti (1995, 1997), McDermot and Wescott (1996), Perotti (1997) and Alesina
and Ardegna (1998) find that fiscal adjustments that are concentrated on the spending side,
7
and in particular on public wages and social welfare spending, are more successful than
adjustments that rely primarily on tax hikes.
In this section we analyse the fiscal adjustment of the Netherlands in some detail to
examine whether the Dutch policy experience is in line with the conclusions of the fiscal
adjustment literature. An important issue here is, of course, how a successful fiscal adjustment
is defined. A fiscal adjustment is generally defined as a period during which government tries
to reduce its budget deficit. To take the impact of the business cycle into account, most
authors focus on an improvement in some cyclically adjusted deficit measure. We follow
Alesina and Perotti (1995) and employ two fiscal impulse indicators: (1) the change in the
primary deficit as share of the GDP of the previous year (FSM1), and (2) an indicator
suggested by Blanchard (1993), which is an estimate of the budget deficit if the
unemployment rate had remained the same as in the previous year (FSM2). Following Alesina
and Perotti (1995), we regressed transfers as share of GDP on a time trend and the
unemployment rate and used the estimated coefficient for the unemployment rate to estimate
what transfers would be in period t if unemployment were the same as in the previous year.
We define the fiscal policy stance as follows. Let u and σ be the average and the
standard deviation of our fiscal stance measure (FSM being either the change in the primary
deficit, or the Blanchard impulse measure). In a given year fiscal policy is:
-
neutral if FSM Є (u – 0.5σ, u + 0.5σ)
-
loose if FSM Є (u + 0.5σ, u + 1.5σ)
-
very loose if FSM ≥ u + 1.5σ
-
tight if FSM Є (u – 1.5σ, u – 0.5σ)
-
very tight if FSM ≤ u – 1.5σ
It is hard to give a precise definition of success, but there is a broad consensus that a
reasonable indication might be if the ratio of public debt to GDP starts to decline after the
adjustment and continues to do so. We take years with either a tight or very tight fiscal policy
according to one of the fiscal stance measures as years of fiscal tightening and follow
McDermot and Wescott (1996) and consider a reduction of at least 3 percentage points in the
ratio of gross public debt to GDP by the end of the third year after the fiscal tightening began
as a workable criterion for judging success.1. Table 1 shows the resulting classification of
years.2 Two conclusions can be drawn. First, it is clear that the selection of a particular fiscal
stance measure affects the classification of years with fiscal tightening. As a consequence, the
1
2
Alesina and Perotti (1995) use a decline of 5 percentage points over the same three year period.
Appendix 1 shows the results of previous studies.
8
choice of the fiscal stance measure also influences the selection of fiscal adjustments that are
considered to be successful. In other words, there are years in which the debt ratio three years
later has declined by 3 percentage points or more, but that are not years with fiscal adjustment
according to the fiscal stance measures used.
Table 1. Classification of Fiscal Policy in the Netherlands, 1970-2004
Measure:
Very loose
Loose
Neutral
Tight
Very tight
FSM1
1975, 2001
1978, 1979,
1971, 1972,
1973, 1977,
1991, 1996
1980, 1986,
1974, 1976,
1983, 1985,
1989, 1992,
1981, 1982,
1988, 1993,
1994, 2002,
1984, 1987,
1999, 2000
2003.
1990, 1995,
1997, 1998,
2004
FSM2
1984, 1989,
1985, 1986,
1971, 1982,
1972, 1973,
1995
1987, 1988,
1983, 1991,
1974, 1975,
1990, 1996,
1992, 1994,
1976, 1978,
1997, 1998
1999, 2001,
1979, 1980,
2002, 2003
1981, 1993,
1977
2000
Note: Years with successful fiscal adjustments are indicated in bold
Which patterns can be discerned in fiscal policy in the Netherlands? Table 2 shows the results
for expenditure, while table 3 shows the outcomes for taxes. The results for expenditure using
the change in the primary deficit measure make sense. However, the unemployment adjusted
deficit suggests that in years with very loose fiscal policy expenditure declines are even
higher than those in years with very tight fiscal policy which is rather counter-intuitive. For
taxes, the result is reversed: now the primary deficit measure yields counter-intuitive results.
For instance, in years with very loose fiscal policy total tax receipts increase.
9
Table 2. Expenditure (% GDP) change: total and components
All years
Very loose
Loose
Neutral
Tight
Very tight
All years
Very loose
Loose
Neutral
Tight
Very tight
Total Investment Tranfers to Wages Non-wage
households
consumption
FSM1
0.20
-0.05
0.18 -0.06
0.08
3.06
0.27
1.06
0.44
0.39
0.37
0.02
0.21 -0.03
0.06
0.26
-0.09
0.28 -0.06
0.05
-0.65
-0.17
-0.11 -0.14
0.07
-0.87
0.08
-0.49 -0.24
0.07
FSM2
0.20
-0.05
0.18 -0.06
0.08
-1.71
0.04
-0.99 -0.49
-0.03
-0.79
-0.05
-0.33 -0.24
0.04
0.59
0.02
0.34
0.05
0.15
1.06
-0.10
0.67
0.08
0.07
-0.56
-0.46
0.28
0.12
0.16
Rest
0.04
0.88
0.11
0.09
-0.30
-0.29
0.04
-0.25
-0.21
0.03
0.33
-0.66
Table 3. Revenue (% GDP) change: total and components
All years
Very loose
Loose
Neutral
Tight
Very tight
All years
Very loose
Loose
Neutral
Tight
Very tight
Total Income Soc.sec.
Indirect Business Rest
taxes
premiums taxes
taxes
FSM1
0.14
-0.06
0.08
0.11
0.03 -0.01
0.60
0.23
-0.63
0.36
-0.04 0.68
-0.78
-0.45
0.04
-0.15
0.04 -0.26
0.11
0.02
-0.07
0.09
0.02 0.05
0.64
-0.02
0.46
0.26
0.04 -0.10
1.62
0.89
0.13
0.26
0.07 0.27
FSM2
0.14
-0.06
0.08
0.11
0.03 -0.01
-2.14
-0.73
-1.32
-0.13
-0.01 0.04
-0.27
0.34
-0.30
0.19
0.01 -0.50
0.18
-0.39
0.49
0.14
0.05 -0.11
0.90
0.16
0.34
-0.02
0.03 0.40
0.73
0.02
-0.07
0.84
0.04 -0.09
Table 4 contrasts successful and unsuccessful adjustments. According to the fiscal adjustment
literature, spending on government wages and transfers ought to be cut in order to
successfully improve the government’s financial position. It is clear from Table 4 that the
Dutch experience is not in accordance with this recommendation. Take, for instance, transfers
10
to households. According to measure FSM1, under both successful and unsuccessful fiscal
adjustments transfers were reduced; the reductions are of similar magnitude. Under FSM2
transfers increased in successful and unsuccessful adjustment, albeit that the increase was
much higher during unsuccessful adjustments, which gives some weak support to the fiscal
adjustment hypothesis. However, government wages, which should decline according to the
fiscal adjustment hypothesis to lead to a permanent decline of the debt ratio, did not decline in
successful adjustments according to both fiscal stance measures. In contrast, in unsuccessful
years this category of spending did decline.
According to the fiscal adjustment literature, unsuccessful fiscal adjustments often rely
on tax increases. As Table 4 shows, this is confirmed for fiscal policy stance measure FSM2.
However, according to FSM1 both successful and unsuccessful adjustments were
characterised by lower total tax revenues, although income taxes were reduced in successful
adjustments in contrast to unsuccessful ones.
In conclusion, the experience of the Netherlands is only to a very limited extent in line
with the conclusions of the fiscal adjustment literature. Although we have followed a similar
approach, our findings do not yield a strong confirmation of the findings of Alesina and
Perotti (1995) and McDermot and Wescott (1996). As our results are highly dependent on the
fiscal policy stance measure chosen, we decided to use an alternative definition of a
successful adjustment, which is independent of the characterisation of fiscal policy being
stringent. We only require for a year to be registered as one with a successful fiscal
adjustment that the debt ratio three years later has been reduced by three percentage points. In
the bottom of Table 4 we show the results using this alternative definition of successful
adjustments. Again, the Dutch experience is not in line with the policy prescriptions of the
fiscal adjustment literature.
11
Table 4. Successful vs. unsuccessful adjustments
# Obs. Total Investment
Successful
Unsuccessful
7
3
-0.14
0.15
0.43
-0.12
Total Income
Nobs
taxes
Successful
7
-1.05
-0.74
Unsuccessful
3
-0.56
0.55
# Obs. Total Investment
Successful
Unsuccessful
7
5
2.60
-0.14
4.10
-0.19
Total Income
Nobs
taxes
Successful
7
1.27
-0.33
Unsuccessful
5
1.77
-0.94
FSM1
Tranfers to Wages
households
-0.07
0.00
-0.10
-0.63
Soc.sec.
Indirect
premiums taxes
-0.64
0.27
-0.20
0.20
Non-wage
Rest
consumption
0.26 -0.48
0.28
1.00
Business
Rest
taxes
0.01
0.05
0.18 -1.29
FSM2
Tranfers to Wages
households
1.54
0.43
2.15
-0.55
Soc.sec.
Indirect
premiums taxes
0.21
0.49
1.75
-0.46
Non-wage
Rest
consumption
0.39
0.38
0.56
2.13
Business
Rest
taxes
-0.02
0.92
0.34
1.08
Alternative definition of successful adjustment
# Obs. Total Investment Tranfers to Wages Non-wage
Rest
households
consumption
Successful
19
0.02
-0.07
0.13
0.05
0.22 -0.31
Unsuccessful 11
0.71
-0.19
0.52
-0.81
0.36
0.84
Total Income
Soc.sec.
Indirect Business
Rest
Nobs
taxes
premiums taxes
taxes
Successful
19
0.32
-0.24
-0.09
0.47
0.02
0.16
Unsuccessful 11
-0.13
-0.24
0.34
-0.09
0.22 -0.36
4. Sustainability of fiscal policy
Assuming that government issues debt with a single-period maturity, the period-by-period
government budget constraint can be written as:
(1)
∆Bt = rBt −1 + Gt − Tt
where Bt denotes the real value of government debt at the end of the period, r is the interest
payable on that debt, Gt is real government expenditures exclusive of debt interest payments,
and Tt denotes real tax revenues. Reformulating eq. (1) and performing recursive substitution
for all future debt yields:
12
(2)
n
[
]
Bt = ∑ 1 / (1 + r ) S t + j + 1 / (1 + r ) Bt + n
j =1
j
n
where S (the primary deficit) is defined as:
(3)
S t = Tt − Gt
If the second term in eq. (2) converges to zero as n becomes large, the outstanding
stock of government debt equals the present value of future government surpluses.
(4)
Lim n→∞ 1 / (1 + r ) Bt + n = 0
n
In that case the government budget is intertemporally balanced. If the limit term is higher than
zero, the government is “bubble-financing” its expenditures. It is important to point out that
the solvency constraint can be satisfied by an infinite series of conventional budget deficits.
The appropriate sustainability test is to see whether the historical process that generates fiscal
data is likely to result in the intertemporal budget constraint being violated. If so, fiscal policy
will have to be changed; something has to give in, be it spending, taxes, or both.
Various tests have been proposed in the literature to examine sustainability.3 Hamilton
and Flavin (1986), who were – as far as we know the first to examine this issue – assume that
the real interest rate is constant and that the deviation of the debt from the sum of discounted
future surpluses growth at rate r. In that can case, one can write:
∞
(5)
Bt = c(1 + r ) t + ∑ (1 + r ) − s Et S t + s
s =1
where Et denotes the expectation operator conditional on information at time t. The
intertemporal budget constrain would only be satisfied if c = 0. If both the debt and the sum of
discounted surpluses are stationary, c = 0. Hamilton and Flavin examined the order of
integration of Bt and St using annual data for the US and found that they cannot reject
stationarity. Various studies have employed similar tests (see appendix 2 for a summary of
studies that include the Netherlands).
3
This part heavily draws upon Artis and Marcellino (2000).
13
Trehan and Walsh (1988) argue that if debt and deficits are integrated, and if interest
rates are constant, then a necessary and sufficient condition for sustainability is that debt and
primary balances are cointegrated. This can easily be seen by writing eq (1) as:
Bt +1 − Bt = rBt + S t
(1a)
If Bt is integrated of order one, then Bt-1 – Bt is stationary by definition, which, in turn, implies
that the overall balance D = rBt + St is stationary, and that, if the interest rate r is constant, Bt
and St are cointegrated with a cointegrating vector (1,r).
Trehan and Walsh (1991) show that an alternative way to examine sustainability is to
test whether the deficit inclusive of interest payments (Dt) is stationary. The attractive feature
of this test is that its derivation is not depending on the assumption of a constant interest rate.
Alternatively, one can test whether expenditures including interest payments are
cointegrated with tax revenues (Trehan and Walsh, 1991; Hakkio and Rush, 1991). If the
series Gt, Tt, and rBt-1 are I(1) variables, the deficit inclusive of interest payments is a zero
mean stationary process if and only if
(6)
Tt − Gt − rt Bt −1
is a cointegration relationship. Ahmed and Rogers (1995) test this for the US and the UK and
accept it, as do Trehan and Walsh (1991), but Hakkio and Rush (1991) reject cointegration.
The latter two tests are performed in the present paper, using the fiscal variables
concerned expressed as percentage of GDP (see also De Haan and Siermann, 1993). Table 5
shows the results.
14
ADF-statistic incl.constant -2.28 -1.94
no constant -0.99 -1.89
Crit.values 1% 5% 10%
incl. constant -3.64 -2.95 -2.61
no constant -2.63 -1.95 -1.62
(T-G-rB)/GDP
T-G-rB
Def./GDP
Deficit
Table 5. Sustainability tests
E-G coint.
-2.10 -3.59
statistic
1% 5% 10%
-4.24 -3.52 -3.17
It follows from Table 5 that there is no convincing evidence that fiscal policy in the
Netherlands is sustainable during the period under consideration. However, this evidence is
weak due to the low power of the unit root tests. Appendix 2 offers a summary of all papers
that we are aware of that perform some kind of sustainability test of fiscal policy in the
Netherlands. It follows that also other previous studies conclude that Dutch fiscal policy has
not been on a sustainable path.
A crucial assumption of the sustainability tests as applied in this line of literature
assume that the present conditions remain in the future. However, it is well-known that the
Netherlands, like many other OECD countries, faces an ageing problem. The next section
therefore discusses the implications of ageing for fiscal policy.
5. Ageing in the Netherlands
Statistics Netherlands (CBS) publishes its forecasts concerning population growth once every
two years. The most recent forecast was published in 2003 (De Jong, 2003), and refined in
2004 (De Jong and Hilderink, 2004). Using four different scenarios4, De Jong and Hilderink
4
The different scenarios are built upon two dimensions. The first dimension concerns responsibilities and ranges
from private responsibilities to public responsibilities. The other dimension concerns the degree of co-operation
internationally, and makes a split between international co-operation and national sovereignty. Using these two
dimensions, De Jong and Hilderink develop four different scenarios. The first scenario is called Strong Europe,
in which the European governments are able to co-operate well and public institutions are able to optimise
economic efficiency, leading to a prosperous future in Europe. The second scenario is referred to as the
Transatlantic Market, in which private responsibilities are given a large role, and public institutions, such as the
European Union, fail repeatedly. The European nations will shift their focus towards the United States, which
will boost international trade, but due to the limited feeling of responsibility towards others, welfare will be very
unequally distributed. In the Regional Communities scenario, the European governments are unable to reform
their Social Security systems and are also unable to stop the expansion of their own bureaucracies. Multilateral
15
construct different population forecasts, as shown in Table 6. Population size ranges from
around fifteen million people in 2050 in the Regional Communities scenario to over twenty
million in the Global Economy scenario (2002: 16.1 million). Additionally, the table also
shows the predicted dependency ratio, which will reach its maximum around 2040, at a level
of between 42.7% and 46.2% (2002: 22.1%)
Table 6. Population forecasts under different scenarios, 2002-2050
Global Economy
2002
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
Strong Europe
Transatlantic Market
Regional Communities
Population Elderly
Population Elderly
Population Elderly
Population Elderly
dependency
dependency
dependency
dependency
x 1000
%
x 1000
%
x 1000
%
x 1000
%
16105
22.1
16105
22.1
16105
22.1
16105
22.1
16374
22.8
16372
22.8
16351
22.8
16321
22.8
16830
24.4
16760
24.5
16596
24.5
16459
24.7
17354
28.2
17171
28.6
16802
28.8
16509
28.8
17884
31.3
17574
31.7
16961
32.1
16500
32.4
18405
34.5
17968
35.3
17087
35.8
16447
35.9
18890
38.3
18325
39.4
17165
40.1
16334
40.3
19316
41.6
18622
42.9
17174
44.0
16137
44.5
19677
42.7
18852
44.2
17104
45.7
15846
46.2
20005
41.4
19044
43.0
16980
44.3
15488
45.0
20335
40.0
19234
41.4
16836
42.8
15107
43.3
Source: De Jong and Hilderink (2004)
In the study Ageing in the Netherlands, the Netherlands Bureau for Economic Policy Analysis
(CPB) compares ageing in the Netherlands with other countries in Europe. As follows from
Table 7, the elderly dependency ratio in the EU-15 is predicted to be around 53% in 2050,
compared to 27% in 2000. However, it should be noted that this value is influenced strongly
by the very high ratios expected in France and Spain.
relations are strongly limited and most countries will be looking inwards. Finally, the Global Economy scenario
assumes a great success in the international co-operation with respect to trade liberalisation. The private sector is
one of the major driving forces towards liberalisation in this scenario, whereas the public sector’s responsibilities
become limited to the supply of pure public goods. The downside of this scenario is an absolute failure of
international co-operation with respect to environmental policy and an ever widening income gap.
16
Table 7. Expected elder dependency ratios (%) in different European countries
Belgium
Denmark
Germany
Greece
Spain
France
Ireland
2000
28
24
26
28
27
27
19
2050
50
42
53
59
66
51
44
29
67
Italy
Luxembourg
Netherlands
Austria
Portugal
Finland
Sweden
United
Kingdom
EU-15
2000
23
22
25
25
24
30
26
2050
42
40
55
49
48
46
46
27
53
Source:(CPB ( 2000)
In the remainder of this section, we summarize the findings based on generational accounting
for the Netherlands. The foundation for generational accounting was laid by Auerbach,
Gokhale and Kotlikoff (1991) who were the first to present generational accounting as an
instrument for policy analysis. Generational accounting is used as a way to compute the
present value of current government policies for different age cohorts. In summary,
governments are limited to this simple constraint: A + B = C + D, where C is the present
value of all future government purchases and D is net government debt. These total liabilities
have to be paid by A, the present value of net contributions of currently living generations and
B, which is the present value of the bill left for future generations (Kotlikoff and
Raffelhüschen, 1999).
Generational accounting may shed some light on fiscal policy sustainability. In line
with the discussion in the previous section, CPB (2000) defines the sustainability by being
able to keep to the solvency condition. The solvency condition implies that the present value
(PV) of all income should be equal or larger than the PV of all future obligations. This is
basically the same solvency condition suggested by Auerbach, Gokhale and Kotlikoff (1991),
who pose that the PV of net payments of the current generation plus the PV of net payments
of all future generations plus net government wealth should be equal to the PV of government
consumption. Fiscal policy is considered to be sustainable if the solvency condition would be
adhered to when current policies would be continued indefinitely. Obviously, this is not
realistic, but it does deliver a clear message concerning the need for policy adjustments.
According to the CPB (2000), current fiscal policies would certainly lead to disaster.
During the first decades of the twenty-first century, the Netherlands is expected to have a
17
budget surplus. From 2016, however, the Netherlands is projected to have a budget deficit due
to the ageing of the population, rising to 3.4% of GDP in 2040 and, due to pressing interest
payments, 9.0% in 2080. The major contributors to the escalating budget balance are the
increased expenditures in healthcare, which are expected to rise from 7.0% of GDP in 2001 to
10.6% of GDP in 2040, and Social Security outlays, where an increase from 10.9% to 15.9%
of GDP is expected over the same period.
At the same time, government debt would initially decrease from 54% of GDP in 2001
to 28% of GDP in 2020, but subsequently increase to 157% in 2080. There is no doubt about
it that these numbers show that current fiscal policy is unsustainable. Especially when it is
taken into account that the CPB recently published a memo updating the numbers from their
2000 study (CPB, 2003). In the original study, the government was expected to have a budget
surplus of 1.8% of GDP in 2007, but now the CPB expects the government to have a 1.7%
deficit instead. To achieve a sustainable policy, tax revenues would have to be permanently
increased with 0.7% of GDP. This coincides with the conclusions from previous fiscal
sustainability studies, in particularly with Ter Rele (1998), who adds that a policy change has
to be implemented quickly, as the necessary change becomes larger when waiting longer.
Generational accounting also sheds light on the generational distribution of financial
obligations. To be able to evaluate the generational distribution of fiscal policy effects, the
generational accounts of newborns have to be compared to those of future generations, as it
refers to benefits over the entire lifetime that way. As can be seen in Table 8, the CPB (2000)
concludes that with the fiscal policies in place, future generations have a net benefit that is
significantly lower than the net benefit of the newly born generation. However, as described
earlier, this policy was deemed unsustainable anyway, and when the proposed measure of
raising tax revenues with 0.7% of GDP would have been taken immediately, a situation would
have occurred in which generational balance would almost be achieved.
18
Table 8. Predicted generational accounts
Age in
1998
unborn
0
20
40
60
80
Net lifetime benefit with current
policies (Thousands of euros)
44.2
58.8
-121.9
-73.5
102.7
128.9
Net benefit with adjusted policies
(Thousands of euros)
52.5
53.6
-128.8
-78.2
101
128.4
Source: CPB (2000)
6. Conclusions
19
References
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School conference paper
Ahmed, S. and J.H. Rogers (1995), Government budget deficits and trade deficits. Are present
value constraints satisfied in long-term data?, Journal of Monetary Economics, 36, 351-374.
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Alesina, A.F. and R. Perotti (1997), Fiscal Adjustments in OECD Countries: Composition and
Macroeconomic Effects, IMF Staff Papers, 44, (2), 210-248.
Artis, M. and M. Marcellino (2000), The solvency of government finances in Europe, in: Banca
d’Italia, Fiscal sustainability, pp. 209-241.
Alesina, A., Perotti, R. and Tavares, J. 1998, The Political Economy of Fiscal Adjustments,
The Brookings Papers on Economic Activity, …..
Auerbach, A.J., J. Gokhale and L.J. Kotlikoff (1991), Generational Accounts – A Meaningful
Alternative to Deficit Accounting, NBER Working Paper, No. 3589.
Bravo, A. and Silvestre, A. (2002). “Intertemporal sustainability of fiscal policies: some tests
for European countries,” European Journal of Political Economy, 18 (3), 517-528
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CPB (2003), CPB Notitie: vergrijzing en schuldreductie – een indicatieve update, CPB, The
Hague.
De Haan, J. and C.L.J. Siermann (1993), The intertemporal government budget constraint: An
application to the Netherlands, Public Finance, 48 (2), 243-249.
De Jong, A. (2003), Bevolkingsprognose 2002-2050: Anderhalf miljoen inwoners erbij,
Bevolkingstrends, 1st quarter, pp. 21-26.
De Jong, A. and H. Hilderink, (2004), Bevolkingsscenario’s voor Nederland,
Bevolkingstrends, 1st quarter, pp. 66-76.
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European Central Bank?, Cambridge: Cambridge University Press, pp. 53-79.
Hakkio, C. and M. Rush (1991), Is the budget deficit too large?, Economic Inquiry, 59, 429445.
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Kotlikoff, L.J. and B. Raffelhüschen (1999), Generational accounting around the globe,
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20
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21
Appendix 1: Episodes of Fiscal Consolidation in the Netherlands after 1970 according to
previous studies
Alesina and
Perotti (1995)
1985, 1991
McDermott and Alesina and
Wescott (1997) Ardegna (1998)
1982, 1983, 1988
Appendix 2. Summary of research on sustainability of fiscal policy (only studies that
include the Netherlands)
Study:
Grilli (1991)
Period and
countries:
1950-86,
10 EU countries
Corsetti and Roubini
(1991)
1960-89
18 OECD countries
De Haan and
Siermann (1993)
1900-88
The Netherlands
Caporale (1995)
1960-91
EU countries
Uctum and Wickens
(2000)
1965-1994
11 EU countries and
the US
Early 1970s-1994
EU countries minus
Greece and
Luxembourg
Artis and Marcelino
(2000)
Afonso (2004)
1970-2003
EU countries
Bravo and Silvestre
(2002)
1960-2000
11 EU countries
Test performed:
Sustainable?
Stationarity of deficit
incl. Interest
payments
Non-stationarity only
rejected for the UK,
and, at a lower
confidence level,
Germany and possibly
Denmark
Problems present in
some countries, incl.
The Netherlands
Yes
Stationarity of deficit
incl. Interest
payments and
cointegration of
expenditures and
revenues
Stationarity of deficit
and debt
Not in Italy, Greece,
Denmark, and
Germany
Stationarity test
Sustainable in
(public debt)
Denmark, Ireland and
the Netherlands
Stationarity test
Mixed evidence,
(public debt)
depending on
particular
assumptions, incl. the
Netherlands
Fiscal policy is
Unit root and codeemed unsustainable
integration tests of
with possible
revenues and
exception of Germany
expenditures
and the Netherlands
Co-integration tests of Sustainable in
Austria, France,
expenditures and
Germany, the
revenues
Netherlands and the
UK
22
Vanhorebeek and Van 1970-1994
Rompuy (1995)
8 EU countries
1870-1993
Belgium
Stationarity test
No, except for France
and Germany
23