Consolidation of public finances after the corona crisis – calculation update

The COVID-19 crisis and the measures to contain the impact on health, the economy and the income of private households and companies have caused public debt to rise sharply. Aid programs and lower tax revenues have significantly increased the deficit ratio. According to Maastricht, the general government deficit ratio amounted to 8.8% of GDP in 2020, following a surplus of 0.6% in 2019. In the current WIFO forecast, another massive deficit of 6.6% is expected for 2021. Only in the following years should the situation in public finances ease somewhat. The crisis is associated with a considerable increase in the public debt ratio, which at 83.5% of GDP in 2020 has once again risen to well over 80%.

Before the COVID-19 pandemic, it was expected that the public debt ratio would fall significantly by the middle of this decade and could even fall below the Maastricht limit of 60% of GDP. The COVID-19 crisis has now exacerbated the situation again. In fiscal terms, the end of the crisis will be followed almost seamlessly by the challenge of financing the significant increase in public pension expenditure due to demographic trends. There will also be significant additional expenditure in the areas of healthcare and nursing care.

The first part of the study examines the question of how public finances will develop on the basis of the current legal situation and reforms that have already been adopted. Using the "Debt Check" generation account model, the general government deficit and public debt are projected up to 2060. In the main scenario, the public debt ratio increases to over 160% of GDP by the end of the period under review. Before the COVID-19 crisis, the same model projected an increase to less than 140%. Although the debt ratio would have met the Maastricht criterion in the medium term, until the 2030s, public finances would not have been sustainable in the very long term even without the COVID-19 crisis. This is even less true now. The projected strong increase in debt is essentially driven by three major areas of expenditure. These are public pension, healthcare and long-term care expenditure. Public revenue as a percentage of GDP will remain relatively stable in the period under review.

Uncertainties regarding the development of the driving factors of the model are taken into account in this study with sensitivity analyses. If demographic ageing were to be more pronounced than in the main scenario (lower fertility, immigration and mortality) according to the ageing scenario of the population forecast by Statistics Austria, then debt would increase to over 220% of GDP by 2060. If fixed monetary transfer payments are only increased in line with inflation in future, this would reduce the public debt ratio by almost 20 percentage points by 2060. However, this would mean a considerable loss of importance of these transfers for private households compared to earned income. The development of interest rates, which is also associated with uncertainties, has a significant influence on the debt dynamics. On the one hand, permanently low interest rates until the end of the observation horizon would limit the increase in debt to around 110% of GDP, although even this level would still represent a significant increase compared to the current situation. On the other hand, there is a risk that the implicit interest rate for public debt could rise again earlier than assumed in the main scenario. If, in such a situation, the markets were to lose confidence in the sustainability of public finances and the risk premium were to rise noticeably, the situation could quickly spiral out of control.

The analysis makes it clear that a significant improvement in the primary balance is necessary to bring the debt ratio back to the Maastricht reference value of 60 percent of economic output. The medium-term sustainability indicator S1 shows that the primary balance would have to be 1.7 percent of GDP higher than according to the recent medium-term economic forecast of the Economic Research Institute in order to achieve this target 15 years after the start of consolidation. This corresponds to an annual improvement in the primary balance of 0.3% of GDP over and above the forecast during the consolidation phase of five years. The longer-term indicator S60 shows that consolidation would even have to amount to 2.7 percent of GDP in order to reach 60 percent in 2060. This results in an additional annual improvement in the primary balance of 0.5 percentage points over five years. If the consolidation period is extended from five to 10 years, then the annual extent of consolidation is lower, but the ultimately necessary improvement in the primary balance is higher at 2 percent for S1 and 2.9 percent for S60. However, a longer consolidation period is associated with a higher debt level during consolidation. In view of the fact that consolidation may not be completed before the next crisis, this can cumulatively lead to ever higher levels of debt. Even before the COVID-19 crisis, the debt ratio was not reduced to below 60% of GDP.

According to the results of the academic literature, the macroeconomic effects of expenditure-based consolidation measures depend on which expenditure is targeted. For example, measures relating to current expenditure have less of an impact on production than measures relating to public investment. A well-developed infrastructure is one of the cornerstones of a location's attractiveness and is an essential prerequisite for private investment activity. Consolidations are only successful in the long term if they address the drivers of dynamic expenditure growth.

The international benchmarking analyses in the study show that Austria has comparatively high expenditure on public services, but at the same time often only mediocre results. Based on country comparisons among the EU member states plus Norway, Switzerland, the UK and Iceland, an efficiency potential of EUR 2.3 billion to EUR 6.5 billion was identified for the areas of general public administration and education up to lower secondary level. Efficiency potentials were determined according to the relative efficiency gaps to countries with both lower or at most the same level of expenditure and better or at least equally good results. In addition to the international benchmarking analysis, an efficiency analysis of government expenditure at federal state level was carried out for the areas of public administration, compulsory general education schools, childcare and care services. An efficiency potential of around EUR 2.4 billion was identified here. The two approaches of the international benchmarking and the benchmarking of the federal states are not methodologically uniform and show overlaps. The results are therefore not additive, but indicate that there is considerable potential for efficiency in the provision of public services in Austria.

The study does not address the question of how this efficiency potential can be leveraged in the individual areas in particular. However, numerous studies identify the distribution of responsibility for tasks, expenditure and financing in the sense of fiscal equivalence as a key lever for exploiting efficiency potential. It should be emphasized that raising efficiency potential is primarily about improving the organization and framework conditions and strengthening responsibilities, and not about cutting services. International observations also point to the potential of digitizing public services. Digital government is associated with the prospect of increased efficiency not only for the administration itself, but also for citizens and businesses. Examples of digital administrative services show possible uses and fields of application.

Considering that the majority of the sustainability gap is due to rising public spending as a result of an ageing society, the focus should also be on older workers remaining in the labor market for longer. In contrast to other expenditure-based consolidations, this would actually strengthen growth. The impact on pension levels of a higher statutory retirement age and corresponding additional deductions due to deviations from the standard retirement age would be cushioned by a higher actual retirement age. Higher labor force participation and a higher full-time employment rate among women would also help to strengthen the sustainability of public finances.