Fiscal sustainability, or public finance sustainability, is the ability of a government to sustain its current spending, tax and other policies in the long run without threatening government solvency or defaulting on some of its liabilities or promised expenditures. There is no consensus among economists on a precise operational definition for fiscal sustainability, rather different studies use their own, often similar, definitions.^[1][2][3] However, the European Commission defines public finance sustainability as: the ability of a government to sustain its current spending, tax and other policies in the long run without threatening the government's solvency or without defaulting on some of the government's liabilities or promised expenditures.^[4] Many countries and research institutes have published reports which assess the sustainability of fiscal policies based on long-run projections of country's public finances (see for example,^[4][5] and ^[6]). These assessments attempt to determine whether an adjustment to current fiscal policies that is required to reconcile projected revenues with projected expenditures. The size of the required adjustment is given with measures such as the Fiscal gap. In empirical works, weak and strong fiscal sustainability are distinguished. Differences are related to both econometric techniques used for examination and variables involved.^[7]

Government's inter-temporal budget constraint

There is no consensus among economists about the correct criterion/definition to be used for fiscal sustainability. The most commonly used criterion is the government's inter-temporal budget constraint or inter-temporal equilibrium condition:

${\displaystyle B_{t}=\sum _{i=1}^{\infty }(1+r)^{-i}PB_{t+i}}$,

where ${\displaystyle B_{t}}$ is the stock of public debt, ${\displaystyle r}$ is the interest rate of public debt and ${\displaystyle {PB}_{t}}$ is the primary balance (negative of primary deficit or government revenues minus government expenditures excluding interest expenditure).

The government's inter-temporal budget constraint states that the initial debt level should be equal to the present value of future surpluses. That is, the government debt must be backed by expected future cash flows.

Many economists have voiced grave concerns over using inter-temporal budget constraint as a de facto definition or criterion for fiscal sustainability.^[8][9][10] Also, it has been shown that under plausible assumptions the inter-temporal budget constraint is in fact not the correct criterion for sustainability.^[8][11][12]

Indicators of fiscal sustainability

There are many different indicators of fiscal sustainability. The indicators measure the fiscal adjustment required to bring public finances back to sustainable track. Specifics of the indicator depend on the operational definition of fiscal sustainability and the underlying economic modelling framework employed in a study. Some of the most commonly used indicators are so-called tax gaps. For example, the infinite horizon tax gap, or S2 sustainability indicator in European Commission phraseology is defined as:

${\displaystyle ITGAP={\frac {(r-g)(b_{t}-\sum _{i=1}^{\infty }({\frac {1+g}{1+r}})^{i}pb_{t+i})}{1+g}}}$

where ${\displaystyle b_{t}}$ is the debt-to-GDP ratio, ${\displaystyle r}$ is the interest rate of government debt, ${\displaystyle g}$ is the growth rate of the economy and ${\displaystyle pb_{t}}$ is the primary balance to GDP ratio.

The infinite horizon tax gap gives the adjustment required to satisfy the inter-temporal budget constraint in terms of a permanent one-time change to projected path of primary balance to GDP ratios. Thus, if ITGAP = 5%, primary balance must be greater than projected by 5% of GDP for each future year. This could be achieved by permanently raising taxes or cutting expenditures 5% of GDP. For derivations and more information, see for example,^[1][4][13] or.^[14]

Fiscal sustainability challenges

There are numerous challenges and threats to the sustainability of public finance which can range from institutional challenges ranging from creating independent fiscal institutions, fiscal responsibility laws, fiscal rules and the management of fiscal risks to changing dynamics in the demographic structure of societies.^[15]
Although these factors are significant, the core indicator of outstanding government debt in proportion to GDP is the go to metric for analyzing the health of a country's public finance sector.^[4] If a country does suffer from a high proportion of outstanding government debt then it is very vulnerable to interest shocks and a negative growth rate. For EU member states in 2016, the expected government debt to GDP ratio is above the 60%.^[4] This is expected to change with the strong support of financial independent institutions assuming they respect the SGP rules.^[4] Additionally, reforms that address the root causes of risks to fiscal responsibility take into account the costs of aging and their components.^[4]

See also

• Government debt
• Government budget deficit
• Fiscal policy
• Government spending
• Government budget
• Public finance
• Generational accounting

References

Other sources

• Bernanke, Ben S. (27 April 2010). "Achieving Fiscal Sustainability". Washington, D.C.: speech at the National Commission on Fiscal Responsibility and Reform.
• Calvo, Guillermo A.; Izquierdo, Alejandro; Talvi, Ernesto (2006). "Sudden Stops and Phoenix Miracles in Emerging Markets". American Economic Review. 96 (2): 405–410. doi:10.1257/000282806777211856.
• Bird, Richard M. (January 2003). "Fiscal Flows, Fiscal Balance, and Fiscal Sustainability".
• Ghosh, Atish R.; Kim, Jun I.; Mendoza, Enrique G.; Ostry, Jonathan D.; Qureshi, Mahvash S. (2013). "Fiscal Fatigue, Fiscal Space and Debt Sustainability in Advanced Economies". The Economic Journal. 123 (566): F4–F30. doi:10.1111/ecoj.12010. ISSN 1468-0297. S2CID 154107217.

External links

• Councils and institutions that focus on fiscal issues and sustainability among other things
• IMF Fiscal monitor
• The World Bank: Fiscal Sustainability, Risks and Vulnerabilities