Henri Bogaert Michel Saintrain

1. Challenges and strategies for Belgian public finances Seminar “Potential Growth and Fiscal Challenges”Federal Planning Bureau, October 27, 2009 Henri Bogaert Michel Saintrain

2. Outline • Where do we come from and where are we going to with unchanged policies? • Where should we go to? • What would imply the consolidation strategy in the medium term? • What would imply the strategy in the long term?

3. A. Where do we come from and where are we going to with unchanged policies? • Caveat about the following figures • 2 FPB forecasts: • May Medium-Term Projections (2009-2014) • September forecast in preparation for the budget (without analysis of public finances) • Recent public finances projection (budget, HCF)

4. Medium-term fiscal prospects Great uncertainty, especially about revenues Measures of the 2010-2011 budget would likely reduce the deficit by 1.5% of GDP I shall use the FPB May projection in the presentation

5. Long-term projection with unchanged policy(% of GDP)

6. B. Where should we go to? • Requirement of the Stability and GrowthPact • Sustainable position • The new Germanrule • The Belgian consensus

7. Requirement of the Stability and Growth Pact • Excessive deficit procedure: deficit below 3% before 2013 • Defining a MTO (defined in terms of structural balance): Close to balance or taking account of the sustainability gap • Transition path towards the MTO: at least a progress of 0.5% of GDP per year

8. Sustainability gap in 2010 • * S2 means: by how much should we adjust the structural primary surplus if we want that the projected revenues cover the projected primary expenditures • The cost of ageing is the increase of the age-related expenditure in p.p. of GDP between 2008 and 2060. It is estimated to 8% by the Belgian Ageing Study Committee. • S2 is not far from the effort that should be done to reach a balanced budget in 2015

9. German rule • 0.35% of GDP structural deficit for the Central Government • 0% structural deficit for the Länder • Cyclical deviations are allowed and favoured • The rule is inserted in the Constitution • Alignment with Germany will probably be unavoidable due to market pressures

10. Belgian consensus is close to the German rule • Balanced budget since 2000. Return to balanced budget around 2015 • No consensus on the distribution of the budget balance rule among the government levels • While there is a consensus on the necessity to frontloading the cost of ageing, going beyond a balanced budget seems politically unfeasible.

11. C. What would imply a balanced budget in the medium term? • Ideally, 3 types of adjustment should be done: • Adjustment of the starting point: erasing the structural deficit progressively • Make the expenditure growth consistent with the potential growth of revenue: expenditure growth more or less equal to potential growth • Let the automatic stabilizers play their role • Caution: this will not necessarily lead to a balanced budget in 2015

12. Whatis the size of the structural deficittoday?In May 2008, wethoughtwewere « close to balance » but not in surplus

13. Actually, structural deficit was worsening and would continue to worsen with current policies

14. What does explain the present level of structural balance?

15. The level of structural balance is higher than we thought, but the expected increase in the structural deficit is high... ...but there is a great uncertainty about the evolution of the structural balance

16. As regards the change over 2010-2015, with unchanged policies, primary expenditure growth is largely above potential growth

17. Projections of primary expenditure growth are largely above potential growth

18. Illustrative scenario 1: Adjustment of primary expenditure growth to potential growth except for pensions and health care • Assumptions of the scenario: • Public consumption growth = 0 in real terms • Pension and health care evolve like in the baseline • Other expenditure grows like potential growth

19. Scenario 2: Adjustment of primary expenditure growth to a zero real growth rate except for pensions and health care • Scenario 2 allows to globally align primary expenditure growth with potential growth. • But, most of the effort is done by Entity II, which leads to a strange result: Entity II should be in surplus and Entity I in deficit • A balanced budget for both entities in 2015 would imply to reduce social expenditure, for instance by indexing them to less than the price increase • Another solution would be a devolution of some competencies to the R&C without transferring the financial means, which is also strange.

20. Conclusion: a balanced budget in 2015 is very ambitious • The level of the structural deficit in 2009 (-2.8) should be adjusted in the medium term : if it starts in 2012, it would mean a structural adjustment of somewhat more than 0.5 p.p. of GDP until 2015. • In the baseline, the increase in the structural deficit after 2009 (-2.6) is due to expenditure growth rates that are not consistent with potential growth. • Consistency could be obtained by: • Zero growth in real terms except for pension and health care, but this implies a surplus in Entity II in 2015 and a deficit in Entity I. • Higher expenditure growth in Entity II, but with a reduction in social security expenditure, including pensions and health care.

21. D. Is a balanced budget in 2015 a “sustainable” Medium-Term Objective? • Or, in other words, can increasing aged-related expenditure be financed… • With reduced potential growth due to ageing ? • While revenue and other expenditure keeps growing in line with potential growth? • This is measured by the S2 indicator assuming a balanced budget in 2015

22. Reaching a balanced budget in 2015 would reduce the sustainability gap by approximately 5% of GDP • But this is not yet sufficient to cover the cost of ageing fully. • The necessary extra adjustment could be obtained, for instance, by a smooth increase in the effective age of retirement (+/- 3 years between now and 2030) • This would imply a progressive extra adjustment representing a reduction of the cost of ageing by 1.6% of GDP between 2015 and 2060. With this strategy, close to the German rule, S2 is approximately zero: there is no sustainability gap anymore.

23. Age-related expenditure and sustainability gap are mainly under the responsibility of the Federal government No impact of the cost of ageing on Entity II. For Entity II, S2 represents only the necessary adjustment in order to stabilize debt. There is no cost of ageing for Entity II and, accordingly, no need to build a surplus.

24. Sustainability gap S2 per entity in 2015 As for Entity II: S2=3.2 represents now the necessary adjustment to stabilize debt : 2.7 plus the cost of ageing 0.5). The impact of the cost of ageing for Entity II is now 0.5% of GDP.

25. Conclusions • Reaching a balanced budget in 2015 would reduce the long-term sustainability gap very significantly • The adoption of an adapted version of the German rule would require a progressive extra adjustment that could be obtained by a smooth increase in the effective age of retirement • Fortunately, the burden of the age-related expenditure is located in Entity I, where the margins created by the reduction of the debt are also located • The payment of the civil servants’ pensions of Entity II by Entity II would reduce the necessary adjustment to be done by Entity I by more than 2% of GDP and would avoid a drastic adjustment of the social expenditure

26. Two difficult trade-offs • Without changing the institutions, between an increase of taxes and a reduction of social security expenditures; this would preserve growth enhancing expenditure mainly located in Entity II • By changing the institutions, between taxes located in Entity I and growth enhancing expenditure that should be compressed by the necessity of financing the devolution of some expenditure of Entity I. This strategy would shelter the Social security. • This presentation shows that the exit strategy depends very much on the estimate of the potential growth and on the present output gap which are still very uncertain. • So what? Wait and see? What is sure is that the expenditure growth is structurally too high in Belgium.