Fiscal Policies for Inclusive Growth

1. SEMINAR ON GROWTH, TRANSFORMATION, AND JOB CREATION FEBRUARY 9-11, 2011, MAPUTO, MOZAMBIQUE Fiscal Policies for Inclusive Growth Abdoul Aziz Wane IMF Fiscal Affairs Department

2. Outline of the presentation • Overview of income inequality and growth • Poverty reduction and income distribution • Overview of income inequality and growth • Fiscal policy and income inequality • Fiscal policy and income distribution • Tax policies for inclusive growth • Expenditure policies for inclusive growth • Social Safety Nets (SSN) • Conditional cash transfers programs

3. Poverty, growth, and inequality • Changes in poverty result from changes in Growth and Inequality • Growth main driver of poverty reduction, but policies affecting income distribution can boost poverty reduction.

4. Poverty, growth, and inequality • Inequality increased in many countries over recent years: • But patterns are different: • Poverty increased in slow-growing advanced countries • Poverty was reduced in fast growing LICs and EMEs • But progress stalled recently (Mozambique)

5. Poverty, growth, and inequality • Impact of growth on poverty reduction established (Ravallion and Chen, 1997; Dollar and Kraay, 2002) • But no consensus on link between growth and inequality

6. Poverty, growth and inequality Mozambique: Rapid growth helped reduce poverty • Yet, progress limited after 2002, including because of high inequality

7. Poverty, growth and inequality • Mozambique : Inequality in Human Development Indicators is also high: • Use of safe water by poorest 60 percentage points lower than for richest • Rate of completion of primary school 40 percentage points lower for the poorest than for the richest

8. Poverty, growth, and inequality • High inequality can reduce growth (Tabellini, 1994 Alesina and Rodrik, 1994): • Credit market imperfections reduce investment and growth in countries with high inequality (Piketty, 1993) • Poorest cannot borrow to invest (lack of collateral, asymmetric information) • Poorest cannot send children to school • Poorest cannot invest in health • Social conflict and political instability (Alesina and Perotti, 1996; Rodrik, 1998)

9. Fiscal policy and income distribution • Sound policies, debt relief, growth created conditions to address inequality and accelerate poverty reduction • Significant creation of fiscal space • Yet high and increasing inequality

10. Fiscal policy and income distribution • Fiscal policies can help reduce income inequality and address bottlenecks to long-term growth provided: • Macroeconomic stability is maintained, including low inflation and debt • Tax and transfer programs improve human capital among poor segments of the population • Under these conditions fiscal policy instruments can also accelerate poverty reduction

11. Fiscal policy and income distribution Some preliminary thoughts: • Tax and transfer programs less effective in LICs & MICs than in industrial countries (Deninger and Squire, 1996) • Before-tax Gini : 0.38 (lower than advanced countries) • After-tax Gini : 0.34 (higher than advanced countries) • Important to look at tax and expenditure policies together • Excessive tax rates can drive economic activity out of the formal sector or out of the economy

12. Tax policies for inclusive growth Tax policy and determinants of inequality • A simple econometric estimation (Gupta et al., 2002): • Inequality declines as the ratio of direct to indirect taxes increases • Direct taxes are more progressive than indirect taxes

13. Tax policies for inclusive growth Tax exemptions and inequality • Exemptions and reduced rates widespread in LICs, but are poor distributional device. • Better off spend more, and so derive greater benefit (e.g., exemptions on food and gasoline) • Mobilizing revenue to finance progressive spending superior to across-the-board tax exemptions

14. Tax policies for inclusive growth Possible lessons for Mozambique • Eliminate sector-specific incentives; • Eliminate tax holidays and CIT sector-specific rate reductions, streamline exemptions (fuel, food, etc.) • Improve taxation of Megaprojects : • remove remaining special incentives from the “Code of Fiscal benefits” • ensure a comprehensive, independent economic modeling of new projects (investor outcomes, public revenues, spin-off economic benefits) • Continue efforts to improve direct taxes: improve property taxation, including land (which is progressive), to finance local social spending • Combat tax evasion

15. Expenditure policies for inclusive growth • Spending better at redistribution than taxation. • Social spending: LT impact on human capital • Public wages: not right instrument to combat inequality • Well-targeted outlays on infrastructure and agricultural can help

16. Expenditure policies for inclusive growth Composition of spending matters • Social spending in Mozambique is relatively low • High wage bill, low revenue cut space for social spending

17. Expenditure policies for inclusive growth: Agricultural spending • Facts for Mozambique : • Rural poverty (56.9%) higher than urban poverty (49.6%) • Rural poverty increased (1.6 ppt); urban poverty declined (1.9 ppt) between 2003 and 2009 • Agricultural spending can help reduce inequality if: • consistent with fiscal sustainability and overall growth (does not crowd out other growth-enhancing outlays) • targeted to low-productivity poor farmers (Dorward et al., 2008: large fertilizer subsidies went to less poor in Malawi) • boosts productivity of poor farmers (fertilizers, machinery, conditionality) • Does not crowd out demand for unsubsidized goods

18. Expenditure policies for inclusive growth Physical capital can help reduce inequality • Social infrastructures (education, health) improve access to social services by poorest but need to be well-targeted and effective • Economic infrastructures (transportation, energy, telecoms, etc…) improve productivity of vulnerable and reduce inequality

19. Expenditure policies for inclusive growthBenefit Incidence Analysis (BIA) Some concepts and facts • Levels matter, but effectiveness of spending key • Well-targeted spending progressive. But, progressive spending may not necessarily be well targeted (PSA). • Targeting expenditure well is more challenging than making it progressive. • Education, health and transfer programs in developing countries progressive, but not well-targeted • Incidence of spending on education and health care often skewed toward the non-poor

20. Expenditure policies for inclusive growthBIA Benefits of targeting • Pro-poor benefit incidence associated with better education and health outcomes and wider health access. • Targeted spending save fiscal resources, improve human capital of the poor (and the population in general)

21. Expenditure policies for inclusive growthBIA –– Education • Primary education spending well-targeted in all regions – but degree varies: Q5/Q1 > 4 in LatAm; only >1.2 in SSA • Secondary education spending well-targeted in Asia and LatAm, but poorly targeted in SSA, MCD. • Tertiary education mostly benefits richest in all regions

22. Expenditure policies for inclusive growthBIA –– Health and Transfers • Health spending well targeted; varying degrees • Asia and LatAm: Q1 gets 1½ and 3 times more than Q5, respectively; Poorly targeted in SSA and EMEs • Transfers progressive, but poorly targeted. • Social security benefits (Chile, Costa Rica, Uruguay) • Food subsidies well-targeted in Jamaica, Tunisia • PSA (Mozambique) progressive; not well targeted

23. Expenditure policies for inclusive growthBIA –– Health and Transfers Extreme poor benefit little from public health spending Improved cost recovery from top quintiles can boost coverage of and access by the poor without increasing budgetary cost

24. Social Safety Nets (SSN) • Non-contributory programs targeted to the poor • Cash transfers, targeted or not, conditional or not; • Food or other in-kind distribution; Public workfare jobs • General price subsidies, e.g., for food or fuel • Fee waivers for essential services (health, education)

25. SSN: Three messages • Message 1:Can address poverty and inequality • Safeguard human capital of the poor by: • Protecting poor during economic downturn • Protecting poor from adverse impacts of structural reforms • Message 2: Need to be financed • Should be targeted to the needy to contain costs • Deficit financing can have adverse effects on macro stability and thus worsen the situation of poor • Message 3: Can improve long-term growth • If financed, and well-targeted toward human-capital-increasing spending

26. SSN: Can go beyond handouts Source: World Bank They can also provide a countercyclical instrument (automatic stabilizer) if large enough and well-designed 26

27. SSN: can help reduce inequality

28. SSN: Their appropriate size? • “Critical minimum level of spending necessary for sustainable safety net system” (World Bank) • Should reflect fiscal situation in country. • What’s needed depends on effectiveness. • Depends on priorities for LT poverty reduction

29. Conditional Cash Transfer (CCT) Programs • Conceptual framework: Transfers conditioned on household behavior can make sense under some circumstances: 1. Economic justifications • Persistently misguided beliefs (parents can believe that earnings do not respond to education level; Attanasio and Kaufmann, 2008) • “Incomplete altruism” (parents can discount their children’s future earnings heavily; reduces incentives to invest in children’s education and health now) • Externalities (especially when optimal private return lower than optimal social return) 2. Political economy justifications • Greater support for a program that asks beneficiaries to do “something to help themselves”

30. CCT: Decidedly progressive… • CCTs have helped reduce poverty (Nicaragua: 7 percentage points; Colombia: 3 percentage points) Source: World Bank

31. CCT: Lasting impact on education and health • CCT fostered substantial increases in health, education – especially among poor households Source: World Bank

32. CCT: Lasting impact on education and health • Because impacts concentrated among poorest, CCTs helped reduce “inequality of opportunities” • Example: Nicaragua

33. CCT: Administrative costs • Cost of running CCT lower than other types of programs

34. CCT: Challenges • Enhancing impact on long-term human capital outcomes (e.g. learning) • Integration with investments on quality… • … And with other social interventions (e.g. workfare) • Preventing LT dependency on public assistance and disincentives for labor force participation. • Enforce conditionality. • Establish clear, routine, entry and exitmechanisms • Putting in place administrative capacity • Upgrade information management systems • Contain costs to reasonable levels • Monitoring and evaluation of performance • Expand gradually as administrative capacity improves

35. Thank you!! Main messages: • Macro stability is key • Raise revenue to finance good quality spending: • Improve direct taxes; • Eliminate exemptions and tax holidays • Ensure allocation of spending consistent with LT goals • Control wages; Improve social spending, agricultural and infrastructure • Ensure spending is well-targeted • Develop a SSN to address high poverty and inequality • CCT to boost human capital and improve LT growth