Fiscal Space, Fiscal Legitimacy and Development

1. Fiscal Space, Fiscal Legitimacy and Development G20 Workshop on Fiscal Space for Growth and Social Policy 19-20 June 2008 Buenos Aires Javier Santiso Director & Chief Development Economist, OECD Development Centre

2. Introduction 1 2 Fiscal Space and Growth 3 Fiscal Legitimacy and Development

3. Bridging OECD and Emerging Economies The Development Centre OECD members 2008 - 23 members Non-OECD members 2008 - 10 members Israel Brazil Romania Vietnam Colombia Chile South Africa India Thailand Egypt

4. Latin American Economic Outlook impact LEO • Activities: • 11 seminars organized on topics related to Latin America • 50 presentations at international conferences • 235 press articles published in 18 countries • 17.500 members of LEO’s newsletter

5. OECD Centre for Tax Policy & Administration Partnership • Enlargement Initiative • Latin American Revenue Statistics Project: • An initiative to extend the OECD Revenue Statistics methodology to a number of Latin American countries. • Mission: • Providing Technical Expertise to the Committee on Fiscal Affairs by examining all aspects of taxation. • Covers international and domestic tax issues, direct/indirect taxes, tax policy and tax administration. • Provide annual comparisons on tax levels and tax structures in member countries. • Recent work on environmental policy and taxation, taxation and growth.

6. Introduction 1 2 Fiscal Space and Growth 3 Fiscal Legitimacy and Development

7. Understanding Fiscal Space Growth Fiscal Space “The capacity of a government to provide financial resources for a desired purpose, subject to the constraint that the fiscal position is sustainable, both over the medium and long-term.” Heller, P. Introduction to “Fiscal Policy: Fiscal Elements of Growth and Development”. Proceedings of G-20 Workshop. Istanbul, Turkey, July 2007. “The gap between the current level of expenditure and the maximum level of expenditures a government can undertake without impairing its solvency” Development Committee of the World bank-IMF Board on Fiscal Policy and Growth, 2006. The four pillars of Fiscal Space Source: Fiscal Policy: Fiscal Elements of Growth and Development”. Proceedings of G-20 Workshop. Istanbul, Turkey, July 2007.

8. Tax structure and channels of growth Growth Taxation Consumption Taxes Income taxes and Social Security Taxes on Property and Wealth Households Companies Special tax Profits Capital Income tax SSC employer SSC employee Property State tax Labour income tax Wealth Tax General taxes (e.g. VAT) Taxes on specific goods and services Affected drivers of growth: Employment, Human Capital Formation Source: Heady, C. “Tax Policy for Growth.” In Fiscal Policy: Fiscal Elements of Growth and Development”. Proceedings of G-20 Workshop. Istanbul, Turkey, July 2007.

9. Tax structure is a creator of fiscal space Growth Source: Latin American Revenue Statistics (LARS), 2008. OECD Development Centre, Paris. Based on data from ECLAC and OECD.

10. Tax Policy and Growth: Implications Growth Corporate taxes andInvestment Income taxes Source: Latin American Revenue Statistics, 2008. OECD Development Centre, Paris. • Reforming top marginal tax schedules may improve incentives: it could also increase inequality. • Reforming labour/SSC taxes is more important for productivity in labour-intensive economies. • Cutting corporate taxes may promote productivity growth and investment.

11. Does the tax structure matter for growth? Growth • Tax “negative effect” of tax on growth declines as you move from : Property tax Corporate income tax Personal income tax Consumption taxes    • Questions : • To what extent do different tax provisions affect investment and productivity? • Does the industry/firm structure matter for the impact of taxes? • Is there a trade off among efficiency, equity, and simplicity? Source: Arnold, J., A. Johansson, C. Heady, B. Brys and L. Vartia. “Tax and Economic Growth”. OECD Centre for Tax Policy Administration /Economics Department Working Paper, 2008

12. Introduction 1 2 Fiscal Space and Growth 3 Fiscal Legitimacy and Development

13. Latin America’s fiscal stance has improved Legitimacy Source: Latin American Economic Outlook 2009 (forthcoming). Information based on investments banks' publications, 2008 Note: countries analysed are Argentina, Brazil, Chile, Colombia, Ecuador, Mexico, Peru, Uruguay and Venezuela during the period July 1997- February 2008, covering 15 presidential elections before 2006 and 8 presidential elections since 2006 (non overlapping elections). Source: OECD Development Centre, Based on Nieto and Santiso (2008). Note: Difference calculated for each period between primary spending in election-year and average on primary spending of the last three non-election years prior to election.

14. However, fiscal recipes remain low Legitimacy Tax revenue for selected countries (Central Government, % GDP, 2006) Source: Latin American Economic Revenue Statistics, 2008. OECD Development Centre, Paris. Based on ECLAC’s ILPES Database and OECD Revenue Statistics Database.

15. Fiscal Progressivity is not a matter of DNA Legitimacy Inequality before and after taxes and transfers Gini coefficient Source: Latin American Economic Outlook 2008. OECD Development Centre, 2007. Based on data by Goñi, López, and Servén (2006).

16. Fiscal Legitimacy is low Legitimacy Firms’ assessment of the neutrality/composition of government decisions/spending (2003-2006) % of citizens who trust tax revenue is well spent (2003-05) Fairer/ Wiser Unfair/ Wasteful Source: “Latin American Economic Outlook 2008”. OECD Development Centre, 2007. Based on Latinobarómetro (2003, 2005) and World Bank Institute, Governance Indicators Database. Based on World Economic Forum, Global Competitiveness Report, 2003-2006.

17. More than quantity, is the quality of spending Legitimacy Source: OECD Development Centre, 2007. Based on PISA (2003) and OECD Education at a Glance (2005)

18. Equity matters: Spending is often regressive Legitimacy Source: Latin American Economic Outlook, 2008. OECD Development Centre, 2007. Based on ECLAC’s Panorama Social, 2007.

19. Growth, Fiscal Policy and Development Conclusions • Fiscal Space is not one-dimensional. • Improving the social contract between citizens (and firms) and the state – fiscal legitimacy – will also broaden fiscal space. • Best practices can be identified to promote growth, equity and the quality of public services. • Fiscal policy must improve the quality (and the quantity) of revenues and expenditures. • Tax administration matters: weak administration limits the ability to: • - raise revenue • achieve a balanced tax structure • engage citizens in a tax-paying democracy

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