Fiscal Consolidation and the Implications of Social Spending for Long-Term Fiscal Sustainability

Abstract

During the economic and financial crisis, fiscal positions across the OECD countries deteriorated sharply. Additional challenges to the sustainability of fiscal balances are posed by ageing population and trends in social spending. Given the scale of the problem, the analysis of fiscal consolidation needs to take into account projected trends in social spending. This paper sheds light on the scale of fiscal consolidation that will be needed to ensure long-term sustainability and on the potential benefits of institutional reforms in mitigating budget pressures of social spending. Based on alternative scenarios, results suggest that in several OECD countries, the fiscal challenges are exacerbated in the long-term by spending pressures related to health and pensions. Therefore, reforms to entitlement programmes need to be an important part of any longer-term sustainability strategy. In particular, reforms of pension and health systems can mitigate budget pressures resulting from ageing populations and hence contribute to fiscal consolidation. Institutional reforms may hence support long-term fiscal sustainability and, at the same time, reduce adverse short-term effects of fiscal consolidation on growth.