ECONOMICS

Downturn hits public finances across many fronts
Economic-stimulus efforts present substantial upfront costs for governments, but they might also have longer-term effects that will take a while to be realized. Beyond its immediate, obvious expense, the economic downturn affects public finances in several ways. Declining share prices, for example, result in lower capital-gains taxes, hitting government revenues. The Economist (11 Mar.)

Public finances
One crunch after another
Mar 11th 2009
From Economist.com

The financial crisis is battering public finances on several fronts

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CALLS for co-ordinated fiscal stimulus to lift the world out of recession were joined at the weekend by Larry Summers, Barack Obama’s top economic adviser. Such co-ordination has been absent up to now, though that could change at the meeting of G20 leaders in London in early April. But there has been plenty of fiscal stimulus, led by America’s $787 billion package, as many governments seek to offset a collapse in private demand. There are worries not only about how much these measures cost up front but their longer-term effects on government finances.

The direct costs of such packages are indeed large. The IMF reckons that for G20 countries stimulus packages will add up to 1.5% of GDP in 2009 (calculated as a weighted average using purchasing power parity). Together with the huge sums used to bail out firms in the financial sector (3.5% of GDP and counting in America, for example), these are immediate ways in which the crisis is affecting public finances across the world. But they are not the only ones.

A downturn affects government finances in other ways. Shares in most rich countries have plummeted. The MSCI developed-world index, which tracks stocks in 23 rich countries, has lost more than half its value since the beginning of 2008. Falling share prices hit government revenues as capital-gains tax takes decline. Similarly, taxes on financial-sector profits, a significant part of government revenue in many countries, have evaporated. And expenditures on automatic stabilisers such as unemployment insurance rise in a recession. All this widens budget deficits.

Direct stimulus measures also push up government deficits and debt, although the type of intervention affects how long-lasting its effects are. Most expenditure, such as infrastructure spending, is temporary (although it affects debt permanently). Revenue measures, such as tax cuts, are politically difficult to reverse. The question is whether this threatens the solvency of governments.

A paper on the state of the world’s public finances issued by the IMF in the run-up to the G20 meetings takes a stab at identifying and measuring the fiscal implications of the crisis for both rich and developing countries. Its conclusions are sobering. For rich G20 countries, fiscal balances will worsen by 6% of GDP between 2007 and 2009. Government debt will come off worse. Between 2007 and 2009, the debt-to-GDP ratio of rich countries is projected to rise by 14.5 percentage points. In the medium term, the outlook is even more worrying. Government debt for the average rich country will be more than 100% of GDP by 2014 compared with 70% in 2000 and 40% in 1980. more...