Expenditure Growth, Fiscal Sustainability and Pre-Funding Strategies in OECD Countries

Abstract

OECD countries are ageing with resulting fiscal pressures. OECD countries can adopt a number of strategies in response, including modifying expenditure plans, increasing growth, raising taxes in the future or undertaking activities to pre-fund the future liabilities. The appropriate policy response for a country will depend on the particular circumstances facing the country. This paper focuses on the pre-funding option without wishing to imply the pre-funding is necessarily the best policy approach for all countries. We define pre-funding as increasing net financial assets which implies either reducing debt or increasing financial assets. We identify 15 OECD countries as having undertaken some pre-funding. This is a higher number than may be expected, partly due to the fact that primary budget balances are more useful indicators of debt dynamics than general government balances. Of the 15 countries we identify 8 as ‘strong pre funders’ which have a history of pre-funding and a forward looking pre-funding strategy. These are Belgium, Canada, Denmark, Finland, Luxembourg, New Zealand, Norway and Sweden. We identify 7 other countries with less aggressive pre-funding strategies as mild pre funders – Australia, Iceland, Ireland, Italy, Korea, the Netherlands and Spain. The most striking characteristic of the strong pre funders is their high tax to GDP ratio – an average of 51.7 per cent of GDP compared to an average of 42.7 per cent of GDP for countries that do not pre-fund. The strong pre-funders also have slightly higher expected increases in pension expenditure (4.5 percentage points of GDP compared to an OECD average of 3.8 per cent). This difference is consistent with the view that higher welfare benefits are associated with tax smoothing at higher initial tax rates.