Need to look well ahead

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By Angel Gurria

The U.S. Office of Management and Budget (OMB) will release its midsession review on Tuesday, the same day the Congressional Budget Office releases its summer update. OMB is expected to estimate the deficit for fiscal 2009 at about $1.6 trillion, slightly below its previous estimate, in part thanks to about $70 billion repaid to the Troubled Asset Relief Program.

However, this is no time for celebration. The need for fiscal consolidations prompted by massive annual deficits and growing levels of debt is evident in many member countries of the Organization for Economic Cooperation and Development in addition to the United States. In the United Kingdom, for example, declining tax receipts have forced government borrowing to its highest level for the month of July since records began.

It is widely known that the current economic crisis weakened the near-term fiscal health of many countries. It is less well known that most of those same countries also face severe long-term challenges that threaten their fiscal sustainability, especially when combined with funding the demands placed on them by the crisis.

In the United States, near-term deficits of 10 percent to 13 percent of gross domestic product (GDP) may appear gigantic -- and they are -- but they are small relative to long-term projections of debt.

According to OMB, debt will grow from around 60 percent of GDP in 2010 to nearly 120 percent in 2040 and 275 percent in 2080 in the absence of fundamental changes to health programs and other actions.

Fiscal sustainability has many facets. It incorporates an assessment of the capacity of governments to honor their debt, the prospects for stable economic growth, predictable levels of taxation and considerations of how future generations will or should share the burden and benefits of current policies and related expenditure.

Fiscal sustainability is therefore much more than a concept to evaluate financial implications; it is also about their social and political dimensions.

In facing up to these implications, OECD countries have experimented with a variety of institutional budget reforms, including the introduction of fiscal rules, especially rules on how to limit spending; methods to encourage better value for money and reform obligations for social and other purposes; and, more recently, the preparation of long-term fiscal projections.

Long-term fiscal projections can raise the profile of fiscal sustainability based on assumptions of current policies, stable taxes, and other key demographic and micro- and macroeconomic parameters. Such projections can help current governments respond to known pressures and risks in a gradual manner earlier rather than later. They can also help future governments position themselves better to manage unforeseen or less predictable fiscal pressures.

In addition, long-term fiscal projections can raise the profile of fiscal sustainability to the attention of our political leaders, provide a framework for public debate on the sustainability of current policies and the possible impact of reforms and centralize responsibility for long-term analysis.

While fiscal projections have been identified as good practice by the OECD since the 1990s, only a few countries actually prepare and use their projections in policymaking. In this light, OECD recommends that:

Fiscal projections should be prepared on an annual basisto draw attention to the long-term consequences of current policies and to eliminate discretion over when projections are produced.

They should incorporate comparisons with past government assessments to highlight whether the government's fiscal position has improved or deteriorated. They should include sensitivity analysis (or "alternative scenarios") for changes in demographic and macro- and microeconomic assumptions to illustrate the exposure to fiscal risks and the general direction of the impact of this exposure.

They should clearly present changes in methodologies, key assumptions and data sources to provide an assurance of their credibility and quality.

Countries should use fiscal projections to illustrate the consequences of past reforms or general policy options.

There are more and more signs that the world may be starting to emerge from the current economic crisis. As economies recover, many countries will have to wrestle with an exit strategy from the unprecedented monetary and fiscal policies used to respond to the crisis.

Long-term fiscal projections will help this process, as they offer invaluable signposts for where and when to act on fiscal pressures to avoid obstacles to growth and promote a cleaner and fairer economy.

Needless to say, fiscal consolidations shouldn't be implemented until economies have really recovered, but a look at long-term fiscal projections today can help prepare for reforms once economies have resumed sustained growth.

Angel Gurria is secretary-general of the Organization for Economic Cooperation and Development.