Debt Sustainability and Economic Convergence of Euro-Area Member States: Challenges and Solutions (Clemens Fuest)

23-02-2015

Several member countries of the Eurozone are plagued by increasing government debt and weak economic growth, raising concerns about fiscal sustainability. This paper discusses policy options to improve fiscal sustainability, focusing on two proposals: more public investment and growth oriented tax reforms. In recent years, a significant part of fiscal adjustment has been achieved by cutting public investment, rather than consumption spending. This suggests that there is potential for viable investment projects, but additional investment should be financed by a restructuring of public expenditure, not by additional public debt. Proposals to revise the Stability and Growth Pact towards extending the room for debt financing of investment or to interpret the existing rules more ‘flexibly’ would undermine the credibility of the pact and question the committment to fiscal sustainability. Tax policy can contribute to more growth by reducing taxes on corporate income and labour income, financed through higher taxes on consumption and higher recurrent taxes on immovable property. There are various options for temporary tax changes which would stimulate private consumption and investment spending in the short term.

Several member countries of the Eurozone are plagued by increasing government debt and weak economic growth, raising concerns about fiscal sustainability. This paper discusses policy options to improve fiscal sustainability, focusing on two proposals: more public investment and growth oriented tax reforms. In recent years, a significant part of fiscal adjustment has been achieved by cutting public investment, rather than consumption spending. This suggests that there is potential for viable investment projects, but additional investment should be financed by a restructuring of public expenditure, not by additional public debt. Proposals to revise the Stability and Growth Pact towards extending the room for debt financing of investment or to interpret the existing rules more ‘flexibly’ would undermine the credibility of the pact and question the committment to fiscal sustainability. Tax policy can contribute to more growth by reducing taxes on corporate income and labour income, financed through higher taxes on consumption and higher recurrent taxes on immovable property. There are various options for temporary tax changes which would stimulate private consumption and investment spending in the short term.