From Analytical Work to Policymaking and Fiscally Responsible Legislation Regional Pension Policy Workshop Majuro, April 25-29, 2016 Thank you for providing me the opportunity here today to present the key findings of our recent study on fiscal policy and income inequality. Income inequality has been rising in many parts of the world in recent decades. This, and the social tensions associated with fiscal consolidation that many countries have faced, have put the distributional impact of governments’ tax and spending policies at the heart of the public debate in many countries. Of course, the question of just how much redistribution the state should do is, at its core, a political one that economic analysis cannot answer. But I think that we can all agree that whatever is the desired level of redistribution, it should be done with fiscal instruments that achieve their distributional objectives at a minimum cost to economic efficiency.   The design of these growth-friendly, efficient redistributive fiscal policies is the focus of my presentation today. It may seem surprising that the Fund is entering into this debate on the design of redistributive policies. The truth of the matter is that we have been at this for a long time. Assessing the effect of tax and expenditure policies on efficiency, and any potential tradeoffs with distributional goals, has long been an important component of the IMF’s policy advice, particularly in the context of its technical assistance to member countries. Furthermore, the design of Fund-supported programs is inevitably influenced by the authorities’ distributional objectives. Our concern for the poor in the design of Fund-supported programs has a longstanding history, going back to the 1980s. The 2011 Review of IMF programs—the “Conditionality Review”—indicated that an increasing number of Fund programs are taking into consideration social aspects, and that social spending has largely been safeguarded in programs. In some countries, such as Sierra Leone, and Togo, conditionality on subsidy reform was accompanied by an analysis of its distributional impact, and, in some cases, by conditionality on measures to protect the poor. Income distribution issues also surface during the Fund’s surveillance of member’s economic policies, especially during discussions of the potential effects of tax and expenditure reforms. I should also highlight the other reason why we are focusing on this issue, that is, the pressure on countries to redistribute, as reflected in public surveys. Our members would like to explore with us how they can pursue distributive policies in an efficient manner. The key message that I want to convey today is that when it comes to fiscal redistribution, design matters. This is consistent with another recent IMF study, which finds that, on average, fiscal redistribution has been associated with higher growth. In our view, there is a diversity of experience across countries with redistributive policies. Some redistributive fiscal policies can help improve efficiency and support growth, such as those that enhance the human capital of low-income households. For other redistributive fiscal policies, a tradeoff between equality and efficiency may be involved. But even when these tradeoffs exist, the appropriate design of policies can help to minimize their adverse effects on incentives to work, save, and invest. Csaba Feher Disclaimer: The views expressed herein are those of the author, and should not be attributed to the IMF, its Executive Board, or its management

Current Reporting Practices and Their Consequences Special features of public pension schemes Social security “balances sheets” are cash accounts (budgets”) In pensions, everything is long-term Demographic trends Impact of regulatory changes Maturity of pension liabilities is several decades No full funding requirement or asset-liability matching either by definition or by regulation No information on complete impact of changes >> decisions made on the basis of short-term effects Contribution rate and base >> future pension expenditures Higher/lower entry pensions >> welfare impact only in the future Indexation >> compounded interest effect Mandatory funded schemes >> higher immediate deficit, lower liabilities Nationalizing private pension assets >> higher future liabilities

Metrics for Public Pension Finances Medium- to long-term expenditure dynamics (IMF) Pros: simple (relatively) to produce and understand captures cycles and volatilities Cons: disregards revenues and the room for additional taxes Changes in Public Pension Expenditures

Metrics for Public Pension Finances Fiscal gap type indicators = immediate or time-contingent adjustment needs to offset the spending increases in the future Examples: Pension-Adjusted Budget Balance Net (Unfunded) Pension Liabilities Pros: Full cost of regulatory changes can be presented Cons: Complicated to project Not straightforward to interpret Doesn’t capture macroeconomic and demographic cycles, temporary regulations Stock/level vs. change Levels: not suitable for international comparison Change: fiscal impact and sensitivity analyses within the same country

Fiscal Rules Definition: A fiscal rule is a long-lasting constraint on fiscal policy through numerical limits on budgetary aggregates which aim to correct distorted incentives to ensure fiscal responsibility and debt sustainability. Common pool problem Myopia Instruments: Numerical targets, expenditure ceilings as medium-term anchors Debt rules, deficit rules, expenditure rules, revenue rules Current practices: Central government or general government, short- to medium term “Sustainability reports” Problem areas: long-term liabilities (PPPs, environment, pensions)

Are Public Pensions a Suitable Suspect for Fiscal Rules? YES. Long-term commitments need long-lasting constraints because of myopia (among other things) Lack of asset-liability matching and the time-inconsistency of maturities lead to distorted incentives Pension liabilities are unreported debt Inter-generational equity > common pool problem CONSIDER: REPORTED PUBLIC DEBT VS. FISCAL GAP (total liabilities – total revenues)

Possible Expansion to Public Pensions Step 1: Establishing reporting standards, projection methodologies and indicators Step 2: Establishing procedural rules, including ones curtailing the growth of unfunded liabilities (mandatory offsetting) Step 3: Fiscal rules, establishing ceilings on the change of both funded and unfunded pension liabilities

Step: Projections, Indicators and Reporting Data and technical capacity to project pension expenditures and revenues Individual earnings data Establishing and maintaining technical capacity Microsim-based cohort models (or simpler models, initially) Behavioral responses (iffy) Indicators (simple, stable, relevant) Total pension liabilities Net liabilities Years when deficit exceeds a benchmark Permanent and time-bound adjustment needs Permanent and time-bound revenue increases Reporting Budget Every time a bill substantially impacts on pension finances Periodic policy reviews

Step 2: Procedural Rules No draft bill should enter legislature without long-term fiscal and distributional impact analyses, including Indicators should show the net impact of regulatory changes, so that it is not dissolved in methodological amendments and modified assumptions All expenditure generating proposals should be accompanied by commensurate revenue-generating proposals: = Regular policy evaluation (“Social Security Advisory Council) Net present value of marginal assets/revenues Net present value of marginal expenditures

Step 3: Fiscal Rules Objectives: Examples: Projections, indicators: forming expectations Procedures: no constraint on pension policy but information is rendered unavoidable Fiscal rules: numeric rules static or dynamic real or relative with/out escape rules Examples: No growth or gradual reduction of unfunded liabilities No growth of gross pension spending, relative to baseline

Thank you! Thank you for providing me the opportunity here today to present the key findings of our recent study on fiscal policy and income inequality. Income inequality has been rising in many parts of the world in recent decades. This, and the social tensions associated with fiscal consolidation that many countries have faced, have put the distributional impact of governments’ tax and spending policies at the heart of the public debate in many countries. Of course, the question of just how much redistribution the state should do is, at its core, a political one that economic analysis cannot answer. But I think that we can all agree that whatever is the desired level of redistribution, it should be done with fiscal instruments that achieve their distributional objectives at a minimum cost to economic efficiency.   The design of these growth-friendly, efficient redistributive fiscal policies is the focus of my presentation today. It may seem surprising that the Fund is entering into this debate on the design of redistributive policies. The truth of the matter is that we have been at this for a long time. Assessing the effect of tax and expenditure policies on efficiency, and any potential tradeoffs with distributional goals, has long been an important component of the IMF’s policy advice, particularly in the context of its technical assistance to member countries. Furthermore, the design of Fund-supported programs is inevitably influenced by the authorities’ distributional objectives. Our concern for the poor in the design of Fund-supported programs has a longstanding history, going back to the 1980s. The 2011 Review of IMF programs—the “Conditionality Review”—indicated that an increasing number of Fund programs are taking into consideration social aspects, and that social spending has largely been safeguarded in programs. In some countries, such as Sierra Leone, and Togo, conditionality on subsidy reform was accompanied by an analysis of its distributional impact, and, in some cases, by conditionality on measures to protect the poor. Income distribution issues also surface during the Fund’s surveillance of member’s economic policies, especially during discussions of the potential effects of tax and expenditure reforms. I should also highlight the other reason why we are focusing on this issue, that is, the pressure on countries to redistribute, as reflected in public surveys. Our members would like to explore with us how they can pursue distributive policies in an efficient manner. The key message that I want to convey today is that when it comes to fiscal redistribution, design matters. This is consistent with another recent IMF study, which finds that, on average, fiscal redistribution has been associated with higher growth. In our view, there is a diversity of experience across countries with redistributive policies. Some redistributive fiscal policies can help improve efficiency and support growth, such as those that enhance the human capital of low-income households. For other redistributive fiscal policies, a tradeoff between equality and efficiency may be involved. But even when these tradeoffs exist, the appropriate design of policies can help to minimize their adverse effects on incentives to work, save, and invest. Disclaimer: The views expressed herein are those of the author, and should not be attributed to the IMF, its Executive Board, or its management