Fiscal Architecture Prof. Sally Wallace Georgia State University Atlanta, GA

Plan for the Afternoon Discuss the basis and uses of fiscal architecture Discuss the implications of fiscal architecture Analyze an exercise (simple example) Discuss uses as training material, and additional considerations

The Central Issue Ministry of Health needs to forecast expenditures for the next 2 budget years Ministry of Health seeking aid for long- term assistance in prevention programs for chronic disease

Simple Forecast 2 years Current PC health expenditures1,345 Projected increase in medical price index6.00% Projected increase in general population1.20% Projected expenditures all else constant$1,443$1,548 Projected percent increase in expenditures, all else constant7.27%

What Else Affects the Forecast? Health status by age by gender Expected changes in health status Changes in age distribution of the population Attitudes toward health education

Alternative Forecasts

Extraordinary Circumstances Over the next 20 years, the incidence of cancer is expected to increase: 65 percent in Eastern Asia 200 percent in Eastern Europe 80 percent in South-Eastern Asia

What is Fiscal Architecture? Central components/characteristics of a country that influence a country’s public finances and ability to adapt to more general public policies:

Demographics Age and age distribution Family size and composition Household composition Racial/ethnic composition of population Population growth Urbanization Education Health status

Economics Concentration of industries Form of doing business Distribution of economic activity Composition of income Resource endowment Size/type of economy

Components, con’t. Institutions: property rights, intergovernmental fiscal relations, ability to change tax structure, mandates, discretion over expenditures Political economy

Why does it matter? In general.. Affect on expenditures, a simple relationship: Exp i = Q g * C g (1) dExp i = dQ g* C g + Q g * dC g (2) Q g = f(client population)

Why does it matter, con’t. Revenue side, Rev i = (taxbase i * taxrate i )*pop i dRev i = dtaxbase i *taxrate i *pop i + taxbase i *dtaxrate i *pop i + taxbase i *taxrate i *dpop i

Why does it matter for policy? Budgeting all levels of government Revenue forecasting – stability of long- term revenue Meeting expenditure needs – mandated, non-discretionary Implications for deficits

Why does it matter for policy? Intergovernmental issues Revenue sharing (forecasts, capacity) Grants development, allocation (measurement of needs, capacity) Other policy initiatives Poverty alleviation Social programs

Some specific components Age Trends: elderly population growing Potential impacts: pension spending, consumption pattern changes, labor supply Options? additional payroll taxes reduced pension benefits

Components, con’t. Economic Base Trends: Differential changes over a variety of countries, some move away from agriculture Potential Impacts: Tax handles may change, demand for certain types of infrastructure Options? Could call for major changes in revenue bases, shift in public services

Other types of components Mobility Health Status Urban/rural split Income distribution

Illustrative Matrix to Identify Fiscal Architecture: Expenditure Needs EducationWater Supply Social Sector Primary Health Roads/ Other (ec. transport dev/other) Demographics Population Urban/Rural Age Composition Migration Health Economic structure Level,trends, changes: Agriculture Manufacturing Trade Etc. Institutional Business regs. Local tax authority Spending rules

Illustrative Matrix To Identify Fiscal Architecture: Revenue Pressures Independent Var.VATImport DutiesCITPITOther Demographics Population Urban/Rural Age Composition Migration Health Economic structure Level,trends, changes: Agriculture Manufacturing Trade Etc. Institutional Business regs. Local tax authority Spending rules

Aging Example Financing pensions out of payroll taxes: P b *B = t*P w *w P b is the number of pensioners, B is the benefit per pensioner, t is the payroll tax rate, P w is the number of workers and w is the average wage per worker

t = (P b /P w ) * (B/w) RHS: Dependency ratio—the ratio of pensioners to working population and the replacement ratio— the ratio of average benefits paid to wages that supply the financing for the pension system What happens as the population ages?

Data on dependency ratio Guatemala Ethiopia Impact on tax rates Options? Payroll tax rate Benefits Privatization options

Exercise II: Expenditures on Education Formula driven in many countries

Education Example Staff salaries/FTE Operations expenses/FTE School administration expenses/FTE Staff development expenses/FTE Facility operation expenses/FTE

Other Issues Role of shocks Relative size of the economy Small countries Islands Major shifts in politics Deficits