Tax Policy Can Help Countries Turn Corner on Debt

Average debt level in advanced economies expected to crest at historic highs

Weakening growth and rising borrowing costs erode fiscal space in emerging economies

More balanced and fairer tax policies can strengthen revenue and improve growth prospects

Budget tightening over the past few years means that advanced economies have been able to narrow budget deficits by 4 percentage points on average by 2013, to half the level seen at the height of the crisis—with the notable exception of Japan, says the latest edition of the IMF’s Fiscal Monitor.

The report, published in April and October each year to track public spending and government debt and deficits around the world, expects public debt in most advanced economies to stabilize in 2013–14.

At about 110 percent of GDP, the average debt level across advanced economies is still 35 percentage points above its 2007 level, and bringing it down still requires sizable efforts. Although most high-debt countries have now delivered close to two-thirds of the adjustment needed to put their debt ratios on a firm downward path, historical experiences suggest that the main challenge will be maintaining this fiscal stance for an extended period of time— until debt ratios reach more comfortable levels.

“Since we are looking at a protracted process, it is particularly important to calibrate the composition of fiscal adjustment so as to enhance long-term growth prospects and preserve social cohesion,” said Martine Guerguil, Deputy Director in the IMF’s Fiscal Affairs Department. “This will both help reach the goal faster and minimize the risks of adjustment fatigue and policy reversal.”

In addition, the report notes that high debt, an uncertain global environment, weak growth prospects, and a lack of well-defined medium-term adjustment plans in key economies, like the United States and Japan, complicate the task. While global growth prospects have generally improved, eyes have now turned to the United States where a fiscal showdown has begun to play out. In a recent speech in Washington, D.C., IMF Managing Director Christine Lagarde cautioned that political uncertainty in the United States over the budget and the debt ceiling does not help the country’s ongoing efforts to deal with other fiscal challenges like entitlement spending reform and a comparatively low revenue base. “The government shutdown is bad enough, but failure to raise the debt ceiling would be far worse, and could very seriously damage not...