This chapter also attempts to quantify the size of the long-term fiscal challenges
confronting EU countries by reporting estimates of fiscal imbalances (FI) for 23 EU
countries. The FI estimates suggest sizable gaps between the fiscal shortfalls reported
under traditional backward-looking debt and deficit measures and those implied by
forward-looking fiscal imbalance measures.
The chapter concludes by suggesting that European countries need to undertake a third
transition - to step back from the current broad provision of social insurance programs
and allow greater scope for individual determination and private provision of these
services. Introducing this important element in structural reforms by encouraging
significant reductions in public spending commitments appears to be the only
economically feasible way of addressing future fiscal challenges. The alternative of
increasing taxes and imposing additional regulatory restrictions on member countries to
preserve the status quo in social protection programs is likely to prove counterproductive.
3.2 Unfunded Obligation Measures
Concern about fiscal sustainability arising out of the current demographic structure in
developed countries has spurred interest in developing forward-looking measures of fiscal
policy. Several alternatives exist for depicting the future course of federal budget
balances. The first and most obvious measure is a projection of future total government
revenues, expenditures and the annual gaps between the two. Although future projections
of this type are reported in the official budgets of many countries, the projections are
usually limited to the next 5 or 10 years. For example, the annual budget reports of the
UK Treasury (HM Treasury, 2006) adopt a 5-year time horizon - with the horizon
advancing by 1 year every year. The same is true of the official budget reports of many
other EU countries.16
Given the obvious inadequacy of such short-term budget projections for designing long-
term policy reforms, several measures have been proposed by budget practitioners and
academic economists. They include (i) simply extending the time horizon of traditional
deficit and debt measures, (ii) accrual accounting, (iii) generational accounting, and (iv)
fiscal and generational imbalances. This section provides a discussion of their strengths
and weaknesses.
Traditional Measures - Government Deficits and Debt
Traditional short-term deficit and debt measures of the national fiscal stance are grounded
in Keynesian macroeconomic theory that considers the gap between revenues and
expenditures as providing a fiscal impulse that could be calibrated for macroeconomic
stabilization over business cycle time horizons. Given the need for greater spending on
welfare programs during economic downturns and the wide prevalence of progressive
income taxation, annual budget deficits naturally move countercyclically. Discretionary
elements of revenues and expenditures could be used, however, to enhance these
countercyclical movements to yield even larger macroeconomic impulses to dampen
business cycles and stabilize the pace of economic activity and growth. A large and
See federal budget reports, for example, of Denmark National Bank (2005), General Administration
of the Treasury of Belgium (2005), Ministry of Finance, Sweden (2005), and several other EU
countries.
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