Proceedings from the ECFIN Workshop "The budgetary implications of structural reforms" - Brussels, 2 December 2005



The public sector produces goods that are mainly used for public consump-
tion. In addition it levies taxes and pays transfers and subsidies to households
and firms. These are modeled in great detail to capture actual systems and
rules as closely as possible. The most important taxes in terms of revenue are
local- and central-government income taxes, VAT, excise duties, corporate taxes,
property taxes and a tax on yield of pension funds. Tax rates are assumed to
remain constant in the forecast period. On the expenditure side 23 different
transfers are distinguished and paid out to individuals of each respective age,
gender and origin group following the actual distribution in 2001. In the same
way expenditures for individual public consumption (mainly educational, health
and social expenditures) are distributed to individuals. These individual (per
age, gender and origin group) expenses are forecasted to increase with the rate
of inflation and the exogenous productivity growth. The remaining collective
public consumption is assumed to grow at the same rate as domestic GDP.

4.2 Unchanged policy

The starting point is to evaluate the sustainability of current policies, and this
requires a precise clarification of what is understood by unchanged policies. This
is complicated since it involves both current tax, transfer and welfare schemes.
The key assumptions made here are the following( further details are given in
Velfærdskommissionen (2004, 2005))

* Transfer incomes are regulated annually by wage increases in the
private sector13.

* The frequency of the population receiving various income transfers
is constant across gender, age and country of origin.

* The frequency of the population using various forms of welfare
services (individual collective consumption) is constant across gender,
age and country of origin. The average cost per person is regulated
annually by the sum of productivity increases and inflation
equal to wage increases.

* Collective public consumption is a constant fraction of GDP.

* Public investments are determined such that the capital-labour
ratio in public production is constant.

* All tax rates (including excise taxes) are assumed constant.
Taxes levied on a per quantum basis are regulated by inflation14 .

* Working hours and the fraction working part time are constant

Broadly interpreted the assumptions made here correspond to assuming un-

13 According to Danish indexation rules"satsreguleringsloven" all transfers are indexed on
private sector wages. However, 0.3 percentage points of the wage increase are transferred to a
public fund "satspuljen" if wage increases exceed 2%. The funds accumulated in "satspuljen"
are to be used for initiatives in the form of transfers or services benefitting recipients of transfer
income. Note that since transfers are taxable income the distribution of part of the funds via
"satspuljen" rather than by full indexation of transfers tends to deteriorate public finances.

14 Currently there is a so-called tax-stop freezing all tax rates, also some at a nominal level
(taxation of houses). In the pro jections the tax-freeze is assumed to be lifted in 2011.

12



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