increasing productivity growth under very general assumptions may worsen the
sustainability problem.
6 Assessing the effects of reforms
The two alternative modes of assessing the fiscal sustainability problems also
capture a fundamental dimension of reform strategy, namely a gradual adjust-
ment vs a front-loading/pre-funding(savings) strategy. The sustainable tax cor-
responds to a pre-funding strategy since the underlying demographic develop-
ments have a clear upward trend. Therefore, this implies a considerable con-
solidation of public finance over several decades. There are several arguments
against pursuing a strict pre-funding strategy. First, it implies that current gen-
erations come to contribute to the financing of a net-expenditure drift primarily
caused by increased longevity of future generations. This is questionable on
equity grounds. Second, the needed amount of pre-funding necessarily depends
on the base pro jection. Substantial uncertainty is involved, and it is therefore
difficult apriori to determine the needed pre-funding. Finally, on political econ-
omy grounds it is hardly advisable to pursue a policy path with substantial
budget surpluses and accumulation of public wealth over a prolonged period
which at the same time requires the policy discipline that standards in public
provision (both services and transfers) should be kept unchanged relative to the
base scenario.
For these reasons the following considers reform elements which have the
property that they are timed so as to match the underlying trends, i.e. they can
be considered as parts of a gradual adjustment strategy. The following focuses
thus on ensuring a profile for public finances such that the primary budget
balance in trend is close to zero. Although some smoothing is allowed, there is
no substantial pre-funding or front-loading.
While the assessment of the sustainability problem in terms of needed tax
changes has served the purpose of clarifying the need for reforms, this does not
have any implications for the instrument choice. The reform proposals consid-
ered below aim at increasing labour supply and employment. The underlying
demographic profile leads to an absolute decline in labour supply, and public
finances in Denmark are as noted above very sensitive to the fraction of the pop-
ulation in employment. This is so since employment affects both public revenues
(via tax payment) and expenditures (via transfer, since most non-employed have
an entitlement to an income transfer in the Danish welfare system). By increas-
ing the employment share of the population it is possible to ensure a financial
basis for existing welfare arrangements without resorting to expenditure cuts or
tax increases.
The following presents two specific reforms - retirement and labour market
reform - as well as a complete reform package recently proposed by the Welfare
Commission (Velfærdskommissionen (2005d)).
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