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Fiscal Policies for Inclusive Growth

Abdoul Aziz Wane

IMFFiscal Affairs Department

SEMINAR ON GROWTH, TRANSFORMATION, AND JOB CREATION FEBRUARY 9-11, 2011, MAPUTO, MOZAMBIQUE

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Outline of the presentation

• Overview of income inequality and growth– Poverty reduction and income distribution– Overview of income inequality and growth

• Fiscal policy and income inequality– Fiscal policy and income distribution– Tax policies for inclusive growth– Expenditure policies for inclusive growth

• Social Safety Nets (SSN)– Conditional cash transfers programs

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Poverty, growth, and inequality

• Changes in poverty result from changes in Growth and Inequality

• Growth main driver of poverty reduction, but policies affecting income distribution can boost poverty reduction.

Absolute Poverty and Poverty Reduction

"Development strategy "

Distribution and Distributional changes

Aggregate income level and growth

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Poverty, growth, and inequality

• Inequality increased in many countries over recent years:

• But patterns are different:– Poverty increased in slow-growing advanced

countries – Poverty was reduced in fast growing LICs and

EMEs• But progress stalled recently (Mozambique)

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15

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Change in Income Distribution for Selected Countries

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Poverty, growth, and inequality• Impact of growth on poverty reduction

established (Ravallion and Chen, 1997; Dollar and Kraay, 2002)

• But no consensus on link between growth and inequality

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0 5 10

0 5 10 0 5 10

Asia and Pacific Europe and Northern America Latin America

Middle East Sub-saharan Africa

Long

-term

ineq

ualit

y in

dex

Long-term rate of change in real GDPGraphs by Region1

Inequality and Growth by Region

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Poverty, growth and inequalityMozambique: Rapid growth helped reduce poverty

• Yet, progress limited after 2002, including because of high inequality

01020304050607080

1996 2002 2008

Mozambique -- Poverty and Inequality (%) Growth rate : 8.8% (average 1996-2008)

Poverty Inequality

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Poverty, growth and inequality

• Mozambique : Inequality in Human Development Indicators is also high:– Use of safe water by poorest 60 percentage

points lower than for richest– Rate of completion of primary school 40

percentage points lower for the poorest than for the richest

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-60

-40

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20

40

60

80

Under-5 mortality rate (per 1,000 live biths)

Skilled birth attendance (% of births)

Use of safe water (%) Completion of primary school (% of children enrolled, right axis)

Mozambique -- Difference between extremes quintiles (Q5-Q1)

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Poverty, growth, and inequality• High inequality can reduce growth (Tabellini,

1994 Alesina and Rodrik, 1994):– Credit market imperfections reduce investment

and growth in countries with high inequality (Piketty, 1993)• Poorest cannot borrow to invest (lack of

collateral, asymmetric information)• Poorest cannot send children to school• Poorest cannot invest in health

– Social conflict and political instability (Alesina and Perotti, 1996; Rodrik, 1998)

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Fiscal policy and income distribution

• Sound policies, debt relief, growth created conditions to address inequality and accelerate poverty reduction– Significant creation of fiscal space– Yet high and increasing inequality

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Mozambique -- Fiscal Space

Inequality (%) Debt to GDP ratio (%)

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Fiscal policy and income distribution

• Fiscal policies can help reduce income inequality and address bottlenecks to long-term growth provided:– Macroeconomic stability is maintained,

including low inflation and debt– Tax and transfer programs improve human

capital among poor segments of the population

• Under these conditions fiscal policy instruments can also accelerate poverty reduction

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Fiscal policy and income distribution

Some preliminary thoughts:• Tax and transfer programs

less effective in LICs & MICs than in industrial countries (Deninger and Squire, 1996)– Before-tax Gini : 0.38

(lower than advanced countries)

– After-tax Gini : 0.34 (higher than advanced countries)

• Important to look at tax and expenditure policies together

• Excessive tax rates can drive economic activity out of the formal sector or out of the economy

Emerging Markets -- Revenue increases and inequality

Source: IMF staff estimates. Data on Gini coefficients from WIDER database. Note: Positive values for a change in Gini coefficient denote an increase in income inequality.

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Revenue Increase (in percent of GDP)

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Tax policies for inclusive growth Tax policy and determinants of inequality

• A simple econometric estimation (Gupta et al., 2002):– Inequality declines as the ratio of direct to

indirect taxes increases• Direct taxes are more progressive than indirect

taxes

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30.0

40.0

50.0

60.0

70.0

2006 2007 2008

Direct taxes as a share of total taxes (in percent)

Mozambique South Africa

0.02.04.06.08.0

10.012.014.016.0

2006 2007 2008

Direct taxes as a share of GDP (in percent)

Mozambique South Africa

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Tax policies for inclusive growth Tax exemptions and inequality

• Exemptions and reduced rates widespread in LICs, but are poor distributional device.– Better off spend more, and so derive greater

benefit (e.g., exemptions on food and gasoline)– Mobilizing revenue to finance progressive

spending superior to across-the-board tax exemptions

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1 2 3 4 5 6 7 8 9 10

Mozambique -- Benefits from Zero-Rating Foodstuffs relative to Income Share (%)

Share of subsidy Share of total income

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Tax policies for inclusive growth Possible lessons for Mozambique• Eliminate sector-specific incentives;• Eliminate tax holidays and CIT sector-specific rate

reductions, streamline exemptions (fuel, food, etc.)• Improve taxation of Megaprojects :

– remove remaining special incentives from the “Code of Fiscal benefits”

– ensure a comprehensive, independent economic modeling of new projects (investor outcomes, public revenues, spin-off economic benefits)

• Continue efforts to improve direct taxes: improve property taxation, including land (which is progressive), to finance local social spending

• Combat tax evasion

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Expenditure policies for inclusive growth• Spending better at redistribution than taxation.• Social spending: LT impact on human capital• Public wages: not right instrument to combat inequality• Well-targeted outlays on infrastructure and agricultural

can help

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0 5 10 15 20Public spending on education (% of GDP)

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0 5 10 15Public spending on health (% of GDP)

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(%)

0 3 6 9Public spending on social sectors (% of GDP)

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dex

(%)

0 10 20 30Public wage bill (% of GDP)

Composition of Spending and Inequality

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Expenditure policies for inclusive growth

• Social spending in Mozambique is relatively low

• High wage bill, low revenue cut space for social spending

2.5 1.9 2.7 3.0 3.76.4 6.0

8.2 8.65.51.2 2.5 2.0 1.7 1.5

1.7 3.12.6 2.5

6.9

0.02.04.06.08.0

10.012.014.0

Social Spending in Selected Countries Average 2000-2007 (share of GDP, %)

Education Health

Composition of spending matters

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Malawi

Angola

Chile

Brazil

Botswana

Nigeria

Tanzania

Zambia

Portugal

Namibia

Mozambique

Compensation of employees (% of total revenue)

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Expenditure policies for inclusive growth:

• Facts for Mozambique :– Rural poverty (56.9%) higher than urban poverty

(49.6%)– Rural poverty increased (1.6 ppt); urban poverty

declined (1.9 ppt) between 2003 and 2009• Agricultural spending can help reduce inequality if:

– consistent with fiscal sustainability and overall growth (does not crowd out other growth-enhancing outlays)

– targeted to low-productivity poor farmers (Dorward et al., 2008: large fertilizer subsidies went to less poor in Malawi)

– boosts productivity of poor farmers (fertilizers, machinery, conditionality)

– Does not crowd out demand for unsubsidized goods

Agricultural spending

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Expenditure policies for inclusive growth

• Social infrastructures (education, health) improve access to social services by poorest but need to be well-targeted and effective

• Economic infrastructures (transportation, energy, telecoms, etc…) improve productivity of vulnerable and reduce inequality

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0 .02 .04 .06 .08 .1Private capital stock per capita

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0 .02 .04 .06 .08Public capital stock per capita

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0 .05 .1 .15Total capital stock per capita

Accumulation of Physical Capital and Inequality

Physical capital can help reduce inequality

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Expenditure policies for inclusive growthBenefit Incidence Analysis (BIA)

Some concepts and facts• Levels matter, but effectiveness of spending key• Well-targeted spending progressive. But,

progressive spending may not necessarily be well targeted (PSA).

• Targeting expenditure well is more challenging than making it progressive. – Education, health and transfer programs in

developing countries progressive, but not well-targeted

– Incidence of spending on education and health care often skewed toward the non-poor

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• Pro-poor benefit incidence associated with better education and health outcomes and wider health access.

• Targeted spending save fiscal resources, improve human capital of the poor (and the population in general)

Benefits of targeting

Expenditure policies for inclusive growthBIA

Education HealthAccess to Information and Communication

Radio (per 1,000 people) 0.48 0.9Telephone mainlines (per 1,000 people) 0.45 0.41

Education OutcomesSchool enrollment, tertiary (% of gross) 0.5 0.58Illiteracy rate, adult (% of people ages 15 and above) -0.46 -0.4

Health AccessBirths attended by health staff (% of total) 0.41 0.56Access to sanitation (% of population) 0.45 0.54Access to water (% of population) 0.57 0.59

Health OutcomesMalnutrition prevalence (% of children under 5) -0.56 -0.54Mortality rate, infant (per 1,000 live births) -0.47 -0.4Life expectancy at birth, total (years) 0.5 0.42

Source: Davoodi et al., 2010

Ratio of poorest to richest

Correlation between Benefit Incidence and Indicators of Access and Outcomes

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Expenditure policies for inclusive growthBIA –– Education• Primary education spending well-targeted in all

regions – but degree varies: Q5/Q1 > 4 in LatAm; only >1.2 in SSA

• Secondary education spending well-targeted in Asia and LatAm, but poorly targeted in SSA, MCD.

• Tertiary education mostly benefits richest in all regions

Developing Countries: Incidence of Education Spending

All Primary Secondary Tertiary

EducationTargeting 55 54 54 52

Good 22 42 23 0Poor 33 12 31 52

Incidence 31 37 26 11Progressive 31 37 26 6Regressive 0 0 0 5

(number of countries)

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Expenditure policies for inclusive growthBIA –– Health and Transfers• Health spending well targeted; varying degrees

– Asia and LatAm: Q1 gets 1½ and 3 times more than Q5, respectively; Poorly targeted in SSA and EMEs

• Transfers progressive, but poorly targeted.– Social security benefits (Chile, Costa Rica,

Uruguay)– Food subsidies well-targeted in Jamaica, Tunisia– PSA (Mozambique) progressive; not well

targeted

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100,000

120,000

Bottom quintile

Q2 Q3 Q4 Top quintile

Number of households that received some support from PSA in the last 12 months

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Expenditure policies for inclusive growthBIA –– Health and Transfers

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Poorest Q2 Q3 Q4 Richest

Mozambique -- Incidence of Public Health Spending • Extreme poor benefit little from public health spending

• Improved cost recovery from top quintiles can boost coverage of and access by the poor without increasing budgetary cost

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Social Safety Nets (SSN)• Non-contributory programs targeted to the

poor– Cash transfers, targeted or not, conditional or

not; – Food or other in-kind distribution; Public

workfare jobs– General price subsidies, e.g., for food or fuel– Fee waivers for essential services (health,

education)

Source: UNICEF, 2010

1/ Excluding pensions

0.00.10.10.20.20.30.30.40.40.50.5

2008 2009 2010 (budget)

Mozambique1 -- Transfers to families (% of GDP)

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SSN: Three messages • Message 1: Can address poverty and

inequality– Safeguard human capital of the poor by:

• Protecting poor during economic downturn• Protecting poor from adverse impacts of

structural reforms• Message 2: Need to be financed

– Should be targeted to the needy to contain costs

– Deficit financing can have adverse effects on macro stability and thus worsen the situation of poor

• Message 3: Can improve long-term growth– If financed, and well-targeted toward human-

capital-increasing spending

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SSN: Can go beyond handouts

Effect Nature of Benefit Strength of Evidence

Protect Promote

Reduce poverty and inequality via redistribution

Enable households to invest–In children’s human capital–In their livelihoods

Help households to manage risks–Avoid irreversible losses–Allow higher risk/return activities

Provide governments:-- room to focus on structural reforms-- a spending line with high multiplier effect

Source: World Bank

They can also provide a countercyclical instrument (automatic stabilizer) if large enough and well-designed

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SSN: can help reduce inequality

ETHIOPIA

MADAGASCAR

MALAWI

SENEGAL

SOUTH AFRICA

CHINA

INDONESIA

MONGOLIA

PHILLIPINES

VIETNAM

ALBANIA

ARMENIA

AZERBAIJAN

BOSNIA AND HERZEGOVINA

BULGARIA

CROATIA

CZECH REPUBLIC

GEORGIA

KAZAKHSTAN

KYRGYZ REPUBLIC

LATVIA

MACEDONIA, FYR

MOLDOVAPOLAND

ROMANIA

RUSSIAN FEDERATION

TAJIKISTAN

TURKEY

UKRAINE

UZBEKISTAN

ARGENTINA

BOLIVIA

BRAZIL

CHILE

COLOMBIA

COSTA RICA

DOMINICAN REPUBLICEL SALVADOR

GUATEMALA

HONDURAS

JAMAICA

MEXICO

NICARAGUA

PANAMA

PARAGUAY

PERU

URUGUAY

VENEZUELA, RB

EGYPT, ARAB REP.

IRAN, ISLAMIC REP.

JORDAN

MOROCCOTUNISIA

YEMEN, REP.BANGLADESH

INDIA

PAKISTAN

SRI LANKA

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50

65

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GIN

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Social assistance expenditures, percent of GDP

Spending on Social Safety Net and Inequality

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SSN: Their appropriate size?

• “Critical minimum level of spending necessary for sustainable safety net system” (World Bank)– Should reflect fiscal situation in country.– What’s needed depends on effectiveness.– Depends on priorities for LT poverty reduction

Source: World Bank and UNESCO for Mozambique

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MOZ EAP ECA LAC MENA SA

Social Assistance Spending (% of GDP)

Average Maximum Minimum Median

Conditional Cash Transfer (CCT) Programs

• Conceptual framework: Transfers conditioned on household behavior can make sense under some circumstances:

1. Economic justifications– Persistently misguided beliefs (parents can

believe that earnings do not respond to education level; Attanasio and Kaufmann, 2008)

– “Incomplete altruism” (parents can discount their children’s future earnings heavily; reduces incentives to invest in children’s education and health now)

– Externalities (especially when optimal private return lower than optimal social return)

2. Political economy justifications– Greater support for a program that asks

beneficiaries to do “something to help themselves”

CCT: Decidedly progressive…• CCTs have helped reduce poverty (Nicaragua: 7

percentage points; Colombia: 3 percentage points)

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Deciles of per capita consumption minus transfer

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Bolsa FamiliaChile SolidarioChile SUFEcuador BDHHonduras PRAFMexico OportunidadesJamaica PATHCambodia: JFPRBangladesh FSSP

Source: World Bank

CCT: Lasting impact on education and health

• CCT fostered substantial increases in health, education – especially among poor households

Source: World Bank

Mexico

Mexico

Mexico

Nicaragua

Honduras

Ecuador

Colombia

Colombia Brazil

Cambodia

Bangladesh

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CCT: Lasting impact on education and health

• Because impacts concentrated among poorest, CCTs helped reduce “inequality of opportunities”

• Example: Nicaragua

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CCT: Administrative costs

• Cost of running CCT lower than other types of programs

Source: World Bank

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CASH AND NEAR CASH PROGRAMS (n=16)

CONDITIONAL CASH TRANSFER PROGRAMS (n=9)

FEE WAIVERS (n=5) FOOD-RELATED PROGRAMS (n=19)

PUBLIC WORKS (n=6)

Administrative Costs as a Share of Total Costs, by Program Type

Average Maximum Minimum Median

CCT: Challenges

1. Enhancing impact on long-term human capital outcomes (e.g. learning)

Integration with investments on quality… … And with other social interventions (e.g.

workfare)2. Preventing LT dependency on public assistance

and disincentives for labor force participation. Enforce conditionality. Establish clear, routine, entry and exit

mechanisms3. Putting in place administrative capacity

Upgrade information management systems Contain costs to reasonable levels Monitoring and evaluation of performance Expand gradually as administrative capacity

improves

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Main messages:1. Macro stability is key2. Raise revenue to finance good quality spending:

– Improve direct taxes;– Eliminate exemptions and tax holidays

3. Ensure allocation of spending consistent with LT goals

– Control wages; Improve social spending, agricultural and infrastructure

4. Ensure spending is well-targeted5. Develop a SSN to address high poverty and

inequality6. CCT to boost human capital and improve LT growth

Thank you!!