In some countries, the magnitude of the shock was such that a large tax increase could not fill the gap. In Spain, despite tax hikes worth more than 4% of GDP since 2010, the tax-to-GDP ratio was only 38% in 2014, compared to 41% in 2007. In Greece, tax increases amounted to 13% of GDP during the same period, but the tax ratio increased by only six percentage points. Elsewhere, political limits to tax increases were reached before the gap could be filled. Willingly or not, priority is being given to spending cuts.
Disillusion about future growth adds to the pressure. The productivity record has generally been weak over the last few years, and this suggests that growth in the years ahead could be slower than previously expected. Revenue growth thus looks insufficient to match the surge in age-related public spending on health and pensions.
This is a very different crisis from those experienced in the 1980s and the 1990s. Back then, the main issue was political: the legitimacy and efficiency of public spending was under attack. In the words of US President Ronald Reagan, government was the problem, not the solution. The state, it was loudly proclaimed, had to be rolled back.
By contrast, today’s concerns are economic. Partisan disagreement about the proper scope of government remains, but there is no overall rejection of state intervention. Often, it is not interests or ideologies that make public spending cuts unavoidable – just facts.
How can governments rise to the challenge? The risk they face is clear enough: absent a profound reengineering, inertial spending – owing to entitlements and civil-service wages – is bound to crowd out spending on new priorities and new policies.
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