http://www.economist.com/finance/displayStory.cfm?story_id=13257904&source=features_box2
The financial crisis is battering public finances on several fronts
CALLS for co-ordinated fiscal stimulus to lift the world out of recession were joined at the weekend by Larry Summers, Barack Obama’s top economic adviser. Such co-ordination has been absent up to now, though that could change at the meeting of G20 leaders in London in early April. But there has been plenty of fiscal stimulus, led by America’s $787 billion package, as many governments seek to offset a collapse in private demand. There are worries not only about how much these measures cost up front but their longer-term effects on government finances.
The direct costs of such packages are indeed large. The IMF reckons that for G20 countries stimulus packages will add up to 1.5% of GDP in 2009 (calculated as a weighted average using purchasing power parity). Together with the huge sums used to bail out firms in the financial sector (3.5% of GDP and counting in America, for example), these are immediate ways in which the crisis is affecting public finances across the world. But they are not the only ones.
A downturn affects government finances in other ways. Shares in most rich countries have plummeted. The MSCI developed-world index, which tracks stocks in 23 rich countries, has lost more than half its value since the beginning of 2008. Falling share prices hit government revenues as capital-gains tax takes decline. Similarly, taxes on financial-sector profits, a significant part of government revenue in many countries, have evaporated. And expenditures on automatic stabilisers such as unemployment insurance rise in a recession. All this widens budget deficits.
Most rich countries have rapidly ageing populations. Unless entitlement systems are reformed (by reducing benefits) or tax bases broadened, fiscal deficits will rise still further. Some of the IMF’s ideas about how to do this will seem unpalatable: it argues that health systems, for example, will have to become less generous. But rich countries were always going to have to come to terms with the fiscal consequences of demographic pressures on existing welfare systems sooner or later. The crisis will bring this problem more urgently to the fore.