8  Concluding remarks 

Long-term debt projections generated by a model like the Treasury’s LTFM are not always useful in communicating the extent of implied policy change. Resolving this issue requires a consideration of the government’s intertemporal budget constraint (IBC), which requires that all government spending must eventually be financed, either in the current period through taxes or over time through interest on debt. The fiscal gap calculates the change in fiscal policy settings needed to achieve a particular debt target at some point in the future. When interpreting the fiscal gap results it is important to keep in mind the following points.[19]

First, like most current assessments of sustainability, the fiscal gap provides only a partial analysis. This is largely because theory and evidence provide limited insight on the long-run relationships between the fiscal position and variables like productivity growth.

Second, the fiscal gap involves arbitrary choices about the target debt-to-GDP ratio (as in Table 5) and the time horizon (as in Table 6). This reinforces Auerbach’s argument in favour of an infinite time horizon and permanent fiscal gap.

Third, because it is a numerical indicator, the fiscal gap does not convey the timing of fiscal pressures. It is important to compliment the indicator with time-plots of projected fiscal aggregates.

Fourth, fiscal gaps will typically involve a sequence of debt reduction, and possibly (temporary) asset accumulation. A fiscal gap indicator says nothing about the gains of a particular financing approach (e.g., efficiency gains from tax-smoothing) or the potential difficulties involved (e.g., sustaining fiscal surpluses, management of a large pool of assets).

On this last point, the economic and policy issues surrounding population ageing are complex (see Turner et. al., 1998; OECD, 2001; Visco, 2001) and go well beyond what can be captured in a single numerical indicator like the fiscal gap. Despite the above caveats, the fiscal gap can indicate, in a numerical sense, the potential size of long-term imbalances between taxes and spending under reasonable policy assumptions - including those considered here, namely broadly constant tax-to-GDP and productivity-linked expense growth. The provision of alternative scenarios allows users to judge the seriousness of any fiscal imbalance based on their views on the path of taxes, spending, interest rates and other variables.

The fiscal gap can illustrate the direction of fiscal policy adjustment, the broad magnitude of that adjustment and how it changes through time. Such a measure can supplement existing indicators such as the balanced-budget tax rate which calculates the tax-to-GDP ratio needed annually to ensure the stability of a particular debt-to-GDP ratio (for example, see Figure 15.1 in Baker, 1999).

The fiscal gap can indicate the intertemporal consequences of fiscal policy. For example, adopting a wait-and-see approach may impose large adjustments further down the track (as in Table 5). Similarly, reductions in the primary balance (say through tax reductions or spending increases) may be consistent with a desired debt-to-GDP ratio over the medium-term. But, extending the time horizon could indicate that such a decision would increase the size of future imbalances (as in Table 6). Because the LTFM assumes that the interest rate and GDP are independent of the fiscal gap, the gaps prime purpose is to highlight the intertemporal distribution of fiscal policy.

Finally, the fiscal gap methodology provides a platform for the further examination of long-term fiscal imbalances under a wider range of assumptions (e.g., demographics, labour force participation, health spending) and modelling techniques (e.g., stochastic analysis).