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Stanford Institute for Economic Policy Research

StanfordUniversity·April2011

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A Sovereign Fiscal Responsibility Index

T.J. Augustine, Alexander Maasry, Damilola Sobo, and Di Wang under the guidance of Honorable David M. Walker. Faculty Advisor: Joe Nation

Inthewakeoftherecent financialcrisis,andinlightof escalatingdeficitsandmounting debtburdensinanumberof majorindustrializednations,the issueoffiscalresponsibilityand sustainabilityhasmovedtothe forefrontofglobaldiscussions andpoliticaldebates,with renewedemphasisonholding governmentsaccountablefor theiractionsorinaction.From theEuropeandebtcrisisto theU.S.budgetdeficitdebates toJapan'srecentcredit-rating downgrade,fiscalissuesarein thenewsaroundtheglobe. Whilemanysovereignstates haveputfiscalresponsibility highontheiragendas,no simpleandcomprehensive metrictoevaluatesovereign fiscalresponsibilitycurrently exists.Manyarguethemerits onhowtodefinedebtandat whatlevelacountrywillentera fiscalcrisis.1Theimportanceand structureoffiscalinstitutions andfiscaltransparencyare alsocontested.Therefore, understandingtherelativefiscal positionofcountriesisdifficult. ThispromptedStanford UniversityandtheComeback AmericaInitiative(CAI)to trytodevelopaSovereign FiscalResponsibilityIndex (SFRI).OurSFRIneededto incorporatebothquantitative andqualitativemetricsthatallow onetoextensivelydefine"fiscal responsibility"aswellascarry outcross-countrycomparisons. Forourstudyweincluded the34nationsbelongingto continued on inside...

About the Authors

T.J. Augustine, Alexander Maasry, Damilola Sobo, and Di Wang are graduate students in the Public Policy Program at Stanford. David M. Walker is founder and CEO of the Comeback America Initiative and former comptroller general of the United States. This graduate team prepared this report on A Sovereign Fiscal Responsibility Index as part of the graduate Practicum in Public Policy, a twoquarter sequence required for Master,s students in both the Public Policy and International Policy Studies Programs. The client for this project was the Honorable David Walker, founder and CEO of the Comeback America Initiative (CAI) and former comptroller general of the United States. The full report can be obtained from the Public Policy Program at [email protected] Joe Nation served as the instructor and an advisor for this research team and directs the graduate student Practicum at Stanford University. He teaches climate change, health care policy, and public policy. Nation represented Marin and Sonoma Counties in the State Assembly from 2000-2006. He received a Ph.D. in Public Policy Analysis from the Pardee RAND Graduate School; his graduate work focused on budget modeling and longterm budget projections.

1 Afiscalcrisistypicallyiscausedbyalossofconfidenceintheabilityofaborrowerto effectivelymanageitsfinancialaffairs.Inthecaseofasovereignnation,itnormally resultsinmuchhigherinterestratesandcanresultinasignificantdeclineinthevalue ofthecountry'scurrency.Theseactionscouldcausesignificanteconomicdisruptionin theaffectedcountryand,dependingonthecircumstancesandthecountryinvolved, aroundtheworld.

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About This Report

The Sovereign Fiscal Responsibility Index (SFRI) is the result of a sixmonthlong master's thesis project completed by a team of four students from the International Policy Studies (IPS) and Masters in Public Policy (MPP) programs at Stanford University. The team conducted the project under the guidance of the Honorable David M. Walker, founder and CEO of the Comeback America Initiative (CAI) and former comptroller general of the United States. The views expressed in this paper are solely those of the authors and not of the Stanford Institute for Economic Policy Research, Stanford University or the experts with whom we consulted. The goal of this project is to provide a simple but comprehensive analytic tool and framework for citizens, research institutions, and advocacy groups alike to use in understanding sovereign fiscal responsibility and sustainability. It is specifically intended to illustrate where the United States is, where it is headed, and how it compares with other nations in the area of fiscal responsibility and sustainability. Importantly, key data sets used to create the SFRI were obtained from the International Monetary Fund (IMF) and other authoritative, trusted, and neutral international organizations.

2 Duetodataconstraints,wehaveincluded34ofthese38countriesinourfinalrankings. ThecountriesthatwereexcludedareSwitzerland,Russia,CzechRepublic,andTurkey.

theOrganizationofEconomic Co-operationandDevelopment (OECD)andtheso-called "BRIC"emergingmarkets(Brazil, Russia,India,andChina).We chosethese38countriesbased onrelevance,interests,time constraints,anddataavailability.2 Tobuildtheindex,wehad tograpplewithtoughquestions arounddefiningdebtlevels, determininghowmuchdebt countriescouldmanage,and theimportanceofdifferent qualitativemetrics.Wealso hadtoconsideracountry's projectedfuturefiscalpathto understanditsrelativeposition. TheSFRIaddressesallofthese controversialtopics. Tothemaximumextent possible,westructuredtheindex inanimpartialmanner.Wedrew allofourdataandstructured mostofourcomponentson theworkandstaffpapersof majorinternationalfinancial institutions,mostnotablythe IMFbutalsotheOECDand EuropeanUnion.However,at timeswecertainlyhadtomake judgmentcalls,particularlyon whattoincludeintheindex andhowtoweightthevarious components.Wewillbevery explicitinourdiscussionabout wherewemadejudgmentcalls andwhatwedrewdirectlyfrom theothersources. Nevertheless,reasonable peoplewillundoubtedlydiffer onthestructureandelements oftheSFRI.Ourpurpose hereistoshowrelatively howcountriesfareinfiscal

responsibility.Webelievethat evenifsomedisagreewith someofourmeasurements,our componentsarenevertheless unbiasedsuchthattherelative rankingsofcountriesremain accurate.Further,weconducted sensitivityteststoensurethe rankingswerereasonableeven ifonevariestheweightingswe applied.Wethusfirmlybelieve theSFRIcanhelppolicymakers thinkthroughwhatconstitutes fiscalresponsibility,wheretheir countrylies,andwhatreforms maybeneeded.

Fiscal Responsibility Is Quantitative and Qualitative

Thefirststepindeveloping theSFRIistodefinefiscal responsibility.Thetermis appliedinmanydifferentways. Whilethetermistypically usedtoconnotegovernment prudenceinlimitingspendingor managingreasonablesovereign debtlevels,italsorelatesto themeasuresandprocessesof thegovernmentinmanaging itsfiscalaffairs.Forexample, theMaastrichtTreatycallson Europeannationstoexercise fiscalresponsibilitythrough maintainingbudgetdeficitsof 3percentorlessofGDPandan overalldebtlevellowerthan60 percentofGDP.Conversely,the IMFcitesfiscalresponsibilityin theestablishmentoftransparent, independentinstitutionsthat monitoralegislature'sspending patterns.

StanfordUniversity·April2011

Ourdefinitionoffiscal responsibilityinvolvesthree factors:agovernment'scurrent levelofdebt,thesustainability ofgovernmentdebtlevelsover time,andthedegreetowhich governmentsacttransparently andareaccountablefortheir fiscaldecisions.Thisimplies thatresponsibilityismorethan managingone'sannualdeficits. Creatingsoundinstitutions,rules, andproceduresthatregulate thebudgetprocessareessential.

Inaddition,theexistence ofappropriateenforcement mechanismsisalsoimportantto ensurecompliance.Manystudies haveshownthatinthelongrun, governmentsneedfiscalrules, transparentinstitutions,and effectiveenforcementtoremain fiscallyresponsible.3 WederivetheSFRIfromthis definitionandcreatethreemajor componentsoftheindex.We measurecurrentgovernment debtlevelsandconsidera

country'sfiscal space.Weassess thesustainabilityofgovernment debtlevelsovertimebylooking atacountry'sfiscal path.Lastly, indeterminingdegreeof transparencyandaccountability, weevaluateeachcountry'sfiscal governance,includingthecurrent rulesandinstitutionsinplace tocheckforresponsiblefiscal decisionmaking.Thesethree majorcomponentsaredescribed below.(SeeFigure1foran overviewoftheSFRIcategories.)

Figure 1. Overview of SFRI Categories

Overall Fiscal Responsibility Score

Fiscal Space

Fiscal Path

Fiscal Governance

Sovereign Debt-toDebt Ceiling Ratio

Projected Future Levels of Debt and Implied Fiscal Space

Fiscal Rules

Fiscal Transparency

Enforceability

Total Debt-to-Debt Ceiling Ratio

Debt Limits

Independent forecasting Body

Enforecement Mechanisms

Foreign-Held Debt Ratio

Budget Deficit Targets

Autonomous Budget/Audit Process

Nature of Monitor Body

Expenditure Rules

Open Government Policies

Nature of Enforcement Body

Revenue Rules

Media Visibility of Rules

3 InternationalMonetaryFund(2009),FiscalRules--AnchoringExpectationsforSustainablePublicFinances,WorkingpaperSM/09/274, Washington,D.C.,IMF.

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Fiscal Space: Staying Clear of One's Debt Ceiling

Thequestionof"howmuch debtistoomuch"frequently permeatesanydebateon fiscalresponsibility,especially internationalcomparisons.Since countriescansustainablyservice differentlevelsofdebt,itiskey tounderstandeachcountry's debtlimitandhowmuchmore debtitcanissue.Theanswer dependsonitsfiscalspace. Fiscalspacerepresentsthe additionalamountofdebtthat acountrycouldtheoretically issuebeforeitisvirtually certaintohaveafiscalcrisis. Fiscalspaceisthedifference betweenacountry'scurrent weighted-averagedebtleveland itsso-called"debtceiling."The weighted-averagedebtlevelis ajudgmentourteammadeto createanindicatormoreaccurate thandebt-held-by-the-public. Westartwiththedefinition ofdebtexhibitedintheIMF's worldeconomicoutlook:gross sovereigndebtobligations, includingintra-governmental holdingslikesocialsecuritytrust funddebt(onemustaddsuch implicitliabilitiesinorderto comparedebtacrosscountries inanequalmanner).Wethen createasecondfactorthatadds sub-nationalgovernmentdebtto grosssovereigndebt.Next,we useathirdindicatorthatisthe amountofsovereignpublicdebt heldbyforeigners.Weighting eachofthesecomponents equally,wecomeupwitha weighted-averagedebtlevel. Inthisway,weaccountforall obligations,aswellasthenature oftheholdersofdebt,toget themostcompletepictureofa country'sdebtlevel. Acountry'sdebtceilingisan IMFtermdepictingthelevelof debtatwhichacountrywillbe unabletoavoidafiscalcrisis (nottobeconfusedwiththe U.S.government'slegal"debt ceiling").4Weborrowthisterm fromanIMFstaffpaper.5Using statisticalanalysis,severalIMF economistsestimateadebt ceilingforeachcountrybased onpastbehavior,stability ofgovernment,andafew economicindicators.6For example,Australia'scurrent weighted-averagedebtlevelis 24percentofGDPwhileitsdebt ceilingis192percentofGDP. Hence,Australia'sfiscalspaceis 168percentofGDP. Clearly,fiscalspaceisan estimateratherthanahard number.Noonecouldexactly predicthowmuchmorerooma countryhasbeforeitexperiences afiscalcrisis.Undoubtedly,a countrycouldhaveafiscalcrisis beforeitreachesitsdebtceiling, aswasthecaseinIreland'sEU bailoutthisyear.Conversely,a countrymaynothitcrisiswhen itreachesitsdebtceiling.Japan's sovereigndebtisnearlyatits debtceilingyetfewsuspect thataJapanesefiscalcrisisis imminent.However,fiscalspace isatleastdirectionallyuseful (Irelandhaslittlespaceleftand Japanrecentlyhaditscredit ratingdowngraded).Further,in thatfiscalspacetreatscountries inanunbiasedmanner,itallows onetoestablishrelativelyhow muchfiscalroomcountrieshave left,preciselywhattheSFRIaims toillustrate.

Fiscal Path: Managing Debt Levels over Time

Equallyifnotmoreimportant thanacountry'sfiscalspaceisits fiscalpath,oritsprojectedfuture levelsofdebt.Acountrywitha mediumlevelofdebttodaybut withprojectedfiscalbalance overtimeismuchbetteroffthan acountrywithalowleveltoday butrapidlyrisinggovernment deficits. UsingIMFFiscal Monitordata onfuturegovernmentspending patterns,weprojectthefuture fiscalpathforeachcountryuntil 2050.7Ourprojectionsreveal acountry'sdebtlevelforeach yearintothefuture.Wethencan measurehowmanyyearsittakes

4 Ostryetal.(2010),FiscalSpace,IMFStaffPositionNote,September1,2010. 5 Ibid. 6 Weshouldnotethattheworkcited(Ostryetal.)isnottheworkorpositionoftheIMFandreflectsonlytheviewoftheauthors. Werecognizenotallmayagreewiththefindings,butwebelievethefindingsaredirectionallyandrelativelyusefulincomparing countries. 7 CalculationsarebasedontheIMF"sOctober2010Fiscal Monitor.Thatpublicationlistseachcountry'scyclicallyadjustedprimarybalance (CAPB)andprojectsincreasesinhealthcareandpensionspendinguntil2050.CombiningthesedatawithprojectedGDPgrowthrates andcurrentinterestrates,weareabletocreateprojectedgovernmentdeficitsanddebtlevelseachyearfromnowuntil2050.

StanfordUniversity·April2011

foracountrytoreachitsdebt ceiling.Forexample,usingIMF statisticsonprojectedspending patterns(assumingnoreforms), theUnitedStateswillhititsdebt ceilingin2027,16yearsfrom now.Othercountries,suchas Sweden,donothittheirdebt ceilingby2050andhencehave morethan40yearsbeforethey reachtheirlimit. Onemustremembertwo importantfeaturesoffiscal spacewhenlookingatthe futurefiscalpath.First,since thedebtceilingisdirectional, fiscalpathisalsodirectional.It revealsapproximatelyhowlong countriesmayhavebeforea crisis,especiallyrelativetoone another.Undoubtedly,afiscal crisiscouldoccurwellbeforethe suggestednumberofyearsof fiscalpath. Second,ouranalysisof fiscalspacesuggestsacountry shouldmaintainatleast50 percentofGDPoffiscalspace toremainlessatriskoffiscal crisis.Countriesunderreal fiscalscrutinytoday--including Greece,Ireland,Portugal,and Japan--allhavelessthan50 percentofGDPoffiscalspace. Forfiscalpath,thenumberof yearsformanycountriesuntil fiscalspaceislessthan50 percentofGDPismuchfewer thanthenumberofyearsuntil theyhittheirdebtceilings.For example,theUnitedStates' fiscalspacewillbelessthan50

percentofGDPoffiscalspace injustthreetofiveyears--and possiblywithintwoyears,given morerecentdeficitprojections.

Fiscal Governance: Rules, Transparency, and Enforceability

Assuggestedbyourdefinition offiscalresponsibility,itis essentialforagovernmenttobe transparentandaccountableto itscitizens.Stronginstitutions, rules,andprocessesareneeded toensuregovernmentsmaintain responsiblebehaviorovertime. FollowingIMFanalysisanddata, weusethreecategoriesinthe fiscalgovernancecomponent oftheSFRI:rules,transparency, andenforceability.

differencesofopinionregarding therelativeimportance,we followtheIMF'smethodologyfor consistencypurposes.9Then,the secondstudyratesthestrength oftherules,withaconstitutional mandatebeingthestrongestand apoliticalstatementtheweakest. Whilethecombinedscoresof thetwostudiesareourown,the inputscomedirectlyfromIMF frameworksanddata.

Fiscal Transparency

Thedegreeoffiscaltransparencywithinacountrytranslates directlyintogreaterfiscal discipline.Itforcesgovernments torevealitsspendingpatterns andreducescorruption.This inturntranslatesintobetter economicperformancesand lowersovereigndebt. Asinfiscalrules,wedraw directlyonanIMFframework onthesubcomponentsthat constitutefiscaltransparency: opengovernment,autonomous budgeting/auditing,and independentforecasting.10The scoringsystemweuseforeach subcomponentistakendirectly fromthisstudy.Tocreatean overallscoreforthefiscaltransparencycategory,weuseour judgmentandweightallthree subcomponentsequally.We dosobecausewedonotfind acompellingreasonwhyany oneofthethreesubcomponents offiscaltransparencyismore relevantthantheothers.

Fiscal Rules

Fiscal rules areeffective methodsofmaintainingfiscal responsibility.Bytheforceoflaw, theylimitagovernment'sability tospendirresponsibly.Countries suchasAustraliaandNew Zealandthathaveimplemented strongfiscalruleshaveseen decliningdebtlevelsand reasonablegovernmentspending. Toassessfiscalrules,we createascoringsystemdirectly basedontwoIMFstudies.8The firststudyratesthetypesof rulesthataremostimportant, withdebtlimitsatthetop andspending/revenuerules atthebottom.Whilethereare

8 InternationalMonetaryFund(2009),FiscalRules--AnchoringExpectationsforSustainablePublicFinances,WorkingPaperSM/09/274, Washington,D.C.,IMF;Kopits,G.(2001),FiscalRules:UsefulPolicyFrameworkorUnnecessaryOrnament?IMFWorkingPaper01/145. 9 Forexample,AndersonandMinarikfindthatspendingrulesaremoreeffectivethandebt/deficitrules,Anderson,B.,andJ.Minarik, "DesignChoicesforFiscalPolicyRules,"OECD Journal on Budgeting,vol.5,no.4,2006. 10 InternationalMonetaryFund(1998),TransparencyinGovernmentOperations,IMFOccasionalPaper158.

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Fiscal Enforceability

Fiscalenforceabilityassesses thedegreetowhichrulesand processesarefollowedand enforced.Arulethatisnot enforceddoeslittletolimitfiscal irresponsibility.Forexample, intheUnitedStates,the congressionaldebtceilinglaw haslittleenforceabilitystrength becauseCongressraisesthedebt ceilingeachtimethefederal debtapproachesitslimit.In addition,theEuropeanMonetary Union(EMU)debtanddeficit ruleshavehistoricallynotbeen effectivelyenforced. Again,weuseIMFguidelines todeterminethesubcomponents offiscalenforceability:automatic enforcementmechanisms,the typeofenforcementbody,the typeofmonitoringbody,and mediavisibility.Basedonan EUscoringindex,weassess countriesineachofthesefour subcomponents.11However, unlikeinfiscaltransparency, hereweexerciseourjudgment anddonotweightthefour subcomponentsequally.We placethegreatestsignificance onanautomaticenforcement mechanismbecauseitisthe mostreliablemethodtoensure compliance.Theotherthree subcomponentsareweighted substantiallylessbecausethey areenablersforenforcement, ratherthanenforcementitself. governancescore,wenormalize thescoresfromeachcategory andthenweightthemequally. Webelieverules,transparency, andenforceabilityareall importantcomponentsanddo nothaveaviewthatonewould bemoreimportantthanthe others. Tocreateanoverallranking fortheSFRI,wetakeeach country'srankwithinthe threemaincomponents(fiscal space,fiscalpath,andfiscal governance)andaverage thoserankingstocreatean overallranking.However,we displayintheoveralltableall threecomponentsbecause eachinitsownrightisa fundamentalcomponentoffiscal responsibility. countriesareAustraliaand NewZealand.Bothofthese countriespassedbudgetreforms andenactedstrongfiscal governanceoverthepast20 years.Asaresult,theirdebt levelshavedeclinedinrecent yearsandtheirfuturepathslook strongandsustainable.They revealthepowerofgoodfiscal governance. Conversely,manytraditional powersfindthemselvesnearthe bottomofthelist.Theso-called PIIIGSofEurope(Portugal, Italy,Ireland,Iceland,Greece, andSpain)areallinthebottom third.Withasovereigndebt greaterthan200percentofGDP, Japanfinishesfourthtolast.The UnitedStatesis28outofthe34 countriesrated.

Results: Emerging Markets, Reformers Lead the Way

Basedonourrankings, themostfiscallyresponsible countriesarenotnecessarily theoneswewouldexpect (seeTable1).Fourofthetop 10countriesareemerging marketsorrecentlydeveloped countries,andvirtuallyevery developingcountryfinishesin thetophalf.Thisturnaround byemergingmarketsstarkly contrastswiththeworldofthe 1980sand1990s,whenfiscal crisesfrequentlyoccurredinthe developingworld. Thetwotop-performing

Fiscal Space Results

Inthefiscalspacecategory, emergingmarketsandrecently developedcountries12(ledby ChinaandChile)areinvery strongfiscalshape,mostof themwithfiscalspacelevels greaterthan100percentof GDP.Scandinaviancountries andformerBritishcolonies alsoappearwellpositioned withfiscalspaceinexcessof 100percentofGDPaswell. Next,withfiscalspacebetween 60percentand95percentof GDP,theCentralandNorthern Europeanpowers(Germany, UnitedKingdom,France,and Spain)arecurrentlyindecent shapebutatriskoffallingunder

Overall Fiscal Governance

Toarriveatanoverallfiscal

11 EUFiscalRulesDatabase,January2011. 12WeincludesixmembersoftheOECDinthe"recentlydevelopedcountries"category.ThesecountrieshavealljoinedtheOECDinthe last20years:Chile,Estonia,Hungary,Poland,SlovakRepublic,andSlovenia.

StanfordUniversity·April2011

Table 1. Overall SFRI Rankings

Country Australia New Zealand Estonia Sweden China Luxembourg Chile Denmark United Kingdom Brazil Canada India Poland Netherlands Norway Slovak Republic Korea Mexico Israel Slovenia Austria Finland France Spain Germany Belgium Italy United States Hungary Ireland Japan* Iceland** Portugal Greece Fiscal Space (% of GDP, 2010) 168.2 163.6 138.1 153.7 184.9 178.0 193.3 153.1 90.8 102.3 106.0 97.3 94.9 92.7 171.6 107.7 124.9 112.1 113.0 105.2 76.4 99.2 58.7 81.5 75.7 42.3 17.8 62.4 53.2 38.1 49.0 17.1 27.8 0.0 Fiscal Path (# of years) 40+ 38.0 40+ 40+ 40+ 22.0 40+ 34.0 27.0 39.0 39.0 40+ 31.0 12.0 22.0 33.0 40+ 30.0 40+ 21.0 12.0 13.0 15.0 12.0 18.0 8.0 7.0 16.0 12.0 6.0 5.0 20.0 5.0 0.0 Fiscal Governance (pts out of 100) 65.9 68.5 61.7 59.0 49.4 61.8 45.9 54.7 66.4 56.9 51.5 56.3 58.0 72.3 47.9 50.9 27.5 50.7 40.5 54.3 67.8 57.9 62.8 60.7 57.4 61.2 59.2 46.0 46.1 48.4 47.2 20.2 45.1 45.0 Overall Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34

*Japan'sdebtratinghasjustbeendowngraded. **IcelandhasalreadydefaultedanditsSustainableFiscalPathreflectsreformsmadesincedefaultoccurred.

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threatshouldtheirdebtlevels increasesignificantly.Next,the PIIIGSarealreadyclosetotheir debtlimitsandmanyofthem arefacingdifficultcircumstances asaresult.Lastly,theUnited States,withroughly60percent ofGDPoffiscalspace,sitsat alevelbetweentheSouthern EuropeanandNorthern Europeancountries.WhileU.S. fiscalspaceisnotasbadasthat ofSouthernEurope,itcould easilydeterioratetosimilarlevels inthenextfewyears. Acrisisofconfidencecan occurduetoavarietyoffactors. Ittypicallyinvolvesamarket reactiontoabeliefregarding thewillingnessandabilityof asovereignborrowertoact andnotsimplywhetherithas passedaparticularmetricor date.Therefore,itisimportant torealizethattheremaining yearsoffiscalspaceare intendedtobearelativeand notabsolutemeasure.Acloser lookattheresultssuggeststhat acountrycanbecomeatrisk whenitsfiscalspacedropsto lessthan50percentofGDP. Japan(49percent),Ireland(38 percent),Portugal(28percent), Italy(18percent),Iceland(17 percent),andGreece(0percent) arethenationscurrentlyfacing creditdowngrades,bailouts, orinvestorspeculations.All thecountrieswithfiscalspace greaterthan50percentofGDP seemtobeonsturdierground. Importantly,withoutreform, theUnitedStatesshouldseeits fiscalspacedroptolessthan50 percentofGDPwithinthenext threeyearsandpossiblyfewer, givenrecentdeficitprojections.

Fiscal Path Results

Onlyeightofthe34 countriesinthesamplewill nothittheirdebtceilingsby 2050.Thesecountriesmainly consistoftwogroupsof countries.First,fast-growing emergingmarketssuchas IndiaandChinahavelow primarybalancedeficits overtimeandareableto growfastenoughtoavoid mountingdebtobligations. Second,formerBritishcolonies andseveralScandinavian countriessuchasAustralia, NewZealand,andSweden havealreadymademanyfiscal reformslimitinggovernment spending.Thereformsare robustenoughsuchthat theIMFbelievestheywill holdgovernmentspending andcorrespondingdebtat reasonablelevelsovertime. InWesternEurope,most countrieshave15to30years untiltheyreachtheirdebt limits.Thissuggeststhatneeded reformshavesometimeuntil theyareabsolutelynecessary, butthelongerreformsare delayedthemoreserious theybecome. Othercountriesareclearly inworseshape.Allofthe PIIIGSandJapanwillhittheir debtceilingswithin15years. TheUnitedStateswilldoso in16years.Andgiventhat crisescanoccurwellbefore acountry'sdebtceilingis reached,thissuggeststhat manyofthesecountries, includingtheUnitedStates, mayhavemuchlesstimeto reducegovernmentdeficits.

Fiscal Governance Results

Inahandfulofcountries theblueprintforwhyfiscal governancedoesmatterexists. Thetopfourcountriesoverall (Australia,NewZealand,Estonia, andSweden)eachunderwent seriousreformsinthepast15 to20yearsandarethetop finishersintheSFRItoday. Manyemergingmarkets performlesswellinfiscal governance.Countriessuchas China,Korea,andChilescore quitewellinfiscalspaceand fiscalpathbuthavelowscores infiscalgovernance.Astheir citizensdemandagreatersocial safetynetandgrowthslows overtime,fiscalgovernancemay becomemorerelevantinthese countriestoensureresponsible spendingovertime. Formanyothercountries, includingtheUnitedStates, fiscalgovernanceismoderateto weak.Whilemostcountriesin theSFRIarerathertransparent, fiscalrulesfrequentlyhave weaklegalstatureandlimited enforcement.Theresultis thatdebthasgrownover timeandthereislittleto preventitfromrisinginthe future.Yet,thesituationisnot irreversible.Forexample,if theUnitedStatesimplemented therecommendationsofthe NationalFiscalResponsibility andReformCommission (NFRRC)today,orapackage ofreformswiththesame fiscalimpact,itwouldmove immediatelytoNo.3infiscal governanceandbecomeone ofthetop10countriesinthe overallSFRI.

StanfordUniversity·April2011

Recommendations: Comprehensive, Timely Reforms Needed

TherecentU.S.housing marketcollapseandensuing financialcrisisremindsus thatcrisesusuallyareboth unanticipatedandextremely costly.OurSFRIindicatesthat whilewecannevertrulyknow exactlywhenacrisiswilloccur, ouranalysissuggeststheUnited Statesisthreetofiveyearsaway fromanindebtednesscrisislike thatoftheEuropeannations currentlyfacingfiscalstrain. Severalotherlargecountries seemtohaveabitmoretime, butneverthelessearlyactionis saferandlesscostly. AstheUnitedStatesthinks throughreforms,weshouldkeep inmindthatfiscalresponsibility isbothquantitativeand qualitative.Onthequantitative side,wewillhavetomake toughdecisionsregardingboth spendingandrevenue.Fromour perspective,theSFRIisagnostic astowhethertofocusmoreon revenuesoronspendingcuts. Therearecountrieswithmuch higher(Sweden)andmuch lower(Chile)taxratesfinishing nearthetopoftheSFRI.What

ismostimportantisthatwedo infactmakethosedecisionsand reverseourdebtpath. Further,theUnitedStates shouldnotforgettheimportance offiscalgovernance.Processand rulereformwillnotonlymake long-termfiscalresponsibility easiertomanagebutitalso canimprovethechancesof budgetcompromiseinthe nearterm.TheNationalFiscal ResponsibilityandReform Commissionplanoffersnotonly astrongfiscalpathbutitalso suggestsimprovementsinfiscal governancethatwillgreatly facilitateresponsiblegovernment spendingintothefuture. Intherestoftheworld,major Europeanpowersalsoneed timelyreforms.France,Germany, andtheUnitedKingdomalso mustfindawaytofurther reducegovernmentdeficitsin thefaceofagingpopulations. Thelongerthesecountrieswait themorecostlyanddifficult reformsbecome. Lastly,manyemerging marketsthatperformwelltoday intermsoffiscalspaceandfiscal pathshouldnotbecomplacent. Fiscalgovernanceisextremely importantinthelongrun, especiallyasemergingmarkets

liberalizeandcitizensdemand morefromtheirgovernments aswealthrises.Enactingfiscal governanceatthisearlystagein theirdevelopmentwillensure long-runfiscalviability. Insum,weopenlyrecognize thattheSFRIisnotperfect andthatwehavemade severaljudgmentcallsinthe developmentoftheindex.We understandthatsomepeople maydisagreewithsomeof ourcomponentsandsomeof thejudgmentsthatwehave made.However,wetested forsensitivities,suchthatthe relativerankofcountrieswould notmovemuchevenifthe weightingsorcomponentswere changed,andwedobelieve thatouranalysisisobjective. Further,westronglyfeelthat thepossibilityofnear-term fiscalcrisisinmanycountries, includingtheUnitedStates, ismuchcloserthanmany believe.Comprehensiveand timelyreformsareneededto ensurefiscalresponsibilityand sustainability--andtoavoida debtcrisisintheUnitedStates thatwouldbefeltaroundthe world.It'stimetobegintoact onputtingthenation'sfinances inorder.

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