Fiscal Space for Sustainable Development

Fiscal space is essential for sustainable development, as it allows governments to invest in crucial areas like healthcare, education, and infrastructure. Governments can create fiscal space by reducing unnecessary expenses and increasing revenue through tax reforms.

A key challenge in creating fiscal space is managing debt levels. According to the article, high debt levels can limit a country's ability to invest in sustainable development.

Effective tax policies are crucial in creating fiscal space. The article highlights the importance of tax reforms in increasing revenue and reducing tax evasion.

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Fiscal space is dependent on a government's ability to raise domestic revenues and to borrow without jeopardizing future stability. This means that governments need to balance their spending with their ability to generate revenue.

The quality of budget allocation processes and implementation is crucial for maximizing fiscal space. Good investments can expand it, just like successful exploration expands a natural resource.

Fiscal space can be thought of as a depletable natural resource. It's created by new revenue, which is dependent on economic growth in an economy, and by the net returns on past investments. It's used up by expenditures that don't return equivalent net present value to the budget.

There are three key requirements for sustaining fiscal space:

These requirements are essential for governments to manage their fiscal space effectively and make the most of their limited resources.

Measuring fiscal space is a crucial step in understanding a government's financial capabilities. It's often done by subtracting non-discretionary spending from total revenue and borrowing capacity.

Non-discretionary spending includes mandatory items like debt service and pensions, which are required by law or economic necessity. In the United States, entitlement programs like social security, Medicare, and Medicaid are also considered non-discretionary.

Wages of civil servants can be a grey area, as firing them can be politically difficult. In the US, they're counted as part of discretionary spending, but in many developing countries, they're included in non-discretionary spending.

To measure fiscal space, governments need to estimate how much they can potentially borrow. This is often done through debt sustainability assessments or fiscal rules passed by the legislature.

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Sustainability models are used by the IMF and World Bank to measure fiscal space in client countries. These assessments combine judgments on the soundness of macroeconomic and structural policies with judgments on the ability to service external debt.

The key economic variables in a fiscal space calculation include the size of the fiscal deficit, the rate of interest on government borrowing, and the growth of the economy and of exports. The IMF and World Bank have used historical episodes of debt distress to empirically estimate the maximum size of a sustainable fiscal deficit.

Differences in the perceived quality of policies and institutions can result in varying amounts of fiscal space, even when economic variables are the same across countries.

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Debt sustainability models are used by the IMF and World Bank to measure fiscal space in client countries. These assessments combine judgments on macroeconomic and structural policies with judgments on the ability to service external debt.

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The key economic variables in a fiscal space calculation are the size of the fiscal deficit, the rate of interest on government borrowing, and the growth of the economy and of exports. The IMF and World Bank have used historical episodes of debt distress to estimate the maximum size of a sustainable fiscal deficit.

A maximum fiscal deficit is computed by imposing a requirement that debt and debt service levels remain below certain threshold values. These threshold values vary according to staff judgment on the quality of institutions and policies in each country.

Developing countries assessed to have weak policies have threshold values that are half the value used for countries assessed to have strong policies. This is why debates over fiscal space can be so contentious.

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Concessional finance can provide a much-needed relief to low-income countries by reducing the cost of capital. Large volumes of debt owed by these countries were written off as part of the Heavily Indebted Poor Countries initiative, first launched in 1996.

This temporary relief has been seen in several large debt-for-nature swaps, where debt service reductions are accompanied by spending increases in specified areas. For instance, Barbados and the Bahamas committed to expand coral reefs and tropical forests with savings derived from refinancing of existing debt at lower interest rates and reduced face values in 2024.

Debt reprofiling, such as through the debt service suspension initiative of the G20, offered countries an option to defer debt service on bilateral official debt in 2020 and 2021. This provided liquidity to governments, but unfortunately did little to halt the slide in public investment in many beneficiary countries.

Certain types of public investment can actually create additional fiscal space for other expenditures if they generate more revenue than the net interest cost of the associated financing.

Fiscal management is a crucial aspect of fiscal space, and it's essential to understand its importance. Public financial management is a key ingredient in strong institutions and policies, and using the Public Expenditure and Financial Accountability (PEFA) toolkit has revealed issues such as budget execution, transparency of fiscal reporting, and public investment management.

Large subsidies for food and energy can eat up considerable fiscal space, but countries can relax fiscal space constraints by shifting spending toward areas that create direct and indirect revenue streams for the treasury. External grants and concessional credits are significant sources of expanding fiscal space in low-income countries.

Tax revenues, strong fiscal management, and access to affordable finance are key instruments to expand fiscal space. Improving fiscal management can help countries make the most of their fiscal space and achieve their development goals.

Budget execution is a critical stage in the budget cycle, and improving it can maximize the existing envelope for health expenditure. PFM improvements during budget execution can reduce the gap between the adopted or theoretical budgetary space for health and actual budgetary space for health.

Effective budget monitoring and evaluation can enlarge budgetary space for health by informing future budget allocations. Improving the quality and consistency of financial data is essential to build stronger arguments for an increase in budget allocations.

Country assessments of budgetary space for health must be comprehensive and include PFM-related issues to provide a realistic picture of the existing or potential budgetary space for health. Incorporating PFM into the approach will provide a broader understanding of the budgetary space available and realistic ways to expand it.

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Budgetary space for health depends on three main components: the overall expenditure envelope, budget allocation decisions, and laws, rules, and systems for budget use, or PFM. The proposed shift in terminology from fiscal space for health to budgetary space for health reflects the need to embrace both revenue and expenditure policies.

The effectiveness and flexibility of PFM systems are critical in determining budgetary space for health. If funds are poorly allocated and used ineffectively by service providers, this may reduce the existing budgetary space for the sector.

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Public financial management is a key ingredient in the broader concept of strong institutions and policies. It's essential to understand that fiscal management is not just about revenue, but also about how funds are allocated and used. The Public Expenditure and Financial Accountability (PEFA) toolkit has been used in 607 assessments at country and sub-national levels to identify issues and trends in public financial management. These assessments have shown that budget execution, transparency of fiscal reporting, and public investment management are common areas of concern.

The annual public expenditure envelope is a critical component that determines budgetary space for health. It's influenced by overall fiscal space, which is dynamic and can be affected by economic growth, revenue, fiscal policies, debt, and other factors. The IMF has updated its list of interconnected factors that influence overall fiscal space, and economic growth plays an indirect role in health spending.

Effective and flexible public financial management (PFM) systems are essential for determining budgetary space for health. This includes how budgeted funds are allocated to priorities and implemented through the health system. If funds are poorly allocated and used ineffectively, it can reduce the existing budgetary space for the sector. The inclusion of PFM and rules and practices of budget use is critical to a comprehensive understanding of budgetary space.

Budget formulation is a crucial stage in the budget cycle, and some PFM interventions can free up resources and make budgetary space for health more flexible or elastic. Using more flexible approaches to formulate health budgets, such as programme- or output-oriented approaches, can enhance flexibility in the use of funds.

Health financing is a crucial aspect of fiscal space, and it's essential to understand how it works. The World Health Organization (WHO) has been actively involved in promoting health financing for Universal Health Coverage (UHC).

The share of the public expenditure envelope allocated to the health sector can greatly impact budgetary space for health. This share is influenced by budget allocation decisions made by the legislature and competitive budget negotiations between the ministry of finance and sector ministries. Political considerations and imbalances in power among different sectors may also play a role.

In some cases, public spending on health and education can contribute to long-term economic growth, which in turn adds to government revenues. For example, the economic rate of return of spending on health and education can be high, generating a positive impact on fiscal space in the long run.

Economically sound investments in health and education can have a significant impact on fiscal space. In developing countries, the buoyancy of tax revenues averages 1.1, meaning that every additional dollar of GDP generates 1.1 dollars of tax revenue. This can significantly expand fiscal space in the long run.

Investing in productive infrastructure assets, such as toll roads, ports, or energy generation, can also generate a positive net revenue stream, expanding fiscal space even in the medium term.

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Fiscal space would decline to 17 percent of GDP by 2026 with a typical recession, limiting the government's ability to stimulate the economy.

A large recession would further reduce fiscal space, leaving only 8 percent of GDP available for stimulus measures.

Implementing stimulus measures similar to those in the Great Recession would cost 9 percent of GDP by 2026, consuming all remaining fiscal space and pushing debt above record-high levels.

The government's ability to stimulate the economy would be severely constrained in the event of another large recession.

Debt exceeding 106 percent of GDP would bring the country close to its maximum capacity, making it difficult to know when problems will arise.

Higher debt levels would reduce the government's flexibility to respond to economic downturns.

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Fiscal space for health is not just about finding more money, but also about how we use the funds we have. Economist Peter Heller identified five opportunities for expanding fiscal space for health in his seminal paper published in 2006.

These opportunities include raising revenue, reprioritizing expenditure, borrowing, using seigniorage, and mobilizing external grants. Fifteen years later, our understanding of fiscal space for health has evolved to include the importance of public financial management (PFM) in the health sector.

The concept of budgetary space for health explores available resources generated through greater overall public expenditure, prioritized budget allocations, and improved PFM. This approach is particularly relevant in the era of the Sustainable Development Goals.

By improving PFM, we can maximize budgetary space for health and support progress towards universal health coverage and the COVID-19 response. This involves engaging in a more comprehensive and effective budgetary dialogue with finance authorities.

Here are the five opportunities for expanding fiscal space for health identified by Peter Heller in 2006: