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Medium-term fiscal policy challenges.

During the economic expansion, Austria made progress with fiscal reform, notably on pensions and with respect to the spending framework, although there was also some backtracking. However, much remained to be done even before the global financial crisis, which is now compounding the challenges. With the recession, the fiscal position is set to deteriorate sharply, as in other OECD countries. Significant fiscal consolidation will therefore be needed once the economic situation improves, all the more so as the fiscal stimulus imparted to cushion the downturn has mainly involved permanent measures. Unlike in many other OECD countries, projected age-related fiscal pressures seem to be relatively small, primarily thanks to past pension reforms. In these circumstances, the authorities should focus on changes in the spending and tax structure conducive to economic growth, alongside further reforms of the fiscal framework and improvements in the efficiency of public spending, especially on health care and education. Genuine progress in these areas, however, is difficult to achieve without fiscal federalism reforms.

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As the global financial crisis unfolded, fiscal policy initiatives were primarily geared to economic stabilisation. Looking ahead, however, other goals of fiscal policy--safeguarding long-term public finance sustainability and supporting long-run economic growth--deserve attention. Against this background, this chapter briefly summarises recent fiscal reforms, discusses consolidation strategies in the context of the recession-induced deterioration of public finances and analyses age-related public spending pressures. It then moves on to the structure of expenditure and taxation and to fiscal rules. To conclude, the main recommendations for fiscal policy are set out.

Institutional context and recent reforms

In Austria fiscal policy is shared between the federal government, nine states (Lander) and 2 357 municipalities. Lander carry out around 30% of all public expenditure but receive only around 5% of all tax revenues. Lander and municipalities therefore receive large transfers from the federal government. The division of competences and fiscal relations between three levels of government are complex and associated with overlapping responsibilities, co-administration and co-financing at all levels of government. Accordingly, inefficiencies have been identified in some areas of public services, in particular primary and secondary education, health care and the social safety net (OECD, 2005; Austrian Court of Audit, 2007, 2009).

Fiscal federal relations in Austria are enshrined in the constitution and governed by two agreements--the Fiscal Equalisation Law (FEL) and the Domestic Stability Pact (DSP). (1) The FEL is a multi-year agreement on revenue sharing and transfers negotiated between the federal government, Lander and municipalities. The current FEL was extended to six years (from four), now covering 2008-13. The FEL rules remain somewhat complex and opaque, despite the following improvements introduced in 2008 (Schratzenstaller, 2008). From 2008 onwards, major transfers from the federal government to Lander and municipalities are no longer set as fixed amounts, but are based on shares in overall tax revenue, and some of them are no longer earmarked. Complex transfer rules were simplified for investment subsidies for housing, environment and infrastructure. From 2011, the new FEL also envisaged changes in the rules governing transfers to municipalities at the Lander level, which would favour smaller municipalities, and the harmonisation of the Lander and local authorities' pension schemes with the general pension scheme.

The DSP sets medium-term fiscal balance targets for all three levels of government (OECD, 2005). In the past, the DSP targets have not always been met, especially at the level of Lander (Schratzenstaller, 2008). The current DSP overlaps with the FEL period. It stipulates that municipalities should have balanced budgets and that Lander should achieve budget surpluses (0.5% of GDP), while allowing the federal government to run small budget deficits. The current recession will make it difficult to meet these targets.

In recent years, Austria implemented several important fiscal reforms. On the expenditure side, the 2003-04 pension reforms were key as they substantially improved the sustainability of public finances (see below and OECD, 2005, 2007a). The reforms, among other things, changed the way the benefits are calculated (by reducing the annual accrual rate and by extending from 15 to 40 years the accounting period for calculating the pension base), established individual accounts, decided on a gradual increase of the statutory retirement age and its equalisation for women and men to 65 years, and harmonised pensions schemes for different occupational groups. The transition to the new system is gradual, spread over several decades. The reforms implied a reduction in pensions benefits compared with the previous system. Initially, these losses were capped at 10%, but in 2004 the cap was lowered to 5% and set to increase linearly by 0.25 percentage point each year until reaching 10% in 2024. The reforms envisaged two early retirement options "corridor" pension and "heavy workers" schemes. The first scheme entitles people with at least 37.5 years of work experience to retire before the statutory age, which initially involved a loss in pensions of 4.2% per year. The scheme is symmetric, implying that the pensions of people working after the statutory retirement age are increased at the same rate. This discount rate was reduced to 2.1% in 2007, in order to reduce pension income losses. The early retirement scheme for "heavy workers" reduces the retirement age by three months per year recognised as "heavy work". In 2008, the scheme for the long-term insured (Langzeitversicherte) was extended to 2013. The labour market impacts of recent developments in early retirement are discussed in Chapter 2.

Austria also embarked on far-reaching budgetary reforms to address some of the deficiencies of the existing framework (Steger, 2008; Meszarits and Seiwald, 2008). These include excessive focus on public spending per se and not enough on outcomes, the lack of a medium-term financial management framework, weak accountability and no autonomy of state bodies. The reforms required amendments to the constitution, which were adopted by Parliament in December 2007. The reforms comprised two stages. The first one, which came into force in 2009, involved the introduction of a multi-annual government expenditure framework. The second one will involve global budgeting, results-oriented management of state bodies, accrual accounting and budgeting, and performance budgeting (see below).

The multi-annual government expenditure framework is based on fixed expenditure ceilings set for four consecutive years, on a rolling basis, at the federal level only. The framework stipulates that the budget law (Bundesfinanzrahmengesetz) be accompanied by a strategy paper that spells out the details of the multi-annual budget plan. Both documents, and any changes to them, have to be accepted by Parliament, limiting room for ad-hoc changes by the government. The law does not allow the government to exceed the limits.

The expenditure ceilings are set for five expenditure headings and for the underlying budget chapters. (2) The first set of ceilings is binding for four years, while the second set is limiting only for the following year--the ceilings for the remaining three years are merely indicative. Around 80% of total expenditure is fixed in nominal terms. Several spending categories (like unemployment benefits and contributions to social security funds) are allowed to vary with the economic cycle, in line with legal entitlements. Expenditures funded by the European Union and the transfers to local authorities, which depend on the amount of taxes at the federal level, are exempted from fixed limits. The framework grants more autonomy to all ministers in administering the funds, including retaining unspent appropriations without any earmarking.

In addition, various reforms were undertaken on the tax side. In 2004-05, the tax structure was adjusted with a view to enhance Austria's attractiveness as a business location (OECD, 2007a). The corporate tax rate was lowered from 34% to 25%; corporate group taxation and more tax incentives for small and medium-sized enterprises to form equity capital were introduced; the tax burden on labour was reduced; and environmental taxes were increased somewhat. The personal income tax reform that came into effect in 2009 increased the tax brackets and slightly reduced the marginal rates, leading to some further lowering of the overall tax burden on households (Chapter 1).

Finally, Austria also initiated health reforms in 2005. Their main goals were to improve planning, organisation and financing in this sector and to ensure a more equitable regional provision of medical care (OECD, 2005). A Federal Health Agency was set up, as well as nine health platforms at Lander level, with an aim to enable the states and the health insurance funds to coordinate service provisions and to enhance the integration of service delivery. On the finance side, health insurance contributions were increased (by 0.15 percentage point, in 2008) and expenditure reductions of 150 million [euro] were agreed (mainly on medication, administrative costs, doctors' compensation and rehabilitation). The 2005 reforms also envisaged measures to reduce administrative costs and to promote an efficient allocation of resources. Several organisational and procedural changes have been introduced since then (Austrian Federal Ministry of Health, 2009). Moreover, in May 2008 the government presented draft legislation with proposals to address the financial problems of health insurance funds. (3) They mainly concerned new and more flexible standards for contracting with doctors and dispensing drugs. This legislation, however, was not passed before the government stepped down. Overall, the financial situation of the health funds and hospitals remains difficult, calling for continued reform efforts.

Fiscal consolidation challenges

In view of the expected increase in the budget deficit and gross public debt (Chapter 1), it is imperative to ensure that long-term fiscal sustainability not be jeopardised. Most recent discretionary fiscal measures adopted in Austria are permanent, addressing structural needs, especially in the case of personal income tax cuts. Consequently, the sustainability of public finances will require offsetting measures down the road. The latest available government projections assume that the budget deficit will decrease from 4.7% of GDP in 2010 to 3.9% in 2013 (Austrian Government, 2009). The government has announced its intention to reduce the deficit below 3% by 2012 but it has not specified the required corrective measures.

As the government does not intend to increase taxes in the coming years, consolidation will require expenditure restraint. In principle, this is a more efficient way of consolidating than tax increases (Cournede and Gonand, 2006; OECD, 2007b). (4) However, in practice expenditure cuts are difficult to implement. Indeed, traditionally, fiscal policy in Austria has tended to be pro-cyclical in upturns as spending was not adequately kept in check (OECD, 2003; Brandner et al., 2006). As to what type of expenditures to cut, there is a case for sparing growth-enhancing outlays, e.g. on investment, R&D and education, to avoid the past mistakes of many EU countries (Barrell at al., 2002). Expenditure cuts will be also required to finance many of the new government's important initiatives, especially on education and labour policies. (5) Moreover, successful consolidation will be critical in the light of age-related public spending pressures (see below).

Risks to long-term sustainability

Austria, like many other OECD countries, will experience population ageing in the coming decades and related changes in spending on pensions, health and long-term care and education. The old-age dependency ratio in Austria (the ratio of people aged 65 or more to the working-age population) is projected to double by 2050 (EC, 2009b). Thanks to the past reforms, pension spending as a percentage of GDP in Austria is expected to increase only modestly, in contrast to many other EU countries (Table 3.1). (6) In this context, it is essential to avoid any further backtracking on pension reform. In particular, the transition period to the new system should not be extended and the conditions of this transition should not be relaxed further. Moreover, the harmonisation of the rules governing public sector pensions for the Lander and local authorities should be completed, as assumed in the FEL for 2008-13 (see above).

The pension spending projections are sensitive to many parameters and therefore also highly uncertain. Under different combinations of plausible key parameters, pension expenditure by 2050 may differ by as much as 8% of GDP. In the worst-case scenario, they may reach around 18% of GDP in 2050, implying an increase of around 5% of GDP (Table 3.2 and IMF, 2007). Against this background, particular attention should be paid to the underlying assumption concerning eligibility to pensions. Between 2004 and 2007, there was a strong increase in inflows into retirement via early retirement due to partial disability and the long insurance period. Moreover, inflows into early retirement due to disability were sustained at a relatively high level. If these trends endure, the eligibility ratio is set to increase. In this respect, early retirement programmes should be avoided and exits to retirement due to disability limited. In a similar vein, special early retirement programmes for public sector workers should be terminated and the "heavy workers" channel into early retirement should be restricted to well-justified cases.

Another strong assumption is that pensions are indexed to inflation and not to wages. This may be politically unsustainable, triggering a change in the indexation system which would imply higher pension spending. (7) On the positive side, pension parameters can be adjusted if certain pension determinants evolve differently than projected, implying higher budgetary costs (OECD, 2005). Every three years a national commission assesses whether changes in demographic projections necessitate amendments in the pension system. If this is the case, the commission proposes corrective measures concerning benefit levels, payroll contributions, accrual rates, retirement age and general government budgetary transfers. However, these procedures are vague and not binding, and thus potentially ineffective. The commission may recommend similar corrections, when changes to the projections of other key parameters (like productivity growth and labour market trends) imply higher pension spending, but is not obliged by law to do so. Thus, it is advisable to make the procedures more precise and binding, by stipulating clear and simple adjustment rules and implementation procedures, and to extend them to key nondemographic pension determinants.

The projections of health and long-term care costs are also subject to large uncertainty (Table 3.2). This partly relates to non-demographic factors of health and long-term care spending, notably the fact that a wider range of pathologies can be treated and the rising relative price of health and long-term care. As health and long-term care costs contribute most to the increase in age-related public spending (Table 3.1) and there has been limited progress with health care reforms in recent years (see above), the authorities should act decisively on this front. Following recommendations in the previous Survey (OECD, 2007a), it is essential to clearly specify and implement cost-cutting measures. To this end, the biannual evaluations of the reforms outlined in the 2005 Health Reform Act should provide the main guidelines. These evaluations should be undertaken in a timely, independent and comprehensive fashion. The Austrian Structural Health Plan should also be further improved by using the experience of the ongoing pilot projects. Finally, the implementation of the agreed provisions on changes in the organisation and financing of the health system should be accelerated and work on new health care legislation should continue.

Spending on education is expected to decline in Austria by 0.6% of GDP by 2050, in line with shrinking school-age populations (Table 3.1). Similar trends are expected in other EU countries. However, if compensation per teacher, or the ratio of teachers to students or attainment rates in tertiary education turn out higher than assumed in the baseline scenario, education spending may actually increase by 2050 (EC, 2009a, 2009b). Combining all age-related spending projections, it turns out that the resulting pressures in Austria, unlike in most EU countries, seem to be relatively small (Table 3.1), even though Austria's comparative advantage -both in relative and absolute terms - has diminished compared with the previous vintage of projections (EC, 2006). Austria has been classified as a low-risk country in terms of public finance sustainability (EC, 2006, 2008; OECD, 2007b). Nonetheless, the high uncertainty of these estimates should not be ignored. If risks did materialise, more significant consolidation efforts would be needed to ensure sustainability. In this context, initial conditions play an important role as they matter for sustainability gaps--i.e. the difference between the actual primary balance and the primary balance needed to stabilise public debt. Prior to the significant deterioration in the global economic outlook, EC (2008) showed that the sustainability gap for Austria in 2007 was broadly closed: with a favourable initial position, Austria could accommodate increasing age-related spending. However, unless the current fiscal stimulus, which mainly involves permanent measures, is offset in the future, the primary balance in Austria is set to worsen, leading to a deterioration of the sustainability gap (OECD, 2009b).

Strengthening fiscal structures and institutions

In view of the relatively limited age-related fiscal pressures in the long run, the key priority for Austria should be improving the structure and effectiveness of public spending and taxes, the fiscal rules as well as the size and effectiveness of the public sector.

The structure and efficiency of public spending

The structure of public spending reflects the society's choices and budget constraints. To the extent this structure can be changed towards expenditure with a positive feedback on growth, fiscal policy can be improved. Investment in human capital, technical progress and public infrastructure are among the key areas in this respect, in the light of the growth literature's empirical findings. Public spending in Austria is dominated by social security benefits, but there is a general perception that it is broadly appropriate, and public expenditures on R&D and education are relatively high by international standards (Figure 3.1).

High public spending on specific areas may not lead to higher GDP, depending among others on the effectiveness of spending. Thus, a key goal should be to ensure value for money in spending programmes. More efficient spending would allow lower taxation and could help contain expenditure (especially in areas where it is expected to increase substantially in the long run, like health care), while meeting social objectives. A systematic international benchmarking of public expenditure efficiency is inherently difficult due to measurement problems. Bearing this in mind, Austria is found to be one of the least efficient countries regarding health care spending based on technical and cost efficiency estimates (EC, 2008). The apparent inefficiency can be attributable to the complex infrastructure and governance of health care services, especially in the case of hospitals, as decision making and financing are divided among different levels of government (OECD, 2005, 2007a). This creates inefficiencies and duplications, and complicates the reform process. Regarding the efficiency of education spending, Gonand et al. (2007) place Austria in the least efficient group of 26 OECD countries in the segment of primary and secondary education. In a broader assessment of education efficiency, based on three different studies, EC (2008) ranks Austria in the middle two quartiles of the efficiency distribution among EU countries (Chapter 4). In contrast, Austria seems to be among the most efficient countries regarding spending on public order and safety (Eugene, 2008).

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Fiscal rules have improved, but further changes are in order

Sound fiscal rules, institutions and budgetary procedures help strengthen budget discipline and supervision, while increasing public finance transparency, accountability and predictability (IMF, 2007; EC, 2008). Austria has improved in these areas over recent years. (8) The introduction of a new four-year expenditure ceiling framework in 2009 (see above) stands out. It is expected to help prevent pro-cyclical spending sprees in good times, enhance the functioning of automatic stabilisers and avoid cuts in public investment.

As the four-year expenditure ceiling framework has just started operating, it is too early to judge its effectiveness. Its success will depend crucially on how well transparency and public clarity is enforced, which may turn out to be more important than pure numerical targets (Ljungman, 2008) as well as on the authorities' ability to establish a strong track record and broad political support (IMF, 2007). Political commitment to the expenditure ceilings is essential to ensure their continuity at times of changes in government. In the future, the authorities may also consider strengthening the framework by explicitly combining it with long-term fiscal objectives (e.g. those required under the provisions of the Stability and Growth Pact), which is currently not the case. This would ensure greater consistency of fiscal planning and add credibility.

International experience shows that a multi-year expenditure framework is more likely to be successful if accompanied by a broader set of public governance reforms (IMF, 2007; EC, 2008). Thus, the government's plans to introduce output-based budgeting and to modernise the accounting system of public finances are very welcome. These reforms were initially expected to be introduced in 2011 (Austrian Federal Ministry of Finance, 2005), but have since been put off to 2013 at the earliest. Given the expected benefits of these reforms, their implementation should not be further delayed. Output-based budgeting links budgetary financial and personal resources to outcome indicators. It thus forces public sector agencies to specify and measure their output, to conduct cost-benefit analyses, and to improve management skills. This leads to more informed discussions on competing budget priorities and promotes transparency in the budget process, which in turn improves public spending efficiency and may promote cost cutting. The implementation of output-based budgeting raises several practical challenges (OECD, 2007a, 2007c; EC, 2008). The main ones relate to setting the right incentives and to avoiding excessive reliance on detailed targets and their monitoring.

The plans to modernise and harmonise the accounting system at various levels of government is another welcome initiative, especially as currently three different accounting systems co-exists -the cash, accrual and cost accounting systems. Their seemingly distinct objectives are rather unclear in practice (Meszarits and Seiwald, 2008). The reconciliation of information among these systems is complicated, making a fair and transparent assessment of the financial situation in the public sector difficult. This also creates obstacles to establishing a conceptual link between financial accounting, budgeting and performance assessment processes.

The tax structure needs to better support economic growth

There is growing empirical evidence about the effects of particular tax types on economic growth (OEGD, 2008, 2009a). Taxes on property, especially recurrent taxes on land and buildings, are found to hamper growth least as they do not interfere directly with labour, physical and human capital. The share of these taxes in Austria is very low by international standards (Figure 3.2) and the decision to repeal inheritance and gift taxes in 2008 did not help to change this situation. In this context, OECD (2007a) and Aiginger et al. (2008) recommended increasing revenues from real estate taxes, which would require upgrading the market valuations of properties as they are outdated (OEGD, 2005, 2007a; Aiginger et al., 2008). Higher land taxes could increase the tax autonomy of sub-national governments, which is small by international standards (Blochliger, 2006; Schratzenstaller, 2008).

[FIGURE 3.2 OMITTED]

Another finding on the links between economic growth and taxes is that consumption taxes create fewer distortions for growth than direct taxes. Leibfritz et al. (1997) show that shifting taxes from labour towards consumption taxes has positive effects on employment and GDP. In general, consumption taxes are more neutral towards saving and investment, and they do not discriminate between foreign and domestic goods and services. In this context, the income tax reform of 2009 is a step in the right direction as it reduced the labour tax burden. Even so, the wedge between official wages and take-home pay will remain large due to high social contributions (Figure 3.2). This wedge has a negative impact on employment, in particular of less productive workers (OECD, 2007a). Thus, lowering income taxes and/or social contributions further could be beneficial (Chapter 2), but would require raising other taxes or reducing public expenditure. If lowering tax rates further is not feasible, then indexing tax brackets could be envisaged to offset fiscal drag. As the tax brackets are indexed neither to inflation nor to wages, the tax burden increases gradually over time with the rise in nominal wages. Extrapolating the past average growth of nominal wages, it would take nearly four years for earners at the lowest pre-2009 tax bracket to reach the new lowest bracket, and over six years for the earners at the highest pre-2009 tax bracket to reach the highest new bracket. The inflation adjustment of tax brackets is among the options of the tax reform advocated by WIFO (Aiginger et al., 2008).

Raising taxes, and in particular consumption taxes, is currently not on the government's agenda. This is understandable given the current weakness of domestic demand. However, once the economic situation improves, such an option would merit consideration. Environmental taxes are one of the areas where consumption tax increases would be warranted (Aiginger et al., 2008). This would not only contribute to the relative rebalancing of labour and consumption taxes, but also help environmental causes. There is a clear case, in particular, for further increasing fuel taxes, even though they were already increased in 2008. Fuel pricing policies are a more efficient means to save energy and reduce CO2 emissions than subsidising energy-saving housing investments, which are common in Austria (OECD, 2004, 2007a). Higher fuel taxes would also help to reduce persisting fuel price differentials between Austria and some of its neighbouring countries, especially Germany and Italy,9 and the ensuing "fuel tourism". The large scale of fuel tourism increases CO2 emissions, which is all the more worrisome as Austria is set to overshoot its 2008-12 Kyoto target (Austrian Court of Audit, 2008). The government should also envisage eliminating the preferential tax treatment of diesel purchased for agriculture purposes. Aiginger at al. (2008) also advocate introducing a CO2 tax on fossil energy sources and raising electricity taxes. Besides environmental taxes, raising excise duties on tobacco and alcohol could be considered (OECD, 2007a; Aiginger et al., 2008).

Any positive growth effects of the tax structure depend also on the administrative efficiency, simplicity, transparency and stability of the revenue system, which may be conducive to higher tax compliance and lower administrative costs (EC, 2008). Thus, unifying VAT tax rates should be considered in Austria. Currently, Austria lags behind the most VAT-efficient OECD countries (OECD, 2009a).

Public employment rationalisation should continue

Successful fiscal policy implementation also depends on the effectiveness and management of public administration staff. In efforts to increase public administration effectiveness, Austria has reduced the number of public employees in recent years. The government's plans to continue with staff rationalisation are welcome (Austrian Government, 2008). However, staff reductions should not come at the cost of the quantity and quality of public services. In this respect, increasing the staff resources of the consumer protection and competition regulatory authorities would be particularly welcome (Chapter 2). (10) Moreover, manpower controls in the public sector (Stellenplan) need to be reformed. Stellenplan, as a part of the budgeting process, fixes at a detailed level the number of public posts at specific grades. This causes unnecessary inflexibility in managing posts between and within ministries (B15nda1 and Bergva11, 2007; Meszarits and Seiwald, 2008). Finally, there is considerable room for rationalising public administration at lower levels of government, which is related to fiscal federalism reforms.

Limited progress with fiscal federalism reforms

The effectiveness of public spending and governance in Austria would benefit from further fiscal federalism reform. The 2005 OECD Economic Survey made the following recommendations: 0 improve tax-sharing arrangements across levels of government; ii) strengthen the tax-setting powers of sub-national governments; iii) improve the transparency and targeting of transfers between levels of government; iv) exploit returns to scale in services provided by municipalities; v) reform the income replacement schemes run by sub-national governments; vi) overcome fragmentation in decision-making, e.g. in the running and financing of hospitals and in the design, financing and delivery of social assistance benefits; and vii) revise the budgetary framework at all levels of government. Since 2005, many more detailed recommendations on how to improve the management and efficiency of fiscal federal relations have been put forward (Austrian Court of Audit, 2007, 2009). As of early 2009, 38% of the 206 recommendations of the Austrian Court of Audit (2007) had been implemented and 22% were in the pipeline. In 2009, the Austrian Court of Audit increased the number of recommendations to 315.

The government is committed to the federalism reforms. In February 2009, it appointed a high-level working group on administrative reform (Konsolidierungsarbeitsgruppe) to facilitate the reform process. The group is headed by the Federal Chancellor and the Minister of Finance and comprises representatives from different levels of the government, including the high-rank representatives of Lander. The group deals with reforms pertaining to the whole public sector. Reform proposals are being developed by an expert group from outside the administration, which are then evaluated by an expert group formed by experts from the administration. First concrete reform proposals concerning the efficiency of administration, especially in education, were expected to be revealed around mid 2009.

The slow progress with fiscal federal reforms was also due to the fact that constitutional reforms have been in limbo, with the lack of a political consensus at various levels of government, an intricate federal structure and related difficulties in reforming key public services being the main obstacles. To make headway on this front, efforts should be stepped up to engage more actively in a dialogue with the stakeholders in order to reach a consensus. Exchanging more information about the implications of such reforms would help, as stakeholders at various levels of government seem to understand them differently

Policy recommendations

The permanent discretionary fiscal measures taken in the context of the current recession will require consolidation once the economic situation improves. This is essential to maintain sound and sustainable public finances, both for the sake of the effectiveness of the demand-boosting initiatives and in the face of age-related pressures. The current government plan to reduce the deficit below 3% of GDP by 2012 lacks detail and thus credibility. It is important to specify soon the areas where action will be taken. These measures should principally take the form of expenditure restraint and, if necessary, of increases in non-distortive taxes. The long-term public spending pressures related to population ageing are relatively contained, but additional improvements could be achieved. Beyond these challenges, there is room for the structure of spending and taxes to adjust and become more growth-friendly. This should be combined with greater spending efficiency, in particular in health care and education. Genuine progress in these areas will not be possible without reforms of fiscal federalism. A summary of specific recommendations is provided in Box 3.1.
Box 3.1. Fiscal policy recommendations

Keeping an eye on long-run sustainability

* The ongoing deterioration in public finances will require
substantial consolidation down the road. It is important to specify
soon the areas where action will be taken. These measures should
principally take the form of expenditure restraint and, if
necessary, of increases in non-distortive taxes.

Containing age-related spending

* The authorities should not backtrack from the past pension
reforms. In particular, the transition period to the new system
should not be extended and the conditions of this transition should
not be relaxed further.

* The pension schemes for civil servants of the Lander and
municipalities should be harmonised fully and more rapidly with the
general pension scheme.

* Special early retirement programmes for public sector workers
should be terminated. The "heavy workers" channel into early
retirement should be restricted to well-justified cases.

* Consideration should be given to making the correction mechanism
of pensions with respect to demographic developments and other key
pension determinants (productivity, labour force participation)
more precise and binding, by stipulating clear and simple
adjustment rules and implementation procedures.

* Health care reform should be continued and health care
expenditures rationalised. The biannual evaluations of the reforms
outlined in the 2005 Health Reform Act should be carried out in a
timely, independent and comprehensive fashion, and the results of
the evaluations fully taken into account in future public health
care policy. Work on legislation improving the financial situation
of the health insurance funds should continue.

Improving the fiscal policy framework and governance

* The reforms of the public finance framework should be continued,
especially those related to output-based budgeting and the adoption
of new accounting rules, and their implementation should not be
delayed.

* The rationalisation of government employment should be continued,
and the mobility of government staff should be increased by
eliminating manpower controls (Stellenplan).

* Fiscal federal relation reforms should be advanced in line with
the recommendations of previous OECD Economic Surveys. In
particular, a greater harmonisation of financing and spending
responsibilities across a11 levels of government, and granting more
responsibility and accountability to all public sector spending
agencies, would help promote good governance and better management
of public finances.

Changing the tax structure

* The tax structure should be further rebalanced from income to
consumption. Excise duties on petrol should be raised further to
limit fuel tourism arising from prices differences with some
neighbouring countries. Raising excise duties on tobacco and
alcohol should be considered.

* Real estate taxes should be increased. The valuation of real
estate for tax purposes should be updated regularly and brought to
market levels.


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Notes

(1.) Austrian fiscal federal relations are discussed in detail in OECD (2005).

(2.) The five main expenditure headings are: general government affairs, court and security; employment, social services, health and family; education, research, art and culture; economic affairs, infrastructure and environment; and financial management and interest. Budget chapters represent the portfolios of ministers.

(3.) Estimates presented by the Austrian social partners in April 2008 indicated that under unchanged policies, the total deficit of the health insurance funds would increase to 0.6 billion [euro] in 2012 (Hofmarcher, 2008).

(4.) The OECD (2007b) simulations suggest that when feedback effects from taxes to GDP growth are taken into account, fiscal consolidation is far better achieved by spending cuts than tax increases. Taxes and transfers reduce incentives to work and save and thus lower GDP growth. The model, however, does not assume any positive effects of public spending on GDP growth.

(5.) Austrian Government (2008) contains many policy measures that will be implemented only if sufficient financing is provided.

(6.) Pension spending is expected to peak at 14% of GDP in 2050 and then to moderate to 13.6% of GDP in 2060.

(7.) Given the retirement age (65 for women and men) and life expectancy (89 years for women and 77 for men) and assuming average inflation of 2% and average wage growth of 3%, the ratio of average pension to average wage would decline by 16% for women and 11% for men during retirement.

(8.) Barrios and Schaechter (2008) note that an index of the quality of fiscal rules improved markedly for Austria between 1995 and 2005, but remained well below the EU average. This index measures the coverage and strength of national numerical fiscal rules, using information on the statutory base, the nature of the body in charge of monitoring and enforcing the rule, enforcement mechanisms and media visibility of the rule.

(9.) In April 2009, the prices of euro-super 95 in Germany and Italy were approximately 25% higher than in Austria, and for diesel prices this difference was approximately 10%.

(10.) This goal is on the government agenda (Austrian Government, 2008), but its implementation is contingent on the availability of budget resources.
Table 3.1. Age-related public expenditure pressures in Austria
are small compared to the euro area

Increase in spending between 2007 and 2050, % of GDP

                     Pensions   Health care   Long-term care

Euro area               2.9          1.4            1.2
Austria                 1.2          1.6            1.1
Belgium                 4.7          1.2            1.3
Finland                 3.3          1.0            2.4
France                  1.2          1.2            0.8
Germany                 1.9          1.8            1.3
Greece                 12.3          1.3            1.7
Ireland                 4.0          1.5            1.0
Italy                   0.7          1.1            1.1
Luxembourg             13.4          1.2            1.6
Netherlands             3.7          1.1            4.3
Portugal                1.9          1.7            0.1
Slovak Republic         2.6          2.1            0.3
Spain                   7.1          1.6            0.8
Other EU countries
Denmark                 0.5          1.0            1.5
Sweden                 -0.5          0.8            1.8
United Kingdom          1.5          1.7            0.4

                     Education   Total

Euro area              -0.2       5.3
Austria                -6.6       3.3
Belgium                -0.1       7.1
Finland                -0.4       6.3
France                  0.0       3.2
Germany                -0.5       4.5
Greece                 -0.2      15.1
Ireland                -0.4       6.1
Italy                  -0.3       2.6
Luxembourg             -0.8      15.4
Netherlands            -0.1       9.0
Portugal               -0.4       3.3
Slovak Republic        -1.0       4.0
Spain                   0.0       9.5
Other EU countries
Denmark                 0.3       3.3
Sweden                 -0.4       1.7
United Kingdom         -0.1       3.5

Source: EC (2009b).

Table 3.2. Alternative projections of age-related public expenditure
in Austria

                                            Increase in public
                                       spending by 2050, I of GDP

                 Spending, % of GDP        OECD scenarios (1)

                   2004       2007         Best   Worst

Pensions         13.4       12.8             --      --
Health care       5.3        6.5            1.9     3.8
Long-term care    0.6 (4)    1.3 (4)        1.2     2.0
Education         5.1        4.8             --      --
Total            24.4       25.4             --      --

                 Increase in public spending by 2050, I of GDP

                   EC scenarios (2)   IMF scenarios (3)

                     Best   Worst       Best   Worst

Pensions              0.2     5.5       -3.0     5.0
Health care           0.9     2.4         --      --
Long-term care        0.9     1.4         --      --
Education            -0.6     0.3         --      --
Total                 1.5     9.6         --      --

(1.) Compared with 2005.

(2.) Compared with 2007.

(3.) Compared with 2004.

(4.) In 2004 long-term care spending contains only federal cash
benefits (Bundespflegegeld), while in 2007 it refers to
total public spending, including also Lander cash benefits
and budget contributions to long-term care institutions.
Source: OECD (2006), EC (2009b) and IMF (2007).
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Title Annotation:Chapter 3
Publication:OECD Economic Surveys - Austria
Geographic Code:4EUAU
Date:Jul 1, 2009
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