Government should report “pension-adjusted” budget/fiscal balance

IMF economists in a new research argue for the same. The idea is that governments should show fiscal numbers adjusting for pensions. This could lead to two things. First, governments having higher pension bills will be under pressure to reform. Two, it incentivises those govts which undertake pension reforms and asking the countries in first category to follow.

This is all the more important as we have so many countries which such dire pension liability concerns.

 Benedict Clements discusses the paper in IMF Blog.

The first problem is that good fiscal policy hasn’t always ruled the day, to put it mildly. Today, pension reform is a priority for the advanced economies as current trends are unsustainable—see Commandment V—and for many emerging and low-income economies that need “to improve coverage of health and pension systems in a fiscally sound manner.”

The second problem is that traditional deficit and debt indicators focus on the health of public finances today, but fail to capture the future impact of pension promises. This means that pension reforms, which often strengthen the fiscal position down the road, might not necessarily improve—and sometimes worsen—traditional fiscal indicators today. The risk is that assessments of pension reforms based on traditional deficit and debt indicators could create incentives to delay or even reverse reforms.

The paper says:

This underscores the need for a fiscal indicator that gives governments credit for pension reforms that improve long-term fiscal health, but also correctly points out when they are moving in the wrong direction.

In a recent Staff Discussion Note, we propose a new indicator—the “pension-adjusted” budget balance—that takes into account the long-term nature of pensions. It focuses on the fiscal sustainability of pensions and provides a level playing field for evaluating a country’s pension policies. The new indicator achieves this by recalculating the traditional budget balance to take into account the intertemporal pension balance (that is, future pension imbalances), rather than the current pension balance.

In other words, and simplifying a little, this means taking account of the difference between the current value of future pension contributions and the current value of all future benefits, from today to a certain date in the future, say 50 years. And not just the difference between pension contributions and benefits today.

Policy lessons:

This indicator can help measure when changes in pension policies are improving or worsening long-term fiscal health. One advantage is that it eliminates incentives to adopt or dismantle particular systems to improve current-period indicators. Of course, overall balances remain key for evaluating the risks surrounding short-term financing needs.

We draw three main implications for fiscal policy design:

  • We should take account of the future impact of pension reforms, or other public programs such as health care, when we analyze fiscal sustainability.
  • To do that, we should look at the sum of future pension balances, the intertemporal pension balance.
  • The “pension-adjusted” budget balance should be viewed as a complement, rather than a substitute, for traditional fiscal indicators.
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