The article first appeared on OMFIF on Nov. 28th,2024.

From fiscal fantasy to fiscal reality

A fiscal crisis is looming across the world. Governments face tepid productivity growth, which is constraining revenues. Meanwhile, pressures on the expenditure side will continue to mount over the coming years owing to rising interest payments, ageing populations, asset maintenance and climate change.

Long-term fiscal projections make for grim reading. For instance, the Congressional Budget Office forecasts that the total US federal deficit will rise to 8.5% of gross domestic product over the next 30 years, from 5.6% in 2024 (see Figure 1). The International Monetary Fund projects that global public debt will approach 100% of GDP by the end of the decade. It is something of a fantasy to expect that governments can operate under current conditions for a prolonged period.

Against this backdrop, OMFIF has published a new report in collaboration with EY. ‘The future of public money’ outlines the need for an urgent rethink of how public spending is framed, conducted and evaluated to ensure governments can meet growing societal demands while improving the sustainability of public finances.

To inform this report, OMFIF and EY conducted three steering committee meetings with public finance experts from organisations including the International Monetary Fund, US Treasury, US Congress, European Commission, UK National Audit Office, rating agencies, banks and academia. These insights are supplemented by analysis of external reports and OMFIF’s research.

Mark MacDonald, global public finance management leader at EY, states ‘There are clear ways in which structures, rules and decision-making processes can be overhauled to dramatically improve the management of public finances’. In general, improvements can be made by embracing new fiscal frameworks, accounting standards and technology.

The starting point is to centre spending allocation decisions on their intended and actual outcomes for the real economy rather than their impacts on government balance sheets alone (i.e. revenues, expenditure, debt). The Next Generation EU project provides a useful example of the clear link between goals, performance and budget allocation to ensure funds go to areas where progress is being made.

More timely and broader evaluation – encompassing non-financial metrics such as environmental and social outcomes – should be used to inform data-driven public spending. Only 19% of Organisation for Economic Co-operation and Development countries currently quantify the impact of climate change in their budgets, suggesting there is scope for more holistic fiscal analysis.

There is an also opportunity with new technology, such as blockchain and artificial intelligence, to undertake real-time tracking and reporting against spending plans to ensure quicker and more accurate evaluation and decision-making. These technologies, alongside digital IDs, can also be used to reduce fraud and error and improve the targeting of public spending to further enhance efficiency. India’s digital public infrastructure highlights the progress that can be made on this front.

There was general consensus among steering committee members on the need to address short-term thinking in budget decisions, which is exacerbated by political cycles. This would involve changing the narrow fiscal objectives used across advanced economies based on public debt or budget targets, which embed short-term decision-making and disincentivise the necessary capital investment to upgrade public assets.

Incorporating intertemporal public sector net worth into policy decisions would make long-term factors more visible and actionable for policy-makers. This measure provides a single metric incorporating the net present value estimate of long-term costs – such as those linked to ageing, asset maintenance and climate change – as well as the potential long-term benefits of public investment.

The broader public financing landscape should play a key role in holding governments to account. The growing interest in sustainable capital markets should incentivise governments to report and act on climate change. Investors can also ensure governments maintain sustainable fiscal policies more generally, while rating agencies and international organisations can support to promote transparency, accountability, technical assistance and innovation in government.

The key message is that governments should be on the front foot and take definitive actions now. Going forward, OMFIF and EY aim to explore in more detail how policy-makers can fundamentally change the course of public finance management systems to practically implement the technical and institutional suggestions outlined in this report. We welcome the insights and participation of policy-makers and public finance experts as we work towards a brighter future of public money.