Bridge over ocean
1 February 2013 CFA Institute Journal Review

Converging World: Countries’ Fiscal Policies Are Becoming More Similar (Digest Summary)

  1. Derek W. Johnson, CFA

Since 1994, spending by developed countries has exceeded their tax revenue. Therefore, much of the developed world is facing a budget deficit. The author discusses this situation in developed countries as well as the fact that fiscal policies around the world appear to be converging.

What’s Inside?

Government spending and tax data from developed countries show that spending has exceeded revenue from taxes since 1994 and that taxes have been stable over time. The author discusses whether there might be some upper limit to the amount governments can tax. Taxes and spending also seem to be converging on a global level.

How Is This Article Useful to Practitioners?

The author finds that in the United States, the eurozone, and within the Organisation for Economic Cooperation and Development (OECD), government spending has been higher than tax revenue and taxes have been relatively stable, with slight changes as a result of economic cyclicality. The biggest differences are between countries. For example, the United States’ total tax rate has been between 30% and 35% of GDP since 1970, whereas the eurozone’s total tax rate has been between 44.6% and 46.6% since 1994.

In addition, the author observes that the spread between the highest and lowest tax and the spending rates are converging. In 1994, the five highest tax regimes in the OECD had an average tax rate of 55.7%, but in 2012, that rate had fallen to 53.6%. The lowest tax regimes in 1994 averaged 30.5%; the average of the lowest tax regimes is now 33%. In high-spending countries that have a tax constraint, the expectation is that they will eventually cut spending. The six highest-spending countries in 1994 lowered spending from 59.4% of GDP to 52.8%. But five of the lowest-spending governments in 1994 increased spending from 32.7% to 36.5%. According to the author, it is reasonable to expect that nations will continue to converge in their fiscal policies.

Abstractor’s Viewpoint

Many developed countries—especially those with higher tax rates—are grappling with how to correct the budget deficits that have been created by almost two decades of spending more than taxes were bringing in. Countries’ choices may be limited if they face tax constraints. The United States seems to be facing higher taxes, whereas the eurozone needs to cut spending.

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