Debt and debt restructuring

There have been several major developments on debt since the previous round-up.

In November 2023, official creditors – led by China – rejected the Zambian government’s deal with its private sector bondholders, on grounds that the bondholders were being treated more favourably than China and other official lenders. Although this left the bondholders ‘very disappointed’ and ‘deeply concerned’, a revised deal was announced on 25 March with a slightly larger haircut.

In December, Ethiopia defaulted on its Eurobond – having previously agreed debt service standstills with its Chinese and Paris Club creditors in August and December. The country now has until the end of March to negotiate an IMF programme, before embarking on debt restructuring negotiations.

In January, Ghana agreed a deal with its bilateral creditors resulting in a further disbursement of its IMF programme – before sacking its finance minister in February. Also in January and February, after no IDA countries issued bonds in 2023, Cote d’Ivoire, Kenya and Benin re-entered bond markets. However, Kenya is paying over 10% interest on its new bond – compared to the 6.9% it pays on its bond that matures in 2024 – which has raised some concerns.

So, how did countries get here? This IMF paper on the drivers of ‘debt surges’ highlights the importance of currency depreciation and the publicly-guaranteed debt (or implicit liabilities) of state-owned enterprises in low-income countries. And what are the lessons of the past? Another IMF paper explores lessons learned from the 1990s Brady Plan which exchanged loans for bonds. The paper finds that participating countries undertook deeper reforms and experienced a substantial decline in public and external debt burdens, as well as a sharp boost in growth.

Further reading on debt and debt restructuring, includes: the World Bank’s annual International Debt Report; Brad Setser’s blog on the deficiencies in the IMF’s debt sustainability analysis, as applied to Ghana, Sri Lanka and Zambia; Sean Hagan’s blog on reform of the sovereign debt restructuring framework – his point on the need for a simultaneous rather than sequential restructuring of official and private claims are well illustrated by Zambia’s experience; and this Special Issue of Development and Change.

Are fiscal rules (net) worth it?

Given fears of a debt crisis, and the current economic climate, fiscal rules – restrictions on fiscal policy set by governments to constrain their decisions on tax and spending – are on the minds of many policymakers right now.

A new report from the Institute for Government (IfG) argues that the UK government is constantly changing its fiscal rules, gaming them by providing “short-term [tax] give aways” that are offset by often unrealistic projections of future tax increases and spending cuts. Tim Leuning proposes a novel but simple reform, that the Chancellor read to parliament a short statement from the Head of the Office for Budget Responsibility (OBR) on the country’s fiscal position, and the budget’s effect on it. Leuning notes that comments by the head of the OBR might have more impact if given such an airing.

The EU is not planning to do this, but the EU Council did recently agree plans to reform the bloc’s fiscal rules. The reform has had a long gestation period and was seen as ‘a bold plan with flaws that can be fixed’. The main thrust of the reform is that country specific fiscal adjustments should be based on common standards for debt sustainability analysis. Recent analysis from Jeromin Zettelmeyer highlights the advantages and disadvantages of the compromises made in the final rules, which he argues remain “a big step forward compared to the current rules”.

A new book, Public Net Worth, suggests that instead of targeting deficits and debt, fiscal rules should target public net worth – the difference between what a government owns and what it owes. Proponents of this approach argue that targeting public net worth would focus attention on non-debt liabilities such as pension obligations; what government is investing in; intergenerational equity; as well as emphasising that solvency is only a means to an end. According to detractors: public net worth is an insufficient measure of fiscal sustainability; the cost would not outweigh the benefits; it is difficult to place value on government assets; and some governments have already rejected the idea.

These debates over the design of fiscal rules will continue ad infinitum and, hopefully, lead to their improvement. But the debates also show that OECD governments are yet to figure all this out, struggle to understand their own rules, and often break them – points that are worth remembering next time a best practice reform from an OECD country is recommended elsewhere.

The Treasury and the centre of government

How should finance ministries be structured to most effectively carry out their functions? There has been increasing debate in the UK around splitting up the Treasury – the UK’s finance ministry – by moving its budget-setting powers into a US-style ‘Office of Management and Budget’ that would sit in a revamped Prime Minister’s department.

In 2023, a government-commissioned report argued for the above change, but according to the IfG, these proposals would not solve the problem of ensuring that policy, driven by the Prime Minister, and budgets, driven by the Chancellor, are aligned. The IfG also argue that splitting up the macro-fiscal and expenditure policy functions could create new tensions, leaving the role of the Chancellor in influencing and scrutinising public spending undefined.

The IfG’s own report on reforming ‘the centre of government’ also finds the Treasury to be too strong relative to other central departments. This results in distorted decision making, with a short-term focus on budget setting making it hard to tackle the cross-cutting and long-term problems facing the country. A strategy vacuum is filled by Treasury spending decisions. But instead of breaking up the Treasury, the report focuses on establishing a stronger Department of the Prime Minister and Cabinet (DPMC) which could set and maintain an overall strategy for the government to follow. Taking inspiration from similar processes in Canada and the Netherlands, the report argues for a new strategy and budget process, jointly managed between the new DPMC and the Treasury. While focused on the UK, this report may be of wider interest for thinking about how to balance strategy and fiscal policy making at the centre of government.

Taxing, globally

The past few months have been momentous for global tax. In November 2023, the UN General assembly passed a resolution to start work on a UN tax convention. There was a clear North-South divide in the voting pattern, which is perhaps not surprising given that African countries had been significant sponsors of the motion while most of the historic OECD membership voted against it – although newer Latin American OECD members did not.

Global tax agreements have previously been hashed out at the OECD, which critics argue should not lead international tax negotiations as it is not fully inclusive and has not made enough progress. Advocates for the UN resolution hailed its passage as a “historic victory”, although some tax campaigners argue that a UN process is unlikely to deliver anything better than the OECD-led process. Martin Hearson suggests how a UN convention can respond to gaps in the current arrangements.

Meanwhile, negotiations are ongoing over the OECD’s two-pillar solution on international corporate taxation, to which 145 countries have now signed up. Pillar One, which reallocates taxing rights on the largest multinationals – those with turnover exceeding €20bn – from their home countries to countries where they make their sales, requires an international tax treaty to come into force. The OECD is aiming for this to be ready for signature by end of June, however the US is unlikely to ratify it and so there are doubts this will ever come into force. Some analysts are also sceptical that developing countries would actually receive more from Pillar One than from home-grown digital services taxes, which the treaty will prohibit. Meanwhile, over 35 countries will begin to implement Pillar Two – the minimum 15% corporation tax rate – this year.

According to the EU Tax Observatory’s 2024 Global Tax Evasion report, the automatic exchange of bank information between countries has led to a large decline in offshore tax evasion by individuals, with the equivalent of 3-4% of global GDP held in tax havens in 2022, down from around 9% in 2015. But the report criticises the global minimum corporation tax, arguing that a series of loopholes have halved the likely revenue gains to around 5% of existing corporate tax revenue. The OECD’s new estimates are more optimistic: an increase of 7-8% of global corporate income tax revenues.

The report also proposes building on the recent break-throughs in global tax cooperation by establishing a global minimum tax on billionaires, equal to 2% of their wealth, which could raise over $200 billion each year. Brazil’s G20 presidency has taken up this proposal, commissioning a report on how this could work in practice.

In contrast, a new IMF note argues that because taxing returns to wealth is ‘generally less distortive and more equitable than a wealth tax’, reforms should focus on strengthening the design of capital income taxes, especially capital gains, as well as closing loopholes and taking advantage of new technology to improve tax compliance.

Taxing, healthily

Health taxes – on harmful goods such as tobacco, alcohol and sugar-sweetened beverages – are an efficient way to raise revenue, reduce the burden of non-communicable diseases, and ease pressure on health spending. A recent World Bank brief found that tobacco and alcohol taxes generate an average of 0.6% and 0.3% of GDP in tax revenue, respectively. While this may seem underwhelming, it represents a major share of public health expenditure: equivalent to 25% of domestic government health expenditure in LICs, 31% in LMICs and 23% in UMICs.

The brief acknowledges questions over the sustainability of health revenues, because revenue will decline if consumption falls. But it points out that even countries with relatively high excise taxes continue to increase revenues when raising taxes. And any long-run declines in tax revenues should be viewed as a policy success rather than a failure, resulting in lower mortality, morbidity, and ultimately economic costs.

In late 2023, in a special issue of the British Medical Journal (BMJ) Global Health focused on health taxes, Paraje, Jha, Savedoff and Fuchs provide rebuttals to the three most common objections to health taxes – that they are regressive, they stunt economic activity, and they promote illicit trade – arguing that none of these hold when long-term effects are considered. The WHO’s latest assessments of SSB and alcohol taxes further contribute to this growing body of international evidence on optimising health tax design.

What is the impact of fiscal decentralisation?

How should we think about the impact fiscal decentralisation might have on public services? Jean-Paul Faguet argues – in a blog introducing a new open-access book, Decentralised Governance – that we should not expect ‘one tidy outcome replicated in many localities, but rather a wide variety of outcomes that range from the strongly negative, through the null (“no change”), all the way to highly positive responses’. Because decentralisation allows local autonomy, it ‘generates a heterogeneity of responses’. So rather than focusing on the effect of decentralisation on education or health or infrastructure, we should look at why decentralised drives improvements in some places, but not others.

In 2001, Indonesia’s ‘big bang’ decentralisation made it one of the most populous decentralised countries in the world, and one of the most studied examples. In a recent paper, Blane D. Lewis provides an assessment of Indonesia’s recent fiscal decentralisation law and its potential impact (hat tip to decentralization.net). He argues that the law’s aims of greater equity of transfers across regions, as well as improved subnational tax collection, spending efficiency and service delivery outcomes are unlikely to be realised. This is because the standard public finance tools used in the law – such as performance incentives, revenue earmarking and expenditure directives – cannot address the main underlying challenges facing decentralisation, such as corruption and clientelism.