While all market analysts agree that the new government of Abelardo De La Espriella will have to implement a fiscal adjustment in Colombia to clean up public finances that are deteriorated with high levels of deficit and debt, carrying out this process could generate an adverse effect on the country’s growth in the short term.
However, there is no consensus
on what could have a greater impact: whether the fiscal adjustment is made through
higher taxes, as could be the case with tax reforms, or if it is
carried out through cuts in public spending, such as those already announced
by the incoming Finance Minister Miguel Gómez.
In order to answer
this question, economists José Ignacio López, president of the economic studies center Anif, and Jonathan Malagón, from the bankers’ guild Asobancaria,
studied the macroeconomic effects of fiscal consolidation in nine
Latin American economies between 1989 and 2024.
In the research, published in
the IPD program of Columbia University in New York, it is stated that fiscal
adjustments based on taxes and those based on reductions in
public spending present similar costs on economic activity. Between -1.1
and -0.9, respectively.
“A consolidation of 1 percent
of GDP reduces real GDP by 0.92 percentage points at the time of impact,
by 0.89 percentage points after one year, and by 0.52 percentage points
after two years,” the document reads.
However, the costs in
growth are very different when countries face high public debt.
“When it is at historically manageable levels, raising taxes is
relatively harmless for growth; it is the spending cuts that hit
harder, possibly because in our economies public spending
(transfers, investment) has a considerable demand multiplier.
But when debt soars, as happened in much of the region after
the pandemic, the outlook reverses radically,” says Malagón in his
column in La República.
According to the research, in
times of high indebtedness, an adjustment program equivalent to 1 percent
of GDP mainly based on tax increases reduces growth
by about 3.1 percentage points, while one based on reductions
in public spending has an effect close to 0.7 points.
“At high debt levels, the production cost of
a tax-based consolidation is approximately 4.7
times greater than that of a comparable spending-based plan. When public debt
is high, tax-based consolidation becomes substantially
more contractionary,” the research says.
López explains that there are several
reasons that help understand this result. On one hand, he says that spending cuts
can send a more credible signal about the future sustainability of
public finances, helping to reduce risk perception and
financing costs. On the other hand, he points out that tax increases
tend to more directly affect consumption, investment,
and production decisions, especially in economies where the tax burden is already high
or business confidence is low.
“The evidence in Latin America suggests
that in times of high debt, fiscal adjustments based on spending cuts are better than those based on higher taxes. Reducing public spending
does not mean cutting indiscriminately. A successful program
must protect high-impact public investment and well-targeted social spending,
while correcting inefficiencies, eliminating low-effectiveness programs, and strengthening budget discipline,” he opines.
In addition, the study found
that the composition of the adjustment also determines its chances of success. According to
the information, fiscal consolidations based on spending cuts show
a greater ability to generate persistent improvements in the primary balance.
“They increase the probability of a
lasting improvement in the primary balance by 9 percentage points at two years and by
16 percentage points at three years, while tax-based plans have no detectable effect,” the research indicates.
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