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Design of fiscal consolidation packages and model-based fiscal multipliers in Croatia*
Milan Deskar-Škrbić** 
Darjan Milutinović**
Darjan Milutinović
Affiliation: Croatian National Bank, Economic Analysis Department, Zagreb, Croatia
 0000-0001-5010-7437
Article | Year: 2021 | Pages: 1 - 61 | Volume: 45 | Issue: 1 Received: June 1, 2020 | Accepted: December 4, 2020 | Published online: March 9, 2021
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FULL ARTICLE
FIGURES & DATA
REFERENCES
CROSSMARK POLICY
METRICS
LICENCING
PDF
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2013
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2014
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2015
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2016
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Structural revenue measures
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Increase of the health
contributions rate
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0,5
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0,2
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Increase of the pension
contributions revenues
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0,1
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0,1
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0,01
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Increase of intermediate VAT
rate
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0,2
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Increase in excises on oil
derivatives
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0,1
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0,1
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0,04
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Increase of excise rate on
tobacco
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0,03
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0,04
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0,01
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Changes in tax on games of
chance
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0,03
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0,01
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Limitation of CIT tax relief
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0,1
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Introduction of tax on
interest on savings
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0,1
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Total structural revenue
measures
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1,0
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0,7
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0,1
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Structural expenditure
measures
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3% cut of public sector
wages
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-0,2
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-0,1
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Cancelation of the holiday
bonus
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-0,1
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Abolishment of the service
loyalty bonus
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-0,1
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Reduction of subsidies
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-0,3
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-0,1
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-0,2
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Constraining intermediate
consumption
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-0,2
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-0,1
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Government investment cut
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-0,4
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-0,1
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-0,1
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Social benefits savings
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-0,2
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-0,1
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Total structural expenditure
measures
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-0,3
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-1,3
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-0,2
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-0,3
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Total structural measures
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0,3
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2,2
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0,9
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0,4
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Note: structural increase of pension contribution revenues is related to the transfer of public employees with accelerated pension plan from the 2nd to the 1st pension pillar. Source: National budget; EC; authors’ calculations.
Source: Eurostat; EC; authors’ calculations.
Source: Eurostat; EC; authors’ calculations.
Note: numbers in brackets correspond to respective model equation. Source: authors.
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2014
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2015
|
2016
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Average
|
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Indirect taxes
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0.0
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-0.1
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-0.1
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-0.1
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Personal
income tax
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-0.2
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-0.3
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-0.2
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Corporate
income tax
|
|
-0.2
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-0.2
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-0.2
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Healthcare
contribution
|
0.0
|
-0.1
|
0.0
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-0.1
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|
|
2014
|
2015
|
2016
|
Average
|
|
Public wages
|
1.2
|
1.3
|
1.3
|
1.3
|
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Intermediate
consumption
|
0.6
|
0.5
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0.5
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0.6
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Subsidies
|
0.0
|
0.1
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0.1
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0.1
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Investments
|
0.7
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0.6
|
0.7
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0.7
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Social
benefits
|
0.2
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0.3
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0.3
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0.3
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2013
|
2014
|
2015
|
2016
|
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Structural revenue measures
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|
|
|
|
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Increase of the healthcare contributions rate
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0,5
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0,2
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Transfer of pension contributions
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0,1
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0,1
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0,01
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Increase of intermediate VAT rate
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0,2
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|
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Increase in excises on oil derivatives
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0,1
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0,1
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0,04
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Increase of excise rate on tobacco
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0,03
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0,04
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0,01
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Changes in tax on games of chance
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0,03
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0,01
|
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Limitation of CIT tax relief
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|
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0,1
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Introduction of tax on interest on savings
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0,1
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Total structural revenue measures
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1,0
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0,7
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0,1
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|
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Structural expenditure measures
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3% cut of public sector wages
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-0.2
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-0.1
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|
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Cancellation of holiday bonus
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-0.3 (0.0)
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|
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Abolishment of service loyalty bonuses
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-0.1 (0.0)
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Reduction of capital transfers
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0.0
(-0.2)
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0.0
(-0.2)
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0.0
(-0.2)
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Reduction of subsidies
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0.0 (-0.3)
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-0.3 (-0.2)
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-0.1 (-0.2)
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-0.2 (-0.2)
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Constraining intermediate consumption
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-0.2
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-0.1
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Government investment cut
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-0.4 (0.0)
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-0.1 (0.0)
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-0.1 (0.0)
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Social benefits savings
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-0.2
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-0.1
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Total structural expenditure measures
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-0.3 (-0.5)
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-1.3 (-0.9)
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-0.2 (-0.4)
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-0.3 (-0.4)
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Total structural measures
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0.3
(0.5)
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2.2
(1.9)
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0.9
(1.1)
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0.4
(0.5)
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Note: new measures of the growth-friendly fiscal consolidation package are bolded in parenthesis. The rest of the measures of the growth-friendly fiscal consolidation package are the same as in the original EDP scenario. Source: authors.
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2013
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2014
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2015
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2016
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EDP
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1.3
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0.6
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0.7
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0.6
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Growth-friendly
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0.6
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0.3
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0.1
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0.2
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Source: authors’ calculations.
Note: these figures shows only key endogenous macro and fiscal variables; figures of other variables are available upon request. Source: authors.
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Research
Fiscal
instrument
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Coenen,
Kilponen and Trabandt (2010)
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Cournede,
Goujard and Pina (2013)
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Gechert
(2015)
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Kilponen
et al. (2019)
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Snudden
and Klyuev (2011)
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Muir
and Weber (2013)
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Zubairy
(2014)
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Public expenditures
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Government
consumption (G)
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0.7-0.8
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0.6-0.8
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0.8
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0.5-0.9
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0.4
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0.5
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0.8-0.9
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Social transfers
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0.0-0.2
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0.2-0.5
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0.4
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0.1
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0.1
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Public investment
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0.8-1.1
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1.3
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1.4
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0.4
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0.6
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Subsidies
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|
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Public revenues
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Personal income tax
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0.2-0.3
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0.2-0.5
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0.0-0.5
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0.1
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0.4
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0.3-0.4
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Corporate income tax
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0.1-0.1
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0.1-0.3
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0.5
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Social contributions
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|
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Indirect taxes
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0.1-0.3
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0.1-0.3
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0.1-0.7
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0.1
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0.3
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Country
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Euro area/EU
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OECD
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meta study
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Euro area countries
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Czechia
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Bulgaria
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USA
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Model
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DSGE
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semi-structural
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across models
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across models
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DSGE
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DSGE
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DSGE
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Revenues
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Expenditures
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2014
|
|
· Increase
of the rate of healthcare contributions from 13% to 15% (0.49% of GDP)
· Increased
social security contributions due to the shift of part of the future pension
contributions to the first pillar (0.12% of GDP)
· Higher
fuel excises (0.11% of GDP)
· Other
revenues side measures: changes in the lottery and gambling taxes, SOEs
dividend and profit withdrawal, increase of telecom fees and other concession
fees (0.1% of GDP)
· increase
of reduced VAT rate from 10% to 13% (0.12% of GDP)
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· Lower intermediate
consumption due to savings, among other, on maintenance costs, transportation
costs, IT services (0.3% of GDP)
· Reduction
of subsidies, mostly to shipyards, HBOR and railways (0.4% of GDP)
· Savings
in social transfers, mostly in the health sector and privileged pension
outlays (0.3% of GDP)
· Reduction
of current and capital transfers, mostly due to replacement with EU funding
(0.1% of GDP)
· Reduction
of subsidies (0.2% of GDP)
· Lower
public investment (0.1% of GDP)
· Extrabudgetary
users and other general government entities, mainly in Croatian Roads and
Croatian Waters (0.4% of GDP)
· Savings
on general government compensation of employees (0.2% of GDP)
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2015
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|
· Increase
of the rate of healthcare contributions from 13% to 15% (0.25% of GDP) - a residual effect of the measure introduced in
2014;
· Changes
in the lottery and gambling taxes (0.05% of GDP) - a
residual effect of the measure introduced in 2014;
· Increased
social security contributions due to the shift of part of the future pension
contributions to the first pillar (0.04% of GDP) - a
residual effect of the measure introduced in 2014;
· Tax on
savings interest (0.07% of GDP);
· Higher
fuel and tobacco excises (0.16% of GDP).
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· Reduction
of subsidies for agriculture, active labor market policies and Croatian Bank
for Reconstruction and Development (0.03% of GDP)
· Social
benefits savings on housing loan subsidies and preferential pensions above
5000 HRK, and consolidation of social benefits (0.05% of GDP)
· Savings
of extrabudgetary users, in particular Croatian Waters, Croatian Health
Insurance Fund, Croatian Highways, Croatian Railway Infrastructure (0.5% of
GDP);
· Reduction
of transfers, mainly guarantee funds (0.13% of GDP);
· Reduction
of investment expenditure of the central and local government units (0.5% of
GDP).
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2016
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· SOEs
dividend and profit withdrawal (0.2% of GDP);
· Higher
fuel and tobacco excises (0.06% of GDP) - a
residual effect of the measure introduced in 2014
· New
treatment of reinvested earnings in the corporate income tax system (0.15% of
GDP)
· Introduction
of capital gains tax
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· Lower
intermediate consumption due to implementation of "standard material
costs guidelines" (0.05% of GDP);
· Further
reduction of subsidies of some activities and substitution with EU funds
(0.16% of GDP);
· Reduction
of social benefits through their further integration and decreasing
unemployment (0.13% of GDP)
· Savings
in other transfers through expiry of certain programs and substitution with
EU funds (0.21% of GDP);
· Reduction
of investment expenditure in defense, health, education, science (0.07% of
GDP)
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2017
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· Reduction
of investment expenditure of the central and local government units (0.5% of
GDP)
· Reduction
of capital transfers (0.5% of GDP)
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Real
GDP growth %
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2014
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2015
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2016
|
|
No policy change
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0.5
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1.2
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1.7
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EDP scenario
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-1.0
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0.6
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1.1
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Required structural measures, % of GDP
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2.3
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1.0
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1.0
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Structural balance, no policy change
|
-5.9
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-5.8
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-6.1
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Structural balance, EDP scenario
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-4.0
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-3.1
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-2.4
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General government balance, no policy change
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-6.4
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-6.0
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-6.0
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General government balance, EDP scenario
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-4.6
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-3.5
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-2.7
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General government debt, no policy change
|
64.7
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68.8
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72.3
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General government debt, EDP scenario
|
63.9
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66.1
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66.8
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|
2013
|
2014
|
2015
|
2016
|
2017
|
|
Q2
|
Q3
|
Q4
|
Q1
|
Q2
|
Q3
|
Q4
|
Q1
|
Q2
|
Q3
|
Q4
|
Q1
|
Q2
|
Q3
|
Q4
|
Q1
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Q2
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Q3
|
|
Pre-EDP consolidation phase
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Main EDP consolidation phase
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Implementation phase of the EDP measures
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Croatia joins EU
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EC proposes opening of EDP for Croatia
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Council opens EDP for Croatia
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Main EDP fiscal package of measures
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EC gives positive assessment of the fiscal
effort
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EDP in
abeyance
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EC proposes closing of EDP for Croatia
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Council closes EDP for Croatia
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Source : authors.
Table 1Structural consolidation measure (% of GDP) DISPLAY Table
Figure 1Structural consolidation measures, % of GDP DISPLAY Figure
Figure 2Structural revenue measures, % of GDP DISPLAY Figure
Figure 3Structural expenditure measures, % of GDP DISPLAY Figure
Figure 4Decomposition of the change of general government balance (pp of GDP) DISPLAY Figure
Figure 5Decomposition of the change of general government debt (pp of GDP) DISPLAY Figure
Figure 6Structure of the macro-fiscal model of the Croatian economy DISPLAY Figure
Table 2Fiscal multipliers: revenue-side instruments DISPLAY Table
Table 3Fiscal multipliers: expenditure-side instruments DISPLAY Table
Table 4Growth-friendly fiscal consolidation package DISPLAY Table
Table 5Weighted expenditure-based fiscal multipliers DISPLAY Table
Figure 7Fiscal and macroeconomic outcomes of the EDP and counterfactual scenario DISPLAY Figure
Figure A2.1Endogenous variables – baseline scenario vs. actuals (levels) DISPLAY Figure
Figure A2.2Endogenous variables – baseline scenario vs. actuals (growth rates) DISPLAY Figure
Table A4.1Model-based approach DISPLAY Table
Table A5.1Announced structural measures during the EDP DISPLAY Table
Table A6.1Forecast of macro and fiscal variables under baseline and EDP scenario (December 2013) DISPLAY Table
Table A6.2Timeline of the EDP consolidation DISPLAY Table
Figure A7.1Revenues DISPLAY Figure
Figure A7.2Expenditures DISPLAY Figure
* The article was judged the best paper in the regular category in the annual competition for the Prof. Dr. Marijan Hanžeković Prize for 2020. ** The authors would like to thank the three anonymous referees as well as Jurica Zrnc, Ozana Nadoveza Jelić, Ivan Žilić, Iva Tomić and Ivica Rubil for valuable suggestions and comments. The views expressed in this paper are exclusively those of the authors and do not necessarily reflect those of the Croatian National Bank.
1 IMF in Regional Economic Outlook: Europe October 2020 (p.11) states that: “The extraordinary policy support needs to be anchored by credible consolidation plans to be implemented once the recovery has taken hold.”
2 Fall in GDP reduces the denominator of the ratio but also triggers the mechanism of automatic stabilizers that leads to a fall in revenues and a rise in some categories of expenditures (e.g. unemployment benefits). We explain these mechanisms in more detail in Section 4.
3 Some authors use micro-simulation models to estimate the effects of various fiscal measures on micro level. See for example Urban et al. (  2018).
4 These include changes in fiscal variables due to the mechanism of automatic stabilizers and/or counter-cyclical reactions of fiscal policy to business cycle developments.
5 Despite this fact, EDP fiscal consolidation did not attract much attention among academics in Croatia. To our knowledge, the only papers that provide an overview and partial evaluation of this fiscal consolidation episode are Bajo and Galinec ( 2013), Ujević ( 2014), Burnać ( 2017), Deskar-Škrbić and Raos ( 2018) and Šimović and Deskar-Škrbić ( 2019). However, these papers have a narrower scope than the present analysis and do not provide empirical assessment of the short-term growth effects of the EDP-based fiscal consolidation.
6 The fiscal multiplier is defined as the ratio of a change in output (∆Y) to an exogenous change in the fiscal variable (∆F).
7 The term "deep structural parameter" was introduced in the 1970s, after Lucas' critic, to distinguish between the derivatives of a behavioral relationship used to define causal effects and the parameters that generate the behavioral relationship (Heckman, 2000).
8 Ministries of finance usually do not have large research departments.
9 The key challenge in this strand of literature lies in the identification of purely exogenous fiscal policy shocks. There are several main approaches to the identification of exogenous fiscal shocks. For detailed overview of different approaches see Ramey ( 2011, 2019).
10 We provide additional details on the timeline of EDP in Croatia in Appendix 6.
11 However, changes in PIT were not a consolidation measure. According to official wording in the proposal of changes in PIT legislature, this measure was introduced in order to stimulate household consumption and GDP growth.
12 Musgrave (1957) defines macroeconomic stabilization as one of the key functions of public finance, along with redistribution and allocation.
13 In order to assess the overall stability of the model we analyzed impulse responses of various exogenous shocks. Impulse responses in all cases converged and we1 found no evidence of "explosive" impulse responses. These results are available upon request.
14 CPI, implicit rate on public debt and unemployment benefits.
15 Appendix 2 shows the results of the baseline simulation. For more details on estmation results and detailed description of data see Appendix 3 and Appendix 8.
16 Chang et al. ( 2019) report the public wage multiplier of -0.03 for the US in the NK DSGE model as they calibrate the model in a way that cuts in public wages crowd-in private consumption. However, their model does not take into account the national accounts identity on GDP calculation (eq. 7).
17 Using input-output data for the Croatian economy Mikulić ( 2019) estimates the import component of total government consumption at around 20%, which is mostly related to intermediate consumption.
18 We are aware of the fact that counterfactual analyses should be based on structural economic models (not subject to Lucas' critique). Hence, counterfactual analyses presented in this paper should be seen an illustrative analytical exercise.
19 IMF applied similar approach in the analysis of the EDP fiscal consolidation episode in Czechia in 2011 (see Klyuev and Snudden, 2011).
20 We concentrate only on the expenditure-based measures as we showed that revenue-based measures yield relatively low fiscal multipliers.
21 Regulation EC 1466/97.
22 However, we are aware that public investments in Croatia are not fully effective as they are often subject of political corruption (Bađun, 2011).
23 REER based on CPI and PPI. Table H11, Croatian National Bank.
24 We tested different specifications of the model and could not obtain statistically significant result with the expected sign in none of specifications.
25 Croatian Bureau of Statistics data. Publication Investments in Croatia.
26 As explained in the subsection on fiscal variables, we treat most of components of government expenditure as exogenous, while government revenues are mostly determined endogenously. This is a standard assumption in this type of analysis. Overbar () ̅ denotes exogenous variables.
27 We only use nominal data on GDP when we need to calculate the share of fiscal variables in GDP. Nominal GDP is calculated as the real GDP multiplied by GDP deflator that is determined by CPI developments.
28 Although some authors also use house prices as a proxy of wealth, in our view consumption in the short run is determined only be liquid form of assets.
29 Equations also include some dummy variables in case of some unexplainable breaks and/or outliers that cannot be explained by economic factors.
30 This equation also contains quadratic trend to improve the fit of the model. More precisely, although investments and consumption adequately describe the dynamics of private employment they cannot capture the size of the amplitude.
31 Of course, as our model does not include the supply-side block that determines the potential output, this equation does not contain output gap. Instead, we use total compensation to employees as a measure of demand-side pressures. However, this variable also captures some cost-push pressures as rising nominal wages can motivate firms to increase prices.
32 Investments serve as a proxy for gross operating surplus of corporations, which is commonly used as a macro base for corporate income tax. However, this variable is not available for Croatia on a quarterly level.
33 Consumption of fixed capital is subtracted, while government sales are added to annul the terms in government consumption identity.
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March, 2021
I/2021
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