Deficit Inertia in U.S., Japan Curbs Global Debt Cuts, IMF Says

The lack of detailed plans for deficit reduction in Japan and the U.S. combined with weak economic growth runs counter to efforts to cut the global debt burden, the International Monetary Fund said.

“The absence of well-specified medium-term adjustment plans in systemic economies like Japan and the United States complicate the task,” the Washington-based IMF said in its Fiscal Monitor report released today. “At the same time, fiscal vulnerabilities are on the rise in emerging market economies and low-income countries”.

The IMF yesterday cut its global outlook for this year and next and warned that a U.S. government default would “seriously damage” the world economy. Growth worldwide will be 2.9 percent this year and 3.6 percent next year, compared with July predictions of 3.1 percent for 2013 and 3.8 percent for 2014.

The world’s largest economy may face the risk of default and is operating under a partially shut government. Congressional leaders have been unable to agree on fiscal policy and a debt limit increase and Republicans have demanded changes in the Affordable Care Act in exchange for allowing the federal agencies to reopen.

“Although a short period of government shutdown would likely have limited impact, a longer period could be more damaging,” the IMF said in today’s report. “A failure to promptly raise the debt ceiling could have even more serious consequences.”

Smallest Deficit

The U.S. is on track to record the smallest annual deficit in five years as accelerating economy and payroll tax increase boosted receipts in 2013, while across-the-board federal budget cuts known as sequestration have kept spending in check. In the first 11 months of the fiscal year that ended Sept. 30, the deficit was $755.3 billion, the narrowest since 2008, the Treasury Department said on Sept. 12.

The IMF report today said the U.S. is failing to address entitlement programs, which it called “key drivers of long-term deficits.”

The growth in U.S. debt over the coming decades will be primarily caused by an aging population that will strain benefits including Medicare and Social Security, the Congressional Budget Office said on Sept. 17.

“A fundamental tax reform aimed at simplifying the tax code and broadening the base by reducing exemptions and deductions, as well as at higher taxation of fossil fuels, could provide new revenue,” the IMF said.

U.S. Forecast

The IMF yesterday cut its growth forecast for the U.S. to 1.6 percent this year and 2.6 percent next year, each 0.1 percentage point less than forecast in July. For Japan, the IMF maintained forecasts of 2 percent growth this year and 1.2 percent next year.

While the fund praised the recent decision by Japanese Prime Minister Shinzo Abe to increase the sales tax to 8 percent from 5 percent, the IMF called for an in-depth plan for cutting the nation’s primary deficit in half by 2015.

“Japan stands out as the country facing the most challenging consolidation,” the IMF said.

Some advanced economies have limited scope to raise more revenue and those that already have high taxes should cut spending to limit debt, the IMF also said.

“In emerging market economies and low-income countries, where the potential for raising revenue is often substantial, improving compliance remains a central challenge,” the IMF said. “Recognition that the international tax framework is broken is long overdue.”

Strengthening the international tax rules would be especially beneficial for developing countries, which rely on corporate taxes from international companies, the IMF said.

To contact the reporter on this story: Kasia Klimasinska in Washington at kklimasinska@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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