Occasional Papers 1 | 2009

THE MAIN TRENDS IN PUBLIC FINANCE DEVELOPMENTS IN PORTUGAL: 1986-2008

Jorge Correia da Cunha Cláudia Braz

November 2009
The analyses, opinions and findings of these papers represent the views of the authors, they are not necessarily those of the Banco de Portugal or the Eurosystem. Please address correspondence to Economics and Research Department Banco de Portugal, Av. Almirante Reis no. 71, 1150-012 Lisboa, Portugal; email: estudos@bportugal.pt

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The main trends in public finance developments in Portugal: 1986-2008∗
Jorge Correia da Cunha and Cl´udia Braz a November 2009

Abstract Public finance imbalances have been one of the main topics of public debate in Portugal, in the last decades. After the accession to the European Community their correction was always identified as a central issue in the context of successive medium-term macroeconomic and fiscal adjustment programmes. The Maastricht Treaty in 1992 stepped up the urgency of achieving sound public finances, as fiscal criteria played a key role in the decision on the participation of Member-states in the euro area. Later, in 1997, the Stability and Growth Pact established the multilateral fiscal supervision framework, focused on avoiding excessive deficits and achieving fiscal positions close to balance or in surplus, in the medium-term. Portugal fulfilled the convergence criteria in 1997, but showed some difficulty in complying with the discipline and objectives of the Pact afterwards. This paper uses the analytical framework currently underlying the multilateral supervision of national fiscal policies in the EU to explain the key features of budgetary developments in Portugal from 1986 to 2008. JEL classification: H62, H20, H50 Keywords: Public finances, fiscal policy, deficit and debt.
The opinions and findings of this paper represent the views of the authors, which do not necessarily reflect those of Banco de Portugal. Address: Banco de Portugal, Economics and Research Department, Av. Almirante Reis no 71, 1150-165 Lisboa, Portugal; E-mail address: jmmccunha@bportugal.pt and crbraz@bportugal; Phone: +351 21 3128358 or +351 21 3130549.

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Previous papers of the authors are useful references, like Cunha and Neves (1995), Cunha and Braz (2003), Cunha and Braz (2006a) and Cunha and Braz (2006b). 2 Reference value for the deficit in the context of the excessive deficit procedure. It is an important part of the criteria for accession to the euro and plays a key role in the framework of the Stability and Growth Pact.

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In 1986, the year of Portugal’s accession to the European Community, the general government deficit according to the accounting rules currently in force (ESA95, base year 2000) amounted to almost 8 per cent of GDP (for details on data compilation, see Box 1). In 2008, it reached a figure close to 2.5 per cent of GDP (Table 1, Figure 1). A remarkable feature is that it never fell significantly below the reference value of 3 per cent of GDP2, even after the coming into force of the Stability and Growth Pact in 1999.

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1

Overview1

Table 1: Main fiscal indicators

2

Figure 1: Actual and structural overall balance and fiscal policy stance
As a percentage of GDP

4 2 -2 -4 -6 -8 0

-10

86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Change in the structural primary balance Actual overall balance Structural overall balance

Sources: INE and authors’ calculations.

Box 1. Data compilation This paper is based on the general government accounts compiled by the National Statistical Institute according to the 1995 European System of National and Regional Accounts (ESA95), which are presented in Annex 1. There is, however, a structural break in the data available from 1994 to 1995 as the accounts for the 1986-1994 period are only available according to the procedures of base year 1995 and in the following period (1995-2008) base year 2000 was used. As shown in the table below, this methodological change had a minor impact on the deficit, but implied an increase of both revenue and expenditure ratios by around 0.8 p.p. of GDP. The main modification affecting the deficit consists of the adoption of “cashadjusted” recording for the receipts of Tax on Oil Products, Tax on Tobacco, Tax on Alcohol and Alcoholic Beverages and contributions to the Social Security subsystem. The effect of this new approach is, nevertheless, not very significant, as, in the national accounts, only the January collection of each year shifts to the previous year. Most of the other changes have no impact on the deficit as, for example, the recording of Financial Intermediation Services Indirectly Measured, which has a positive effect on interest received by general government and intermediate consumption and a negative effect on interest payments, or the consideration of the value of production to be used by general government itself, which increases sales of goods and services, on the revenue side, and intermediate consumption and investment, on the expenditure side.

3

and social payments in kind.3 per cent of GDP and was mostly related to compensation of employees (1. 5 at the end of 2005. The impact on social payments in kind reflects the amount paid on services provided by corporate hospitals. which began at the end of 2002 and is still underway. it is of utmost importance to mention the gradual transformation of public hospitals into corporations.a In the period prior to the start of the transformation process (2001). increase.2 per cent of GDP in compensation of employees. In terms of the compilation of national accounts. In this regard. respectively). which. For the hospitals involved. functions and/or financing often lead to the inclusion or exclusion of entities in the sector. as changes in the legal status. expenditure associated with the hospitals converted between 2002 and 2008 included in general government accounts totalled approximately 2. The items most influenced by this process are compensation of employees and intermediate consumption. The fact that this process took place gradually over a number of years since 2002 (34 hospitals at the end of 2002. the units classified in the general government sector are not necessarily the same over the entire period. 2 by mid-2004.A different type of structural break may occur even while using the same base year in the compilation of national accounts.3. in turn. Indeed. intermediate consumption and social payments in kind. a 4 tu t v‹u t }yu t ˆ Šyu t ˆ ~Šu t y tu t ˆ wyu t }vu t ttu t ~}u t vyu t wvu t ¥¤¤£ ¯«­® ­¬«ª²±±±° ¯«­® ­¬«ª © ¡ž¨§ŸŸ¦ ¥¤¤£ œ¢¡ žš  œŸžœœ››š™ p|rmnmŒ nnmopqz posl‚rp€xp nml€m posl‚rp€xp lrpoos| op{lz l†poplr‰ rkl€…s†rk| plm‚p…oplr‰ †pp„kn€…p ‡k rklm†rp€…k †lrp…„m€ nm|kƒ posl‚rp€xp nmlkj psrpqpo nml€m psrpqpo lrpoos| op{lz psrpqpo xmj psrpqpo nmlkj ‘ih gd f–•ed™ ’˜—–•’”“’‘ ˜f•de–——”——” – f“d•–— ”•— “’‘  f’”“dŽ . this change implies the adoption of a management model closer to the practice of the private sector and a funding scheme based on payments made by the State per medical act provided (instead of an annual overall transfer from the State Budget). 17 during the course of 2007 and 9 during the course of 2008) introduces several structural breaks in the recent past.8 and 0. corporate hospitals cease to be part of general government and are included in the non-financial corporations’ sector. net of these hospitals spending with medicine co-payments and contracts with private health service providers when they were still included in general government. 0. which decrease when the change takes place.

when a major change of VAT rates led to a substantial increase of tax receipts). The policy package adopted in 2002 in order to correct the excessive deficit included a hike in the standard rate of VAT and several short-term measures. partially resulting from the composition of expenditure and income. taxes on production and imports (excluding VAT). unemployment-related expenditure and other benefits). in particular a sizeable amount of temporary measures. The structural measures on the expendi5 . already in the framework of the Stability and Growth Pact. until 1989. in the breakdown of several key variables: taxes on income and wealth (into taxes paid by households and by firms). allowed the fulfilment of the fiscal criteria for the accession to the euro area. concerning the macroeconomic series. in spite of a continuous deterioration of the structural primary balance. a hike in interest expenditure in the first years and a sudden deterioration in cyclical conditions in 1993. according to the accounting rules then in force (ESA79). such as Banco de Portugal’s long-term historical series or public accounts data.In terms of data compilation. interest payments. as interest expenditure stabilised as a ratio to GDP and economic activity decelerated. From 1990 to 1993 the trend reversed owing to an adverse conjunction of expansionary discretionary measures (with the exception of 1992. In the first years of the period. were used. As an alternative. temporary measures and the structural primary balance provides a useful insight into the dynamics of the Portuguese public finances in the last two decades (for details on the calculation of the cyclical component and the definition of temporary measures see Boxes 2 and 3). In these cases. the growth rates underlying Banco de Portugal’s historical series were used. it is also useful to highlight that the sequence of accounts of ESA95 does not provide all the details necessary for the analysis carried out in this paper. In 2001. From 1994 onwards the deficit again showed a declining trend as a consequence of a sustained fall in interest payments related with nominal convergence. Lastly. the deficit exceeded 4 per cent of GDP. and social payments in cash (into pensions. explained to a large extent by a positive contribution of the cycle and the decline of interest payments (Figure 2). for example. This occurs. other sources of information. This context. enhanced in a first phase by discretionary measures and afterwards by particularly favourable cyclical effects. the National Statistical Institute did not compile a retropolation for the period before 1995. decisively marked by the impact of disinflation. The breakdown of the annual change in the overall balance into the contributions of the cyclical component. relevant not only for the calculation of ratios but also in the context of the cyclical adjustment methodology. there was a sharp decline in the deficit.

As a consequence. but only transitorily have an impact on its rate of change as. however. the accumulated change in the structural primary balance over this period was close to zero and in 2003 and 2004 even deteriorated. Portugal was subject to an excessive deficit procedure. for example.p. the considerable improvement in the structural balance mostly relied on short-term measures on the expenditure side (which permanently affect the expenditure level. the freezing of automatic progressions in careers. For the second time in a short period. the National Health Service and the financing of municipalities. ture side implemented from 2002 to 2004 were relevant in some major areas such as the public employees’ pension system. The fiscal adjustment programme delineated to correct it put a strong emphasis on structural reforms to dampen expenditure growth. which exceeded 2 per cent of GDP in both of these two years. Portugal only avoided incurring on excessive deficit once again through an accrued recourse to temporary measures. in particular compensation of employees and pension outlays. instrumental to curb the growth of current primary expenditure. of GDP 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Change in the structural primary balance Contribution of interest payments Change in temporary measures Change in the cyclical component Sources: INE and authors’ calculations. In 2006 and 2007. 6 .Figure 2: Breakdown of the change in the overall balance 4 3 2 1 0 -1 -2 -3 -4 -5 p. The political decision of not using temporary measures in 2005 unveiled the magnitude of the deterioration of the structural fiscal position. but failed to tackle the reforms of public administration and the private sector social security system.

Momigliano and Tujula (2001) and Neves and Sarmento (2001)). Cos. when defining. As regards the “corrective arm”. as well as the annual minimum convergence required for the Member-states that have not yet reached it. The cyclical adjustment methodology In recent years. such as the European Commission. several tax increases. The MTO’s are currently under revision in the context of the establishment of the appropriate criteria and modalities to take into account implicit liabilities. changes in unemployment benefits procedures and reduction in the co-financing of medicines). Langenus. however. There are several methodologies for cyclical adjustment of the budget balance. and the ongoing process of stepping up the effectiveness of tax administration.5 per cent of GDP. after a halt in 2006 and 2007. the fiscal adjustment imposed on Member-states incurring excessive deficit situations in the recent period has also been measured in terms of the change in the structural balance. i.the limitation of early retirements. and the magnitude of temporary measures. Mohr. in particular in indirect taxation. which were decisive to avoid a deficit of more than 3 per cent of GDP. Following the 2007 fiscal outcome the excessive deficit procedure was closed. As far as the European System of Central Banks (ESCB) is concerned. The structural deficit was. Dool. set at that time at 0. which is crucial to achieve a sound fiscal position. at the “preventive arm” level. the medium-term fiscal objective based on this variable. Indeed. one year ahead of the deadline initially set down. a cyclical adjustment methodology was adopted in 2001. adjusted for cyclical effects and temporary measures. This evolution raises the issue of how important were the measures implemented in 2005-2007 in curbing expenditure growth. which has since then been followed by Banco de Portugal (see Bouthevillain. Box 2. 3 7 .e. still significantly above the medium-term objective (MTO). most of them implemented by international organizations. the cyclically adjusted budget balance has gained relevance as one of the indicators used in the assessment of the underlying position of public finances in European Union Member-states. Cour-Thimann. the reform of the Stability and Growth Pact increased the role of the balance adjusted for cyclical effects and temporary measures. 3 The most prominent features of 2008 fiscal developments were the return to the pattern of increasing structural primary current expenditure ratio to trend GDP. the OECD and the IMF.

Additionally. c Currently. the series under consideration is further extended on the basis of projections and expert judgment. given the sharp decline in economic activity projected for 2009 and the still very low or negative growth foreseen for the next years. is not possible for the elasticities of the fiscal variables with respect to the macroeconomic bases (ξBj . As such. taxes on production and imports (private consumption). The cyclical component of a specific budgetary category is calculated by applying a constant elasticity to the trend deviation of its macroeconomic base.GDPr ∗ Bj GDPn (1) The last estimate of this elasticity for Portugal. however. In the standard implementation the following categories are adjusted (with corresponding macroeconomic bases in brackets): taxes on income and wealth paid by households (private sector wage bill). while on the expenditure side.a It should be highlighted that trend values obtained using this filtering technique become predominantly determined by observable values towards the end of the sample period (the so-called “end-point bias”). To overcome this problem. carried out at the end of 2006. as it would be necessary to have the impacts of discretionary measures affecting these fiscal variables for the period before 1995. trend nominal GDP is consistently defined as the real trend GDP. In this framework. the final result was similar to the previous one (0. which are not available.49). trend values are affected by changes in growth prospects of the macroeconomic bases.50. b In particular at the current juncture. The trend is estimated using a Hodrick-Prescott filter with a smoothing parameter of λ=30. taxes and social contributions are adjusted.b On the revenue side. multiplied by the actual GDP deflator. taxes on income and wealth paid by firms (operating surplusc). generally only unemployment-related expenditure is corrected. The elasticities of the macroeconomic bases visBj a `-vis GDP (ξMj . which suggest some caution on the interpretation of cyclically adjusted figures. the semi-elasticity of the budget balance to GDP can be obtained indirectly from the following formula: ∆BB ∆GDPr GDPr = j ξBj . Given that the analysis developed in this paper covers the period from 1986 to 2008.GDPr ) and the weights of the fiscal variables on GDP ( GDPn ) were updated but.This methodology assumes that the fiscal variables influenced by the economic cycle have other-than GDP macroeconomic bases that better explain their development. estimated using the same procedure. an update based on data for the same time span would have been advisable. In order to calculate ratios. the most recent information is influenced by significant revenue windfalls that would incorrectly affect the estimates. a 8 . pointed to a semi-elasticity equal to 0. calculated on the basis of 1995-2005 data (see Braz (2006)).Mj ). This exercise. overall. social contributions paid by the private sector (private sector wage bill) and unemployment-related expenditure (number of unemployed). private GDP in the case of Portugal.Mj ∗ ξMj .

This 0. In these conditions.d Figure B shows the contribution of each macroeconomic base to the composition effect. composition effect and the implicit semi-elasticity Figure B: Breakdown of composition effect The relation between the implicit semi-elasticity and the composition effect is given by the following formula:Implicit semi − elasticity = 0. Additionally. This Output−gap particularly explains the high implicit semi-elasticity and low composition effect in 2005. Figure 4 shows the contributions of structural revenue and primary expenditure ratios to the annual change in the structural primary balance.49 semi-elasticity was used is called the composition of growth effect and has been quite small in the recent period. d Looking at the fiscal outcomes over the period 1986-2008. it appears that the implementation of fiscal policy was far from optimal in terms of macroeconomic stabilization. and the gap of the number of unemployed was much more negative than the output gap.49 value is the theoretical semi-elasticity that would occur in each year if the composition of growth was balanced. the gaps of private consumption and the private sector wage bill were still positive. as in that year the output-gap was close to zero. it would have been possible to achieve a much sounder fiscal position without major strains.49 + Composition ef f ect . the implicit semi-elasticity may differ significantly from that value in each year. loosened in most years. it should be highlighted that the fiscal stance. As presented in Figure A below. the 1993 composition effect is explained by the fact that while the output gap was already negative in that year. The difference between the cyclical component calculated using the ESCB methodology and the one that would be obtained if the 0. In the years 9 ¹¶ »¶ º¶ ¸¶ ¾¶ ½¶ ´¶ · ¶ ¶¶ ¼¼ ¹¼ »¼ º¼ ¸¼ ¾¼ ½¼ ´¼ ·¼ ¶¼ ¼¹ ¹¹ »¹ º¹ ÅÍÌÇÇÌ Æ ÀÄÅÄÃÀÂÁÀ¿ ÕÕÄ¢ ÌÈÖÊ É ÀÅÍÌà ÌÅÖÚÄÉÒ ÆÀÄÅÂÁ¡ÃÆÀÍ ÌÅÖÚÄÉÒ ÒÑÐ ÌÅÖÚÄÉÒ £ÌÔÀÕÂÁÌÆ¡ ÇÀ ÉÌ¢Á¡  ð êïáîèìíâäíì ä ë êãáéèâç æ åäãâáà ñ ¸µ ¶³ ò ó ô õ ö ÷ õ øù ¶µ¶ ó ú õ ûü ý þ ¸µ¶ ÿ ¶µ· ³ ¸µ· ³ ¹¶ »¶ º¶ ¸¶ ¾¶ ½¶ ´¶ ·¶ ¶¶ ¼¼ ¹¼ »¼ º¼ ¸¼ ¾¼ ½¼ ´¼ ·¼ ¶¼ ¼¹ ¹¹ »¹ º¹ ÔÅÄÍÄÅÃÖÕÌØÄÁÌà ÅÄÍÄÕÂÁ× ¶µ´³ ÓÒÑÐ Ç À ÏÎ ÅÆÌÆÀÂÁÀÍ ÕÖÍÄÕÍÔ¿ ¸µ· ³ ÓÒÑÐ Ç À ÏÎ ÅÍÌÇÇÌ ËÅÊÀÉÈ ÇÀ ÆÀÄÅÄÃÀÂÁÀ¿ ¶µ· ³ ßØÞÝ ÜÛÔÅÄÍÄÅÃÖÕÌ ÄÁÌà ÌÈÖÉÌÚÙ ð êïáîèìíâäíì ä ë êãáéèâç æ å äãâ áà ¶µ´ ¸µ· ¶µ· ¸µ¶ ¶µ¶ ¸µ¶³ . ¶µ· Figure A: Cyclical component. measured by the change in the cyclically adjusted primary balance excluding the impact of temporary measures. but on average over the whole period it will not be the case. although quite significant in several years. in general pro-cyclically (Figure 3). such as 1990 or 1993. As an example.

0 -4.p. Luxembourg. Note: a) The cyclical position of the economy is assessed by the change in the output gap which approximately represents the difference between the growth rates of GDP and trend GDP.0 -2. Finland.p. Italy.7 and 5. Figure 3: Fiscal policy and cyclical position Fiscal stance (change in the structural primary balance) 4.0 Sources: INE and authors’ calculations. 4 10 . Portugal and Spain. while in this period cyclically adjusted revenue and primary expenditure increased by 3. Ireland. The sizeable rise of the structural revenue and structural primary expenditure ratios appears as a peculiar feature of public finance developments in Portugal.0 -3. while the years below the line correspond to periods of tightening.represented above the 45 degree line a loosening of the fiscal stance occurred.0 2.6 percentage points (p. Indeed. Greece.0 1. contrasting with the general trends in the euro area (12).4 Table 2 clearly highlights that point for the years from 1995 to 2008. they declined by 2.0 0.2 p. using the AMECO database.p. It also Comprising the first 12 participating countries.0 3. Figure 5 shows the gradual convergence of the cyclically adjusted primary current expenditure ratio in Portugal to the euro area (12) average from 1997 to 2005.0 2. i. Belgium.7 and 14.0 0.0 -1. The most common outcome was a simultaneous increase in both structural revenue and structural primary expenditure. Germany.1 and 1.0 03 Pro-cyclical tightening of fiscal policy Counter-cyclical tightening of fiscal policy 07 95 92 86 96 88 06 94 02 01 05 91 04 99 89 87 08 97 00 98 90 93 Counter-cyclical loosening of fiscal policy -2. in the euro area (12).4 p.e..) of nominal trend GDP.0 -4. Netherlands. of GDP in Portugal. For the period as a whole structural revenue and structural primary expenditure increased by 10. Austria. France.0 Cyclical position a) (change in the output gap) Pro-cyclical loosening of fiscal policy 4.

0 -1.0 91 Change in structural primary expenditure (% trend GDP) -4.0 4. approaching but staying below the euro area (12) average.0 96 90 08 98 04 93 92 01 89 1.0 2. Note: See Box 1.0 05 99 07 87 97 00 02 88 0.0 06 94 Improvement -2.0 95 03 86 2.0 -2.0 structural primary balance -4.0 Change in structural revenue (% trend GDP) Sources: INE and authors’ calculations. illustrates the upward trend of the cyclically adjusted tax burden after 2001.0 0.Figure 4: Change in structural revenue and structural primary expenditure Deterioration of the structural primary balance 4.0 of the -3.0 3. 11 .

4 3.4 -1.2 1.3 1.4 -1.6 Figure 5: Cyclically adjusted tax burden and primary current expenditure: comparison with euro area developments 44 42 As a p ercentage of GDP Cyclically-adjusted tax burden: EA12 40 38 36 34 32 30 Cyclically-adjusted primary current expenditure: EA12 Cyclically-adjusted primary current expenditure: PT Cyclically-adjusted tax burden: PT 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Source: European Commission (AMECO database).5 1.1 1. 12 .3 -2.6 -2.9 -2.7 -0. Note: The concept of tax burden used by the European Commission includes taxes on production and imports paid to the EU budget and excludes imputed social contributions.Table 2: Change in the main fiscal indicators in the 1995-2008 period: comparison with euro area developments) Percentage points of GDP Overall balance Cyclical component Cyclically adjusted overall balance Interest expenditure Cyclically adjusted primary balance Cyclically adjusted total revenue Cyclically adjusted primary expenditure Public debt Source: European Commission (AMECO database).1 5.2 5.9 3.7 -2. 1995-2008 Portugal Euro area (12) 2.

this type of incentives is mitigated. In the latter case. Firstly. whose implementation was focused on the actual balance. however. a cautious approach is called for with respect to measures or effects which give rise to a deterioration of the budget balance. temporary measures can be easily characterised. these temporary measures should. which also do not have a lasting impact on rates of change of revenue or expenditure items.Box 3. e. with a subsequent loss of transparency. to avoid contributing to political incentives for window dressing. given that they made it possible to comply with the benchmark value without the need to enforce permanent measures. in exchange for the assumption of future liabilities with pension payments). Secondly. so as not to create incentives to their presentation as temporary measures. or which basically modify their time profile in the medium to long run (self-reversing measures. have significant limitations and warrant particular caution.g.g. in order to prevent the increasing complexity of fiscal developments assessment (0. as part of the focus on sustainability is obtained by excluding temporary measures when assessing compliance with the medium-term objective or convergence towards it. Temporary measures Temporary measures affecting the general government balance and/or debt have been implemented in a number of EU Member-states in the past few years. possibly only one year (one-off measures.1 per cent of GDP is frequently used as threshold). Finally. They can be defined as policy decisions that change the level of general government revenue and/or expenditure during a very limited period of time. their assessment may require very detailed information. Governments may implement temporary measures with a view to responding to exceptional circumstances or to facilitate gradual fiscal adjustments. e. In conceptual terms. In the framework of the original version of the Stability and Growth Pact (SGP). In this regard. temporary measures were very appealing to countries with higher deficits. may also signal the governments failure to take appropriate measures to correct structural imbalances. Their identification and the quantification of their effects. but permanently influence their level (e. and/or depend crucially on the treatment of certain operations in national accounts. which is not publicly available. in any case. transfers of companies to public pension systems. these measures should not be mistaken for other short-term measures or effects. This includes both deficit decreasing and deficit increasing measures. Recourse to temporary measures.g. however. But. In the revised SGP. 13 . sales of non-financial assets). the freeze of automatic wage progressions for one or two years). several aspects should be highlighted. be restricted to large transactions. in the context of fiscal policy assessment. the calculation of structural adjustment should include the impact of deficit-increasing discretionary decisions. Thirdly. they create room for implementing permanent measures regarding structural problems affecting public accounts. Banco de Portugal has adopted the definition of temporary measures used in the European System of Central Banks.

the increase of the structural revenue ratio to trend GDP was one of the driving forces of Portuguese public finances from 1986 to 2008. 5 Revenue 14 .Includes receipts from taxes on income and wealth. considered in the analysis carried out in this paper. in principle. Based on this definition. As already highlighted. and their respective impacts on the budget balance. while other selected deficit increasing measures may be considered on a case-by-case basis. It predominantly reflected the rise in the tax burden. the table below presents the temporary measures. taxes on production and imports and social contributions. tax and social contributions receipts exceeded 85 per cent of overall revenue.5 In the last years. The sustained growth of the tax burden was possible after the reforms of direct taxation in c v‚ ‚ f&0& cb v‚ f&0 ) cb „‚ … “&0 ) d c v‚ v f&0f cb „’ c wv ‚ cb „‚ p10f cb ‚v cb wv cb se p10& cb ed 210 ) cb ed 210 ) %$#" !  ¨§§ © ©  ©¨§¦¥¤ }w|n{uyzoqzyq x wpnvuot s rqponm a7V5@4 V65 7E5VR 76@Q779G6@G 8@ B6QA654B 9FA E@48 7V99G@4l 2))f a Xk ‰` j i—R E5V 5 8@ 6@QA5AQ@CI r9 9FA 4@8 6@Q779G6@G 9FA 8@ B6QA654h ())f 7A6H@GG5 C56@QA56 8@ 6@Q7QD94 9FA B6Qt@CC@8 – hq 9FA @A 76@QAHgQ4A6@G 6Q A69EA7H fVe p))f a Wx T™ V65 —T— – ˜ —T – •”x R 76@Q769I 8@ A69EP5I 94H AH8 9FA 4@8 A45I49A6H@G 9FA 75 A69E649D@B C54969B @A 7A9775 8@ 49876543 “))f a ‘‘x R 76@Q769I 8@ A69EP5I 94HAH8 9FA 4@8 A45I49A6H@G 9FA 75 A69E649D@B C54969B @A 7A9775 8@ 49876543 a ‰ ˆ ‡X †R 6@QAHAQA76Q C5QG656Q8 …6@6 5 @A a6@QA57QAQ4HG97R 7AQV94G r5A 8@ 9C5g 7459445 r5A 8@ A69E9CAA97 P456QV4@54Ar9 9FA 8@ AG9889 B6Q6Q5E9ƒ 1))f P5t4@A@E €yx 9FA 6@ 7CC@A B6Q4H5A794 8@ 7AFBQ4 9FA 8@ 9C5g u4@tA96 76@QA5GQ6HEE@G9C9A V9rQ8 9FA 97H @A 7AFBQ4 9FA 8@ 9C5g 7459445 r5A 8@ A69E9CAA97 P456QV4@54Arq f))f 79G69GQC g3ih 8@ 9C5g )))f a ` XYXW V65 U TSR 76@Q769I 8@ A69EP5I 94H AH8 9FA 4@8 A45I49A6H@G 9FA 75 A69E649D@B C54969B @A 7A9775 8@ 49876543 (''& 2 In this regard. reaching a peak of 43. but only if they are outside the control of the government.5 per cent in 2007 (Figure 6). effects related to court rulings and natural disasters are considered as temporary.

Note: All the values are cyclically adjusted and exclude the impact of temporary measures. After the reforms of direct and indirect taxation several other discretionary measures were adopted in order to fine tune the existing structure or execute active tax policy.6 Indeed. The increase of structural tax revenue from 1986 to 2008 was explained not only by discretionary measures. they laid down the foundation of a modern tax system. the taxes on real-estate and real-estate transactions are direct taxes in the public accounts. the structural evolution of the economy. which led to a growing weight of medium and large companies more prone to fulfil tax obligations. 6 15 . but also by several structural trends. Further.1989 and indirect taxation in 1986 (see Boxes 4 and 5). the fast expansion of the general government wage bill. The most relevant are: the long-term trend of consumption patterns towards a larger share of goods and services taxed at the standard rate of VAT. For example. the system became potentially less vulnerable to tax evasion and fraud. Figure 6: Breakdown of the structural revenue 45 40 35 30 25 20 15 10 5 0 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Other current revenue Capital revenue Base year 1995 Total revenue Base year 2000 As a percentage of trend GDP Tax and social contributions revenue Sources: INE and authors’ calculations. The taxonomy of taxes in public accounts (direct or indirect) does not exactly match the national accounts categories (taxes on income and wealth and taxes on production and imports). in particular in the distribution sector. but in the national accounts are included in taxes on production and imports. broadening the tax base and decreasing tax rates. tax-induced distortions in several key areas were reduced and the ability to raise revenue increased. As a consequence.

everything else constant. Note: All the values are cyclically adjusted and exclude the impact of temporary measures. tax benefits or a combination of both.the sharp growth of pension expenditure of the public employees’ subsystem. The national accounts data show that as short a time ago as 1995. Figure 7: Breakdown of the structural tax burden 16 Taxes on production and imports As a p ercentage of trend GDP 14 12 10 8 6 4 2 0 Taxes on households income Taxes on firms income Social contributions 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Sources: INE and authors’ calculations. As such. Secondly. the tax burden in Portugal was much lower than the average for the euro area (12) (Table 3). implying a parallel increase of the contributions required to finance it7 . Overall. in particular in the more recent period. the government may choose to pursue a certain goal through explicit expenditure. it still appears as a relatively low tax country when Actual contributions of general government entities as employers include not only the amounts resulting from the application of the rates defined in law to gross wages. and the improvement in the effectiveness of tax administration. the growth of expenditure of former public employees pensions in the past few years has contributed somewhat artificially to the increase in the tax burden in Portugal. but also the State transfer necessary to balance the system. whose scope and value has been gradually increased. such as social transfers or interest on 7 16 . 8 Comparisons of the tax burden between countries may be distorted by several legal or institutional features. all main categories of the tax burden contributed to the rise of structural tax revenue (Figure 7). On the contrary. several items of expenditure. In this regard three issues should be highlighted. the decline in nominal interest rates had a sizeable negative impact on the receipts of taxes on income.8 In 2008. The first option will show a higher tax burden. Firstly.

3 12.1 Sources: European Commission (AMECO database) and authors’ calculations.9 17. final withholding tax on interest income declined substantially.0 1.9 14.compared with the same group of countries although the gap has narrowed substantially. partly as a result of the rise in all major categories of taxes and social contributions in Portugal. In terms of the composition of the tax burden.0 Tax burden Taxes on income and wealth Taxes on production and imports Social contributions of which: actual social contributions to the CGA subsystem of which: imputed social contributions Euro area (12) 1995 2008 40. discretionary tax measures had a significantly positive impact on revenue in 1995-1996. unemployment benefits are exempt from income taxation. most receipts from taxes on income and wealth paid by households are raised through personal income tax withholding schemes on labour income.0 3. Portugal has a relatively high ratio of taxes on production and imports to GDP. on its turn. as already mentioned. the receipts from the taxation of public employees’ wages recorded a buoyant growth until 2002 paralleling the swift expansion of the general government wage bill.0 10.2 12. For instance.8 2008 37.9 8. The hike in its ratio to GDP in the first years after the 1989 reforms and its relative stability afterwards are noticeable.0 15. Table 3: Tax burden: comparison with euro area developments As a percentage of GDP Portugal 1995 31. Finally.4 13. decreasing the tax burden recorded in national accounts relative to alternative arrangements.3 1. Secondly. in particular in matters related to the public employees’ pension system (see footnote 7). Firstly. in particular from 1992 to 1999. but afterwards do not appear to have had a major effect on the ratio of the amounts collected to public debt may or may not be subject to taxation. the treatment of social contributions in national accounts is not fully comparable between different countries.5 1.1 12. lower than the average in the context of the euro area. Since 1989. in Portugal.4 1. Four other points are worth mentioning. The revenue from taxes on income and wealth and social contributions is.6 13.4 40. Thirdly. Figure 8 shows the structural evolution of this type of taxes from 1986 to 2008. pensions and interest.7 0.5 11. 17 .5 9. The net reimbursements related with the final settlement of the tax on the previous year’s income are also an important factor behind yearly developments.

Firstly. due to the increase in the number and importance of situations where withholding schemes or pre-payments are mandatory. This reform followed the main trends underlying the changes in the design of direct taxation in the OECD countries in the eighties: base broadening of the taxes on income. Direct taxes in Portugal: 1986-2008 The reform of direct taxation implemented in 1989.0 2. The introduction of the new taxes led.0 5. and partial integration of personal and corporate income taxes. several types of income are subject to final withholding schemes.0 1.0 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Sources: INE. Figure 8: Structural receipts of taxes on income and wealth paid by households 7. implying a simultaneous increase of some items of expenditure. which did not take into account the information on taxpayers’ personal characteristics. by taxes on income structured according to the nature of different groups of taxpayers: the personal income tax and the corporate income tax. in many cases. Specifically concerning the personal income tax.0 4. partly due to the elimination or reduction of tax benefits. in spite of the predominantly unified nature of the tax. three additional features are worth mentioning.0 3. A tax on the value of real-estate was also introduced. such as public employees’ wages and interest on public debt started to be taxed. Ministry of Finance and authors’ calculations. basically. reduction of the tax rate on firms’ profits.0 Taxes on income and wealth paid by households Tax on interest income Tax on public employees' wage bill As a percentage of trend GDP 6. 18 . consisted. the increased effectiveness of tax administration is the main factor underlying the slightly upward trend recorded in the last years. in the replacement of several taxes structured on the basis of the sources of income. several incomes. decrease of marginal rates. and the number of tax brackets. in particular the top ones. previously exempted. Secondly. Finally.trend GDP. to an anticipation of receipts. Box 4.

Concerns over tax competition justified successive reductions in the tax rate from 36. in particular those related with the treatment of expenditure with some long-term saving instruments and home purchases. Also designed to enhance equity. widespread in particular among small and medium sized firms. a 19 . five at the outset. 2001 and 2006). The main changes to the corporate income tax implemented between 1990 and 2008 stemmed from arguments of tax competition. Refers to the process where tax brackets are either not adjusted for inflation or fail to keep pace with earnings growth. the general goal of promoting investment and the fight against tax evasion and fraud. the personal income tax has been subject to many changes. independently of the level of income. The marginal tax rate for the highest incomes. to 36 per cent in 1991. almost every year. limiting the fiscal drag. with the creation of a new tax bracket. Still having in mind the promotion of equity. set down initially at 40 per cent. Particular reference should be made to the transposition of the parent-subsidiary directive into Portuguese legislation. 32 per cent in 2000. to increase afterwards to the present seven (1999. it was implicit that an annual update close to expected inflation would take place. increasing in 2006 to 42 per cent. The rules approved in the context of the EC/EU relative to corporate income tax focus on aspects considered crucial for the proper functioning of the single market. though keeping the main features of its architecture. 30 per cent in 2002 and 25 per cent in 2004 and currently in force. for tax credits. causing in either case an automatic rise in tax revenues. in 1992.Finally. was kept unchanged until 2005.a Since its inception in 1989. Beyond the level of marginal rates. the substitution of deductions to net income related with tax benefits. reference should be made to the partial convergence of the taxation of pensions to taxation of employment income. and the choice between the enlargement of tax benefits and the reduction of the tax burden on labour income. the incorporation of rules approved at the EC/EU level. although an automatic scheme for the indexation of tax brackets.5 per cent in 1990. Most of them concerned the definition of tax benefits. This change meant that any expenditure with a privileged treatment in the context of the personal income tax allows the same reduction in the tax liability. on the basis of equity concerns. The number of tax brackets. given the constraint of having a minor impact on revenue growth. the distortions in the labour market deriving from the personal income tax also depend on the number of tax brackets and the amount of specific deductions for employment income. in 1998. in 2006-2007. should be highlighted. but mostly explained by the need to increase revenue. which aims at reducing the differences between taxation rules for nationally organised groups of companies and taxation rules for EU-wide groups. was firstly reduced to four (1991). allowances and credits was not initially contemplated.

Secondly. over the last few years. VAT is a major source of tax revenue. Whenever it was necessary to increase tax revenue. most revenue from the taxation of firms’ income took the form of prepayments and the final settlement of the tax on the previous year income. several new benefits were introduced with the aim of promoting investment and the restructuring and expansion abroad of companies based in Portugal. Looking at the developments in the 1986-2008 period. After the 1989 reform. as a consequence of changes of rates. in the Budget for 2006). In the first case. several items of the firms’ costs became liable to autonomous taxation. through behavioural changes. to a lesser extent. successive rate reductions occurred whose impact on revenue has essentially materialised with a one year time lag. In the following years. Firstly. Finally. the upward trend in receipts over the last few years results predominantly from the stepping up of tax administration. and the move to more fuel-efficient vehicles. to a major extent. as the tax on diesel is lower than the tax on petrol. which is based on the preceding year’s turnover with minimum and maximum values (1250 and 70000 euros. the most noticeable feature is that the rising trend of this item of revenue is basically explained by VAT. however. Accordingly. Having in mind the same objective. For the purpose of curbing tax evasion and fraud in corporate income tax a special pre-payment was introduced in 1998. other taxes on specific items of expenditure are also an important part of taxes on production and imports receipts. the Tax on Vehicles Sales have since the last years of the nineties evidenced declining trends. VAT was a key instrument. on the gradual deceleration of car sales. in the Budget for 2005. As in the other Member-states of the EU. several structural developments in the economy and the stepping up of the effectiveness of tax administration. On the contrary. in the context of the corporate income tax. respectively. it is predominantly due to the increasing number of diesel cars. The growth. Three points should be highlighted. the sharp rise of the receipts until 1997. In the case of Portugal. The structural evolution of taxes on income and wealth paid by firms is presented in Figure 9. 20 . of tax expenditure in the corporate income tax led to the introduction of an overall limit on tax benefits in the Budget for 2005. the explanation relies. both the Tax on Oil Products and. partly explained by the evolution in profits of some of the main taxpayers and the growth of final withholding taxation. as Figure 10 shows.As already mentioned. Regarding the Tax on Vehicles Sales. the 1989 reform implied a decrease of tax benefits on corporate income. These long-term trends are enhanced in periods of high fuel prices. the amount of corporate income tax to be paid cannot fall short of 60 per cent of what would have been due if the tax benefits had not been used.

0 1.5 Tax rate: 30% Reduction of the tax rate from 36. more recently.0 3. 9 21 . as such. pollution emissions subject. only partially offset by an upside quality effect. The quality effect stems from the sale of vehicles belonging to different ranges concerning engine capacity and. the employers’ rate was reduced from 24. to different rates in the context of this tax. up to 2008 the contributions of the Social Security subsystem only recorded minor adjustments: regarding employment income.75 per cent in 1995. and contributions of general government entities as employers were gradually introduced and increased.0 2.5 2. Figure 11 shows the evolution of the structural actual social contributions by subsystem in the period under analysis. the co rate of employers’ contributions was increased from 8 to 10 per cent of gross wages in 1994. The sustained growth of overall CGA contributions basically mirrors the evolution of pension expenditure in this subsystem (see footnote 7).9 The relative reduction of other taxes on production and imports until 1994 is basically explained by the decrease in customs duties. In the Caixa Geral de Aposenta¸˜es (CGA) subsystem. The upward trend in the Social Security subsystem recorded since the second half of the nineties may be explained by an increase in self-employment contributions and more effective collection procedures.5 3. and self-employment contributions were increased in several steps.5 to 23. After the creation of a unified scheme in 1986.5% to 36% As a p ercentage of trend GDP Tax rate: 32% Tax rate: 34% Tax rate: 25% 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Sources: INE and authors’ calculations.Figure 9: Structural receipts of taxes on income and wealth paid by firms 4.

0 4.0 3.0 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Social Security subsystem Caixa Geral de Aposentações subsystem Sources: INE.0 6. Figure 11: Structural actual social contributions by subsystem 9.0 2.0 2.0 7.0 7.0 5. 22 .0 6.0 As a percentage of trend GDP 8.Figure 10: Structural receipts of taxes on production and imports 9.0 3.0 1.0 5.0 As a p ercentage of trend GDP 8.0 Tax on oil products Tax on vehicles sales 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 VAT Other taxes on production and imports Sources: INE and authors’ calculations.0 4.0 1. co .0 0.0 0. Caixa Geral de Aposenta¸˜es and authors’ calculations.

limited to the value added at each phase.This change was a consequence of Portugal’s participation in the European Community. previously taxed at the standard rate. an intermediate rate of 12 per cent was introduced. The decision of not adopting a single rate was mostly related with equity concerns. they were set at zero and 8 per cent (reduced rates). the zero rate was abolished and the goods and services that benefited from that rate were included in the list of goods and services taxed at a new reduced rate of 5 per cent. which was reduced from 17 to 16 per cent. in 1992. In 1996. the standard rate of VAT was increased. from production to retail. a substantial change in VAT rates was implemented. firstly. in order to expand receipts. the standard rate of VAT increased from 16 to 17 per cent. Imports are taxed by their overall amount. involving the introduction of VAT. In July 2008. VAT coexists with specific taxes. The VAT required by the Community directives is a general tax on consumption of goods and services. the Tax on Oil Products was created in 1986. The standard rate of VAT returned again to 17 per cent in 1995 and the additional revenue was allocated to Social Security in order to offset the effect of the decrease of employer’s social contribution rate. Its tax base is however. implement decisions approved at the EC/EU level and enhance the competitiveness of some sectors. benefiting restaurants services and some foodstuffs.Box 5. fulfilling in advance the rules approved at the Community level on the harmonisation of indirect taxation. The former reduced rate of 8 per cent was eliminated and the goods previously taxed at that rate were split between the new 5 per cent rate and the standard rate. Community membership also had a decisive influence on other areas of indirect taxation. This was further enhanced by the taxation at the standard rate of many goods and services that previously benefited from the reduced rate. 23 . with a significant increase in receipts. In 2002 and 2005. applied in all phases of the economic circuit. Exports are not subject to VAT and are only taxed in the country of destination. Initially. 16 per cent (standard rate) and 30 per cent (increased rate). Indirect taxes in Portugal: 1986-2008 The reform of taxation on goods and services was essentially implemented in 1986. in particular the sharp reduction in import duties. to 19 per cent and then to 21 per cent. In 1988. Later. Thus. it was reduced to 20 per cent. Its introduction implied an increase in the tax burden. benefiting from the decline of international oil prices. in the context of packages of measures aiming at the reduction of the fiscal deficit. while other indirect taxes were abolished or modified. In parallel. The decrease of the standard rate had the opposite effect. In the cases of car sales and consumption of oil products and tobacco. The abolition of the zero rate implied an important base broadening. as a combined result of base broadening and curtailing tax evasion and fraud. VAT rates were changed several times since its introduction.

Figure 12 summarizes the results of this exercise for the period 2000-2008 using the ESCB methodology described in Kremer. Braz. in which the Tax on Motor Vehicles sales replaced the Car Tax. rising at the same time the annual tax on the use/ownership of the cars. the Car Tax also became dependent on carbon dioxide emissions. beyond the inevitable creation of a time lag in VAT collection as far as imports from other Member-states are concerned. for which the tax administration was not fully prepared. further opportunities for tax fraud emerged temporarily. Firstly. At the same time the limits of the ranges for the rates set down by municipalities were reduced.As regards the VAT administration the main change occurred in 1993 as a consequence of the inception of the single market. which was levied in accordance with the engine size. the taxation on car sales was modified in 1988. the positive residual in 2000 is mostly related with social 24 . an inaccurate quantification of the effects of policy measures and the change in items that affect simultaneously general government revenue and expenditure. Indeed. at the end of 2003/beginning of 2004 a reform of taxation of real-estate was implemented. in particular in the context of the 2007 reform of the taxation on vehicles. the abolition of tax borders in intra-Community transactions made necessary an adaptation of VAT returns. Beyond VAT. the unit rates of the Tax on Oil Products were set at fixed amounts simultaneously with the liberalisation of the prices of petrol and diesel at the end of 2003. Indeed. One of the more striking features is the magnitude of the residuals in almost all years from 2000 to 2008. Finally. This scheme replaced a system based on administrative prices. These opportunities of tax fraud were curtailed through changes to the tax returns and closer cooperation between national tax administrations. Secondly. Its explanation may to some extent be associated with the drawbacks of the cyclical adjustment methodology. the impact of tax elasticities and a residual. A useful approach to the analysis of tax developments consists of the breakdown of the change in the structural tax burden into: the effect of legislative changes. Langenus. three areas of taxation on goods and services recorded major changes from 1986 to 2008. amplifying the impact of the 1993 recession. where the unit amounts of the tax appeared as a residual. This policy guideline was gradually enhanced. Momigliano and Spolander (2006). Brosens. this reform also decreased the taxation on the acquisition of new cars. The new Municipal Tax on Real-Estate transactions has lower rates. while the calculation of the taxable value was changed in order to take into account the characteristics of properties and not stated values. On average. the decoupling of the macroeconomic bases from GDP. re-establishing some equity in the treatment of property built in different periods. which were in general much lower than the actual amounts of the transactions. In 2006. which will approach market value. with the creation of the Car Tax. The main innovation of the new Municipal Tax on Real-Estate relied on the revaluation of the taxable value of property. In this framework.

On the contrary. once it is essentially associated with the specific behaviour of several taxes on production and imports.p. at the preventive level. As a whole.1 p.6 p. the sign of the residual reversed but apparently not yet as a result of the decrease in the transitory part of effectiveness gains. due to the increase of the State subsidy to the CGA subsystem also recorded on the expenditure side. while the negative residual in 2003 is mainly concentrated on corporate income tax and might be explained by a poorer evolution of profits than the one of its macroeconomic base. the cross-checking of databases became a common practice. which will tend to vanish in time. 3 Expenditure As already mentioned. the increase totalled 9. Table 4 presents the comparison of public expenditure ratios to GDP between Portugal and the euro area (12) for the longest period available in 25 .8 p. recourse to the administrative derogation of bank secrecy increased substantially. Firstly. five main areas are worth mentioning. In 2008. Social payments and.8 p. Secondly. of trend GDP (around 10. of trend GDP).see Box 1) (Figure 13). of trend GDP corrected for the impact of the 1995 structural break in the data . based on a wider use of information technology and stepped up human resources. an automatic system for the seizure of moveable and immoveable goods and financial assets was implemented. an effort has been made to identify taxpayers who belong to risk groups in terms of fraud and evasion in order to alert them to their tax obligations. the evolution of public expenditure is crucial for understanding Portuguese fiscal developments in the period under analysis. whose ratio to trend GDP went up by 15. but that a part of the revenue windfalls recorded in this period also stemmed from the collection of overdue amounts.contributions. taxpayers who do not fill in their tax returns are notified. compensation of employees were the items of primary current expenditure that contributed the most to this evolution (Figure 14).p. Lastly. structural expenditure as a ratio to trend GDP grew in more than half of the years from 1986 to 2008. while investment decreased only slightly between 1986 and 2008. Indeed.p. It is worth noting that the improvement in administrative procedures has a permanent nature. to a minor extent. This outcome was driven by structural primary current expenditure. Regarding procedures. at the corrective level.p. Thirdly. The major factor behind the positive residuals in the period 2004-2007 is the enhancement of the effectiveness of tax administration. interest payments declined significantly (-4. Fourthly.

which is the 1995-2008 period. might also distort international comparisons relating to public expenditure. the strong growth of total expenditure in Portugal contrasts with a decline in this variable as a percentage of GDP at the euro area level. the comparisons with other countries are often influenced by the delimitation of the general government sector.p. as it is the case of public-private partnerships. The differences in the general government perimeter may only have an effect on the composition of public expenditure. 26 . other countryspecific factors. terms of data. or. for example in the case of health services financed publicly but provided by entities classified outside the general government sector.10 As shown.5 0. Three points should be highlighted in this respect.Figure 12: Breakdown of the change in the structural tax burden 1. Note: a) For further details on the methodology used to calculate these contributions.0 -0. in particular in the areas of health and education. see Kremer et al. of trend GDP a) 1.5 -1. may also have an impact on the time pattern of government expenditure (and. alternatively. Firstly. such as the recording of expenditure related with the public employees’ pension system in Portugal. as such. public expenditure in the economy was still slightly below the euro area (12) av10 International comparisons between levels and developments in public expenditure may prove useful but should be made with caution. Indeed. Finally. Secondly. differences in the tax system concerning the taxation of social benefits and the existence of tax allowances and tax credits instead of explicit expenditure might have a non-negligible impact on the level of overall public expenditure as measured in national accounts. (2006) and Braz (2006).0 2000 2001 2002 2003 2004 2005 2006 2007 Legislation changes Decoupling of the macro base from GDP Impact of tax elasticities Residual Overall change in the structural tax burden 2008 Sources: INE and authors’ calculations. it is important to know for each country the degree of outsourcing in the supply of several goods and services usually provided publicly. In spite of this evolution.0 0.5 p. on its level in each period).

3 p. to be compared with 45. by the fact that most health and education services were provided by entities classified inside the general government sector in Portugal. and the strong rise thereafter. in particular as regards expenditure composition.Figure 13: Breakdown of structural expenditure 50 45 40 35 30 25 20 15 10 5 0 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Interest expenditure Base year 1995 Base year 2000 As a percentage of trend GDP Total expenditure Primary current expenditure Capital expenditure Sources: INE and authors’ calculations. which was not the case). of GDP in the period from 1995 to 2008 (the offsetting effect is on other current expenditure).6 per cent of compensation of public employees in Portugal. Correcting for this effect. 27 . As mentioned in Box 1. the gradual transformation of public hospitals into corporations affects the analysis of public finance developments. suggests that the degree of maturation of the social security system was then lower than in other euro area countries (or that the Portuguese system became relatively more generous. in addition to a the high average relative wage of public employees. the relatively low value of this item in Portugal in 1995. but this is not the case for current expenditure. compensation of employees as a ratio to GDP would have increased by around 1.4 per cent in the euro area. On the contrary. education and health represented 55. erage in 2008. in 1995. the relatively high ratio of compensation of employees vis-`-vis the euro area average was explained.p. Concerning social payments in cash. as it results in an increase in social payments in kind and a decline in compensation of employees and intermediate consumption in the general government accounts. Indeed. Note: All the values are cyclically adjusted and exclude the impact of temporary measures. according to the functional classification of expenditure.

As in the last few years expenditure on pensions of former public employees has been increasing substantially. as well as the already mentioned transformation of public hospitals into corporations (which occurred at the end of 2002. mid-2004. 28 .7 p. from the 11. Note: All the values are cyclically adjusted and exclude the impact of temporary measures. the figures for compensation of employees are affected by this recording scheme. In addition. of trend GDP). Indeed.p.Figure 14: Breakdown of structural primary current expenditure 22 20 18 16 14 12 10 8 6 4 2 0 Other primary current expenditure Base year 1995 Compensation of employees Base year 2000 As a percentage of trend GDP Social payments Intermediate consumption 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Sources: INE and authors’ calculations. as it also includes the amount required to ensure the financial balance of the public employees’ pension system. are related to pensions (Figure 15). The remaining increase in social payments results predominantly from social payments in kind (3.p. mostly. it should be noted that this expenditure item is influenced by the fact that. The evolution of social payments stemmed. Lastly. and implied an increase in this item by approximately 2.1 p.p. 6.0 p. of trend GDP) and is explained by both a strong growth in spending on medicines copayments and contracts with private health-care providers.5 p. in Portugal. of trend GDP increase in structural social payments in the period from 1986 to 2008. from the behaviour of pension expenditure. end-2005 and during the course of 2007 and 2008. only part of actual social contributions of general government entities as employers is calculated as a fixed rate on wages.p. it should be mentioned that developments between 1995 and 2008 in interest expenditure in Portugal and the euro area (12) were broadly similar.

3 As in Portugal there are two main public social security subsystems. essentially the impact of a composition effect and discretionary measures. excluding the annual update.p. to the annual average growth rate of old-age pension expenditure.1 13.6 p.p.8 8. was also very significant from 1986 to 2008: 4. stemmed mainly from the ageing of population and contributed by 2.6 12.0 16.4 38.3 5.1 11.9 5.6 46.2 per cent (Figure 17).8 2.8 4.2 15. of trend GDP) can be explained by three factors: (i) the annual updates of pensions.9 10. disability and survivors’ pensions of the Social Security subsystem between 1986 and 2008 (reaching 3. which stood at 13. Euro area (12) 1995 2008 50.7 1.1 5.0 11.3 43.9 3.7 2.0 p.p.Table 4: Expenditure: comparison with euro area developments As a percentage of GDP Portugal 1995 43. particularly relevant in the case of old-age pensions. this has definitely been the least important over the last few years. It is worth mentioning that between 1994 and 1999 the slowdown in the growth rate of the number of pensioners was explained by the gradual increase in the retirement age for women from 62 to 65 years old.5 2008 45. of the annual growth rate of old-age pensions.0 p. the hike in the average pension. they contributed more years to the system.1 0.8 2.5 1. comprising private sector workers (Social Security subsystem) and public employees (CGA subsystem). This effect was a consequence of the higher wages the new retirees received during their contributory careers.3 3. Among the three factors underlying pension growth in the Social Security subsystem. on average. The strong rise in the number of pensioners. in 1990. on average.3 3. reflecting. The strong increase in expenditure on old-age.6 2. In addition. it incorporates the effect of the introduction of 29 .9 43.6 Total expenditure Current expenditure Social payments (except in kind) Compensation of employees Interest Other current expenditure Capital expenditure Investment Other capital expenditure Source: European Commission (AMECO database). six months per year.1 10.9 16.2 12. but it is also due to the fact that. they are analysed separately.8 1. the pensions of this subsystem were updated above expected inflation in most years under consideration (Figure 16).4 3.0 13. (ii) the increase in the number of pensioners. Finally. Concerning the former. (iii) the additional change in the average pension.7 46.

Pension expenditure in the public employees’ subsystem increased by 3.6 per cent on average in this period).5 Pensions Social payments in kind Unemployment benefits Other social payments in cash Change in social payments p. which has followed inflation quite closely.5 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Sources: INE and authors’ calculations. in 30 .5 0.0 -1. Pensions were. however. Again. nearly frozen in 2003 and 2004.0 0.Figure 15: Breakdown of the change in structural social payments 2. there was an additional effect in 2003 and 2004.formerly the average gross wage of the last three months.5 per cent for each year below the age of 60. Concerning the update of former public employees’ pensions.1 p. it is worth referring to the fact that in general they were annually adjusted in line with the update of the wage scale.0 -0. which involved a new definition of the initial pension .p. Figure 18 illustrates the breakdown of the rate of change of this item according to the same explanatory factors as in the case of the Social Security subsystem.4.p. Further.5 -1.and the introduction of penalties for those who retire before reaching the age of 60: . It is worth mentioning that the substantial increase in the number of pensioners in 2003 is mainly the result of an extraordinary rise in requests for retirement before the entry into force of new rules from January 1 2004 onwards. following the transfer of pension funds to the public employees’ subsystem.0 1. afterwards the average wage of public employees net of social contributions of the last three months . of trend GDP 1. of trend GDP in the period from 1986 to 2008. As far as the number of pensioners is concerned. related with the inclusion of pensions of former employees of several public corporations in general government expenditure. a strong growth can be observed in all years of the period from 1986 to 2008 (around 4. the 14th month in the payment of pensions.

Note: a) Measured by the private consumption deflator. the unsustainable evolution of expenditure would have stemmed from the gen31 . Occasionally. several discretionary measures contributed considerably to the growth of pension expenditure in the public employees’ subsystem. to higher wages just before retirement. The magnitude of the increase in the average pension (not explained by the annual update). has also been very significant in almost all years of the 19862008 period due. In the CGA case. population ageing and maturation of the system were the main explanatory factors. which usually follows quite closely the change in the number of pensioners. 2006-2007 and to a lesser extent in 2008. a significant rise in the retirement requests delayed the deceleration of pension expenditure in the context of the reform of the Retirement Statute introduced at the beginning of 2006. The latter was particularly significant in the years after the approval of the New Public Employees Pay System.Figure 16: Update of pensions of the SS subsystem and inflation (observed and budgeted) 25 20 Update of pensions (SS subsystem) Per cent 15 10 5 0 Inflation Inflation considered in the Budget a) 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Sources: Authors’ calculations. as the compensation for taxation in the context of the personal income tax. In the absence of the recent reforms of Social Security and CGA pension subsystems. In the first case. public expenditure on pensions would have continued to grow much above nominal GDP. offsetting any consolidation effort carried out by fiscal authorities. the adjustment of pensions initiated before the New Public Employees Pay System and the introduction of the 14th month in the payment of pensions. essentially.

Figure 17: Breakdown of the growth rate of old-age pension expenditure of the SS subsystem 35 30 25 20 15 10 5 0 -5 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Update Number of pensioners Residual Sources: Social Security statistics and authors’ calculations. Note: a) Measured by the private consumption deflator. Percentage points 32 . erosity in the calculation of the initial pension and eligibility conditions. in conjunction with the age structure of general government employees. It is also worth referring that the fact that CGA paid higher pensions for similar contributory careers raised equity concerns (see Box 6).

b Law no. 187/2007 of 10 May. for specific regulations. • Increase in the financial penalty for early old-age retirement from 4. in a context of severe public finances imbalances. led to a worsening of the system’s sustainability in spite of introducing the calculation of the initial pension based on the wages of all the years of the contributory career. 4/2007 of 16 January and Decree-Law no. a 33 .5 to 6 per cent per each year relative to the statutory age of retirement (only possible for contributors with at least 30 years of contributory career and 55 years old).b This aimed at implementing a package of measures to face the population ageing challenge. in 2000 and 2002. Indeed. 32/2002 of 20 December). as accrual rates were higher on average. co Note: a) Measured by the private consumption deflator. These ones. during 2006. resulting in a new Social Security Framework Law published at the beginning of 2007.a As such. the discussions with the social partners on a reform of the Social Security subsystem started. two revisions of the Social Security Framework Law were approved (Law no. The reforms of public pension systems In 2005. Box 6. 17/2000 of 8 August and Law no. The main changes introduced by this reform were the following: • New rule for the annual update of pensions based on inflation. however. it was already consensual that structural reforms in key areas were essential to curb the upward trend of expenditure and ensure fiscal sustainability. real GDP growth and the amount of the pension (see table below).Figure 18: Breakdown of the growth rate of pension expenditure of the CGA subsystem 40 35 30 Update Number of retirees Residual Percentage points 25 20 15 10 5 0 -10 -5 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Sources: Caixa Geral de Aposenta¸˜es and authors’ calculations.

If beneficiaries intend to counteract the financial penalty of the sustainability factor. For subscribers joining the CGA subsystem after September 1993. when the new retirees would have their pensions calculated according to the Social Security subsystem rules. 35/2002 of 19 February. it was decided to anticipate the convergence to the private sector rules. • Reinforcement of the incentives for the postponement of the retirement beyond the statutory age. on a voluntary basis.e In addition.• Introduction. introduced in 2002c . to a new supplementary public system of individual accounts. The new legislation came into force at the beginning of 2006 and essentially included a gradual increase (by six months in each year) of the retirement age from 60 to 65 years old and of the contributory career for a full pension from 36 to 40 years.d Thus. with the reform of the Retirement Statute. This means that. of a ’sustainability factor’ which will reduce new pensions in accordance with the increase in life expectancy at 65 years old. At mid-2007. from 2008 onwards. by mid-2005. they may opt to postpone the retirement age or contribute. 52/2007 of August 31. the expenditure on pensions of the CGA subsystem would follow a structural growth trend over the next years. the system became a closed one as the new public employees hired from January 2006 onwards have started to contribute to the Social Security subsystem. in order to ensure full compatibility with the new Social Security Framework Law (for more details on the impact of the recent reform of the Portuguese public employees’ pension system see Campos and Pereira (2008)). 60/2005 of December 29. e Law no. which are less favourable. • The transition to the new formula for the calculation of the initial pension based on the wages of all the years of contributory career. which would be mitigated in about 25 years time. in the absence of a reform. Similarly to the private sector subsystem. f Law no. d c 34 . additional changes in the public employees’ pension system were implemented. in general terms. the rules for the calculation of their initial pension would be those of the private sector subsystem.f Decree-Law no. will be faster. their contributory careers would have to be 40 years instead of 36 years to have access to a full pension and the replacement rate would also be lower.

5 IAS ≤ Pension < 6 IAS 6 IAS ≤ Pension ≤ 12 IAS CPI CPI-0. 2% ≤ GDP < 3% CPI+20% GDP (min. this reform. Figure 19 presents the breakdown of compensation of employees into three components: the wage bill.p. pension expenditure in Portugal was foreseen to increase by 5.5 p.p. will significantly decrease the risk of unsustainability of public finances in Portugal. The downward revision vis-`-vis the previous update is mainly a due to different projection assumptions.5% GDP CPI In the European context. for this period in Portugal. of trend GDP) and results. if implemented consistently in conjunction with the attainment of a sound fiscal position. the Economic Policy Committee and the European Commission made public updated projections for pension expenditure in the European Union Member-states for the period from 2007 to 2060.5 p.5 p.p. CPI+0.) CPI CPI-0. of GDP from 2004 to 2050. rise previously projected.p.5 IAS 1.The new rule for pension indexation GDP < 2% Pension < 1. an increase in its ratio to trend GDP can be observed in most years until 2005. CPI-0.1 p. this reform of the public pension systems justified an update of the official projections of pension expenditure. allowing the reclassification of Portugal from the high risk group of countries in terms of sustainability to the medium risk group of countries. part of this evolution stems from the current procedure of recording as actual social contributions of general government the amounts transferred by the State in order to ensure the financial balance of the public employees’ pension system. In any case. which mainly encompass general government expenditure with health care subsystems benefiting public em35 ¦ ¥­©©¨¶ µ´³²¦  ¬“±– ‹“¯ €“„€ Œ ‰€“”Œ‰ Ž‰‹’ ‹®‘ŠŽ „€ ¯• €“’‘ °“¬ ®‘®‰‰® ¯‹€““® ­©©¨ „€ Š“ ‰Œ Š“¬ €‰ «ª©©¨ ‹§ ¦ ¥ ¢¡œ ¡¤  £ ¢  ¡  Ÿž š™ š ˜œ ›š™ ˜—– Š€‰Œ• €‹’’‘Š ”“‰ŽŠ Œ €“’‘ „€ ‹Œ ‰ Ž‹Œ‹ „€ Š‰ … ˆ‡†… „ƒ ‚ €~ . As already mentioned. The part of the evolution of compensation of employees in the last decade to be explained by actual social contributions is more than half of the overall change observed in this item (2. which has already been analysed in more detail.p.7 p. More recently.p.75 p. instead of the 9.p.3 out of 3. actual employer social contributions and imputed social contributions. The increase in pension expenditure as a ratio to GDP is expected to reach only 2. Concerning compensation of employees. which were approved at the Economic Policy Committee in October 2007.p. to a large extent.25 p. GDP ≥ 3% CPI+20% GDP CPI+12.7 p. Accordingly. below the euro area and European Union averages. Imputed social contributions. from the rise in expenditure on the pensions of former public employees. in particular those concerning migration flows.

The relative rise in the wage bill does not stem from annual updates of the public employees’ wage scale above inflation. Regarding the number of general government employees. which corresponds to the increase in wages due to normal promotions and progressions in careers and the rise of the average wage resulting from the renewal of the population of public employees. This residual essentially incorporates the wage ’drift’.ployees.3 p. the number of public employees and a residual. In addition. as those were broadly in line with expected inflation as assumed in the budgets. corrected for the effect of new corporate hospitals classified outside the general government sector.p. in reasonable anticipation of the disinflation process (Figure 21). were reasonably stable as a ratio to trend GDP in the period under analysis. and the effect of extraordinary revisions of careers. the period from 1986 to 2002 witnessed a strong rise. it is worth mentioning that in both 2003 and 2004 there was a quasi-freezing of the update of the public sector wage scale in the context of the measures undertaken to control the growth of public expenditure. in particular until 1991 36 . of trend GDP increase in the period under analysis. This rise was quite significant in the 1986-1992 and 1996-2002 periods. Figure 19: Breakdown of compensation of employees As a percentage of trend GDP 12 10 8 6 4 2 0 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Wage bill Wage bill (corrected for the effect of new corporate hospitals) Actual employers' social contributions Imputed social contributions Sources: INE and authors’ calculations. Regarding the wage bill. there was a 2. Figure 20 shows the breakdown of the growth rate of the wage bill into three explanatory factors: the update of the wage scale.

essentially based on tenure. These developments contributed to a significant wage premium associated with working in the public sector vis-`-vis the private a sector. Part of this evolution stemmed from an automatic scheme of promotions and progressions in careers. These authors also conclude that this wage premium is particularly high in several occupations. while intermediate consumption increased by 1. 4. the introduction of the New Public Employees Pay System in 1989-1993. of trend GDP (slightly more when corrected for the impact of new corporate hospitals net of the effect of the 1995 structural break in data).and after 1997. In 2003.7 per cent per year in the former case and 3. In addition. new rules for promotions were already in force but the amounts involved were still not representative of the new steady state. in particular the implementation of the rule of only one employee hired for each two that leave service from mid-2005 until 2008. the residual also incorporates the impact of discretionary measures such as making public employees’ incomes liable to taxation in 1988-1989 (simultaneously increasing gross wages). mostly as a result of the control of hiring. Its implementation.p. In 2008. Indeed. The other items of primary expenditure as a ratio to trend GDP show diverse patterns in the 1986-2008 period (Figure 12). where general government is the main employer. The New Public Employees Pay System was designed with two main objectives: the public employees pay system needed to regain internal fairness and public sector salaries needed to become more competitive in relation to those paid by other sectors for the same job or the same qualifications. to a lesser extent. involved in most years a substantial rise in the average pension of the public systems and. The dynamics of pension expenditure and compensation of employees in the period from 1986 to 2008 analysed above. other current expenditure and other capital expen37 . and extraordinary revisions to several specific careers namely between 1997 and 2002. which. which was basically frozen from mid-2002 onwards.2 per cent in the latter (Figure 22). however. investment and other primary expenditure (encompassing subsidies.4 p. although different in their nature. The residual effect was also very significant in almost every year from 1986 until 2002. distorting to a certain extent the initial purposes of the reform. both defined in real terms: on average. In the 2006-2008 period it declined. in the average public wage. the number of public employees remained more or less constant and showed a slower growth in 2004-2005. in particular those related with the provision of education and health care services. correcting for the impact of the transformation of several hospitals into public corporations. according to estimates produced by Campos and Pereira (2009) has been increasing. resulted in a substantial across the board increase in wages of public administration careers.

it should be noted that the reduction in other primary expenditure stemmed almost entirely from the developments concerning subsidies. to some extent. Lastly. of trend GDP. nevertheless. These developments followed quite closely those of the implicit interest rate on public debt. interest expenditure as a ratio to trend GDP showed a clear declining trend in almost every year of the period under analysis. 2000 and 2006-2008. co diture) declined by 0. with the exception of 1990-1991.Figure 20: Breakdown of the rate of change of public employees wage bill (corrected for the effect of new corporate hospitals) 30 25 Residual Update of the wage scale Number of public employees Percentage points 20 15 10 5 0 -5 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Sources: Caixa Geral de Aposenta¸˜es and authors’ calculations. This one can be partly explained by accession to the European Community and the use of structural funds. in particular as far as the construction and exploitation of tollfree motorways is concerned.p. it is worth highlighting that the rise observed in this item over the entire period is. though not very pronounced. The decline observed thereafter can. as illustrated in Figure 23.9 p. in particular at the beginning of the nineties. As already mentioned. In the case of investment a rising trend is noticeable up to 1997. considerable given that on average intermediate consumption represented only 10 per cent of primary expenditure. be justified by the use of public-private partnerships. The disinflation process contributed significantly to the reduction of the public debt interest rates.7 and 0. Regarding intermediate consumption. since public debt was then predominantly composed of short-term instruments. respectively. such as Treasury bills. and by floatingrate instruments such as saving certificates and most bond issues and loans 38 .

mainly as a result of the decline in the currency risk premium. In this respect. amounting to more than 12 per cent of GDP.Figure 21: Update of the public employees wage scale and inflation (observed and budgeted) 18 16 14 12 10 8 6 4 2 0 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Inflation considered in the Budget a) Inflation a) Update of public employees wage scale Source: Authors’ calculations. the level of interest rates. the implicit interest rate on public debt reached a minimum of 4. in comparison to 15. Finally. Per cent 39 .0 per cent at the beginning of the period. the nominal convergence required to ensure the participation of Portugal. Overall. the substitution of public debt at below market interest rates held by the central bank and financial institutions. Note: a) Measured by the private consumption deflator. as well as their differentials with other countries. by public debt with market interest rates. the tightening of monetary and exchange rate policies. the gradual substitution of tax exempt public debt by public debt subject to income tax from 1989 onwards.3 per cent in 2005. Until 1993 there were still increases in the “real” implicit interest rate of public debt mainly explained by three factors. reference should be made to an important operation. geared to absorbing the excess banking liquidity deposited with Banco de Portugal. As nominal convergence progressed. in the euro area became the key objective of economic policy. Firstly. from the outset. provided by the domestic banks. recorded a sharp reduction. Secondly. on a compulsory basis. From 1992-1993 onwards. which took place at the end of 1990.

but also creating the conditions for a growing role of non-residents in Since data is only available from 1990 onwards. the relevant concept of public debt is total gross debt at nominal value outstanding at the end of the year and consolidated between and within the sub-sectors of general government. In 1986. 11 40 . which. The impact of the increased integration of financial markets was crucial in this period. not only reducing. the currency risk premium. public debt as a ratio to GDP was clearly below the 60 per cent reference value (56. Figure 24 presents the evolution of this variable in Portugal for the period between 1986 and 2008. however. increased the importance of this variable. in particular by making it relevant to the definition of each Member-state’s medium-term fiscal objective. reaching 66.Figure 22: Growth rates of real average pension and public employees’ wage 14 12 10 8 Real public employees average wage Real average pension Per cent 6 4 2 0 -2 -4 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Source: Authors’ calculations.4 per cent. a retropolation was made based on the work by Sousa (1998).11 According to the data now available. The revised Stability and Growth Pact. in particular. 4 Public debt In the framework of the Maastricht Treaty and the Stability and Growth Pact.1 per cent in 1997). benefited the implicit interest rate on public debt. as already mentioned. The debt ratio ended up by not playing an important role in the initial stage of the fiscal surveillance mechanism at the European level. the debt ratio was very close to 60 per cent and at the end of the period under analysis was above that threshold. in the year relevant for the participation in the euro area.

3 p. Indeed.Figure 23: Implicit interest rate on public debt 18 16 14 12 Per cent Implicit interest rate on public debt Inflation a) "Real" implicit interest rate on public debt 10 8 6 4 2 -2 -4 0 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Sources: INE and authors’ calculations. and the effect of interest expenditure net of economic growth. In fact. rise in the debt ratio results from a debt increasing contribution of deficit-debt adjustments of 10. the debt ratio rose 41 . government debt securities of euro area countries became virtually perfect substitutes and until the end of 2007 there was no significant market discrimination on the basis of sovereign risk. Over the period as a whole.p.0 p. In the period after the outset of the euro area. (Figure 25). to around 78 per cent in 2008. These effects were partially offset by the debt decreasing impact of the primary balance that amounted to 6. up to 2008.7 p. Note: a) Measured by the private consumption deflator. This situation changed in 2008 in a context of high uncertainty stemming from the international economic and financial crisis.p. which reached 3. general government financing. in cumulative terms. the 7. The evolution of the debt ratio can be broken down into three factors: the contribution of the primary balance.p. interest expenditure net of the effect of economic growth (“snowball effect”) and deficit debt-adjustments. with the elimination of the exchange rate risk as a consequence of the participation in the euro area.p.4 p. the share of Portuguese government debt held by non-residents rose from around 7 per cent at the beginning of the nineties.

The favourable impact of the primary surpluses was clearly concentrated in the years from 1988 to 1992. until 1996. Firstly.p. while 2005 was the most unfavourable year due to a significant primary deficit. “snowball effect” (4. In the remaining years. with interest outlays broadly stabilised. regarding deficit-debt adjustments. the primary deficits in the years from 2002 to 2004 and 2008 would have had a more important contribution to the debt ratio increase. In this respect it is worth highlighting that.9 p.p. in 1992 and between 1996 and 1998. several factors were be42 As a p ercentage of GDP .p. privatisation receipts contributed significantly to the reduction of the debt ratio. in particular between 1987 and 1989. Secondly. the important amount of deficit-debt adjustments at the beginning of the period. After 1998. the impact of strong nominal economic growth surpassed the high level of interest expenditure up to the economic downturn in 1991.3 p. the contribution of this item to the evolution of the debt ratio was not very important and was broadly in line with the economic cycle. as a result of primary deficits (5. in the absence of temporary measures. two points are worth highlighting.).) and deficit-debt adjustments (4. by 14.p. Concerning the “snowball effect”.3 p. in spite of the declining trend in interest payments.). Lastly.1 p.Figure 24: Evolution of the public debt ratio 70 65 60 55 50 45 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Sources: INE and authors’ calculations. This situation was reversed afterwards. may partly arise from data inconsistencies (see footnote 11).

fiscal developments were also characterised by a sustained growth of current primary expenditure. equity injections not reclassified as capital transfers. At its best. the structural deficit hovered around 3 per cent of GDP. Overall. During this period. the decrease in interest payments stemming from nominal convergence and the prospect of participation 43 . These included changes in general government deposits.Figure 25: Breakdown of the change in the debt ratio Primary balance contribution Contribution of interest expenditure net of economic growth effect Deficit-debt adjustments Change in the debt ratio 8 6 p. inter alia. 5 Concluding remarks One of the key features of public finances in Portugal since accession to the European Community has been the creation of a modern tax system.p. consolidation efforts were minimalist. hampering the achievement of a sound fiscal position. partly related to the provision of education and health services. very similar to those of most advanced economies. the difference between accrual and cash recording of taxes and social contributions. From 1993 up to the end of the nineties. essentially related with the dynamics of public pension systems and the expansion of compensation of employees. of GDP 4 2 0 -2 -4 -6 -8 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Sources: INE and authors’ calculations. EU transfers and several expenditure items. hind the quite erratic evolution of deficit-debt adjustments. debt settlements by the Treasury.

though correcting the excessive deficit. The 2008 and 2009 developments. still significantly above the MTO. changes to unemployment benefit rules and the reduction in medicines co-payments). particularly in the last months of the year. much influenced by the international crisis. an evaluation of the additional effect that can be expected from the reforms launched over the last years taking into account the likelihood of their consistent implementation. The structural deficit was. one year ahead of the deadline initially set down. A critical assessment of mediumterm fiscal prospects in Portugal is. in the absence of sizeable temporary measures.5 per cent of GDP. Since 2008. but only a transitory impact on the rates of change (as. when interest expenditure ceased to decline and economic activity decelerated. point to a high level of uncertainty and leave many scenarios open. fiscal developments in the euro area Member-states have been affected by the economic crisis. Four aspects are crucial in this respect. in particular regarding public pension systems and public administration. its implementation benefited from the ongoing stepping up of tax administration. and changed to some extent the views on the sustainability of Portuguese public finances. In Portugal. On the one hand. not clear cut. however. leading to an excessive deficit. Thirdly. On the other hand. in particular temporary measures. In the short-term. the definition of a medium term fiscal consolidation programme is crucial. the limitation of early retirements. basically failed as it relied too little on structural measures on the expenditure side and too much on VAT increase and short-term measures. The policy package adopted then. the freezing of automatic progressions in careers. The unsustainability of this approach became evident in 2001. 44 . set at that time at 0. it was a success as it allowed the closure of the excessive deficit procedure in 2007. In 2005. In this context. Secondly. the programme placed stronger emphasis on major reforms on the expenditure side. the quantification of the impact of measures taken in 2006 and 2007 that have a permanent effect on the revenue and expenditure levels.in the euro allowed an expansionary stance of fiscal policy in most years. Firstly. Fourthly. Further. Portugal once again incurred an excessive deficit. The programme approved to correct it presented some similarities but also major differences vis-`-vis the 2002-2004 a policy. it relied heavily in a first stage on tax increases and short-term measures on the expenditure side. the recent budgetary evolution has not differed substantially from that observed in this group of countries. in addition to the distinct stance on temporary measures. however. the confirmation of the reversible nature of the fiscal stimulus measures approved and put into practice since mid-2008. for example. the strictness of the constraints resulting from the Stability and Growth Pact and market reactions.

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Rita Lameira 2009 1/09 THE MAIN TRENDS IN PUBLIC FINANCE DEVELOPMENTS IN PORTUGAL: 1986-2008 — Jorge Correia da Cunha.OCCASIONAL PAPERS 2007 1/07 FINANCIAL SECTOR ASSESSMENT PROGRAMME PORTUGAL: BANKING SYSTEM STRESS-TESTING EXERCISE — Economics and Research Department 2/07 MISS: UM MODELO PARA AVALIAÇÃO DA SUSTENTABILIDADE DA SEGURANÇA SOCIAL PÚBLICA PORTUGUESA — Maximiano Pinheiro. Vanda Geraldes da Cunha MISS: A MODEL FOR ASSESSING THE SUSTAINABILITY OF PUBLIC SOCIAL SECURITY IN PORTUGAL — Maximiano Pinheiro. Cláudia Braz Banco de Portugal | Occasional Papers i . Luísa Farinha. Vanda Geraldes da Cunha 2008 1/08 HOUSEHOLD WEALTH IN PORTUGAL: REVISED SÉRIES — Fátima Cardoso.