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Fiscal policies¡ªthe tools employed by governments related to revenue collection and expenditure¡ªplay a crucial role in key development areas. They can help create the conditions for long-term fiscal sustainability, short-term macroeconomic stabilization, economic growth, and poverty and inequality reduction.

Raising tax revenue is essential for countries to fund their development needs and foster economic growth. Tax policies can also address equity concerns and support sustainable growth. On the expenditure side, policies can support long-term development through supporting and protecting human capital and building infrastructure.

Additionally, governments can use tax and expenditure policies to correct market failures and enhance economic efficiency and welfare. This involves aligning taxation and spending with societal objectives, prioritizing the least distortive taxes, focusing on activities with the highest benefit-to-cost ratio, and striving for cost-effectiveness.

Fiscal sustainability refers to the government¡¯s ability to maintain its tax and spending policies at a level that ensures long-term service delivery without risking insolvency. A sustainable fiscal path is crucial for macroeconomic stability, including low inflation and sustainable external balances, and long-term growth. Fiscal sustainability becomes particularly critical when economies face unexpected shocks, often requiring increased government spending and resulting in larger fiscal imbalances. A sustainable fiscal path is essential for governments to effectively respond to crises while preserving long-term economic health.

Context

Fiscal policy plays a key role in stabilizing the economy in the short term. During downturns, governments can boost demand through increased spending, with automatic stabilizers such as unemployment benefits and income taxes adjusting as needed. Conversely, when the economy overheats, higher taxes or reduced spending can curb excess demand and mitigate inflation. Sound fiscal policies can also create buffers to address extraordinary shocks. 

In the long run, reliable fiscal policies promote economic growth by providing essential goods and services, building human capital and creating fiscal space for infrastructure investments that drive higher economic growth.  

In many developing countries, fiscal policy requires improvement. Low-income countries struggle to address macroeconomic instability, respond to shocks, and provide adequate public goods or infrastructure investment to support medium-term growth. During periods of crises, effective fiscal policy becomes even more critical to protect vulnerable households and businesses, highlighting the need for better economic management.

Ensuring macro-fiscal policy stability requires strong fiscal institutions, such as well-designed fiscal rules, fiscal councils, and intergovernmental transfers. Fiscal rules can strengthen macro-fiscal credibility by setting quantitative limits on key indicators such as fiscal balances, debt levels, or expenditure growth. These rules make fiscal policy more predictable, improving access to financial markets, lowering borrowing costs, and enhancing governments¡¯ ability to stabilize output in the short term. Over the long run, increased government investment driven by sound fiscal policies supports sustainable economic growth. Effective intergovernmental transfers are essential to correct fiscal imbalances and economic disparities, enhance service delivery while ensuring fiscal accountability.

Strategy

ľ¹ÏÓ°Ôº helps client countries in analyzing the effectiveness of fiscal policy and assessing how it supports growth, responds to shocks, and addresses key risks and vulnerabilities. ľ¹ÏÓ°Ôº provides recommendations to close potential gaps through a core diagnostic for policy dialogue -the Public Finance Reviews (PFR).  

ľ¹ÏÓ°Ôº provides macro-fiscal recommendations on:

• Reduction of persistent budget deficits and their financing
• Enhancing sustainable fiscal policy across the whole government, including local governments, considering debt sustainability.
• Limiting cyclical fiscal policies for effective demand management
• Identifying and managing fiscal risks steaming from natural disasters, on state-owned companies, dependence on natural resources.
• Designing or strengthening of fiscal institutions such as Fiscal Rules, Independent Fiscal Councils

Resources

Tax revenue collection is critical for countries to finance investments in human capital, infrastructure, and essential services for citizens and businesses. It is also key to setting the right price incentives for sustainable private-sector investment.

Context

Developing countries face significant challenges in generating sufficient tax revenues to finance investments in human capital, infrastructure, and essential services. Multiple crises in recent years have exacerbated this challenge by reducing revenues while increasing the need for public spending.

The need to increase revenue collection is particularly acute in countries that currently collect less than 15 percent of GDP in taxes. This level of taxation is too low to provide essential public services and put the country on a path to sustainable growth. Yet 83 percent of low-income countries and 48 percent of lower middle-income countries collect at a rate below this threshold. In countries affected by fragility, conflict, and violence, the average tax-to-GDP ratio was as low as 12.6 percent in 2023.

To resume economic growth, reduce poverty, and support climate action, countries need to increase tax collection and make tax systems more equitable and efficient. They need to balance goals such as increasing revenue mobilization, promoting growth, and reducing compliance costs with ensuring that the tax system is fair and equitable. 

More efficient tax systems can also enable the private sector to play an important role in creating jobs.

Strategy

ľ¹ÏÓ°Ôº is the largest provider of finance for domestic revenue mobilization. It also provides governments with guidance and support to reach their tax potential and make their tax systems more efficient and progressive.

In October 2024, commitments among active operations to support interventions related to domestic resource mobilization totaled $5.4 billion, of which $3.4 billion was for countries that are eligible to borrow from the International Development Association (IDA), the World Bank¡¯s fund for world¡¯s poorest countries.

ľ¹ÏÓ°Ôº is supporting countries in not only collecting more but also collecting better. Reform priorities include:

• Broadening tax bases by rationalizing inefficient, ineffective, and poorly targeted tax expenditures, particularly for personal income taxes, corporate income taxes, and value-added taxes;
• Mobilizing resources from undertaxed bases, such as capital income and residential property;
• Increasing the progressivity of personal income taxation;
• Increasing the use of taxes that correct for negative externalities;
• Curbing corporate tax avoidance and evasion, including base erosion and profit shifting, and ensuring fairer and more effective taxation of the digital economy;
• Enhancing capacity to tackle tax evasion and other illicit financial flows;
• Improving the effectiveness of natural-resource taxation;
• Strengthening and digitalizing tax administration;
• Tapping into other revenue sources, including non-tax and non-debt instruments; and
• Expanding engagement on revenue aspects of trade policy and customs administration.

Resources

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Public expenditure¡ªthe money spent by governments to provide goods and services¡ªis crucial for macroeconomic stability, income distribution, and economic growth. In supporting economic development governments must balance short-term output stabilization and long-term fiscal sustainability. Effective and efficient public expenditure management is a vital tool to achieve high-return investments in human and physical capital while meeting debt service obligations.

Context

Across the world, countries allocate on average about 33 percent of their GDP to public expenditure. In low-income countries, however, this share is notably lower, at around 20 percent of GDP. 

Public spending is categorized into current expenditure and investment. On average, current expenditure accounts for over 80 percent of total public spending, while investment represents less than 20 percent.

Low-income countries face unique challenges due to rapid population growth, disaster response and security and social protection needs, and infrastructure and human capital gaps. These issues are compounded by high public debt. Improving the efficiency and effectiveness of public expenditure has become critical growth and fiscal sustainability.

Public spending must be:

• Sustainable: aligned with revenue and taxation, and consistent overtime;
• Efficient: maximizing welfare while minimizing costs; 
• Stabilizing: adjusting aggregate demand based on economic conditions; 
• Redistributive: investing in education and health for disadvantaged groups.

Strong budget institutions and accurate fiscal multiplier estimates are essential for effective public spending management. High-quality service provision, whether public or private, is key to ensuring long-term benefits.

Strategy

ľ¹ÏÓ°Ôº provides extensive guidance and support to client countries on expenditure policy to enhance spending efficiency and effectiveness. The policy dialogue and recommendations focus on several key areas to ensure that expenditures are aligned with development goals and are managed transparently and efficiently. 

Policy recommendations for expenditure often include: 

• Improving public investment management to ensure infrastructure projects are well-planned, cost-effective, and climate resilient.
• Strengthening social protection systems through better targeting and expanding safety nets to support vulnerable populations.
• Enhancing spending efficiency by cutting low-impact programs and shifting resources from recurrent costs, such as subsidies, to capital investments in high-impact sectors like infrastructure, education, and health.
• Public sector wage bill reform;
• Identifying opportunities for efficiency savings in the procurement of goods and services.
• Enhancing public financial management through medium-term budgeting, transparent procurement, and accountability mechanisms.
• Integrating climate considerations into public spending by mainstreaming adaptation and mitigation efforts in budgeting and investment planning.

Resources

Latest Reports

Blogs and Stories