The IMF warns countries about drastic tax increases due to the possible blow to the economy

The International Monetary Fund warns countries, in its World Economic Outlook Report, published this Tuesday, that fiscal adjustments such as drastic tax increases can cause “a negative cycle of slowing activity.”

That is why in their outlook for 2024 they recommend making “gradual fiscal adjustments” to face shocks futures and correct debt, especially in the case of lower-income countries.

However, they hope that this year countries will tighten their policies aimed at curbing high levels of public debt, through tax increases and lower public spending, “which will affect global growth.” Therefore, both fiscal and monetary policy will be the economic mantras of 2024.

The growth outlook has changed little or nothing from its January report of this year. On the growth side, they expect that the global economy “will continue to grow at a rate similar to that of 2023” this year and next. They have revised one tenth upwards with respect to their perspectives at the beginning of the year, leaving an expansion of 3.2% for the end of this year and the next.

“There is little change to global growth forecasts from the January 2024 report, with some adjustments in major economies, including further strengthening of the projection for the United Statesoffset by modest downward revisions in all countries.” Although they remember that the projections for 2024-2025 are “below the historical annual average” (2000-2019) which stood at 3.8%, they emphasize.

Thus, for the United States, it is expected to close 2024 growing at 2.7% (six tenths more than expected in January) and subsequently slow down to 1.9% in 2025. Precisely, this slowdown in 2025 will be caused for a gradual fiscal adjustment and the weakening of labor markets that will cause a contraction in aggregate demand.

For its part, the euro zone economy will perform worse. The IMF’s revision for this year is downward and next year will be the same (-0.1%), leaving a timid GDP growth of 0.8% by 2024 and a slight recovery of 1.5% in 2025. They argue that the effects of the shock in energy prices and a fall in inflation supports the growth of citizens’ real income and that drives recovery.

Germany will be the big drag this year in the euro zone, followed by France. Europe’s locomotive undergoes a downward revision of one tenth compared to the IMF report in January, with a growth of 0.2% this year and the timid recovery to 1.3% in 2025 (two tenths below what was forecast at the beginning of the year by the entity). The Gauls will have similar behavior, GDP growing only seven tenths this year and 1.5% next year. In both years the revision is downwards by three tenths compared to January.

Although the slowdown in the EU’s two largest economies will be offset “largely by improvements in several smaller economies, including Belgium and Portugal,” the IMF says.

Italy will remain completely static, with growth both this year and next. comes from 0.7%with a downward revision of four tenths in 2025 compared to January predictions.

Finally, Spain will be the economy of the big five in the euro zone that will grow the most. For this year the IMF has made an upward revision of growth by four tenths and places GDP expansion at 1.9% and for 2025 it leaves it exactly the same (2.1%).

Finally, they expect growth in China to slow to 4.6% from 5.2% in 2023, despite the fact that Xi Jinping’s government has set a goal of growing 5% this year. In the first trimester recorded a growth of 5.3%, according to the data known this Tuesday. By 2025 growth will be 4.1%. This slowdown will continue over time “as the positive effects of specific factors – including the post-pandemic boost to consumption and fiscal stimulus – are eased and the weakening of the real estate sector persists“they argue.

Gradual fiscal policies

The IMF proposes “a renewed focus” on fiscal consolidation to create a budgetary margin that can face future crises and stop the increase in public debt, since it is expected that central banks begin to relax their monetary policies this year and the economies “are in a better position to absorb the economic effects of the fiscal adjustment.

At the same time, they highlight in the report that countries currently facing electoral processes in 2024 guarantee “that any new tax cuts or spending increases are financed and do not widen budget deficits to preserve the planned fiscal adjustment path.”

But in the organization led by Kristalina Georgieva they reiterate that the adjustment must be “gradual” to avoid the negative effects that a drastic tax increase or cuts can cause economic growth in the short term. “Avoiding an abrupt adjustment is justified to mitigate the risk that sharp spending cuts or tax increases trigger a negative cycle of slowdown (…) that undermine political support for fiscal reforms, the implementation of which can often take time” , say IMF experts.

Although it is a downside risk, IMF technicians assert that “an excessively sharp turn” towards tax increases and spending cuts, beyond what was expected, “could lead to slower than expected growth and reduce the impetus for reforms”. The technicians appeal to what the euro zone economies experienced during the 2010-2015 crisis: “It illustrates how concerns about debt sustainability can lead to significant cuts in budget deficits with important negative consequences for growth.”

The ratio of the structural fiscal balance to GDP is expected to increase by 1.9 percentage points in the United States and 0.8 percentage points in the euro zone in 2024.

Decreasing inflation

Regarding inflation, from the entity They predict a big drop. In the world as a whole, it is expected to be 5.9% in 2024, from 6.8% in 2023, and to close 2025 at 4.5%. By country, they expect developed economies to enter the expected path of 2%. Specifically, in the United States the CPI would fall to 2.9% this year, from 4.1% in 2023, and would close 2025 at 2%.

For its part, the eurozone will set a CPI of 2.4% this year and next year it will remain more or less stable (2.1%). Germany will correct its prices from 6% this year to 2.4% next year and will reach the desired 2% in 2025. France is expected to close this year at 2.4% and drop to 1.8% next year. Italy will have a CPI of 1.7% this year and 2% next year. Finally, Spain will be the one with the highest inflation, with 2.7% this year and 2.1% next year.