Countries should repurpose fiscal policies to weather future challenges: President Tharman

SINGAPORE – Governments should make adjustments to taxes and spending in order to manage debts and put their finances on a sustainable track, an approach that would also better enable them to tackle future challenges like ageing and climate change, President Tharman Shanmugaratnam said.

These efforts to repurpose fiscal policies should be focused on more than raising taxes or cutting spending, although these measures will likely be necessary, he said in a lecture at the Massachusetts Institute of Technology (MIT) Sloan School of Management on Dec 9.

“This should not be simply a call for fiscal austerity,” he added.

“The challenge is to make these adjustments while repurposing fiscal policy more fundamentally: so that people can see that the adjustments are fairly distributed across society; can see the value in government spending that their taxes support, and so that the adjustments do not permanently reduce growth.”

Mr Tharman said that a longer delay to bring debts back onto a sustainable track will mean larger adjustments in taxes and spending, and more excruciating political choices will need to be made. This risks unravelling the social fabric on which democracies depend, and which sustains their prosperity, he noted.

He added that advanced economies have been given a wider leeway to run up debts, and this has created a systemic risk of financial instability.

The gross debts of Group of Seven countries now average about 120 per cent of gross domestic product, ranging from Germany’s 63 per cent to Japan’s 240 per cent.

In the case of the United States, around 18 per cent to 19 per cent of total federal revenues is now spent on interest payments.

“No one knows exactly where the limits will be, but it is clear that the debts cannot keep rising indefinitely without creating significant risks of financial instability,” Mr Tharman said.

This comes as the largest challenges for governments lie ahead. Virtually all advanced economies have ageing societies, resulting in significantly higher healthcare and pension costs, and a smaller tax base, he noted.

Governments will also have to spend more on climate change, to mitigate its effects and deal with its fallout, in the occurrences of extreme weather events and disasters, he added.

In addition, advanced economies are spending more on defence, as a result of geopolitical fracturing and increased conflicts.

Mr Tharman spoke after receiving the MIT Golub Center for Finance and Policy’s Miriam Pozen Prize

in recognition of his leadership in international financial policy

.

He received the US$200,000 (S$259,000) prize, and a fellowship named in his honour will be awarded to an incoming MIT Sloan Master of Business Administration student, to be selected in 2026. The President’s Office has said Mr Tharman will be donating the prize money to charity.

Past recipients of the award are the former head of the Bank of Israel and vice-chairman of the US Federal Reserve Stanley Fischer, in 2021; and former Italian prime minister and European Central Bank president Mario Draghi, in 2023.

In his speech, Mr Tharman noted that the current system of taxes and transfers in most advanced nations no longer breeds optimism – among contributors as well as recipients.

“We therefore need new fiscal choices and new forms of risk sharing that can rebuild optimism and preserve the social fabric,” he said.

“Not merely raising taxes or cutting spending, but choices that allow us to build new compacts – especially new compacts in healthcare, in retirement, and to address climate change.”

He offered three reorientations that governments can make to fiscal policy.

First, refocus spending on public goods, not just individual benefits. This includes spending on public education, public healthcare systems, public transport systems, lifetime learning institutes, sporting facilities, parks, and other public amenities.

“Those who gain the most from being able to access high-quality public services and systems are the poor and the middle-income groups,” he said.

Research now shows that such access and shared spaces foster interaction across income groups as well as ethnic groups, he added.

“It is how you create a sense of community, how you create the social glue among people from very different backgrounds,” he said.

“Importantly – and this too is well supported by research – moving away from ‘bowling alone’, from an epidemic of loneliness and a lack of social interaction, is critical if we are to address the mental health and well-being challenges of today’s generation,” Mr Tharman said.

Secondly, he suggested that governments shift their focus from transfers aimed mainly at reducing inequality, to public schemes and forms of risk-sharing that relieve economic insecurities.

Mr Tharman said surveys show people are far more concerned about insecurities in their lives than about inequality by itself.

These, he said, include insecurity in jobs and in housing, insecurities related to major health setbacks that will lead to large bills, and insecurities in retirement, including the risk of living longer than their savings will allow for a decent standard of living.

“A focus on economic insecurity, not merely inequality, is a progressive agenda, because the people who benefit most from being relieved of economic insecurity tend to be poorer,” he added.

Thirdly, fiscal and macroeconomic policy should move away from a heavy focus on managing the regular business cycle. Instead, governments should move towards preserving the fiscal space needed to address major crises.

Mr Tharman noted that the world has experienced one major global financial crisis, two pandemics and several wars in the last 20 years, with more crises to come.

“What we increasingly see are perpetually large budget deficits and prolonged ease in monetary policy, that leaves very little space to address the major crises when they come,” he said.

This leaves little room to tackle longer-term challenges like the defining challenges of climate change and a pandemic-prone world, he added.

Mr Tharman also elaborated on two major drivers of future fiscal costs – healthcare and retirement income security.

On healthcare costs, he said governments should strive to reduce the impact on official budgets and taxes, while making sure that the majority of the population, including the poor, has access to healthcare.

He said the young, healthy and wealthy should be drawn into universal healthcare systems, through means like subsidies if necessary, so that there are enough resources to support others who need it.

Co-payments can also be helpful to ensure that doctors do not over-prescribe, and that individuals do not take on more drugs or treatments than needed, he added.

More importantly, governments should reduce the need for healthcare by helping people stay healthy, as interventions on this front are not very expensive, and have an extremely high social return.

On retirement income security, Mr Tharman noted that there has been a major shift from traditional pensions to “defined contribution” systems that are more financially sustainable, where retirees withdraw what they put into their own accounts.

However, this could leave the poor without enough retirement savings, so governments have to find ways of supporting them outside of the pension scheme.

“There is an important middle, of pension schemes that can serve ordinary workers well, while ensuring the sustainability of pension schemes,” he said.

“In Singapore, this is achieved by complementing a defined contribution system with government support to build up the accounts of poorer workers or those who haven’t had jobs throughout their lives, like many women, for instance.”

Mr Tharman acknowledged that putting government finances on a sustainable path will be a challenge in many advanced economies. But he said the aim cannot just be to raise taxes or cut spending, which will be difficult to get support for.

“We have to repurpose fiscal policy to involve people in the common good – by refocusing spending on public goods, not just on transfers to individuals; by reducing the risks of economic insecurity that the poor and broad middle class perceive as major concerns in life, not merely inequality; and by expending less fiscal resources on managing the business cycle, so as to preserve fiscal space to tackle major crises,” he said.

“It is also how we breed the sense of mutual support and solidarity that is needed to sustain prosperity itself.”