As in the data (CONFIS, 2004), central government revenues amount to 15.6% of GDP made up of non-tax revenues (1.5% of GDP) and tax revenues (14.1% of GDP). Consistent with the tax collection figure, with the observed revenue composition and with the model’s tax definitions, the baseline consumption tax rate is calibrated at 12%, the capital income tax rate at 26.4% and the labor income tax rate at 0.9%. On the other hand, central government primary expenditures represent 16.6% of GDP of which approximately 0.6% of GDP is classified as capital spending. As is apparent, the central government primary balance exhibits a deficit of 1% of GDP and a with-interest deficit of 5.5% of GDP, revealing the burden of a debt of 54% of GDP.

Decentralized government accounts are built on the basis of the model economy specification and data. The rest of the public sector invests 2.2% of GDP in infrastructure and exhibits an overall surplus of 2.4% of GDP. This brings the combined overall public sector balance to a deficit equivalent to 3.1 of GDP. Given interest rate and growth rate prospects, if the described fiscal policy parameters remain unchanged, the current stance is unsustainable. It is made sustainable by appropriate lump-sum transfers to the government. By construction, if this adjusted fiscal policy stance is assumed to remain forever, the economy will remain or converge to its steady-state equilibrium, as described in the preceding section.<sup>12</sup> Let us assume this is the case.

The preceding portrait of the public finances does not offer a complete panorama, however. The current expenditures of the central government are assumed to remain constant in the future (at 16% of GDP) which is indeed a bad assumption. This assumption does not take into account the major source of concern with respect to the evolution of the public finances: future unfunded state pension liabilities. Figure 1 displays the path of expected deficits of the state social security system (solid line) as calculated by the DNP. In 2004 the pension deficit is approximately 3.1% of GDP. From then on it will increase steadily up to a peak of 6.2% of GDP in 2014 and then decrease gradually. Nevertheless, deficits will remain over 3% of GDP up until year 2040. Even disregarding the “inherited” fiscal imbalance, it is clear that unfunded pension liabilities will represent a major source of fiscal stress and intertemporal solvency problems in the years ahead.

The expected path of current expenditures of the central government is constructed by adding to the baseline expenditures path (i.e. 16% of GDP from 2003 onwards) the amount associated with the dotted line in Figure 1, which corresponds to the difference between the estimated future deficits of the state pension system and the amount of pension transfers already incorporated into the 2003 central government budget (approx. 3% of GDP).

Holding constant other fiscal policy parameters, the new path of expenditures will push the economy off its steady state balanced growth trajectory and lead to an explosive growth of the government debt, eventually violating the transversality condition (NoPonzi Game condition). The question is how to finance the future path of government

> 12 Keep in mind that the correction of this part of Colombia’s fiscal imbalance and well as its effect on economic behavior are not being addressed in the ensuing policy experiments.

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