capital stocks in each of these functions is adjusted by a uniform number of percentage points.

- _<u>infhd+eff</u>_ <u>. The higher government growth rates of</u> _infhd+tx_ are imposed with one exception, “other government”. Instead of financing this increase in fiscal space with higher taxes, it is financed by an improvement in allocative government efficiency, represented by an endogenous reduction in growth for the function “other government”. This is an improvement in allocative efficiency since, as opposed to HD and infrastructure, the other government function does not have any direct positive effects (in terms of productivity, HD or other consequences).

- _<u>infhd+fg</u>_ <u>. The growth  rates for the government functions of</u> _infhd+tx_ are imposed, this time without exception (i.e., also for “other government”). Instead of financing this increase in fiscal space with higher taxes or improved efficiency, it is financed by an endogenous increase in foreign grants.

- _<u>infhd+mix</u>_ <u>. The government growth rates of</u> _infhd+tx_ are imposed without exception also for this scenario. However, instead of relying on a single source of the needed fiscal space, this simulation mixes the three sources that were singled out in the preceding simulations (taxes, efficiency and grants). The increases in tax rates, foreign grants and efficiency are now one third of the increases under _infhd+tx_ , _infhd+eff_ , and _infhd+fg_ , respectively, _i.e._ , getting 2 percent of GDP from each. This seems more realistic than mobilizing 6 percent of GDP from a single source.

- _<u>inf+mix</u>_ <u>. The sources of fiscal space are the same as for</u> _infhd+mix_ . However, the growth in government spending is limited to the infrastructure area; for HD, the growth rates are the same as under _base_ .

- _<u>hd+mix</u>_ **<u>.</u>** Here, the increase in fiscal space is used to increase spending on HD; for infrastructure, the growth rates are the same as under _base_ .

The results for these simulations are summarized and contrasted with those of the base scenario in Figures 3.1-3.4; the discussion also refers to Appendix Tables A3.8-A3.13, which contain more detailed numerical results on macro indicators (real growth and GDP shares), MDG indicators, the government budget, the balance of payments, and sector GDP (growth and shares).

<u>Tax-financed expansion in infrastructure and HD spending (</u> _<u>infhd+tx</u>_ <u>). Figure 3.1 shows the</u> resulting change in government final demands (measured as shares of GDP) in an average year in the period 2020-2030, i.e. the period when the tax increase is implemented in full. As expected, the tax increase (at 6 percent of GDP) leads to a spending increase in the priority areas that is similar in magnitude. In terms of real growth, government consumption and investment increase by 0.9 and 1.3 percentage points, respectively, compared to _base_ (Table A3.8; Table A3.10 shows the government budget as share of GDP). Very small growth gains, of around 0.1 percentage points, are recorded for GDP and absorption, while household consumption growth declines by 0.3 percentage points, leading to a higher poverty rate (Figures 3.2 and 3.3; Tables A3.8 and A3.9 show growth rates and GDP shares for macro indicators, respectively). Other MDG indicators improve thanks to the increase in government services, but only to a minor extent. Among the production sectors, the strongest GDP growth 9