Mitigating measures protect living standards and boost resilience

The Government will continue to use fiscal policy as a powerful tool to protect jobs and provide resilience. According to the fiscal budget proposal for 2021, introduced before Parliament today alongside the fiscal plan for 2021-2025, the impact of the COVID-19 pandemic on the Treasury is estimated to be negative in the amount of ISK 192bn next year. Taxes will be a total of ISK 52bn lower in 2021 than they would have been without the decisions taken by the Government during the current electoral term.

Fiscal policy used systematically to combat the recession

The fiscal budget proposal continues the policy laid down this year with the Government’s emergency measures, which focus on broad and strong measures to support the economy, save jobs, protect households, and lay the foundation for value creation after the pandemic-induced crisis subsides. The Treasury’s strong position at the onset of the pandemic has enabled the authorities to respond decisively to its repercussions by supporting distressed households and businesses. The fiscal budget proposal reflects the Government’s intention to overcome difficult circumstances and use fiscal policy as a powerful tool in that effort. No further cutbacks will be required of Government functions, and all key transfer systems will be protected. In order to guard against increased expenditures, new spending increases are restricted to pandemic response measures.

The impact of the Covid-19 pandemic on the Treasury is negative in the amount of ISK 192bn in 2021. The factor weighing heaviest is the ISK 89bn contraction in tax revenues caused by reduced activity in society. Treasury revenues are also reduced because of measures undertaken in response to the pandemic, including reimbursement of value-added tax on labour, expedited reduction of the bank tax, and cancellation of the bed-night tax, which cost the Treasury about ISK 17bn combined. In addition, unemployment benefits are expected to increase by ISK 23bn. Expenditures for various mitigating measures are estimated at ISK 35bn, and dividend payments are expected to decline by ISK 27bn.

Welfare, healthcare and education at the forefront

Welfare, healthcare, and education are the functions that will receive the most funding, with over 60% of total Treasury allocations.

One of the Government’s top priorities in its operations is to strengthen the healthcare system so as to improve services irrespective of users’ financial position or domicile, lower patients’ co-payments, and build nursing homes. In 2021, allocations to healthcare will increase by a further ISK 15bn, excluding wage and price movements, with the construction of the new Landspítali hospital weighing heaviest, with an increase at nearly ISK 7bn.

Allocations to social, housing, and insurance weigh heaviest on the expenditures side of the budget, at 26% of total allocations. Key priorities for this electoral term include increasing the tax-free threshold for elderly persons’ earned income, lengthening childbirth leave, increasing initial contributions towards construction of rental housing for low-income people, and implementing legislation on participating loans. The Act on Participating Loans, which enters into force on 1 November 2020, will help individuals with limited income and assets to acquire their first apartment.

Allocations to education and culture are expected to increase by nearly ISK 6bn in 2021. Of that total, ISK 2bn are earmarked for the expected increase in student numbers because of the COVID-19 pandemic, and the criteria in the newly passed Act on the Icelandic Student Loan Fund are taken into account. An additional ISK 1bn will be allocated to university-level education in accordance with the objective of bringing Iceland’s university funding in line with the OECD average. Furthermore, the educational system has been strengthened at the upper secondary and university levels, and work is well underway on an ambitious language technology plan that will make it possible to use the Icelandic language in all equipment and in software from global IT leaders.

Estimated allocations to innovation total ISK 25bn, an increase of just over ISK 5bn relative to the estimate for 2020.

Strong emphasis has been placed on research and innovation, including with the establishment of Kría, an investment fund intended to promote development, growth, and competitiveness in the domestic economy. Moreover, concessions for companies’ research and development (R&D) activities will be more than trebled relative to 2017, to over ISK 7bn in the 2021 fiscal budget proposal.

Allocations to IT projects will be increased substantially, or by ISK 2.3bn. Under the leadership of the Ministry of Finance and Economic Affairs, the Digital Iceland bureau has made a major push towards the digitisation of public services in cooperation with Government institutions.

Environmental affairs have been highly important for the entire electoral term. This includes the action plan for climate, soil conservation, and reclamation. Furthermore, increased allocations have been made towards broad infrastructure development at tourism sites, alongside increased patrolling. A total of nearly ISK 24bn are earmarked for environmental affairs in the coming year, an increase of ISK 3.4bn relative to 2020. The largest single item is an increase in allocations to the Avalanche Fund for the strengthening of avalanche defence structures.

A lighter tax burden

Next year, taxation will be some ISK 34bn lower in 2021 than it would have been without the Government’s tax cuts from 2017. Furthermore, the special pandemic response measures reduce Treasury revenues by more than ISK 17bn in 2021; therefore, taxes in 2021 will be a total of approx. ISK 52bn lower than they would have been without the changes implemented since 2017.

Tax changes in recent years have entailed reforming the tax system with an eye to increasing disposable income for the lowest income groups, boosting the competitiveness of the domestic economy, and working towards achieving the Government’s environmental goals. The most broad-based measures are changes in personal income taxes, which will be fully implemented in 2021, with a three-bracket tax system and a lower tax burden for the lowest-paid groups in society. In all, disposable income for the lowest-income persons will rise by just over ISK 120,000 per person per year, increasing aggregate disposable income by ISK 21 bn per year.This does not include the special increase in the personal deduction in 2018, in the amount of nearly ISK 2bn, which has also been of benefit to households.

The payroll tax has also been lowered considerably during the term, and firms’ tax burden will be ISK 8bn lower in 2021 than it would have otherwise. This does not include the temporary payroll tax reduction to address the impact of wage hikes according to the Living Standards Agreement. The total R&D expense reimbursed by the State has also been doubled.

The emphasis that the Government has placed on environmental protection and on limiting CO₂ emissions is reflected in the revision of certain taxes. The carbon tax has been increased significantly during the term, and a tax has been imposed on emissions of fluorinated greenhouse gases. Simultaneously, value-added tax has been waived on purchases of eco-friendly motor vehicles, bicycles, and home charging stations.

The fiscal budget proposal provides for an increase in the tax-free threshold for inheritance tax, which will lower levies by an estimated ISK 500m in 2021 and will benefit smaller estates the most. In addition, the review of the investment tax base is in its final stages. Finally, there are plans for new or increased tax subsidies to support organisations that work in the public interest, the so-called third sector, in the amount of ISK 2.1bn.

Investment initiative

Allocations to investment are high in historical context, at ISK 111 bn. The largest single investment project is the construction of the new Landspítali hospital, which is to receive allocations totalling nearly ISK 12bn in 2021.

Allocations to various investments increase by just over ISK 36bn relative to the 2020 budget. The year-on-year increase is due in large part to mitigating measures undertaken by the Government, and to the Government’s policy of supporting the economy until activity picks up again, including with a special initiative for investment in infrastructure, brainpower, and knowledge. The total scope of the investment and development initiative in 2021 is ISK 27.2bn.

Fiscal plan 2021-2025: Turning around deficit operations the key objective

The most important challenge facing the Government during the term of the fiscal plan for 2021-2025 will be reversing the public deficit caused by the COVID-19 pandemic and bringing debt accumulation under control. Under circumstances like these, deficit operations do not represent economic losses. The funds are being used to strengthen households’ and businesses’ financial position and to prevent the permanent loss of jobs and value. The objective is to support and stimulate the economy so that when the pandemic-induced recession ends, Iceland will emerge as a competitive society whose prosperity is based on strong human capital and a vibrant economy.

The Government’s first responses to the economic impact of the COVID-19 pandemic entailed using the Treasury’s strong position to protect households and businesses against the worst of the shock by implementing a variety of measures. The purpose of the measures was to support households’ and businesses’ liquidity and solvency to the extent possible, supporting them until the economic situation improved as it was hoped that the pandemic would be short-lived.

Halting debt accumulation: an explicit objective

The combined deficit for 2020 and 2021 could come to as much as ISK 600bn. Public sector debt according to the debt rule in the Act on Public Finances could therefore rise from 28% of GDP at the end of 2019 to 48% of GDP by end-2021.

The Government considers it important to set clear and realistic targets for halting the rise in the public debt-to-GDP ratio no later than in the final year of the fiscal plan, thereby stopping the spiral of deficit operations and debt accumulation, with the aim of returning Iceland to fiscal strength.

In order to achieve this objective, measures must be taken to improve the fiscal performance by ISK 37,5bn per year in 2023-2025, an amount equivalent to just under 3% of public sector turnover or slightly more than 1% of GDP relative to the baseline fiscal scenario and the current macroeconomic forecast. Measures of this magnitude are essential to ensure continued fiscal sustainability, so that public sector finances will be conducive to economic stability and the Treasury will be able to provide a cushion against economic shocks in the future.

With these performance improvements, gross public debt will be more than ISK 230bn lower at the end of 2025 than if the measures had not been taken. It is assumed that debt accumulation will halt at about 59% of GDP instead of peaking at 65% of GDP. The debt ratio will then continue to decline on the basis of the potential output growth assumed in the fiscal plan.

Bill of legislation on extended deviation from fiscal rules introduced before Parliament

The report accompanying the fiscal plan for 2021-2025 states that, in order to prevent too harsh a fiscal response as early as 2023, it is necessary to deviate from numerical fiscal rules for longer than the three years provided for in the Act on Public Finances. Otherwise, it would be necessary to reduce a deficit of 6% of GDP to 2.5% virtually at a single stroke.

Therefore, alongside the presentation of the fiscal plan, the Minister of Finance and Economic Affairs is presenting a bill of legislation amending the Act on Public Finances. This entails that the requirements laid down in Article 7 of the Act on Public Finances, no. 123/2015, regarding the overall balance and the public debt ratio, referred to as numerical fiscal rules, will not apply in 2023-2025.

Late presentation of fiscal plan

According to the Act on Public Finances, the fiscal plan is to be presented no later than by 1 April each year. Because of the COVID-19 pandemic, Parliament passed a temporary amendment to the Act on Public Finances, authorising the presentation of a revised fiscal strategy, fiscal plan, and fiscal budget proposal no later than on the day Parliament convenes for the autumn legislative session. The revised fiscal strategy was introduced in August and passed on 3 September. The fiscal plan, which entails a more detailed presentation of the objectives in the fiscal strategy, is introduced today, alongside the fiscal budget proposal.

Further information can be found on www.fjr.is