Ministry of Finance
October 4, 2002
The 2003 fiscal budget:
Budget speech by Minister of Finance,
Geir H. Haarde to the Althingi
I hereby present the 2003 Fiscal Budget to the Althingi. In my speech I shall give an account of the main elements of the budget as well as the macroeconomic premises upon which it is based.
I expect few would refute that this country currently enjoys more economic stability than it has for many years. Inflation is declining rapidly, as is the current account deficit; household purchasing power has been increasing steadily since 1994 and is now higher than ever before; interest rates have been falling quickly and indebtedness of both enterprises and individuals has been substantially reduced.
According to most indications, the Icelandic economy is coming to life once more after a short-term downturn and ahead of us lies a new period of economic growth, as is predicted in the new economic forecast and which I will subsequently discuss.
The period of major economic growth at the end of the previous decade differed in many respects from other such periods in Icelandic history. To some extent this was due to favourable external conditions, but the government's responsible economic policies and positive structural changes in economic and industrial affairs were also important. Through further liberalisation of the business environment, the authorities have encouraged the growth which has occurred and laid fertile ground for new growth to emerge.
The real test of economic management, however, is during a downturn. The mild downturn through which we now appear to have passed showed that times have changed in economic management in Iceland. Icelandic history, unfortunately, has plenty of sad examples of economic upswings which have not been used to good advantage due to hasty and short-sighted economic management. In this instance, fortunately, there is no question of such.
Icelandic economic history in recent decades appears to indicate that there is no avoiding major downturns following an upswing. This is fortunately not the case. The universal rule may be that poor economic management leads to such catastrophes, but responsible economic management in good times and careful action in times of contraction can, as the current state of public finances indicates, ensure continuing development despite a stormy economic environment. If both enterprises and individuals can trust in stability and make their plans accordingly, then we can prevent spiralling prices and difficult times following on the heels of major economic upswings. Instead of plunging downwards out of control the economy could touch down lightly to take off once more.
In a recent article on the Internet, a young economist studying and working abroad discusses the rapid adjustment which has taken place in Iceland in the past year or two. In his opinion the landing has been incredibly soft compared to other countries' experience of the after-effects of as powerful an upswing as we have experienced in recent years. He points out that this year's budget is evidence that the turnaround which has occurred in treasury operations in the past decade is not just the result of expansion, but rather a permanent change in policy. Financial market professionals in Iceland have expressed much the same sentiments.
The budget for 2003 reflects the sound situation of public finances and the government's policy of restraint in public finances. The budget anticipates a revenue surplus of just under ISK 11 billion and treasury credit budget surplus of ISK 10 billion. As before, the surplus will be used to reduce Treasury debt and obligations and to strengthen its position in other respects, for instance, with an increased balance in the Central Bank. It could be mentioned that from 1999 to year-end 2003 payments made by the Treasury to the Civil Servants' Pension Fund at current prices, including this year's budget, amount to ISK 53 billion, or the equivalent of almost one-quarter of the state's total obligations to the Fund which were previously not financed. This action prevents major expenditures in the future which otherwise could easily cripple the Treasury in relatively few years' time. This is a matter of concern for all taxpayers and not just public servants.
Net debt of the Treasury will be approximately 19% of GDP at year-end 2003, based on the present budget, whereas it was 34.5% in 1996. Just how successful this has been is evident from the fact that the state's interest expenditure in excess of interest income has dropped by ISK 4.4 billion from 1998 to 2003. These funds definitely make a difference when it comes to funding important social programmes and reinforcing the foundations of Icelandic industry.
The policy of restraint in government finances in recent years has played a major role in creating conditions for the extensive tax reduction which was approved by the last parliament and will be fully implemented next year, without disturbing the main objective of the government spending policy, to return a surplus. Among these measures was a 50% reduction in net worth tax for individuals and corporations and a very substantial cut in corporate income tax. It is important to continue to reduce taxes and thereby increase the competitiveness of Icelandic industry and improve living standards in the country.
From 1998 to 2003 the cumulative national Treasury surplus is heading towards ISK 47 billion. At the same time, the cumulative treasury credit budget surplus, or the funds available to reduce obligations and strengthen the Treasury's balance with the Central Bank, amounts to just under ISK 67 billion. If a special loan had not been taken to strengthen the Central Bank last year, the cumulative treasury credit budget surplus would be over ISK 92 billion for this period. The major share of this loan was re-loaned to the Central Bank, with part also used to increase its initial share capital; in return, the national Treasury enjoys interest revenue and dividends.
Next year the third stage of the increased children's benefits decided upon by the government in 2000 will be implemented. Income-linked cuts to these benefits will be reduced, at the same time as the amount of the benefits and maximum income will be raised. These changes will result in a considerable increase in the disposable income of families with children, not least those with low incomes. The net result of the government's actions is that children's benefits will now be some ISK 2 billion higher in 2003 than they would otherwise have been.
In recent years the government has introduced a number of changes to the social insurance system aimed at improving the situation of senior citizens and the handicapped. This past year a law came into effect providing for a special increase in benefits, in addition to lowering income-linked reductions to these benefits. The changes have had an impact on increasing the purchasing power of social security benefits. It should also be mentioned that a short time ago the government decided to take up formal co-operation with the National Association of Senior Citizens in drawing up proposals for changes to social security system benefits and for development of nursing homes. It is hoped that the results of these efforts will be available within a few weeks.
National Treasury expenditure has decreased as a percentage of GDP since 1998 and the aim is to reduce it still further. This has been achieved at the same time as proposals in the government's policy platform for a variety of reforms have been put into effect, as I have described. This success is explained by operating restraint and new administrative procedures encouraging better utilisation of public funds. It is a source of satisfaction for those of us who believe in individual initiative and free enterprise to see the public share in our society's economic activity decreasing. At the same time it must be instructive for those people who believe in public regulation and economic restrictions to see how increased deregulation and decreased state control of industry go hand in hand with improving the standard of living in the country and strengthening its welfare system.
It is important to continue along this path. A cautious and responsible public finance policy, aimed in particular at keeping the growth of expenditures within moderate limits, encourages stability in economic affairs. It opens up possibilities for further tax reductions, both for individuals and corporations, and is an important premise for further industrial development and improved standards of living.Mr. Speaker, I should now like to focus on the principal economic premises of this budget.
The Prime Minister has explained to the Althingi the results of the economic forecast as presented in the national economic plan used as a basis for the budget. I will merely touch on the main points, in particular as they affect the budget.
Recent developments in economic affairs reflect primarily a very sudden adjustment in the economy in the wake of a major upswing in the preceding years. Inflation has fallen substantially this year and is likely to be within 2% over the year and 2.5% in the coming year, or well under the inflation objective of the Central Bank. Unemployment has increased temporarily but according to most indications it will decrease shortly.
One of the most interesting conclusions of the national economic forecast is that the current account deficit, which has been recorded every year since 1995, is expected to disappear this year and the outlook is for a balance in foreign trade in 2003.
This trend does not surprise me. The government has stood by its policy of giving the market a chance to adjust to changes in the economic environment without intervening. This policy was strongly criticised not so long ago. The lack of justification of such criticism is now evident. Strong economic management has created conditions enabling individuals and corporations to respond to external fluctuations without coercive measures on the part of the state. The symptoms of overheating have subsided and equilibrium has been achieved once more.
The current account development is the best evidence of how the flexibility of the Icelandic economy has increased in recent years. Here the structural changes which I mentioned previously have made the greatest difference and have, together with government policy, completely revolutionised doing business in Iceland. The new framework for monetary policy should be mentioned especially in this context, together with the new Central Bank Act, both of which have already proved very effective.
The dire prophecies concerning the effect of the current account deficit did not take into account the changes which have taken place in the Icelandic economy. Those of us not blessed with the ability to see into the future must make use of recognised economic principles and knowledge of the situation and past developments to draw conclusions as to coming trends in economic affairs.
It is thus hardly surprising that people who are more interested in doing damage to the government than in forecasting actual economic developments in an informed and constructive manner should end up throwing darts in an unlit room. The game can go well enough until the lights come on and the results are revealed, when precious few darts usually turn out to have hit the target.
The rapid adaptation of the economy enables the country to advance forward once more to increased growth. According to most indications this will be the case in the coming years. The national economic forecast predicts zero economic growth for 2002, instead of the contraction forecast earlier. Growth of 1.5% is predicted for 2003 and of almost 3% on the average for the years 2004-2007. National expenditures are expected to drop by 3% in 2002. This can be attributed in particular to a drop in investment, as corporate investment is expected to be about 20% less than in 2001. In 2003, however, national expenditure is expected to increase by 1.5%. It should be mentioned here that these figures do not assume that the heavy industrial projects now being negotiated will become a reality. Were they to be included in the equation, this would naturally mean higher figures.
One of the most important measures of successful economic policy is the purchasing power of household disposable income. This figure tells us more about the development of living standards in the country than most others. In Iceland, purchasing power of household disposable income has increased steadily since 1994, with no end to this trend in sight. Purchasing power is expected to increase by 1.5% in 2002 and a 2% increase is forecast for 2003.
National savings have also increased substantially in recent years in the wake of decreasing national expenditure and are currently an estimated 19% of GDP, whereas in 2000 they were about 14%. Positive foreign trade developments have led to a reduction in the net national debt. The country's net foreign debt decreased this year and a further decrease is predicted for next year.
I should next like to turn to the 2003 budget itself. It provides for an estimated Treasury surplus of ISK 10.7 billion. By comparison, it could be pointed out that the revenue surplus in this year's revised budget is ISK 17.2 billion. I will discuss the year 2002 in particular in the debate on the supplementary budget which has already been presented to the Althingi. The lower surplus for the coming year is primarily the result of the fact that profits from sale of assets are expected to be ISK 7 billion lower than anticipated in this year's budget.
Care has been taken to ensure that the effects of tax reductions are balanced by spending restraint so that they will remain within the framework of the government's financial policy. The Treasury revenue surplus, after deducting profits from sale of state assets, is estimated at ISK 2.8 billion according to this year's budget and ISK 2.2 billion in the 2003 budget. Here it should be borne in mind that the budget provides for using ISK 1.2 billion specifically of the sales value of assets to finance tunnel construction. If this is taken into consideration, the revenue surplus for 2003, not including profits from sales of assets and special allocations there from, will be ISK 3.4 billion. The treasury credit budget surplus is estimated at ISK 10.1 billion, as compared to an estimated ISK 20.6 billion this year. The decrease is the result of lower income from sales of assets and lower repayments on loans granted.
The estimated revenue for the 2003 budget is based on the main conclusion of the economic forecast that the economy is getting back on track after a mild downturn and that growth will increase once more next year. Based on this, tax revenues are expected to increase by ISK 5.3 billion to ISK 232.5 billion. The increase in tax revenue over the previous year can be attributed to increased personal income taxes resulting from higher incomes and to an increase in the social insurance fee. This is balanced against a decrease in personal and corporate net worth tax and a reduction in corporate income tax.
Total state expenditures for 2003 are estimated at ISK 253.3 billion, an increase of ISK 7 billion from the revised budget for this year. The increase is just under 3%, with the result that overall expenditure remains constant in real terms year-on-year. Total expenditure decreases, however, as a percentage of GDP as compared to this year. Calculated at fixed prices, the result is that general operating costs remains practically unchanged year-on-year, as do investments and maintenance, while interest expenditure decreases. Consumption and operating transfers on the other hand, increase in real terms as was pointed out earlier.
The principal change from the previous year is that contributions to shared housing for the handicapped are increased substantially to shorten waiting lists, based on proposals from the so-called "waiting-list committee". The operating basis of health care institutions is strengthened and contributions to universities raised due to increased enrolments. Consumption and operating transfers increase in real terms from the previous year, in part because men's and women's rights to childbirth leave will be equalised next year and due to increased benefits, such as children's benefits. New investment and maintenance expenditure will remain constant as previously mentioned. Contributions to new road works will, on the other hand, increase substantially, by over 20% from the budget proposals due to the special financing of tunnels with profits from the sale of assets. On the other hand, many major projects are reaching the point of completion this year and next year, including the building of the new Annexe of the Althingi, a children's hospital and a new wing for the Iceland University of Education. Finally, the Treasury's interest expenditure is estimated to decrease by ISK 500 million next year.
I have now summarised the main points of the 2003 budget. Normally, discussion at this stage is of a rather general nature. The responsible financial management it represents is good evidence of the government's sound economic policy and effective economic management. This economic management demonstrates both a secure and sound grasp of the current economic situation in Iceland, as well as progressive vision aimed at strengthening the infrastructure of the Icelandic economy, including both households and corporations.
We must remember that the country's value creation and affluence, which are the basis for the living standards we enjoy today, do not simply happen. They have to be created, and in order to do so individual initiative must be given a chance. The role of the authorities is to ensure the necessary conditions for this to be realised. The changes which have taken place in the economic framework and situation in Iceland in recent years mark one of the largest steps ever taken forward in this respect. The changes will also bring results – in terms of steadily improving standards of living in the years to come. The 2003 budget is an important stage on our way forward.
I propose, Mr. Speaker, that, upon the conclusion of this reading, the budget bill be sent for a second reading and to the parliamentary Budget Committee. Now as before, I request the Committee's close and constructive co-operation and hope we will be able to conclude the handling of the budget in early December in accordance with Althingi's agenda.