Fiscal plan 2022-2026: The right measures delivered progress and a positive outlook

The Government’s measures in response to the global COVID-19 pandemic have been highly successful, and the medium-term outlook is more favourable than was assumed last year. Households’ disposable income increased in 2020, and the contraction turned out considerably less than previously estimated. These are the main elements of the fiscal plan for 2022-2026, introduced today.

The actions taken by the Government in the past year have mitigated the economic crisis, with well over 3,000 companies and tens of thousands of individuals benefiting from a variety of support measures amounting to tens of billions of krónur.

In the next few years, the economy is expected to rebound strongly, and the Government’s principle objectives in the fiscal plan are to support economic growth and halt debt accumulation.

Responses to the pandemic

The Government’s objective is for Iceland to emerge from the current economic situation an even stronger and more competitive society where prosperity is based on a robust economy and the vigour of its people. The main focus of pandemic response measures is three-fold:

1. Fiscal policy in the service of resilience. Fiscal policy applied systematically to ensure stability and create economic resilience. Emphasis placed on safeguarding the progress made in social welfare and healthcare.
2. Valuable jobs, investment, and increased prosperity. A strong foothold for an economy driven by valuable jobs and investments. Emphasis on education, research, innovation, infrastructure, and environmental and climate issues. Targeted reforms to the economic and employment framework, with the aim of boosting long-term prosperity
3.  More efficient services and fiscal sustainability. Modernisation of the public sector in accordance with changed needs and conditions. Digitisation of services and strengthening of local government structure. Ensuring resilience against unforeseen shocks with debt reduction and fiscal sustainability, so that the burden will not be borne by future generations.

Strong foundations

The Government’s ability to respond to this economic crisis is based not least on the Treasury’s strong position at the beginning of the pandemic. In recent years, Iceland’s economic framework has been strengthened systematically with tax cuts, simplification of the regulatory framework, fortification of the economic policy framework, and reduction of public debt. In addition, increased GDP growth has been used to strengthen public services and further shore up the strong social welfare system that has been challenged in the past year.

Public services and the transfer system have not been cut back despite a large operating deficit. At the same time, special support has been provided to the households and businesses that have been most profoundly affected by the pandemic.

Because of this strong, systematic response, domestic demand contracted less than 2% and households’ disposable income increased in 2020. The outlook is for the economy to grow by nearly 5% in 2022, and a large share of the pandemic-induced contraction in GDP looks set to be recouped in the next few years, especially if the most optimistic scenario in the fiscal plan materialises.

Contraction much smaller than forecast

New figures from Statistics Iceland show that the year-2020 contraction was smaller than had been forecast. These figures indicate that the Treasury deficit totalled about ISK 200bn, or 6.6% of GDP, in 2020 – some ISK 70bn less than was projected in November and December. This is due in part to more positive economic developments and stronger private consumption than had been anticipated.

In 2021, the Treasury outcome is expected to be negative by 10.2% of GDP, which is broadly in line with the estimates in the fiscal budget and the fiscal plan for 2021-2025, which assumed a deficit of 10.6% of GDP. During the horizon of the fiscal plan, it is also assumed that the outlook for the Treasury and public sector will be more favourable than before.

The fiscal plan assumes that the Treasury outcome will gradually improve until the primary balance turns positive in 2025. In 2026, the outcome is expected to be negative by ISK 59bn, or 1.4% of GDP, at which time it will have improved by nearly 9% of GDP since 2021.

The prospect of a better outcome also entails that the need for consolidation measures to halt debt accumulation by end-2025 will decline by one-fifth, to ISK 102bn.
The fiscal plan states that temporary economic support will be continued as needed until the economy has rebounded satisfactorily. The objective, however, is to scale down special support measures rapidly in 2022, as firms become increasingly able to operate without support.

A stronger recovery in 2022 and 2023

The economic recovery is projected to be weaker in 2021 but stronger in 2022 and 2023, when it will be driven by rising tourist numbers. A total of 720,000 tourist arrivals are projected this year, a 50% increase relative to 2020.
According to Statistics Iceland’s final forecast prior to the fiscal plan, GDP growth is set to measure 2.6% this year,
4.8% in 2022, and 3.8% in 2023. Based on that forecast and forecasts from the beginning of 2020, GDP will still be ISK 130bn less in 2024 than it would have been if the pandemic had not occurred.

Debt accumulation halted in four years

In the next few years, Treasury debt will increase markedly, yet the debt position will nevertheless improve relative to the last fiscal plan. This is due to greater economic resilience than was widely expected and a strong economic rebound, which will cause public debt to rise less steeply than was assumed at the time of the last fiscal plan. Debt is expected to peak at 54% of GDP in 2025 instead of the more than 60% provided for in the previous fiscal plan. Furthermore, the Treasury outcome is expected to by ISK 60bn stronger in 2021-2025, even though it is assumed that measures to halt debt collection by more than ISK 7bn per year in 2023-2025 will be scaled back relative to the last fiscal plan.

In coming years, continued emphasis will be placed on public sector reform, not least through the use of digital services and information technology. In the Government’s investment initiative, ISK 12bn have been earmarked for such projects in 2020-2025. This investment will deliver not only improved communications between the Government and the public, but also financial benefits for households, businesses, and – last, but not least – the Treasury. The success achieved in adopting this new technology and in recouping the output lost due to the pandemic, including with Government measures, will determine how extensive performance-enhancing measures will have to be in order to halt debt accumulation during the horizon of the fiscal plan.

Job creation the key task

High, protracted unemployment is one of the biggest problems Icelandic society faces. Unemployment roared after the COVID-19 pandemic struck, even though some weakening occurred beforehand, particularly in the tourism sector. Unemployment is projected to measure between 4% and 5% by the end of the horizon. This is somewhat above the average of recent decades, as well as a probable indication of persistently higher unemployment than Iceland has been accustomed to, if no action is taken. This trend is due in part to the fact that the impact of the pandemic is longer-lasting than originally hoped; therefore, it is clear that more people will be outside the labour market for a longer period of time. Partly because of this, the Government has strongly emphasised measures enabling job-seekers to add to their skills and education. Furthermore, broad-based job creation measures have recently been announced, with particular focus on the long-term unemployed. These measures are expected to create roughly 7,000 jobs through end-2021.

Safeguarding social welfare and moving forwards

The fiscal plan for 2022-2026 reflects the strategy of the past four years, which has been adopted by a Government spanning the entire political spectrum from left to right. The plan reflects both the priorities and the progress that have been achieved with the Government platform. The platform laid down a strategy of strengthening the social welfare system, embarking on large-scale infrastructure investment, and lowering taxes, as well as setting ambitious environmental goals. The scope afforded by a period of robust GDP growth was used to fulfil promises of increased welfare and purchasing power, and the resilience of the economy has simultaneously boosted with significant debt reduction.

During its term in office, the Government has emphasised broad-based social infrastructure development. This includes strengthening healthcare services, strengthening the educational system at the upper secondary and university levels, placing increased emphasis on research and development, introducing a major transportation initiative, strengthening various law enforcement and border-related projects, increasing regional development funding, building up infrastructure at tourist destinations and increasing patrolling, and taking environmental action. During the term, spending on functions has been increased by more than ISK 80bn in real terms, of 12%.

Key priorities during the Government’s term in office

• Allocations to innovation, research, and knowledge sectors have increased more than 70%.
• The secondary and tertiary educational system has been strengthened, and legislation on a new Student Loan Fund has been passed.
• Allocations to transportation and telecommunications have increased by over 60% in real terms, from ISK 36bn to nearly ISK 60bn.
• Since 2017, allocations to social, housing, and insurance affairs have been increased substantially, or by ISK 95bn.
• Operational contributions to healthcare have increased markedly and will equal nearly ISK 258bn by 2022.
• Allocations for investment in the healthcare system will be ISK 19bn higher in 2022 than in 2017, owing largely to the construction of the new Landspítali hospital.
• Allocations for environmental affairs will be increased substantially. Among key priorities are soil conservation and wetland reclamation; furthermore, emphasis has been placed on reducing levies on eco-friendly transportation and supporting energy switching.
• Allocations and tax subsidies relating to climate action have increased by over ISK 7bn since 2017.
  
  

Levies on households and businesses have declined markedly during the term

Key changes

• The tax system was reviewed with the aim of boosting disposable income for low-income groups, boosting the competitiveness of the economy, and working towards the achievement of the Government’s environmental objectives.
• The largest single tax cut in the past four years is the change in personal income tax, which took full effect at the beginning of the year. Individuals’ disposable income will be ISK 23bn higher each year of the horizon of the fiscal plan.
• The increase is largest for the lowest-paid workers, or about ISK 120,000, with the changes. This is an important improvement, particularly during difficult times like these, and they play a large part in the fact that disposable income did not fall in 2020 despite the economic crisis.
•  Payroll taxes have fallen markedly during the term. Companies’ tax burden is now about ISK 8bn lower per year than it was previously.
•  The investment tax base was reviewed, and the tax-free threshold was doubled at the turn of the year, and tax treatment of capital gains on the sale of vacation property and other second properties has been equalised.
• The tax-free threshold for inheritance tax was increased significantly at the beginning of the year, with levies set to decline by about ISK 500m as a result.
• A bill of legislation providing greatly increased incentives for individuals and firms to support activities for the public good has been introduced and is expected to reduce Treasury revenues by about ISK 2bn per year.

Agreement with municipalities extended

Each year, in connection with the preparation of the fiscal plan, an agreement is made between the State and the municipalities on the basis of the Acton Public Finances. The current agreement was made on 30 September 2020,
in connection with the current fiscal plan, and covers the period from 2021 through 2025.

Given that a short time has passed since the fiscal plan was prepared and the current agreement signed,and because there will be only minor changes stemming from the update of the outlook for the municipalities’ outcome and debt position, the so-called Jónsmessunefnd has agreed that the current agreement, for 2021-2025, will remain valid for 2022-2026.

On the fiscal plan

The fiscal plan for 2022-2026, which is now introduced, is the current Government’s last fiscal plan before the next Parliamentary elections. At the same time, this is the first time since the entry into force of the Act on Public Finances in 2016 that a Government has been in power for a full electoral term and has therefore been able to follow through on its economic and fiscal policies as laid down in its fiscal strategy and further developed in each year’s fiscal plan and fiscal budget.

This year’s fiscal plan is introduced under extraordinary circumstances. The current fiscal plan was approved later than usual, or in December, and Parliamentary elections are scheduled for September 2021. This entails that a new fiscal plan will be presented by a new Government in spring 2022, and it will be based on a new fiscal strategy, which will be introduced no later than at the time the fiscal budget proposal for 2022 is introduced. These extraordinary circumstances and the importance of the contribution of public finances to economic policy in the coming term are reflected in the fiscal plan’s emphasis on re-establishing a sound fiscal situation in the next few years.