Treasury finances 1997-1998. 7. Medium term outlook

Treasury Finances 1997-1998
Iceland, December 1997

As before, the Ministry of Finance, in cooperation with the National Economic Institute and the Central Bank, has estimated the outlook for the economy, as well as the Treasury finances in the next few years. The medium-term scenario until year 2001 includes the figures of the 1998 Budget Proposal, while no additional measures have been included in the following years. Also excluded are any windfall revenue gains as a result of privatisation efforts. The underlying assumptions allow for a moderate growth in social transfers and public consumption, and take into account the effects of the new wage agreements and investments in the power-intensive industry.

Average change per year	%
Gross domestic product	3.4
National expenditure	3.1
Private consumption	4.0
Public consumption	2.3
Investment	1.2
Exports of goods and services	4.8
Imports of goods and services	4.1
Wages	5.4
Consumer price index	3.6
Real per capita disposable income	3.3
Unemployment rate	3.1

Economic growth is estimated nearly 3S% on average during the period 1998-2001. This growth is slower than experienced in the last few years, but higher than expected in the neighbouring countries. The outlook is also for continued growth in employment and purchasing power of households. Exports are expected to increase by about 5% on average, while growth in imports are estimated 4% on average, thus the deficit on the current account is expected to decrease to about 1% of GDP towards the end of the projection period. Foreign debt is expected to fall from 47% of GDP at the end of 1996 to 41% of GDP in 2001. The level of inflation is expected to rise to around 3% on average.
The medium-term scenario envisages a balanced budget measured on accruals basis, throughout the projection period. The primary balance, i.e. excluding net interest payments, shows a substantial surplus in the range of 1S-2% each year. Treasury debt, as a percentage of GDP falls gradually during the projection period, from 46% at year-end 1997 down to 39% in 2001.

The Ministry of Finance has, in cooperation with the National Economic Institute and the Economic Research Institute of the University of Iceland, launched a pioneering work of generational accounts for Iceland. Generational accounts originated in the United States, but have been published for a number of countries in recent years.

Generational accounting. Generational accounts attempt to show in a given base year an individual's payments to the government for the remainder of his/her life and what the same individual receives from the government for the remainder of his/her life, assuming unchanged policy throughout the time period. The result is the individual's net tax payments over the remainder of the lifetime. This can be calculated for each generation of each gender. The same is then calculated for a future generation and compared to a newborn individual, which gives the generational gap. Depending on the size of the generational gap it is possible to estimate to which extent a policy change is needed to close the generational gap and the generational effects of each type of policy change which should prove sustainable.

Results for Iceland. Data collection in Iceland proved easier than in most countries, mainly due to the small size of the population. For instance, it was possible to distribute 92% of the income of the general government by gender and age of individuals. The comparable percentage in the Danish accounts is 73%.
The results are highly dependent on the assumptions made on demographic development, economic growth rate and the interest rate. The assumptions made for the Icelandic generational accounts in the general case were an economic growth per capita of 1S% and a 6% interest rate.
Initial results show that in the base year 1995, a newborn individual can expect to pay 700 thousand krónur more to the Treasury than he/she receives in transfers and services from the Treasury. Future generations, however, can expect to pay 1,900 thousand krónur more than they receive. Thus, the net tax burden of future generations is 161% higher than for the generation born in the base year.
In order to eliminate this generational gap, an increase in tax revenue or decrease in expenditure of around 1% of GDP is needed. However, the different policy changes considered have very different effects depending on the age and gender of the current population. Cuts in expenditure for education effect the younger generation, while an increase in income tax affect the working population.

Base year 1993	Generational gap %
Iceland1	31
Denmark1	-56
Norway	53
Sweden	31
U.S.A.	100
Germany	27
Italy	446
1) Base year 1995. Source: OECD Economic Outlook, June 1995.

For comparison with generational accounting already made in other countries, the calculations were repeated with an interest rate of 5%. Under this assumption, the generational gap is reduced from 161% to 31%, which is similar to the result for Sweden. The estimate for Norway is somewhat higher, or 53%, while the estimate for the United States stands at around 100%.