Fiscal Strategy Plan for 2020-2024: Increased resilience in the economy

The fiscal strategy for the years 2020-2024 reflects the strong position and discipline in government finances in a slower-paced economy. The strategy is a key factor in the important task of co-ordinating public finances, monetary policy and labour market developments to maintain economic stability and the prosperity people in Iceland are currently experiencing.

The fiscal strategy ensures a continued budget surplus. Taxation of households and businesses is being reduced, while the Treasury's debt position and interest burden continues to decline steadily. A National Fund will be established to respond to potential financial shocks. At the same time, substantial funds will be invested in facilitating the conclusion of collective bargaining agreements on the labour market and a substantial increase made in public investment when a decline in business investment is foreseen.

Treasury debt resulting from the refinancing of the financial system has been fully paid off and other liabilities due to deficits in the past years have also been reduced sharply. This has substantially reduced the interest burden. Customs duties and commodity taxes on manufactured goods have also been abolished in recent years. Few countries in the world are now as open to international trade as Iceland.

ISK 4 billion in additional appropriations for transport projects

The Government's focus in the Medium-term Fiscal Strategy is based on the last fiscal strategy and the policy statement of the coalition parties. Broadly speaking, expenditures on the various government functions are similar to those outlined in the financial strategy for the years 2019-2023. Specific measures, general restraint and additional dividends have created scope for increasing appropriations to in this strategy to several areas.

Excluding changes due to various technical adjustments, changes in the expenditure framework of the current fiscal strategy will amount to an ISK 2.6 billion decrease in 2019. The major factor here is the shifting of projects related to the construction of the new National University Hospital, together with various road construction projects.

In 2020, changes in to the expenditure framework of the previous strategy will amount to ISK 13.3 billion, ISK 20.2 billion in 2021, ISK 27.8 billion in 2022 and ISK 24.3 billion 2023.

The principal changes are the following:

• Extension of maternity/paternity leave to 12 months in 2020 and 2021; the cost of this action will amount to ISK 900 million in 2020, ISK 2.7 billion in 2021 and ISK 3.8 billion annually from 2022 onwards (in connection with collective wage agreements).
• An increase of ISK 2.1 billion in the initial contributions to subsidised housing from the year 2020 to the year 2022 (in connection with collective wage agreements).
  A total of ISK 4 billion additional increase to transportation infrastructure projects from 2020 onwards.
• Significant increase in appropriations to innovation projects. The largest items here are an ISK 1.1 billion increase from 2020 in connection with the EU Framework Programmes for education, research and technological development, increased contributions for reimbursement of costs to companies in research and development, as in the 2019 budget these contributions increased by ISK 1 billion and will increase by ISK 250 million annually from 2021 onwards. In addition, grants for innovation are expected to increase by ISK 500 million in 2020, by ISK 1.5 billion in 2021 and ISK 2 billion in 2022-2024.
• Investment in hospital services will continue, with the construction of the new National University Hospital the most significant. The intention is to complete construction of the hospital in 2025. Total investment in hospital services will amount to more than ISK 74 billion during the period.
• Appropriations for new nursing home facilities will increase by ISK 500 million in 2020, ISK 1.5 billion in 2021, and ISK 2 billion in 2022 and 2023.
• Changes in the implementation of tax measures from the premises of the current medium-term fiscal strategy. These include ISK 1.6 billion in connection with child benefits, ISK 400 million to support book publishing and ISK 400 million to improve the operating environment of private media companies.
  Increased appropriations for environmental affairs, especially in the context of the government's climate programme.
• Changes to the student loan system through a grant scheme.
• Initial grants for the purchase or construction of subsidised housing increase considerably in the years 2020–2022, amounting to ISK 3.8 billion annually.
• A new marine research vessel will be constructed during the period.

Proposals supporting the negotiation of responsible collective agreements

Wage increases during the upswing period, which has now lasted uninterrupted since 2011, have provided households with greater benefit than ever before. On the other hand, they have led to an increase in labour costs far beyond that of Iceland's main trading-partner countries, and thereby significantly reduced the competitive position of Icelandic companies.

All indications are that further general wage increases will in these circumstances lead to inflation and increased unemployment. The Government has submitted a number of proposals designed to facilitate the negotiation of responsible collective agreements. The aim is to increase support for construction of low-income housing and for first-time buyers, given that housing prices and rents have risen well in excess of wages in recent years. The increase in maternity/paternity leave payments and the extension of the leave period that the government intends to implement during its term of office also comprise an improvement to living standards.

Household disposable income will increase substantially

In recent years, the government has systematically applied benefits and tax transfer systems to improve the situation of persons in greatest need of assistance and assist the private sector in meeting the high wage levels that characterise Icelandic business operations.

In 2014, the first cuts to personal income tax began; tax on intermediate incomes has been reduced by over 3 percentage points in three steps, in 2014, 2015 and 2017. Further changes to personal income taxes are planned, aimed at substantially increasing household disposable income, especially for the lowest income earners. The first phase of these measures came into force at the beginning of this year when the personal deduction was increased by one percentage point in addition to the statutory indexation increase and a 3.7% rise in the higher tax rate floor. The impact of this first phase is more advantageous to lower income groups than to those with higher incomes.

In February 2019, the Minister of Finance and Economic Affairs announced plans for major changes to reduce personal income tax. These include the introduction of a new lowest level tax rate and changes to the cut-off points for higher brackets and to the personal deduction. The aim is to address specifically the needs of the lowest income groups in the labour market.

The proposals assume that the second half of the 0.5 percentage point reduction in employers’ social security contribution will be implemented in 2020; the fee was reduced by 0.25 percentage points at the beginning of 2019. This reduction is intended to strengthen the operating environment for business and boost corporate competitiveness in light of major cost increases recently and thus give them increased leeway in their operations, among other things to meet wage demands.

The tax rate on financial income tax rose from 20% to 22% in January 2018. At the same time, the maximum exemption for interest income was raised and a review is planned of this tax base. The impact of this is still expected to be visible in revenue estimates for the second half of the electoral term. Finally, the proposal assumes that the bank levy will be reduced in four stages over the period 2020-2023, from 0.376% to 0.145%. The reduction is aimed at giving banks scope for a reduction in lending rates. This would improve the situation of both households and corporates, as the financial system White Paper stressed that the increasing cost-efficiency of the financial system would be passed on to consumers in a lower interest rate differential.

Increased resilience with debt reduction

Following the continuous economic growth in recent years, the Treasury's financial position is strong. The Treasury has been operated with a surplus in recent years, and an additional fiscal surplus is anticipated in 2020-2024 amounting to around 0.8-1% of GDP each year.

Significant progress in reducing public and private sector debt, as well as economic changes, has given the economy greater resilience to external shocks. The Treasury's gross debt has declined rapidly in recent years, after peaking at ISK 1,501 billion in 2012, and is expected to amount to just over 830 ISK billion at year-end 2019.

The main objective of fiscal policy will be to continue to consolidate the Treasury's position as far as possible while increasing public activities, and especially investment, to offset slack developing in the economy.