2023 fiscal budget proposal: protecting purchasing power and combating inflation

Safeguarding a strong position and taking targeted but sensible steps forwards – these are the main tasks for the coming term. This is the main theme of the fiscal budget proposal for 2023, presented today by the Minister of Finance and Economic Affairs and set for submission to before Parliament on 13 September.

The proposal places emphasis on further strengthening infrastructure and basic services, protecting real wages, and preserving the real value of social security benefits. In other areas, expenditures are reduced after increasing steeply in recent years, so as to combat inflation and strengthen the economic and social pillars for the future. According to the budget bill, the central government deficit will amount to ISK 89 bn.

A new reality

The situation in Icelandic society has changed radically in the past two years. Two years ago, aggressive support measures were needed to protect households and businesses and help them to rebound strongly after the pandemic.

This has now materialised. Private consumption has never been stronger, tourist numbers are far higher than previously hoped, about half of Icelandic firms are short-staffed, and the outlook is for net migration to be positive by nearly 10,000 persons in 2022. The economy has grown steadily stronger, and unemployment has shrunk in recent months.

Households’ position has strengthened markedly

Real wages are at an all-time high, and monthly income per capita has risen by ISK 60,000 in excess of inflation since 2016. Purchasing power has therefore grown by 22% in the interim, and this improvement in living standards has been protected in spite of the rise in inflation. Real wages among low-paid workers who are fully employed have risen more than real wages among high-income workers during the period.

An analysis of Icelandic income tax returns, carried out in June, shows that total income has risen for all income groups in recent years, real wages have risen, and the tax burden has been eased for all groups except the highest-paid. Furthermore, 82% of net public revenues from income tax and local tax come from taxpayers in the upper half of the income distribution. Few countries can boast greater equality than Iceland, which also has the lowest proportional poverty rate measured by the OECD.

Strong income growth, interest rate cuts during the pandemic, households’ strong position, and population growth have led to steep rises in house prices. This has significantly strengthened homeowning households’ asset position, but it also means that it takes longer for prospective buyers to save up for their first home.

Even so, the share of first-time purchasers among those buying property is not lower now than it has been in previous years. Among other measures, buyers can use private pension savings to save for their first home, and they receive a 50% discount on stamp fees. It is vital to keep working to ensure that entering the housing market does not become even more onerous. One of the Government’s main aims is to increase the supply of reasonably priced homes, and since 2016 the State and local authorities have allocated capital contributions towards 3,100 rental apartments for lower-income groups. There are numerous signs that house price inflation is slowing markedly, that the number of homes for sale has begun to rise, and that the supply of new properties will begin to grow starting in 2023.

Fighting inflation with responsible measures

This summer the Government announced changes to the fiscal plan aimed at combating overheating and inflation in the economy, as can be seen, among other things, in the fiscal budget proposal. Measures include permanently reducing the central government’s travel expenses, postponing several expenditures until 2024, and reducing contributions to political parties. Also worth mentioning are a review of planned investment, consolidation of State expenditure following the surge of the past few years, and postponement of part of the new scope for expenditure. No consolidation will be required in connection with social security benefits, unemployment benefits, the judicial system, health insurance, healthcare institutions, or institutions for the elderly.

In addition to measures designed to reduce overheating and lower inflation, the Government has placed emphasis on mitigating the effects of inflation on the most vulnerable groups in society through a significant increase in benefits and the introduction of special supplemental child benefits.

It is assumed that a large share of increased Treasury revenues from inflation will be used to preserve the real value of social security system benefits and income tax system benchmarks. The budget proposal provides for a 6% increase in social security system benefits, which is 1.1% over and above Statistics Iceland’s inflation forecast.

Revenue growth through a stronger position

Treasury revenues are set to increase markedly between years, not least because of favourable economic developments, lower unemployment, and planned measures to reduce overheating and inflation. The increase can be seen in value-added tax, investment tax, personal income tax, and payroll tax, among other things.

In coming years, the biggest project for the Treasury on the revenues side will be a comprehensive review of public levies on motor vehicles and fuel. The State’s revenues from motor vehicles and fuel have contracted sharply as progress has been made in transitioning to more fuel-efficient and environment-friendly motor vehicles. New solutions must therefore be found so that the country’s transportation system can be developed and maintained effectively.

A continually growing group of motor vehicle owners pay very little for their use of the road system, as Treasury revenues from eco-friendly cars are very limited. The aim is to develop a fee system that is more usage-based, and changes to be made in 2023 in motor vehicle taxes, excise taxes, and emissions limits will be designed as the first steps towards such a system. This will bring revenues back towards the previous equilibrium and foster participation by more car owners in the unavoidable cost of maintaining the road system.

Strengthening basic services and working against overheating

Expenditure growth is assumed to be modest in 2023, with GDP growth used to strengthen the fiscal position and work against overheating and inflation. Total Treasury expenditure is estimated at ISK 1,296.5bn in 2023, an increase of ISK 78.5bn relative to the 2022 National Budget.

Spending on social, housing, and insurance affairs will increase the most, but healthcare remains the largest expenditure item by far, at nearly ISK 320bn. Allocations to environmental affairs also increase markedly relative to the prior year, including measures for carbon sequestration and greenhouse gas emissions reduction and measures to improve the condition of tourist destinations located within nature conservation areas.

Allocations to healthcare have increased by ISK 40bn relative to 2020. In addition, emphasis has been placed on:

• Increased allocations for hospital operations.
• Construction of the new Landspítali hospital and development of new nursing home space.
• Increased allocations for health insurance.
• Steadily improving mental health service.
• Reduction of patients’ co-payments.

Expenditures relating to social, housing, and insurance affairs rise the most between years and have increased by ISK 33bn relative to 2020. The expenditures have centred on the following, among other functions:

• Steadily improving living standards with stronger basic services and transfer systems such as disability and old-age pension benefits in a changed economic environment.
• Capital contributions for the construction of economical housing; for instance, 3,100 affordable rental apartments have been built with State contributions since 2016.
• Increased housing benefits to support those most in need.

About ISK 26.4bn will be used for various new and expanded projects in 2023. These include:

• Increased allocations for reimbursement of research and development expense.
• Increased contribution for housing benefits.
• Contribution to reduce patients’ co-payments.
• Expansion of Landpítali’s Grensásdeild
• Work on paving connecting roads.
• Temporary contribution for measures to counteract the adverse impact of the pandemic on vulnerable groups.
• Increased allocation for operation of new nursing home space.

Investment has increased substantially in recent years and will be above its long-term average in 2023; however, it will contract marginally so as to combat overheating and inflation. Projects include the following:

• Construction of new Landspítali hospital; estimated expenditure in 2023: ISK 13.4bn.
• Investment in transport/traffic structures: ISK 4.9bn.
• Investment in Digital Iceland and IT projects: ISK 2.5bn.
• Contributions to energy transition and green solutions: ISK 1.6bn.

Strong position in choppy global waters

The global economic outlook has deteriorated rapidly, not least because of higher energy prices, and there is the risk that the situation will grow even worse in Europe. The impact on Iceland has been limited, as Iceland’s share of renewable energy is among the highest in the world, the fishing industry is strong, and demand for travel to the country is brisk. Tourist numbers are now on a par with the pre-pandemic period. The outlook is for Iceland’s GDP growth to be among the highest in the OECD this year, and for inflation as measured by the harmonised index of consumer prices (HICP) to be the second-lowest in Europe.

In order to continue supporting strong social welfare and healthcare systems, it is important not only to bring inflation under control but also to build up fiscal strength for the long term. Iceland looks set to reach a milestone in 2023, in that the ratio of Treasury debt to GDP is expected to decline slightly between years. The successful sale of holdings in Íslandsbanki has played an important role in this. The 57.5% stake sold to date is valued at around ISK 108bn, which slightly exceeds total public investment for 2023.