Treasury finances 1997-1998. 2. Economic policy

Treasury Finances 1997-1998
Iceland, December 1997

The main characteristics of the Icelandic economy have changed notably in recent years. The business climate has dramatically improved following extensive restructuring. At the same time, the economic situation has markedly improved and Iceland has enjoyed a delightful mixture of economic growth, low inflation and falling unemployment. The fiscal deficit has also rapidly diminished, heading for a balance in 1997 and 1998.

The overriding economic policy concern of the Government is to maintain and strengthen the stability of the Icelandic economy to ensure continued economic growth and increased employment. A credible fiscal and monetary policy is seen as a prerequisite for this, through lowering interest rates and encouraging private investment. Another important policy consideration has been to move the Icelandic economy towards openness and liberalization of markets, especially the financial markets. Significant structural reforms have also been implemented in the public sector with corporatisation of public enterprises and privatization, most notably in the financial sector.

The changes that have taken place in Iceland in recent years have strengthened the Icelandic economy and made the business sector more competitive than before. This surfaces in a much improved business climate, a growing export sector and stronger investment activity. As a result, Icelandic enterprises have in the past few years rapidly increased their investment activity abroad. Also, these changes have paved the way for increased foreign investment in Iceland, especially in power-intensive industry. Foreign investment is also gathering strength in other sectors of the economy.

The 1998 Budget Proposal reflects this policy emphasis. For the second year in a row, a surplus is foreseen, thus reversing a trend of continuous deficits since the mid 1980s. It is important to aim for a surplus in the coming years to strengthen national savings, lower public debt and reduce the debt service payments that accumulate.

A stronger fiscal position has also made it possible to lower taxes and increase expenditure on health care and education. In this context, the personal income tax and the child benefit systems were revised earlier this year to reduce marginal effects. The Minister of Finance has also initiated a thorough review of the overall tax system in Iceland in light of the most recent changes in Europe and possible steps towards tax harmonization in the European Union.

In order to prepare for the significant demographic changes as a result of the ageing of the population, the Government has recently introduced a pension reform scheme aimed at increasing national savings. The reform implies that a larger share of personal income will receive favourable tax treatment if this is invested in long-term pension schemes. This follows a recently legislated reform of the public pension funds making them fully funded. Furthermore, under the auspices of the Ministry of Finance, the Economic Institute of the University of Iceland has recently presented the first ever generational accounts for Iceland, underlining the need for further fiscal restraint in the coming years.