sou · GOB383 · 2001-01-01 00:00:00 — The capacity of public finances and policies to adapt to shocks, and the political choices regarding adaptation to such shocks and timing of adaptation measures are also relevant. For this reason, the state of public finances and budget consolidation measures are addressed in the next section. 3 Balancing of public budgets It has been suggested that public finances in the Nordic countries are especially vulnerable to cyclical fluctuations due to the high levels of revenues and expenditure (TemaNord 1997: 595). From the perspective of public finances the recession of the 1990s represented an attack on two fronts: revenues declined while expenditures increased. Unem- ployment and other economic and social adversities meant that more people were in need of financial assistance from the public purse. Public expenditure thus soared, though it should be noted that not all of this was due to the increases in transfers systems. In both countries the private sector, especially banking, also needed considerable support. At the same time there were significantly fewer people in employment contributing to the public purse. Moreover, as industrial and trade activity declined, there were falling tax incomes from these sources, too. The first-aid solution to the budgetary problems was to increase borrowing, but as the bad years continued to accumulate and public deficits grew rapidly, it became increasingly obvious, not least due to pressure from foreign financing sources, that some solid remedies for the public finance situation were needed. The expected upturn in the economic cycle was not predicted to be sufficient, and both revenue increases and expenditure decreases had to be considered in order to restore balance. Cutbacks in public expenditure followed, and there were also tax increases in both countries. By 1998 public budgets in both countries had achieved a balance of revenues and expenditure comparable to the situation prevailing before the crisis. In fact, at the turn of the millennium and in international compari- sons were among the countries with the soundest budgetary situa- tions. Somewhat paradoxically, the view has prevailed in both coun- tries that the harsh cutback measures have been the best policy for saving the welfare state from future cyclical attacks and cost-pressures created by the ageing population (see e.g. formulations in ). But again, looking closer at the balancing of the public budgets, some considerable variations between the countries can be found. This section will identify some of these differences and emphasise that they resulted from deliberate choices made in economic policy and other political areas. 32 Balancing of public budgets 3.1Problems in public finances The macroeconomic problems and the inexorable rise in unemploy- ment faced public financing with a situation of increased expenditure and declining revenue. In both countries the imbalance was financed with loans. Figure 7 shows the development of public indebtness between 1980 and 1998. Data for 1980s are included to illustrate the different borrowing traditions in and . Between 1980 and 1990 gross debts ranged from 44 percent to 67 percent of GDP in , 12 and 18 percent of GDP, respectively, in . was quite exceptional in international comparisons in this respect.1 The trends from 1990 on are almost identical: a very rapid increase in indebtedness from 1990 to 1993 (in ) or 1994 (in ) followed by a slow decline since then. In relative terms the increase in was clearly more alarming.2 In absolute figures, a debt of 50 billion in 1990 had become a debt of 420 billion in 1998 (Data received from 1999, ). (Figure 7.) 1Net indebtness in both countries has been at a lower level. For instance, pension funds have allowed to have a significantly lower net indebtedness level than that suggested by its gross indebtedness. Still even in a comparison of net debts has had a lower level than . 2Still the indebtness level in 1993 and since at the level of around 60 percent of GDP is close to a European average. Balancing of public budgets 33 Gross debt of the public sector in and –98, percent of GDP Source: database (Summer 1999 update). The state of the budgetary balance is often taken as another indicator of the soundness of public finances. Taking the adverse economic situation into account, it is hardly surprising that between 1989 and 1993 both and went from surplus to deficit. But as had a deeper drop in GDP performance, which by 1993 had resulted in almost double the unemployment of , one might expect this to be reflected in public finances, too. But perhaps surpris- ingly, the figures for public deficits reveal that rather than had the bigger problems, at least if the share of public deficits is the yardstick. moved from a surplus of 6.0 percent of GDP in 1989 to a deficit of 7.1 percent in 1993, while went from a surplus of 5.4 percent in 1989 to a deficit of 12.3 percent in 1993. (Figure 8.) 34 Balancing of public budgets Public deficits as percentage of GDP in and –98 and estimates for 1999–2000 Source: database (Summer 1999 update). On the basis of the data on public deficits in 1998 both countries appear to have managed to balance their budgets. In addition to foreign borrowing, both countries obviously reacted to their uniquely bad defi- cit situation by implementing balancing measures. The shift towards more balanced budgets happened in 1993 in both countries, and by 1998 both had achieved balanced budgets. This was due partly to the economic upswing, but it also to a large degree resulted from policy adjustments. The estimates for 1999 and 2000 included in the figure show that the trend of improving balance is expected to continue in at roughly the same pace, while is expected to experi- ence an interruption.3 The report for by a group of economists argues that the balanced budgetary situation has been a lasting effect of the consolidation programmes (TemaNord 1997: 19). In international comparison few countries have been able to balance their public budgets with such success (see e.g. Mäki et al. Thus not only were the drop in economic performance and the deterioration 3 The difference results from policy choices. According to the Finnish Governments long-term budget plans, the aim is to reach a 5 percent surplus in order to create a reserve for future economic downswings and increasing pension expenditures (). In the government has decided to use some of the space created by the improvement (e.g. by restoring replacement levels of certain benefits to those prior to cuts) (1999). Balancing of public budgets 35 of public finance at the beginning of the decade unique in the industrial world, but the subsequent recovery and consolidation process also seem to be without parallel. The IMF country reports describe the con- solidation in as an unqualified success (IMF 1999a), and use strikingly successful for (IMF 1999b). The similarities with regard to the public deficit and the pace of budget consolidation suggest that both countries felt the need to bal- ance public budgets equally strongly. While strictly economic reasons have been underlined as motivation for balancing, in the public debate two additional reasons for the tight fiscal policy have emerged. Firstly, it has been argued a major shift occurred in the economic policy para- digm. Secondly, and joined Union. On the other hand, there were differences, too. In the recent past had a history of more fluctuation in financial balances, whereas during the 1980s continuously strived to avoid deficits (Pekkarinen and 1993). The countries also differed in their aspirations concerning EMU membership. For some, the fact that had decided to enter EMU may signal that it took the balancing of deficits more seriously because of the deadlines for meeting the convergence criteria. Thus although data on deficit development show a parallel development, and despite the arguments for a similar shift in the economic policy paradigm in both countries, differences in past history and present preoccupations may have affected the timing and strength of reactionary measures. 3.2Public expenditures and revenues Given the described difficulties in the economy, along with high unemployment and problems with public budgets, it seems appropriate to argue that both countries were under the most severe pressure since the 1930s to carry out adjustment measures. The policy reactions to this predicament are now addressed: how did and respond to the new circumstances? It was suggested earlier that in addition to possible differences in the severity of cutbacks, there may also have been variations in timing and in the way cutbacks were executed. To consider these issues we first examine the development of total public expenditures and reve- nues in the two countries to discover how consolidation was under- taken. The interest here is i) in the balance between expenditure cuts and revenue raising, ii) in when the cutback measures were introduced, and iii) in how savings measures were distributed. 36 Balancing of public budgets Yet it should first be emphasised that intentional policy changes certainly do not account for all of the improvement that occurred in public finances; part was surely due to the upswing in the economy. If public budgets are vulnerable to cyclical fluctuations, as economists suggest (TemaNord 1997), it can be expected not only that they deteriorate rapidly and profoundly at times of economic crisis, but also that they recover quickly at times of economic upswing. Public finances may thus improve automatically or intentionally.4 In principle, governments can seek to balance public budgets by increasing revenues or (and) decreasing expenditures. The former method means tax increases, the latter involves cutbacks in existing policies and programmes. Neither of these measures offers an easy route forward for governments. There was already some agreement in and in the 1980s and through to the early 1990s that tax levels were high. Widening of tax bases in the tax reforms in (1989–90) and (1991) proved one way to reduce the pressure to increase the overall taxation rate without an equal loss in tax revenues (see e.g. 1998). As both countries already had relatively high overall taxation rates and were among those with the widest tax bases in the world, there was some pressure to direct consolidation measures towards expenditures. As a first step to assessing the extent of intentional savings we can look at the expenditure in national budgets.5 Figure 9 shows how the expenditure trends in both countries are reasonably alike, at least when public expenditure is measured as percentage share of GDP. The figure shows how the share of public expenditure increased when GDP decreased and that its decline since 1993 has been slower than that increase. Comparing the developments for 1990–93, it can be seen that experienced the most pronounced growth between 1990–91.6 The rising trend decelerated for the next two years, and ceased in 1992. For , expenditures also increased from 1990 to 1991, but most 4This distinction is a simplification, as of course governments intentionally seek to affect the economic development, too. It is, however, difficult to say how much of the economic recovery is due to government policies and how much to other reasons. 5I thank at for his help in getting data. 6This is not only due to economic recession. The Social – led coalition government made their last budget before the Parliamentary elections in 1991. The budget proposal came up with considerable improvements in the welfare sphere (e.g. a considerable increase in the level of unemployment benefits) - and increased public expenditures. SOU 2000:83 Balancing of public budgets 37 strongly between 1991 and 1993. Since 1996 expenditures have declined faster in . Public expenditure as percentage of GDP in and –98 Source: database (Summer 1999 update). A decomposed view of public expenditure development over the period 1980–98 reveals different levels and paths experienced by the two countries. even had declining trend in public consumption expenditure in the 1980s, while was consistently increasing its share of public consumption expenditure as percentage of GDP. The changes of the early 1990s were much more dramatic in , and the declining trend for since 1992 is again consistent while for the decreases seem to have halted in 1995. (Figure 10.) 38 Balancing of public budgets Public consumption expenditure in and –98, percent of GDP Source: database (Summer 1999 update). As regards the share of income transfer expenditures the higher level in in the 1980s is again apparent (Figure 11). The cost expansion of the early 1990s in aligned it with within a few years. Since the mid-1990s the curves have again slightly diverged. Income transfers in and –98, percent of GDP Source: database (Summer 1999 update). In both countries the budgetary problems have resulted in a higher level of debts to manage than in the early 1990s. This is also visible in public expenditures, as interest costs for debts have to come from other expenditures. Comparing the share of interest costs to GDP, it can be Balancing of public budgets 39 seen that the situation from 1980 to the present has not radically altered in (Figure 12). In fact, the figure shows that interest costs peaked higher in relation to GDP in the 1980s cycle than in the 1990s. However, for the 1990s were drastically different from the previous decade, and the after-effects of the economic crisis on public expenditures are also highly visible in terms of interest costs. This contrasting scenario in may be underlined by another ratio: in 1980 interest costs accounted for 2.3 percent of total public spending, in 1990 for 3.1 percent and in 1998 for 9.3 percent (own calculations from budget figures). In terms of interest rate expenditures, the two countries look more similar at the end of the 1990s than at the beginning of the 1980s. Interest expenditures for public debts in and –98, percent of GDP Source: database (Summer 1999 update). The entire public sector in had higher revenues than expendi- tures in 1990, after which revenues declined and expenditures increased, as can be imagined. 1993 is the clear turning point for reve- nue trends; expenditures continued to increase until 1997, and a bal- ance was reached in 1998. The prognosis for future trends is for reve- nues to continue to increase rapidly, while expenditure development is held stable. The development of state finances is quite similar (Figure 13). Between 1990 and 1993 revenues dropped sharply at the same time as expenditures increased, and the turning point in revenue trends again occurred in 1993. The subsequent marked increase in revenues reflects the enhanced economic activity and improved employment situation. Revenues from taxes have increased by around 6 percent a 40 Balancing of public budgets year since 1994. Revenues from value-added taxes have risen most, reflecting the recovery of domestic demand. (1999a, ). State expenditures and revenues in 1990–98, million in 1998 prices Source: Data received from , . Although a clear improvement in revenues is apparent, it needs to be emphasised that the balancing of state budgets in was not achieved via tax increases. Those that were implemented were minor; they included i) increases in individual social security contributions, and ii) a so-called loan tax for the first three crisis years, which involved a delay in paying out tax returns (paid later without any interest). The tax rate remained very during the decade. In 1990 the tax rate was 45.2 percent, and fluctuating less than 2 percent in the intervening years it was 46 percent in 1998 (1999b, ). Tax increases have thus played only a minor role in the balancing of state budgets.7 Improvement on the revenue side has occurred more thanks to the upswing in the economic cycle. When assessing budget balancing in one thus needs to look closer at the expenditure development, although the figure does not reveal what this would look like without saving measures. In policy rhetoric it was argued that cuts were necessary to restore trust in the Finnish economy. From this perspective cuts may also have contributed to the balancing 7 In addition to state tax the Finns also pay a municipal tax. Many municipalities have increased taxes during the 1990s. Balancing of public budgets 41 of public budgets in an important symbolic way, if they helped to boost economic activity. According to calculations by , the cuts amount to a total saving of 57 billion between 1991 and 1999 (). Of this total, 35 billion was saved between 1991 and 1995 during the government term of the Centre Party – led coalition government, and 22 billion between 1995 and 1999 during the government led by the Social and the National Coalition Party. Overall this is equivalent to 8 percent of the 1999 GNP. Yet as can be seen from the figure above, savings measures of even this magnitude could not curtail the rise in expenditures. A crude breakdown of savings show that major cuts were achieved by reducing state subsidies to municipalities; 14.5 billion was cut from state subsidies to local authorities. Cuts in various income trans- fer programmes make up another major savings category, totalling over 25 billion . specifically, unemployment insurance cuts worth 5.5 billion were implemented, while a cut of 4.5 billion was targeted at employment measures. Expenditure on pensions was reduced by 4.5 billion and sickness insurance by 3.5 billion . Increases in sickness insurance contributions amounted to savings of 1.5 billion . Cuts in family benefits totalled 1 billion , in housing allowances 5 billion , in student allowances 0.5 billion , and cuts in other social protection expenditure totalled 0.5 billion . All other savings (subsidies to agriculture and firms, administra- tion costs and foreign aid being the most important categories) account for a total of 14 billion , (). These figures make clear that the social security system was the main target for savings. Cuts in state subsidies affected the financing base of municipalities and their potential to provide services. As about 80 percent of municipal expenditure goes to health care, social care and education, the state subsidy cuts have substantially affected the financing base of welfare services. Including state subsidy cuts, it can thus be roughly calculated that in about 70 percent of all savings measures were implemented in the social policy sector (trans- fers and social- and health care services). If one equates cuts in state subsidies with the social and health services, approximately two thirds of social policy – related savings were achieved via transfer cuts, and one third by service cuts. 42 Balancing of public budgets In , the Bildt government made savings during 1992 and 1993, but according to the budget consolidation took place in earnest only between 1994 and 1998. On the basis of estimates of total savings during the 1990s (1999, ) it can be calculated that 85 percent of savings were implemented after 1994. In 1994 the fiscal balance was –10.3 percent, while four years later in 1998 the balance was positive (+ 2.4 percent), having thus strengthened considerably by more than 12 percentage points. Figure 14 shows that revenues increased faster than expenditures declined. As in , the expenditure level was still higher in 1998 than in 1994. Yet in relation to GDP development, it is clear that much of the improvement resulted from the expenditure side (8 percent reduction compared with almost 5 percent increase in total revenues). According to the this improvement has chiefly been due to the impact of the governments consolidation programme, not to cyclical or other temporary factors. State expenditures and revenues in and 1998, million SEK Source: Data received from 1999, . The Swedish consolidation programme was designed for 1995–98 (TemaNord 1997: appendix). It contained balancing measures worth and was established in connection with the conver- gence programme of 1995. In , a further Balancing of public budgets 43 of savings was added to the programme. Altogether this corresponded to savings of 8 percent of GDP for the four-year period 1995–98. According to calculations by the the impact of the measures was mostly felt between 1995 (3.5 percent of GDP) and 1996 (2.0 percent of GDP). The Swedish consolidation programme included both tax increases and cuts in expenditures. The savings programme was estimated to yield as increased revenue, and as reduced expenditure (TemaNord 1997: appendix). Prime Minister book Den som är satt i skuld är inte fri lists the savings and how they were distributed over time (Table 4). Two thirds of the savings were introduced during the short period between and Spring 1995. Timing and impact of savings decisions in –98 Savings decisions prior to 1994 Negative effect from decreases in incomes Source: Data received from 1999, . Of the tax increases, the most notable was the introduction of the indi- vidual social insurance contribution (allmän egenavgift) in 1993. The contribution has since gradually been increased and in 1998 it was planned to amount to 6.95 percent of gross income (TemaNord 1997: appendix). The national income tax was raised from 20 percent to 25 percent for incomes above a given level (i.e. for those with the highest incomes). Another important tax increase involved the property tax. There were other changes directed at raising more revenues, too, and the total impact of the consolidation programme on revenues was . Almost all expenditure cuts during the Bildt government and prior to 1994 were targeted at social security. They amounted to (cuts in pensions , in sickness insurance , in family policy , in rent allowance , and in housing subventions ). Between 1994 and 1998 heavier cuts were introduced and they were more evenly distributed between different administrative sectors. 44 Balancing of public budgets detailed information on cuts in the various Ministries budgets, it can be only roughly calculated that cuts in the budget amounted to less than 50 percent of all cuts. This sum does not include cuts in labour market policy measures. On the expenditure side the programme included cuts in pensions, sickness insurance, unemployment benefits, child allowances, changes in indexing of social security benefits, and other measures. It is noteworthy that a deliberate policy choice was not to make cuts in services, as it was thought shortcomings in health care or child day-care might have negative effects on health and life opportunities (and Wennemo 1998: 19). 3.3Balance sheet on budget consolidation in and While collecting material for this report it proved to be difficult to obtain detailed information on how consolidation was achieved. The account given here was based on general lists from the Ministries of Finance in both countries, and should thus be taken as a rough indicator of developments. detailed investigations would surely be helpful to further evaluate policy choices regarding cutbacks. On the basis of the material accessible for this report, a preliminary conclusion on the robustness of the intentional balancing measures is that the governments in both countries consolidated public budgets equally successfully. National assessments made at the Ministries of Finance come up with a very similar picture: in the savings amounted to 8 percent of GDP (GDP in 1999 figures), and in also the savings amounted to 8 percent of GDP (GDP in 1998 figures). As a result of the consolidation measures, public deficits were trans- formed into a surplus in both countries in a roughly similar and speed, but the way this was achieved differed.