What is the likely impact on public finances from the ageing population?
While boosting labour utilisation and productivity will help maintain GDP growth at a higher rate, Sweden’s rising dependency ratio over coming decades implies substantially greater redistribution via public finances. The reforms designed to put public pensions onto a robust financial basis have eased future budgetary pressures significantly. Nevertheless, health and elderly care expenditures are still expected to absorb a steadily rising share of GDP over the next 40 to 50 years. These pressures will be attenuated by greater utilisation of available labour, especially where it involves people shifting from public benefits into employment, but it will also require vigilance in the management of public finances.
Public finances in the longer term
Per cent of GDP
Source: Statistics Sweden; Ministry of Finance.
How can the government prepare for the demographic changes?
The government, well aware of the importance of good fiscal management, has set itself the ongoing target of a fiscal surplus of 2 per cent of GDP over the cycle, in order to provide for long term sustainability of public finances. Achieving this target for the next 15 years or so would allow net assets to be accumulated that can later be drawn down to finance the additional spending pressures arising as demands on health and elderly care services climb. With a prudent fiscal framework in place, Sweden’s public finances are already in much better shape than in most other OECD countries and the country has virtually no net public debt. According to OECD estimates, structural budget surpluses have averaged around 1¾ per cent of GDP since 1997. But tax cuts and expenditure increases, including for sickness and disability benefits, have produced an estimated structural surplus of only ¾ per cent of GDP in 2003. Hence, strict fiscal discipline will be necessary to achieve the government’s objective of a 2 per cent surplus over the cycle. The costs of slippage in meeting this target could be significant and might jeopardise long-term fiscal sustainability.
Cyclically adjusted general government net lending
Per cent of potential GDP
Note: Numbers differ from Economic Outlook 74 because of the new accrual-based national accounts.
Source: OECD.
What can be done to facilitate an improvement of central government finances?
The government’s present projections show a return to a 2 per cent general government surplus by 2006, but only on the assumption that outlays remain well under the expenditure ceilings. If additional spending were to eat up these margins, as has tended to happen in the past, then the return to a sustainable longer term path would be delayed, unless taxes were raised. This alternative is unpalatable, given the already very high tax wedges. The risk could be reduced if the expenditure ceilings were redesigned to ensure that budget margins are not used for discretionary spending, but reserved for unexpected macroeconomic fluctuations. For the same reason, implementation of the 121 point plan agreed between the government and its supporting parties would compromise the medium-term path if it involved additional spending: adhering to the political commitment to finance any new measures is thus crucial. More generally, ongoing reassessment of expenditure priorities and pruning low-priority programmes would help to make room for new initiatives and/or further tax cuts.
How can upward trends in local government taxes and expenditures be curbed?
Local authorities are also facing growing expenditure pressures, which translate into higher tax rates because they are required to balance their budgets. Large local tax hikes have partly undermined the labour supply benefits of the state income tax cuts. At the same time, the equalisation scheme may to some extent discourage local authorities from expanding their tax base. One option might be to shift part of local governments’ revenue base to property, which would also make local tax revenues less susceptible to fluctuations in economic activity, while another alternative would be to make counter cyclical adjustments to state grants. Both of these would reduce the tendency for the present balanced budget rule to ratchet up local expenditures during economic upswings, and then increase tax rates when activity slows.
Local government tax rates
Per cent
1. Excluding church tax.
Source: Statistics Sweden; OECD calculations.
How could the fiscal framework be refined to help long-term policy appraisal?
For the longer term, it would be useful to refine the current framework so that all the instruments and targets are brought together in a more integrated and transparent way. This would involve interlinking the expenditure ceilings, the balanced budget requirement on local authorities and the employment rate target of 80 per cent with the government’s objective for the national accounts based general government surplus. It would also make it easier to assess the additional policy efforts required, indicate how improvements on one element would flow through to the others, and provide a consistent benchmark for measuring progress against long term objectives.
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