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Contents | Executive summary | How to obtain this publication | Additional info
The following OECD assessment and recommendations summarise chapter 3 of the Economic survey of Iceland published on 28 February 2008.
Contents
Strengthening the fiscal policy framework could reduce macroeconomic volatility
Since the early 1990s, Iceland has been using a top-down “frame-budgeting” approach and, in recent years, it has also published medium-term budget projections and guidelines for expenditure growth in real terms. However, this has not arrested a tendency towards expenditure drift, which has limited the potential stabilisation role of fiscal policy. There is thus a clear need for strengthening the framework. The government has recognised this and intends to present proposals to Parliament in its spring session. According to the National Audit Office, a number of ministries and agencies have repeatedly overspent their annual budgets with few consequences, despite existing regulations. One reason for insufficient spending discipline is that “frame-budgeting” is not implemented for a multi-year period, which would address the problem of expenditure base drift. To the extent that medium-term plans exist, they have in practice been more a forecasting exercise than a means of budgetary restraint. Moreover, the real expenditure targets are very global and allow large overruns in nominal terms, often related to wage increases. Moving towards a fiscal framework with binding nominal medium-term expenditure ceilings for each ministry would increase spending discipline, improve the counter cyclical impulse from fiscal policy and be more consistent with the inflation targeting framework. Nominal ceilings consistent with the Central Bank’s inflation target would enhance transparency and thus increase the enforceability of fiscal rules; as well, they would increase the public ownership of the objective of controlling inflation. While automatic stabilisers should be allowed to run their course (at least on the revenue side), public investment seems to be an instrument which is ill-suited for demand management. Instead, public investment should be geared to enhancing the growth potential of the economy. Both international and Icelandic experience suggest that timing and implementation problems make investment a poor means of stabilisation policy. Rather than trying to fine tune public investment according to perceived cyclical requirements, expenditure should be implemented on the basis of medium term plans derived from careful and independent cost-benefit analysis. Future direct tax cuts that are desirable for efficiency reasons (but not reductions in indirect taxes) should also be part of a medium- to long-term strategy, which should include quantified objectives for the budget balance (such as a surplus over the medium term) or appropriate government debt levels relative to GDP.
Fiscal rules should be extended to local governments
Fiscal rules at the local government level also need to be strengthened. Municipalities account for one-third of total public spending and more than one half of total government investment. While the local government income tax rate is capped, equalisation payments rise automatically with central government revenues and municipalities have shown even less restraint than the central government in using windfall revenues during the economic boom for additional expenditure. The government has begun negotiations with the local authorities to address these problems, offering debt relief and increased equalisation payments in exchange for the adoption of ceilings on debt and real expenditure growth (including investment). In principle, the same fiscal rules that apply to the central government should also be introduced for local governments in order to achieve national expenditure and stabilisation objectives. The diversity of municipalities, especially their very different demographics, needs to be taken into account, however, as well as costs arising from new central government legislation.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.The complete edition of the Economic survey of Iceland 2008 is available from:
- SourceOECD for subscribing institutions and many libraries
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OLISnet, under "Publication Locator", for government officials with accounts ( subscribe)
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Additional information
For further information please contact the Iceland Desk at the OECD Economics Department at eco.survey@oecd.org. The OECD Secretariat's report was prepared by Hannes Suppanz and Andrea de Michelis under the supervision of Patrick Lenain. Research assistance was provided by Ane Kathrine Christensen.
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