Economic Survey - Norway 2004: Fiscal Reform

 

Does fiscal consolidation need to be more ambitious?

The key requirement for fiscal policy is to establish and maintain credibility of the fiscal rule, faced with spending pressures that will intensify during this decade and onwards, because of rising health spending and public pension commitments, even with reforms to the calculations of benefits as recently proposed. A faster return to the 4 per cent spending rule path than currently envisaged is thus desirable, especially because if markets see that pressures to overspend are irresistible, the currency will tend to appreciate. A further delay of the return to the original oil-rule path would undermine the credibility of the fiscal guidelines. The adoption of a multi-year budget anchor could be a means of achieving fiscal objectives.

Does the planned pension reform address the ageing issue?

Even if adhered to, the fiscal policy guideline will provide little in the way of additional budgetary resources to meet longer term spending pressures from an ageing population. The use of oil money under the rule would increase by only about 1 percentage point of GDP by 2030 relative to its present rate. Gross spending on public pensions, if no reforms are put in place, would rise by some 10 percentage points of GDP. Spending on health is also likely to rise as the population ages. Long term fiscal sustainability should thus be given more priority in policy-making, and room for manoeuvre in current fiscal policy should be decided within those lines. Norway’s unusually large prospective increase in public pension spending reflects generous benefits, a still-maturing system, and (especially) marked expected increases in future life expectancy. Reforms in the old-age pension system are currently under discussion, and three of the suggested measures - to introduce a life expectancy factor which automatically reduces the pension level for an age group if life expectancy increases, to make pensions more actuarially fair, and not to index pensions fully to wages - would reduce the expected increase in spending by 4 percentage points of GDP. These changes should be phased in soon.

Long-term developments in pensions and oil revenues

Per cent of mainland GDP
Source: Ministry of Finance.

To what extent can funding help?

The Pension Commission also suggests replacing the Petroleum Fund and the National Insurance Fund with a new pension fund, supplementing the (reformed) pay-as-you-go (PAYGO) system. How such a fund would operate, and indeed what liabilities it would actually fund, are issues still to be clarified. In any event, funding by itself would not solve the pension problem as the present value of pension liabilities substantially exceeds the combined expected assets of the Petroleum Fund and the National Insurance Fund. Reforms to curb future pension outlays of the sort described above are thus still imperative. One possible advantage to the course suggested by the Pension Commission is that it would be politically difficult to take resources out of a fund that was earmarked for pension payments and use them for other purposes. Pressures to increase public spending in other areas might then be easier to resist. It is important that if the new pension fund is adopted, revenues should be invested in line with the guidelines for the present Petroleum Fund. These would ensure that a large part of oil revenues are invested in foreign financial assets to neutralise pressure on the exchange rate. Safeguarding the capital value of the Fund over time would require fiscal policy to be conducted consistently with the fiscal rule.

How is  non-pension spending being reformed?

Health and long term care expenditures will also put pressure on (especially local) budgets as the population ages, highlighting the need for higher revenues and lower spending elsewhere. A “modernisation” programme for the public sector was launched when the government came to office in 2001. This programme aims at better use of resources, for example by encouraging market solutions in the public sector, but needs to be pursued further. In particular, all for profit contestable services could be privatised, while ensuring a level playing field between public and private providers of public services. To this end, the introduction of VAT compensation for all municipal purchases from private companies is a welcome step. Central government should decentralise responsibility to local governments and design appropriate incentives to encourage public entities to reach mutually agreed performance targets. At the same time, the role of cost-benefit analysis in spending decisions should be strengthened.

Are sickness benefits being brought under control?

While spending on old age pensions will start accelerating in a decade, spending on sickness benefits and disability pensions is already mounting rapidly. The number of persons on long term sickness and different disability schemes has increased dramatically since the mid 1990s. Measures to reduce the recourse to sick leave need to be taken. A 2001 agreement (without financial incentives) between the unions, employers and the government to cut the amount of sick leave by 20 per cent from mid 2001 to the end of 2005 will be difficult to fulfil as sick leave has already risen by more than 10 per cent since then. Hence, the authorities should explore other mechanisms to reduce absence rates, notably through a tightening of the sickness benefits or of their eligibility criteria. Furthermore, enhanced monitoring of the working capabilities of beneficiaries should be further strengthened by the National Insurance Authority.

Sick leave

As a percentage of contractual worker-days

Source: Ministry of Finance.

How can disability pensions be curtailed?

Despite above average life expectancy, Norway has a higher share and a higher inflow of people on disability pensions than most other OECD countries, and so far, few of these eventually re enter the work force. There is also a substantial flow out of long term sick leave into disability schemes. As a result, 10 per cent of the working population and a third of those over 55 are now on disability pensions. The corresponding expenditures put severe pressure on public finances: about 5 per cent of GDP per year is now being spent on disability, rehabilitation and sickness benefits. This disquieting development can partially be explained by Norway’s high participation rate, which means that people more prone to fall sick or into disability nevertheless join the work force. Still, it is plausible that important causes are the overall generosity of the benefit system and inadequate monitoring. To reduce the inflow into permanent disability, a temporary disability benefit is now granted (for a period of between one to four years) when future work-capacity of the individual in question is uncertain; permanent disability pension will only be granted when the individual has no work-capacity. However, further efforts should be made to reduce attractiveness of the schemes and to counter abuses facilitated by complaisant doctors and weak controls. Moreover, independent audits of disability claims should be instituted.

Figure 4.6. International comparison of disability benefit indicators

1. The rate is corrected for persons receiving both contributory and non-contributory benefits (overlap for Canada unknown).
Source: OECD.

How can adverse trends in labour utilisation be reversed?

Norway has among the highest participation and employment ratios in the OECD, notably among women and older age groups, and one of the lowest structural unemployment rates. Yet, average hours worked are relatively low, probably reflecting the high participation rates among women, who typically demand part time work. But average hours worked have also declined faster than in other OECD countries largely, but not only, because of rising recourse to sick leave, as noted above. Enhancing micro efficiency in the labour market is important in order for Norway to remain one of the best performing countries. Removing work disincentives from the benefit system, including those discussed above for sickness and disability, should remain the priority objective in this area. Recent measures reforming the unemployment benefit scheme - a reduction of the maximum duration and replacement rate for benefits, along with a tightening of eligibility requirements    are further steps in the right direction. Finally, a cash benefit - introduced in 1999 for parents not using the publicly-funded childcare centres - tends to reduce female participation in the labour force. Hence, the scheme could be substituted by a voucher system for families to be spent in formal private or public childcare centres, thereby reinforcing the current per user public financing system.

What reforms are proposed to the tax system?

A tax reform is in the pipeline. Tight labour supply and a bias toward housing consumption can be traced in part to tax disincentives. Furthermore, the tax system creates both incentives and opportunities for classifying labour income as lower-taxed capital income. The tax reform proposed by the Skauge Committee makes a good start to correcting these distortions. Closing tax planning loopholes and increasing property taxes while phasing out the wealth tax as proposed by the Committee should be considered. Carefully planned and progressive tax reductions should also be envisaged, especially at the bottom and the top income brackets.

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