Fiscal Budget 2005 – A Good Basis for Continued Growth

The growth of the Norwegian economy is robust, and employment has picked up. A broadly neutral fiscal stance has over the past couple of years facilitated an expansionary monetary policy, and the krone exchange rate is now more in line with its level prior to the strengthening starting in 2000. As a result, the outlook for the exposed sectors is improved. Low interest rates have fuelled the growth in domestic demand. The proposed budget for 2005 provides a good basis for continued growth in the mainland economy. With a modest net tax relief, and a real spending growth of 1¾ per cent, the Fiscal Budget for 2005 provides an overall neutral stance.

Growth in Mainland Norway GDP (i.e. excluding petroleum and shipping) is forecast at slightly above 3 per cent both in 2004 and 2005. Employment growth has picked up and is estimated at 0.8 per cent in 2005. Labour force growth has so far dampened the decline in unemployment. The unemployment rate is estimated to average 4.1 per cent in 2005, down 0.3 percentage points from 2004 average.

As set out in the guidelines for economic policy ( Report 29 (2001-2002), fiscal policy shall be geared towards a gradual and sustainable increase in the use of petroleum revenues. Over time, the structural, non-oil budget deficit shall correspond to the real return on the Government Petroleum Fund. However, the actual implementation of fiscal policy must take into account business cycle fluctuations around the suggested medium term path. A pension reform is an important element in securing fiscal sustainability in the long run. As a follow-up of the Pension Committee’s report delivered earlier this year, the Government plans to present a report on a pension reform to the Parliament during the present year. Moreover, the implementation of a tax reform aims at stimulating labour supply, and strengthening the business sector.

Economic policy aims at stabilizing developments in production and employment. In the present phase of the business cycle, where the growth of the Norwegian economy is about to become more balanced, an expansionary fiscal policy could trigger a renewed strengthening of the Norwegian krone and a weakening of the exposed sector. This would be unfortunate. Measured by its impact on Mainland GDP, however, the 2005 budget implies an approximately neutral fiscal stance.

Fiscal Policy

The main features of fiscal policy in 2005 are:

• A structural, non-oil budget deficit in 2005 estimated at NOK 66.4 billion. This is an increase of NOK 6.3 billion from 2004 to 2005, corresponding to an increase of 0.4 per cent of trend-GDP for Mainland Norway. More detailed analyses indicate that the proposed budget has a broadly neutral effect on the overall activity level of the economy

• A real underlying growth in Fiscal Budget expenditures of about 1¾ per cent from 2004 to 2005

• Tax changes which reduce paid taxes and excises by about NOK 1.65 billion from 2004 to 2005. On an accrued basis, new tax measures imply a net tax relief of about NOK 3.3 billion

• A non-oil budget deficit estimated at NOK 74.3 billion in 2005. This deficit is covered by a transfer from the Government Petroleum Fund

• Based on an average oil price of NOK 230 per barrel in 2005, the central government’s net cash flow from the petroleum activities is estimated at NOK 204.5 billion

• Net transfers to the Government Petroleum Fund, excluding transfers to the Fiscal Budget, are estimated at NOK 130 billion. In addition, interests and dividends on the accumulated capital in the fund are estimated at NOK 40 billion. The consolidated surplus in the Fiscal Budget and the Government Petroleum Fund, including interests and dividends, is thus estimated at NOK 170 billion in 2005

• General government net lending is estimated at NOK 170 billion in 2005, equivalent to 9.8 per cent of GDP. General government net assets are estimated at about NOK 1 550 billion or 88 per cent of GDP at the end of 2005

• A real growth in local government total income from 2004 to 2005 of close to NOK 3½ billion, or slightly above 1½ per cent.

Tax policy

In March of this year, the Government passed a report to the Storting on tax reform ( Report no. 29 (2003-2004)). Chapter 1 of this report is available in English at The main objectives are to achieve a more fair taxation of labour income and to stimulate labour force participation. The tax proposals in the 2005 budget include a first step of the reform. The main proposals pertaining to the tax reform are:

• Surtax rates on labour income to be reduced by 2.5 percentage points for income bracket 1 and 4 percentage points for bracket 2. The maximum marginal tax rate (including employer’s National Security contribution) is thus reduced from 64.7 per cent to 61.5 per cent. Further reductions are foreseen for 2006
• The basic allowance for wage income to be increased both by a rate increase and a higher upper limit
• Tax relief from changes in the surtax and basic allowance amounts to some NOK 7.7 billion
• Dividends and capital gains between companies to be tax exempt from 2004 ( confer press release 81/2004 Tax exemption for companies’ income from shares)
• A dividends and capital gains tax of 28 per cent on individuals to take effect from 2006. Returns on capital corresponding to a risk-free rate will be exempt. Legislation on the tax (the so-called shareholder model) is proposed in the 2005 budget
• Reductions in the highest marginal tax rates and introduction of the shareholder model will pave the way for an abolition of the split model from 2006. The prevailing splitting of business income of self-employed into capital and labour income will no longer be necessary
• The wealth tax to be eased by increasing the threshold for taxation and introducing a joint valuation rate of 65 per cent for all shares and investment fund units. The tax reform calls for the wealth tax to be halved in the course of 2006 and 2007 and aims at its abolition
• Certain deductions and special provisions to be scaled back with the view of simplifying the tax system and financing the reform. The retrenchments amount to an increase of revenue of about NOK 1.1 billion.

Further tax changes in the 2005 budget proposal, not directly linked to the tax reform, include, inter alia:

• A one percentage point increase in VAT-rates. The general rate rises from 24 to 25 per cent, the rate on food from 12 to 13 per cent and the low rate from 6 to 7 per cent. The rate increases are expected to increase revenues by some NOK 6 billion
• Abolition of the tax on imputed rent from owner occupied dwellings and second homes
• Increase in the maximum allowance for charitable gifts from NOK 6 000 to NOK 12 000
• Abatements to the special tax system for shipowners
• A tax incentive to promote low-sulphur fuels.

In sum, the Government’s proposals on direct and indirect taxation involve a certain shift of the total tax burden away from income taxes towards consumption. The proposed changes imply a net reduction in taxes paid of NOK 1.65 billion from 2004 to 2005. New tax measures entail net tax reductions amounting to about NOK 3.3 billion on an accrued basis.

During this parliamentary period and including proposals in the 2005 budget, the overall net tax relief amounts to some NOK 21.6 billion.

More detailed information in English on the tax proposals contained in the 2005 budget is available here.

Monetary Policy

Norges Bank’s implementation of monetary policy is geared to maintaining low and stable inflation (confer Report no. 29 to the Storting (2000-2001)). The operational target is defined as an annual increase in consumer prices of close to 2.5 per cent over time. As a main rule, it is expected that consumer price increases will fall within an interval of +/- 1 percentage point from the inflation target. The interest rate decisions of Norges Bank shall be forward looking, and pay due attention to the uncertainty attached to macroeconomic estimates and assessments. It shall take into consideration that it may take time for the policy changes to take effect, and it should disregard disturbances of a temporary nature that are not deemed to affect underlying price and costs increases.

The regulation stipulates a flexible inflation targeting regime for monetary policy. The long-term role of monetary policy is to provide the economy with a nominal anchor. In the short and medium term, monetary policy must balance the need for low and stable inflation against the outlook for output and employment.

Since December 2002, Norges Bank has reduced its key interest rate (the sight deposit rate) by 5.25 percentage points. The sight deposit rate now stands at 1.75 per cent.

The Government Petroleum Fund

At the end of the second quarter 2004, the market value of the Government Petroleum Fund was NOK 942.4 billion. The market value is now estimated to grow to NOK 1 053 billion at the end of 2004 and to reach NOK 1 244 billion at the end of 2005.

In the Revised National Budget 2004 the Government proposed a set of ethical guidelines for the Petroleum Fund, which was endorsed by the Parliament. The Government will in late 2004 appoint an Ethical Council for the Petroleum Fund. The Council will, in accordance with the ethical guidelines, advice the Ministry of Finance on specific companies that should be excluded from the Petroleum Fund.

Outlook for the Norwegian Economy

After two years of weak growth, the mainland economy picked up from the second half of 2003. Low interest rates and high real income growth have stimulated domestic demand, and the growth in private consumption and housing investment have been strong. Household demand remains the main driving force for growth both in 2004 and 2005. Weaker krone exchange rate and stronger growth internationally have improved the outlook for the exposed industries. Growth in exports of traditional goods has been moderate, but will be somewhat stronger next year, according to revised estimates. Mainland GDP is estimated to increase by slightly over 3 per cent both in 2004 and 2005.

The upswing in the mainland economy is reflected in the labour market. Employment has picked up and the number of vacancies has increased. However, an increase in the labour force has so far dampened the decline in the unemployment rate. According to the Labour Force Survey, the seasonally adjusted unemployment rate was 4.5 per cent in the second quarter of this year, 0.2 percentage point lower than one year earlier. On an annual basis, the unemployment rate (Labour Force Survey) is now estimated to decline from 4.4 per cent in 2004 to 4.1 per cent in 2005.

Consumer price inflation has been low so far this year, due to weak growth in housing rents, falling import prices and increased competition in some domestic sectors. The growth in the consumer price index (CPI) is expected to pick up from ½ per cent this year to 2¼ per cent next year. The pick-up in CPI growth is partly due to increasing prices on imported consumer goods and an increase in VAT of 1 percentage point from 1 January 2005. Adjusted for changes in excise duties and excluding energy prices, consumer price inflation (CPI-ATE) is expected to pick up from ¼ per cent in 2004 to 1¾ per cent in 2005.

Wage growth has decreased since 2002 and is estimated to average 3¾ per cent in 2004. Due to a higher wage carry-over, wage growth is forecast at 4 per cent in 2005.

Key projections for the Norwegian economy. Volume change from previous year. Per cent

Key figures for the Petroleum sector

Source: Ministry of Petroleum and Energy and Ministry of Finance.

Central government net lending (surplus). NOK billion

Source: Statistics Norway and Ministry of Finance.

Key figures for the Fiscal Budget (incl. social security) and the Government Petroleum Fund before loan transactions. NOK billion.