State Aid. Differentiated social security contributions
- Additional information

Introduction

Reference is made to the Authority's letter of 16 May 2003 (Doc. No: 03-2951-D), in which the Authority asks questions regarding the Norwegian Government's letters of 25 March and 10 April 2003 and requests additional information. The Norwegian authorities are pleased to submit the following comments and information on this matter:

Notification of a transitional period – additional information

As explained in our letter of 25 March, the abolishment of the current system as from 2004 would have major negative effects on employment in the regions in question. However, the Competition and State Aid Directorate claims that it would have been possible, at an earlier stage, to introduce measures that would have alleviated the adaptation problems for the industry.

The Norwegian authorities acknowledge that if the negative decision against Sweden is the only factor that is taken into consideration, this could indicate that the Norwegian system would have to be considerably revised. However, the Norwegian authorities continue to hold the view that the Norwegian system must be independently assessed on its own merits by the Authority, taking into account the specifics of the Norwegian situation. Neither the subsequent signals from the Authority in meetings nor the correspondence with the Norwegian authorities seem to indicate any automatic revision of the present system. Thus, the assumption that the Norwegian authorities should have anticipated that the system “by and large could not continue” does not seem to justified, cf. our comments under section 7.2.1 in our letter of 25 March. Given the conditions described in our letter it is difficult to see what concrete adaptations the undertakings could have been recommended to make at that stage. Thus, we maintain the position taken in our letter of 25 March, although we acknowledge that the considerations put forward by the Authority and those put forward by the Norwegian authorities do not coincide on this point.

The Authority states that it would appreciate receiving additional arguments for why enterprises in zone III are thought to need the same transitional period as those in zone IV, in spite of facing a smaller increase in the tax burden. The Authority also states that it would appreciate additional comments or calculations demonstrating the effect of transitional periods of one or two years, respectively, for each of the zones, and compared to the notified three year period. Below follow some additional arguments and comments on this matter.

An increase in the regional social security tax would result in a direct cost increase for the undertakings in question. Without a transitional period the increase in the social security tax would be 9.0 and 7.7 percentage points in zone IV and III, respectively, which corresponds to an immediate increase in the firms’ labour costs of 8.6 and 7.2 per cent (as soon as the allowed de minimis threshold is reached). By comparison, the average annual wage growth in Norway during the period 1992-2002 was 4.3 per cent. In the period 2004 to 2006 the annual wage growth is estimated at 4.5 per cent, cf. Report no. 1 (2002-2003) to the Storting on the National Budget. If no transitional period is granted and provided there are no immediate wage decreases in response to the tax increases, the increase in labour costs of the firms in question in 2004 (when de minimis aid is not taken into consideration) would be almost three times higher than the normal annual increase in labour costs (13.9 and 12.5 per cent in zone IV and zone III, respectively, compared with the estimated annual wage growth rate of 4.5 per cent). With a three-year transitional period, the increase in labour costs would be about half of that (6.8 and 6.5 per cent in zone IV and zone III, respectively).

In these regions, as elsewhere in Norway, wage rates are (mainly) determined through bargaining between the labour unions and the firms or the employers’ associations. Reductions in a firm’s profitability due to the tax increase may affect the unions’ bargaining position and may thereby be partly reflected in a lower increase in regional wage rates. Due partly to downward rigidities in nominal wages (and partly to centralised wage settlements), the possible regional wage responses to a significant reduction in the firms’ profitability can safely be considered very limited in the short run, and would certainly not be fully reflected in the wage rates fixed in the first subsequent wage settlement. In a situation with no transitional period, a full and immediate pass-over in regional wages of the costs induced by the higher tax rate would imply an acceptance by the unions or the employees not only of a lower increase in nominal wages, but in fact of a significant reduction innominal wages. This is simply not realistic . A transitional period of three years, as opposed to no transitional period or a period of one or two years, would i.a. allow for a higher degree of wage adjustment to take place before the full tax rate is introduced. Thus, a transitional period of three years, as opposed a shorter one, would not only postpone the rise in costs to firms, but also reduce the maximum level of costs the firms would have to bear. Hence, both in zone III and zone IV, a transitional period of three years would mean that fewer firms would run into immediate liquidity crises and the total loss of employment/jobs would be reduced.

As the differentiation scheme has been in effect for so many years, the firms have relied on it when deciding on their investments and making contracts for future deliveries. To a large extent such investments are irreversible. Some contracts may entail a relatively long period between the date of agreement and the date of delivery. A significant and unexpected increase in labour costs would lead to lower, and possibly negative, returns on investments that have already been decided upon, and thereby increase the probability of bankruptcy. A transitional period would reduce the unexpected decline in returns on investment decisions made at an earlier stage. At the same time, business decisions made during the transitional period would take account of the announced phasing-out of the reduced tax rate.

In a situation with low economic growth and increasing unemployment, the immediate short-term effect of a sudden increase in labour costs is more dramatic than it would otherwise be. The profitability margins of the industries in these regions are on average low, cf. the figures on the total return on assets for companies registered in zone III and zone IV for the year 2001. 1The total return on assets for companies registered in zone III, zone IV (and zone V) are 6.4 per cent and 5 per cent, respectively, compared with 7.4 per cent in total for all zones, cf. Table 1, Annex 1. The possible total tax increase for the group of companies that may exceed the de minimis threshold would, measured as a ratio of total operating profit in 2001, be about 24 per cent in zone III and almost 40 per cent in zone IV. Based on the 2001 figures, the possible total tax increase would have constituted a significant part of the aggregate total operating profit in the zones concerned. The situation has deteriorated since then. In 2002 the number of bankruptcies in the counties of Troms, Nordland, Nord Trøndelag, Sør Trøndelag and Hedmark increased by 41, 56, 16, 22 and 16 per cent, respectively, compared with 2001 figures. Only the county of Oppland had fewer bankruptcies in 2002 than in 2001. In the first quarter of 2003 the number of bankruptcies increased in all regions compared with the first quarter of 2002. The county of Oppland suffered an increase of 24 per cent. (The figures are not yet available by zones.) The figures reveal that, though the situation may be even more critical in zone IV than in zone III, the industry in both zones is now in such a difficult economic situation that the sensitivity to an abnormal increase in costs would be very high.

The low profitability margins may imply that a significant number of companies would be facing potential liquidity crises or bankruptcy on a short-term basis when the possibilities for costs reductions are limited. The fact that the profitability margins of the industry in these regions are low on average also indicates that there are limited possibilities for increasing product prices. In many cases, lower growth in nominal wages would be the main alternative to closures or reduction in activity. A transitional period would give a lower immediate rise in wage costs and would allow more time for the firms in question to adjust before having to pay the full rate. Due to the economic situation a transitional period of three years, rather than a shorter period or no transitional period, is important both in zone IV and in zone III.

Thus, in the view of the Norwegian authorities, a transitional period of three years as opposed to a shorter period or no transitional period, would most probably reduce the number of closures or necessary downscaling of production resulting from the increase in the contribution rate. However, a transitional period of three years is a very short period for undertaking wage-adjustments when the inflation rate is relatively low. A longer period would therefore be preferable both for zone III and zone IV. The relative differences between the two zones are very small compared with the need for wage adjustments in both zones. A differentiation of the transitional period between the two zones would in our view be unfortunate in the present situation. In both cases a transitional period of less than three years would be too short.

Notification of a new transport aid scheme – additional information

As regards the areas that qualify for regional transport aid, we note that the Authority doubts whether the proposed area for transport aid is in accordance with the first condition in the fifth indent in Annex XI of the State Aid Guidelines for National Regional Aid. Norway is prepared to accept the Authority’s view concerning the replacement of areas/municipalities in counties with a population density below 12.5 inhabitants per square kilometre (Hedmark, Oppland, Telemark and Aust-Agder) with areas/municipalities in Sør-Trøndelag and Møre og Romsdal. As the enclosed statistics show, the total population of the municipalities within the regional state aid map in the counties of Hedmark, Oppland, Telemark and Aust-Agder is 209 593 inhabitants. The population of the municipalities in Sør-Trøndelag and Møre og Romsdal included in the proposed transport aid scheme is 179 792. This means that the population within the area eligible for transport aid in Møre og Romsdal and Sør-Trøndelag is lower than in the first-mentioned counties, which have population densities below 12.5 inhabitants per square kilometre, and that the proposed area is in accordance with the fifth indent of Annex XI to the State Aid Guidelines for National Regional Aid.

As mentioned in the Authority’s letter of 16 May, the four municipalities in Møre og Romsdal (Herøy, Hareid, Ulstein og Aukra) are outside the area eligible for regional state aid that was approved by the Authority in 1999. The regional state aid map is notified for investment aid and not for handicaps due to extra transport costs. As regards transport, companies in those four municipalities face permanent disadvantages as they are islands without any road connection with the mainland.

Companies have to use ferries for all transport of goods between the islands and the mainland. This entails extra transport costs because of:

• the cost of the transport (ferry ticket)
• the extra time involved, which also means extra transport costs
• less flexibility in general. There are generally no ferry connections between the islands and the mainland during the night. This may result in extra transport costs as one has to wait until the next day in order to complete the transport.
• less flexibility regarding when actual transport can take place. Bad weather conditions during the winter may mean that the transport is delayed for several hours or maybe even until the following day.

The Norwegian Government is of the opinion that Annex XI of the State Aid Guidelines allows for a certain flexibility in the selection of areas that are eligible for transport aid. In the light of the arguments above, the Government therefore maintains the notification of the transport aid map as proposed in our letter dated 25 March 2003, including the four municipalities Herøy, Hareid, Ulstein and Aukra.

Notification of continued differentiated social security contribution in Nord-Troms and Finnmark

Reference is made to the Competition and State Aid Directorate’s comments to our notification of a continuation of the current aid scheme in zone V. The Norwegian authorities maintain the position taken in our letter of 10 April.

Definition of undertakings eligible for reduced rates within the agriculture/forestry and fisheries sectors

As mentioned in our letter of 25 March this year, we would come back to a definition of the relevant undertakings within the agriculture, forestry and fisheries sectors for which the current system of differentiated rates would continue to apply. We regret that we, due to the complexity of the matter, have not yet been able to produce a complete draft Regulation which includes such a definition. However, in the following we will present the draft definition of the relevant categories of undertakings that may continue to apply reduced rates. The following definition procedure is strictly related to this particular case on differentiated social security contributions, and does not imply a pretension to decide the general limitation in scope of the state aid rules as regards the agriculture/forestry and fisheries sectors.

Our main concerns when drafting a definition of the relevant undertakings are the compliance with the EEA Agreement as well as having a practicable and comprehensible set of rules for internal purposes. The EEA Agreement does not include a definition of which types of undertakings fall outside the state aid rules. The explicit limitations in scope as regards the agriculture/forestry and fisheries sectors are connected to a listing of products falling outside/inside the EEA Agreement, see Article 8 and Article 20, cf. Protocol 3 and Protocol 9.

One of the important issues should then be to establish which undertakings are engaged in the production/distribution of the types of products falling outside the EEA Agreement. Technically, we propose a two-stage operation, i.e. two sets of cumulative conditions, in order to determine whether the undertaking may continue to apply differentiated rates. The first condition is that the undertaking has to carry out activities falling within certain industrial classifications established by Statistics Norway. The second condition is that this activity must be carried out as regards products falling outside the EEA Agreement.

This is our proposal for types of activities eligible for reduced rates:

1. Growing of crops; market gardening; horticulture
2. Farming of animals
3. Growing of crops combined with farming of animals (mixed farming)
4. Agriculture and animal husbandry service activities, except veterinary

activities

5. Hunting, trapping and game propagation including related service activities

1. Forestry and logging
2. Forestry and logging related service activities, except for the measuring of

wood

05.01 Fishing

05.02 Operation of fish hatcheries and fish farms

15.1 Production, processing and preserving of meat and meat products

15.2 Processing and preserving of fish and fish products

15.3 Processing and preserving of fruits and vegetables

15.4 Manufacture of vegetable and animal oils and fats

15.5 Manufacture of dairy products

15.6 Manufacture of grain mill products, starches and starch products

15.7 Manufacture of prepared animal feeds

51.2 Wholesale of agricultural raw materials and live animals

51.31 Wholesale of fruits and vegetables

51.32 Wholesale of meat and meat products

51.33 Wholesale of dairy products, eggs and edible oils and fats

51.381 Wholesale of fish and crustaceans

61.103 Domestic sea transport, but only as regards fish carriers

63.12 Storage and warehousing, but only as regards management of grain silos

If the activities of the undertaking fall within one of these industrial classifications, the additional condition is that the activity carried out is connected to a product falling outside the EEA Agreement. For the agriculture and forestry sector, this will follow from Protocol 3 to the EEA Agreement. As regards the fisheries sector, the scope of products falling outside the EEA Agreement follows from Protocol 9 to the EEA Agreement. Reference is also made to the Joint Declaration on the Agreed Interpretation of Article 4 (1) and (2) of Protocol 9 on Trade in Fish and Other Marine Products, which states that this sector falls outside the scope of the EEA Agreement.

If the undertaking carries out the relevant activity as regards both products falling inside and products falling outside the EEA Agreement, or carries out both relevant and irrelevant activities according to the list of industrial classifications, the principal rule should be that the undertaking is not eligible for reduced rates. However, if the irrelevant activity - or the activity carried out with irrelevant products - is insignificant seen in relation to the total activities of the undertaking, the current differentiation of rates should be allowed for all the wage costs, according to a de minimis reasoning.

Further information

Please find enclosed the report “Regionale og distriktspolitiske effekter av differensiert arbeidsgiveravgift” from the independent committee “Effektutvalget”. The survey made by the Institute of Transport Economics in Norway (TØI) regarding additional transport costs in the regions notified will be finalised by 6 June 2003. The Authority will then receive a copy.

Yours sincerely,

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