Iceland Needs To Put In Place 'Challenging Fiscal And Monetary Policies': OECD

by Ulrika Lomas, Tax-News.com, Brussels

07 September 2009

Included in its recently published 2009 economic survey of Iceland, the OECD has described the fiscal consolidation measures which need to be implemented to put public finances back on a sustainable path, and to pave the road for a successful euro-area entry.

As one of the consequences of the financial collapse, the OECD projects Iceland's public deficit to be above 10% of GDP in 2009, adding to the public debt burden. The OECD Survey focuses on a strategy designed to cut the deficit vigorously over the coming years, with the goal of reaching balance.

The IMF also called for this as a condition of the Stand By Arrangement. The strategy includes both tax increases and spending cuts, but the former are easier to introduce immediately.

As a starting point for the tax increases, the OECD Survey recommended reversing the tax cuts implemented in the boom years, which Iceland can no longer afford. This would involve increases in the personal income tax and lifting the reduced rate of VAT.

However the OECD considers that undoing the past tax cuts is insufficient to yield enough revenue; in choosing other measures, priority should be given to those that are less harmful to economic growth, such as broadening the tax base, or that promote sustainable development, such as introducing a carbon tax.

The OECD also proposes an increase in unemployment insurance contributions to a level that would be expected to balance the fund’s accounts over the economic cycle, as planned.

Expenditures that expanded rapidly in recent years are good areas to look at for savings, according to the OECD Survey. Government wages often outpaced those in the private sector, as the then booming financial sector raised the demand for more skilled workers.

With retention no longer a problem, the OECD proposed that government wages should be frozen or even cut in nominal terms, implying significant declines in real terms, at least in 2009. The Survey noted that public investment, which rose at an annual average rate close to 10% over 2003-07, will need to be scaled back as much as possible.

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