A strong recovery vouches for a clear strengthening of public finances

14 September 2021 | News

The Swedish economy is in a strong phase of recovery. GDP will increase by 4.3 percent this year. The recovery is supported by an expansionary fiscal and monetary policy and a gradual lifting of restrictions. Despite extensive increases in expenditure and further tax cuts this year, the general government deficit is expected to be significantly smaller than last year. In addition to the strong recovery during the year, the reduced deficit can largely be explained by high income from tax on capital. Next year, net lending will strengthen further, and public sector net lending will then be close to balance. But the structural balance is still lower than the target level in 2022. At the same time, the debt will already be under the target level for the debt anchor next year.

Strong growth in the economy this year as well as the next

Overall, GDP growth was good during the first two quarters of the year, despite the fact that the infection rate was high during much of the spring. Several factors suggest that the recovery will continue at a good pace for the rest of the year. The indicators are strong although they have slowed somewhat recently, monetary and fiscal policy is expansionary, the demand for Swedish exports is strong and household net lending is high. Given the high rate of net lending, households have the opportunity to increase consumption of, among other things, services that can be accessed again as the pandemic restrictions are being lifted.  This means that the recovery is increasingly borne by household consumption, which is expected to grow at a good pace also during the beginning of 2022. Measured as a calendar-adjusted annual average, GDP will increase by 4.3 percent this year and the Swedish economy will reach full resource utilization around the turn of the year 2021/2022. Growth will be strong next year as well, with GDP increasing by 3.2 per cent.

However, several circumstances contribute to uncertainty about both the global and the Swedish economy in the short and the long term. It is still uncertain how the spread of infection will develop in large parts of the world and how big the effects of the pandemic will be on the Swedish economy this year and in coming years. The spread of infection is high in some places and in several countries the vaccination rate has come to a standstill. This risks leading to extended or reintroduced restrictions in several countries. This may exacerbate the shortage of inputs that has already led to production stoppages in some areas of industry. In addition, cement supply can affect large parts of industry if a more permanent solution to the issue of continued lime mining on Gotland cannot be found. In the long run, this could have consequences for growth in the Swedish economy.

Both tax revenues and expenditure subject to the spending cap will increase this year

Tax revenues fell sharply last year, mainly as a result of the sharp slowdown in the economy, but also as a result of both temporary and permanent tax cuts. This year they will be increasing strongly instead, as the economy recovers. Revenues from all forms of tax will be higher than last year. Next year, revenues will increase at a relatively rapid pace as growth in the economy remains high. Household capital gains will rise this year to the highest level ever recorded. This is a consequence of the unexpectedly sharp increase in stock market prices and housing prices. Capital gains are not expected to remain at the current high levels, but will return to customary levels in the coming years.

Even though tax revenues increase rapidly, the tax ratio will fall by 0.3 percentage points this year. This is mainly due to the tax ratio being upheld last year, despite tax cuts, as the possibility of short-term layoffs meant that taxes on labour did not fall as much as GDP. Further tax cuts this year will also help reduce the tax ratio.

Capped spending is increasing even more this year, from last year’s high level. This is mainly due to continued pandemic-related crisis measures, primarily in the health and medical care area. Other areas where expenditure will increase significantly this year are: transportation (increased investment in and maintenance of roads and railways), education and university research (temporary increase in opportunities for adult education and at universities and colleges, and increased funding for child and youth education) and the labour market area (more people in labour market policy programs). The increase in expenditure this year is mainly offset by a reduction in expenditure in the business sector following the gradual reduction during the year of pandemic-related crisis measures. Next year, spending-capped areas will decrease since pandemic-related expenditure has ceased in several areas. Total government spending is already falling this year, however, as a result of a sharp decrease in net lending from the Swedish National Debt Office. This is because several of the loans raised on behalf of the Riksbank (Sweden’s central bank) are falling due and being repaid.

Decreasing public sector deficits

The coronavirus pandemic and the emergency measures introduced to mitigate its economic effects resulted in a large deficit in public sector net lending last year. Tax revenues decreased at the same time as government expenditures increased sharply. This year, the general government deficit will be smaller, but it will still amount to 1.9 percent of GDP. Central government expenditure increases further. At the same time, central government revenues will increase significantly this year, even while the upturn is being held back by tax cuts. In total, the state deficit is decreasing by SEK 27 billion, compared with last year.

The local government sector reported a surplus last year due to the growth in spending being relatively weak as a result of many activities not attaining normal levels. At the same time, revenues increased strongly as a result of a sharp, although temporary, increase in central government grants. This year, expenditure will increase significantly more. However, since tax revenues are increasing more strongly than last year while government subsidies increase further, the local government sector will show a significant surplus again this year.

Next year, the general government deficit will decrease significantly when most of the temporary supports cease. Central government net lending will then show a small surplus. In the local government sector, however, the surplus will be replaced by a deficit as a result of the reduction in central government grants.

The structural balance – i.e. financial savings adjusted for cyclical variations and one-off effects – is expected to show a deficit corresponding to 1.6 per cent of potential GDP this year. This is a 0.3 percentage points higher deficit than last year. The Maastricht debt is above the target level for the debt anchor this year, but just below the upper limit. To counteract the economic effects of the pandemic, it has been reasonable to budget for deviations from the target level [1]. However, the structural balance is below the target level next year as well. Given that resource utilization in the economy will have reached normal levels in 2022 and that net lending, without additional reforms, will already be below the target level, there is, according to a strict interpretation of ESV's calculations, no scope for unfunded reforms if the surplus target is to be achieved. At the same time, the fiscal policy framework states that savings should be strengthened at a moderate pace with normal resource utilization, which may leave some room for unfunded reforms in 2022. [2] But the government should in the budget bill point out a direction for how savings will be returned to the target level.

Stronger budget balance every year compared to the June forecast

Compared with ESV's June forecast, both GDP growth and employment growth have risen slightly. Total earnings have increased as well. This contributes to the fact that tax revenues have been revised upwards for all forecasted years. The largest elevation is for the current year. Taxes on labour as well as on capital and consumption are expected to be higher. Household capital gains have been raised throughout the period, primarily as a result of the strong outcome for 2020.

Both the total expenditure and the capped expenditure areas have been written down for 2021 compared with ESV's June forecast. The largest revisions, concerning the expenses for net lending and the EU fee, are due to outcomes and due to Sweden's discount on the EU fee for 2021 being paid this year instead of 2022, which we expected in June. For 2022, expenditure has been revised upwards, which is largely explained by the new profile of Sweden's discount on the EU fee. Lower expenditures and higher revenues mean that the central government budget balance has been sharply revised upwards in 2021. The budget balance has also been strengthened for 2022-2024.

General government net lending has been revised upwards by almost SEK 50 billion, or 0.9 percentage points of GDP, for 2021 and by between SEK 11 and 14 billion in the coming years.

The measures and reforms of SEK 74 billion, corresponding to 1.5 percent of GDP, that the government has announced for the budget bill for 2022 have not been taken into account in the forecast. The net effect on savings will probably be less than SEK 74 billion as the measures will generate tax revenues.

[1] The surplus target implies that net lending must be one third of a percent of GDP on average over a business cycle.

[2] What is meant by a moderate rate is not specified, but it is stated that "[…] as a rule of thumb, [that a deviation shall] decrease at the same rate as usually occurs in the absence of active political decisions”. Which would imply that there is no scope for further reforms. However, given that the business cycle assessment is unusually uncertain, while the Riksbank's ability to support demand may be considered rather limited, the framework could, in the current situation, justify a slower pace in the reversal of the deviation. The low central government debt also means that it is possible to recover the deviation at a slower pace without jeopardizing the financial markets' confidence in fiscal policy.