Fiscal Budget 2007: Supporting a Continued Balanced Development

The performance of the Norwegian Economy continues to be strong for the fourth year running, fuelled by low interest rates and strong growth in petroleum investment. The economic upswing is expected to continue in 2007. Employment is at an all-time high, and unemployment is falling. In order to underpin positive economic developments, the Government proposes a budget for 2007 with a structural, non-oil deficit at NOK 71 billion, up close to NOK 6 billion from 2006 and closely corresponding to the expected real return on the Government Pension Fund – Global.

Growth in Mainland Norway (excluding petroleum and shipping) is forecast at 2.9 per cent next year, down from an estimated 3.4 per cent in 2006. Employment growth is estimated at 1.3 per cent in 2007 and the unemployment rate is expected to decline further. The influx of workers from other countries, in particular Sweden, Poland and the Baltic countries, has contributed to relatively modest wage growth this far in the business cycle.

The guidelines for economic policy, in place since 2001, stipulate that fiscal policy shall be geared towards a gradual and sustainable increase in the use of petroleum revenues. Over time, the structural, non-oil central government budget deficit shall correspond to the expected real return on the Government Pension Fund – Global, estimated at 4 per cent. Long-term budget challenges, due to future increases in pension costs and other age-related expenses, underline the need for a prudent fiscal policy.

Since the fiscal guidelines were established, the use of petroleum revenues has exceeded the expected real return on the Government Pension Fund – Global. The Government now proposes a fiscal budget for 2007 with a spending of petroleum revenues close to the expected 4 per cent real return on the Fund. This implies an increase in the use of petroleum revenues from 2006 to 2007 (in 2007-prices) of nearly NOK 6 billion, equivalent to 0.3 per cent of Mainland Norway trend-GDP.

The budget proposal allows for some important policy measures. Priority has been given to measures to improve the provision of welfare, to ensure day-care for all children, to strengthen the economic situation of local governments and to increase appropriations for e.g. hospitals and transport. Foreign aid will increase to 0.97 per cent of estimated gross national income for 2007.

In line with previous announcements, the Government proposes to increase the tax level in 2007 to equal the 2004 level. The Government’s proposed tax changes imply an increase in net tax revenues of about NOK 2 billion on an accrued basis from 2006 to 2007.

Fiscal Policy
The main features of fiscal policy in 2007 are:

• A structural, non-oil budget deficit of NOK 71 billion. Excess spending of petroleum revenues compared to the expected 4 per cent real return on the Government Pension Fund – Global is estimated at NOK 0.8 billion, down from an estimated NOK 7 billion in 2006.
• A structural non-oil deficit corresponding to 4.6 per cent of Mainland trend-GDP, which is 0.3 percentage points higher than in 2006.
• A real growth in Fiscal Budget expenditures from 2006 to 2007 of 2¾ per cent.
• Tax changes amounting to NOK 2 billion on an accrued basis, increasing the overall level of taxation to the 2004 level.
• A non-oil fiscal budget deficit estimated at NOK 57 billion. The deficit is covered by a transfer from the Government Pension Fund – Global.
• An increase in total revenues for local governments of 2.2 per cent from 2006 to 2007.
• A central government net cash flow from petroleum activities of NOK 365 billion.
• A net transfer to the Government Pension Fund – Global of NOK 308 billion.
• A consolidated surplus in the Fiscal Budget and the Government Pension Fund, including interest and dividends, of NOK 387 billion.
• An estimated market value of Government Pension Fund – Global at the end of 2007 of NOK 2 182 billion. Including the domestic part of the Government Pension Fund, the Government Pension Fund – Norway, the capital is estimated at NOK 2 288 billion. Old age pension obligations under the National Insurance Scheme is estimated to increase by NOK 286 billion to NOK 4 158 billion by the end of 2007.
• General government financial balance (net lending) is estimated at 18.6 per cent of GDP in 2007, down from 19.5 per cent in 2006.

Tax policy
The main tax proposals for 2007 include:

• An increase in the surtax on personal income by reducing the threshold in the highest bracket and increasing the threshold in the lowest bracket with less than the estimated wage growth from 2006 to 2007.
• An increase in the basic allowance for wage and pension income in the income tax.
• A broadening of the tax bases in the net wealth tax, including increased tax values for homes and other real estate and for securities, combined with increased minimum allowances.
• Curtailed tax-favoured private pension saving schemes, including the abolishment of the wealth tax exemption for individual annuities and of the favourable tax treatment of new premiums paid on employer sponsored group annuities. The right to deduct from taxable income new premium payments under individual pension savings schemes (IPAs) is abolished with effect from 12 May 2006.
• A reintroduction of regionally differentiated rates in employer’s social security contributions. The Government’s proposal has been approved by the EFTA Surveillance Authority.
• Introduction of a tax on NOx emissions from 1 January 2007. This is an important contribution to meeting Norway’s obligations pursuant to the Gothenburg Protocol, which regulates long-range air pollution. Certain affected industries will be compensated.
• The value added tax rate on food will be increased from 13 to 14 per cent.

The distributional effect from the tax changes are in favour of low income earners. Those having a gross income of less than NOK 400,000 will on average pay the same or less tax, whilst those with a gross income in excess of NOK 400,000 will pay more tax. The largest tax increases will apply to those with gross incomes in excess of NOK 1 million, mainly due to increases in the surtax and the net wealth tax. The largest tax reductions will apply to incomes between NOK 150,000 and NOK 200,000.

More detailed information in English on the tax proposals contained in the 2007 budget is available on the Ministry's budget site.

Monetary policy
The monetary policy regulation of 29 March 2001 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 shall balance the need for low and stable inflation against the outlook for output and employment.

Norges Bank’s implementation of monetary policy is geared towards maintaining low and stable inflation. The operational target is defined as an annual increase in consumer prices of close to 2.5 per cent over time. 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 cost increases.

The key rate (the sight deposit rate) was on 17 August 2006 increased by 0.25 percentage points to 3 per cent. Norges Bank has advised that monetary policy is oriented towards a gradual increase in the interest rate – in small, not too frequent steps – towards a more normal level.

The Government Pension Fund
The Government Pension Fund was established 1 January 2006 and consists of two parts: "The Government Pension Fund - Global", which is a continuation of the Petroleum Fund, and "The Government Pension Fund – Norway", which was previously known as the National Insurance Scheme Fund.

The investment strategy of the Pension Fund – Global is reflected in a benchmark portfolio composed of equity and bond indices from the majority of countries in which the Fund is invested. The equity portion of the benchmark portfolio has been 40 per cent since 1998. However, the Ministry of Finance has received recommendations from Norges Bank and the Ministry’s Advisory Council on Investment Strategy to increase the equity portion of the portfolio to 50 or 60 per cent. The Ministry will assess these recommendations closely.

At the end of 2006, the market value of the Government Pension Fund – Global is estimated at NOK 1 756 billion. The Fund is estimated to grow to about NOK 2 182 billion by the end of 2007. The market value of the total Government Pension Fund, including both the global and domestic part, is estimated at NOK 1 857 billion at the end of 2006 and NOK 2 288 billion at the end of 2007.

General outlook
Economic growth has been above trend for the past three years and the upswing has been broadly based. Low interest rate and high income growth has fuelled private consumption. Growth in petroleum investment has also been strong. Profitability in the business sector is high, and the growth in Mainland fixed business investment has been firm.

Mainland GDP is expected to increase by 2.9 per cent in 2007. Continued low real interest rates are expected to fuel private consumption. At the same time increased public consumption will provide growth impetus to the Mainland economy. The outlook for the Mainland business sector is favourable and growth in Mainland fixed business investment is expected to continue. However, high capacity utilisation can be an obstacle for growth in some sectors, and an increasing number of companies are facing difficulties in finding qualified labour.

A vigorous economic expansion has contributed to a tightening of the labour market. Employment growth has been high and the unemployment rate has fallen. In the National Budget the unemployment rate (Labour Force Survey) is expected to decline from 4.6 per cent in 2005 to 3.3 per cent in 2006 and 3.0 per cent in 2007. After the cut-off date for the budget, Statistics Norway announced an upward revision of unemployment rates reported this far in 2006. In light of the corrected figures, the Ministry of Finance estimates for the unemployment rate will rise by ¼ percentage points in both 2006 and 2007, to 3½ per cent and 3¼ per cent respectively. However, the revision does not influence the overall economic outlook presented in the budget.

Wage growth has been relatively modest so far in this business cycle, which must be seen in the context of inflows of labour from other Nordic countries, Poland and the Baltic countries. However, a tightening of the labour market suggests higher wage growth ahead. Wage growth is expected to pick up from 3¾ per cent in 2006 to 4½ per cent in 2007.

The consumer price index (CPI) is estimated to increase by 2½ per cent in 2006 and by 1¾ per cent in 2007. Adjusted for changes in excise duties and excluding energy, consumer price inflation (CPI-ATE) is expected to pick up from 1 per cent this year to 1½ per cent next year.

The oil price has increased substantially since 2003. In the middle of August the oil price was NOK 480 per barrel, but has since fallen somewhat. The projection in the National Budget 2007 is based on an oil price of NOK 425 per barrel in 2006 and NOK 390 in 2007.

Key projections for the Norwegian economy. Per cent ¹>

¹> Constant 2003 prices

² >In the National Budget 2007, the estimate for the unemployment rate (Labour Force Survey) is 3.3 per cent in 2006 and 3 per cent in 2007. Based on the recent upward revision by Statistics Norway of the unemployment rates so far in 2006, the Ministry of Finance now estimates the unemployment rates at 3½ and 3¼ per cent in 2006 and 2007 respectively, about ¼ percentage point higher in both years .

Sources: Statistics Norway and Ministry of Finance

Key figures for the petroleum sector

Key figures for the Fiscal Budget and Government Pension Fund NOK billion

¹> Excluding Government Pension Fund – Norway in 2005

Source: Ministry of Finance

General government financial balance. NOK billion

¹> For 2005, the Government Pension Fund – Norway is included in other central government accounts

Sources: Statistics Norway and Ministry of Finance