Next week the Swedish government will submit its 2016 budget bill, a bit overshadowed by the ongoing refugee crisis. The Social Democratic-Green Party minority government will present a number of proposed changes on both the tax and expenditure side, but as usual most of these measures have already been announced. They have also been on the agenda for some time, since most were included in the budget bill that Parliament (the Riksdag) voted down last year. Taxes are to be raised 2016 by a total of 40 billion Swedish kronor, including decisions in the Spring Budget Bill, by means of various rule changes. A bit more than 15 billion kronor are in the budget bill and of the tax hikes about 10 billion kronor was implemented in 2015. These include cutbacks in existing income tax deductions for home renovations, normalisation of employer social insurance fees for young employees, limits on indexation of the lower threshold for paying central government income taxes and higher fuel taxes. The expenditure side is dominated by school-related programmes and by efforts to improve labour market skills and matching between job seekers and vacancies, which account for about 9 billion kronor in spending. Stimulus measures aimed at boosting residential construction are another important budget item, totalling 5.5 billion kronor. In the social insurance area, the time limit on sick pay will be removed. The increase in maximum unemployment benefits that has already gone into effect will cost some 2.5 billion kronor yearly starting in 2016. In addition, new programmes related to immigration and integration were recently unveiled.
Shifting economic policy direction
To some extent, the government is shifting the direction of Swedish economic policy. It rejects the previous non-socialist Alliance government’s tax cuts as instruments for stimulating economic growth and employment. Instead its main tools will be education, investments and better labour market matching: highly consistent with traditional Social Democratic policy. The government’s proposed tax hikes are broad-based. Although reductions in renovation deductions and higher petrol tax are probably not especially popular among voters, the government is avoiding such hot-button issues as real estate tax or mortgage interest deductions. The Alliance’s earlier expansion of earned income tax credits has been criticised by the government, but it is only phasing out a small part of them. Compared to the overall tax cuts implemented by the Alliance government, revenue enhancements in the new budget are rather small. The latest shift in fiscal direction will probably not have such a large impact on the underlying economy. For example, the National Institute of Economic Research (NIER) has pointed out that increased jobless benefits may contribute to somewhat higher equilibrium unemployment. Higher employer social insurance fees for young employees have been criticised by both employer organisations and the political opposition, but evaluations that have been made rather clearly point out that this subsidy was an ineffective and expensive way to create jobs for young people.
Economic policy tensions to rise
Looking ahead, however, economic policy tensions are likely to increase. The Swedish economy is chugging along at a decent pace, causing unemployment to fall somewhat while tax revenues swell, as evident in National Debt Office statistics for recent months. But this economic strength is still not enough to eliminate public sector deficits or to get anywhere near the official target of achieving the lowest unemployment in the European Union by 2020, even though unemployment has recently has fallen more than expected. The government is also aware of this, and its jobless forecast for 2018 is 6.5 per cent. Its ambitious target entails both political advantages and disadvantages for the government. Placing the jobs issue at the centre of attention is a conscious choice that, in the past, has usually proved to be a successful strategy for rallying the labour movement. Nor is the government trying to play down its target; instead it maintains that measures will be launched along the way to enable it to meet this goal. Because the target is to be achieved only in 2020 – two years after the next scheduled election – there is some breathing space. Yet relatively soon, the government must unveil a clearer strategy for how it will achieve its unemployment target. Otherwise it will be an excellent attack point for both the opposition and for those portions of the political left, including the Swedish Trade Union Confederation (LO), that want to see an aggressive fiscal policy. As specified by its December Agreement (DA) with the opposition Alliance parties, the government can now push its economic policy through Parliament. But in reality, it is now facing rather difficult choices. One major problem is that the government and the opposition are now gridlocked in important ways.
Taxing policy dilemmas
The government is facing several taxation policy dilemmas. Since there is heavy spending pressure in many areas – such as defence, immigration, infrastructure and the schools – it is easy to argue on behalf of continued tax hikes. This is underscored by the government’s decision to play down the impact of the tax burden on economic growth. But in practice, there are various restrictions. For example, during the 2014 election campaign, the Social Democrats promised not to touch the real estate tax and to let most of the Alliance government’s tax cuts remain in place. Reversing this position would jeopardise the government’s popular support. The situation is especially tricky when it comes to housing-related taxes. The International Monetary Fund (IMF), the Organisation for Economic Cooperation and Development (OECD), the European Commission and other organisations are pointing out with increasing clarity that the Swedish tax system favours home ownership in a way that diverges from international norms, for example because of low real estate taxation and the ability of borrowers to deduct home mortgage interest. Accelerating home prices in recent months have also led Sweden’s Riksbank, National Debt Office and Financial Supervisory Authority to jointly call for quick action by the government and Parliament. Aside from concern about voter reactions, the unwillingness to act is also based on a probably exaggerated fear of triggering a large downturn in home prices, which in turn would have major macroeconomic consequences. A consensus between Social Democrats and Moderates – the dominant Alliance party – is likely to be necessary to break the deadlock, but the December Agreement tends to decrease interest in agreements between the main political blocs.
Fiscal policy target and framework creating gridlock
The overall fiscal policy target and framework are also creating gridlock. So far, the finance minister has adhered to the krona-by-krona principle, which implies that every proactive decision which weakens public finances must be accompanied by an equivalent revenue enhancement. A change in this respect would open up the government to opposition criticism for fiscal irresponsibility, but it would also weaken the Finance Ministry’s position in the budget process. As for the budget target, the surplus target (1 per cent of GDP over an economic cycle) is likely to be replaced by a balanced budget target. This is logical in light of Sweden’s low central government debt, and also because for demographic reasons, the public pension system is no longer contributing to a net lending surplus. But in itself, this change will hardly create any extra manoeuvring room during the 2014-2018 parliamentary term, since no fiscal surplus is within reach yet. The idea of introducing a separate central government capital spending budget in order to open up more fiscal room cropped up in public discourse last spring, but we do not believe that such a path will be tested in practice. This is because transparency and a coordinated budget in which expenditures receive equal treatment are of great value.
Abandon the budget target or raise taxes?
The government’s current argument is that its unemployment target can be achieved without restructuring the labour market, for example by weakening the existing employment security laws or opening the way to a new category of low-wage jobs. Nor is the government yet prepared to loosen the straitjacket imposed by the fiscal policy framework. Instead it is hoping that educational and matching programmes will be instrumental in pushing down unemployment. But looking ahead, it is difficult to envision the government being able to fulfil all its ambitions and expectations without easing any of the restrictions that surround economy policy making today. One possibility is to carry out large tax hikes in order to make room for spending programmes that will lead to higher employment, at least in the short term. We believe that this is not very likely, though, since it represents both economic and political risks – among other things by opening the way for the “taxes-benefits” conflict that the Alliance would very much like to see.
Time to abandon krona-by-krona principle?
So it is more likely that the government will abandon the krona-by-krona principle and follow LO’s policy of using fiscal stimulus measures to push down unemployment. Swedish monetary policy is now close to the end of the road, which strengthens the arguments in favour of letting fiscal policy assume greater responsibility. In addition, central government debt is rather low and a slight upturn in such debt would hardly threaten confidence in the Swedish economy. Of course it can be argued that according to most assessments, cyclical unemployment is already quite low and that the country needs restructuring policies – not demand stimulation. But the type of restructuring policies that the government most warmly embraces, such as education, home construction subsidies or infrastructure projects, also cost money. Given today’s fraught political situation, it seems unlikely that the government would challenge the trade union movement by submitting less palatable proposals such as easing labour law protections. In choosing between meeting its unemployment target or the existing official budget target, there are many indications that the government will choose a pragmatic solution in which it will not achieve either of these targets.