Fiscal Sustainability Report 2016

Fiscal Sustainability Report 2016

The NIER assesses the long-term sustainability of Sweden’s public finances annually at the government’s request. Public finances can be considered sustainable if government income under current rules is sufficient to fund future expenditure to maintain the public sector commitment. The assessment is based on long-term projections of government income and expenditure under various assumptions.

The projection horizon generally extends to 2040, but the report also contains projections through to the year 2100. The aim of sustainability assessments of this kind is not to produce long-term forecasts but to identify potential future imbalances in public finances at an early stage.

Net lending and net wealth the key assessment criteria

Long-term unsustainable public finances are characterized by growing government deficits and a long-term decline in net financial wealth, defined as the public sector’s financial assets less its liabilities. Government deficits, or negative net lending, normally lead to higher debt and so reduced net financial wealth. For this reason, developments in net lending and net financial wealth in the long-term scenarios are key when assessing the sustainability of public finances.

One sustainability criterion is that net financial wealth must stabilise as a percentage of GDP in the longer term. This is consistent with the intertemporal budget constraint used to calculate the S2 sustainability indicator. A stricter criterion is that net wealth must be more or less unchanged at current levels. This means that resources are not systematically transferred from one generation to another and so ensures a fair distribution between generations. A balanced budget in the longer term will meet these sustainability criteria under reasonable assumptions.

Current taxation insufficient to fund unchanged public sector commitment

The sustainability analysis is based on long-term scenarios where government income and expenditure are calculated under the assumption that the tax system is unchanged and the public sector commitment is maintained. An unchanged public sector commitment means here that personnel density in the provision of welfare services is kept constant and that replacement rates for social transfers are maintained.

The analysis focuses on one base scenario and two alternative scenarios. The base scenario includes an assumption of a rising retirement age and a decreasing need for welfare services among the elderly. In this scenario, government consumption increases from 26.1 per cent of GDP in 2015 to 28.6 per cent in 2040. This is due mainly to demographics, with a growing share of elderly people in the population.

With unchanged taxes, this means that today’s government deficits will gradually increase. In the base scenario, net lending deteriorates to −3 per cent of GDP in 2040, and net financial wealth to −16 per cent of GDP. This scenario is not therefore sustainable based on the criterion of unchanged net financial wealth relative to GDP.

In the first alternative scenario (unchanged behaviour), the retirement age is assumed to be constant, as is the need for welfare services in different age groups. In this relatively pessimistic scenario, government consumption climbs to 29.6 per cent of GDP in 2040, with the result that net lending falls even further than in the base scenario to −4.4 per cent of GDP.

The second alternative scenario (reduced personnel density) assumes that personnel density decreases by 0.3 per cent per year. Otherwise the assumptions are the same as in the base scenario. In this alternative scenario, which entails an erosion of the public sector commitment, net lending gradually improves to −0.5 per cent of GDP in 2040, while net financial wealth falls relative to GDP but is still positive in 2040.

In neither the base scenario nor the two alternative scenarios are public finances sustainable in the sense of balanced net lending or net financial wealth holding at current levels. Long-term sustainability can, however, be achieved by reducing expenditure or raising taxes.

To fund an unchanged public sector commitment while keeping net lending balanced, the tax-to-GDP ratio will need to increase by 2.7 percentage points in the base scenario from 43.1 per cent in 2016 to 45.7 per cent in 2040. In the alternative scenario with unchanged behaviour, the tax-to-GDP ratio has to climb more than 3.7 points to achieve a balanced budget in 2040. In the alternative scenario with reduced personnel density, the ratio needs to rise by just 1 percentage point.

Sustainability analyses intended as a basis for adjusting fiscal frameworks rather than steering current policy

Fiscal sustainability analyses cannot be used to steer current policy. Any imbalances identified may nevertheless form a basis for discussion of how policy should be adjusted. The considerable uncertainty associated with the calculations necessitates judicious interpretation, but they remain an important input when formulating or updating intermediate fiscal policy targets such as the surplus target.