Fiscal Budget 2006 - Continued Strong Economic Growth

The performance of the Norwegian mainland economy continues to be strong, and growth in the mainland economy is now well above trend. Employment is picking up and the unemployment rate is falling. A broadly neutral fiscal policy stance is therefore maintained to limit the growth impetus to the mainland economy from the use of petroleum revenues.

Growth in Mainland Norway GDP (excluding petroleum and shipping) is forecast at 3¾ per cent in 2005 and 2 ½ per cent in 2006. Employment growth is estimated at 0.8 per cent in 2006 and the unemployment rate is expected to average 4.1 per cent in 2006, down 0.4 percentage points from the estimated 2005 average.

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 real return on the Government Petroleum Fund, estimated at 4 per cent. However, the actual implementation of fiscal policy must take into account business cycle fluctuations around the suggested medium-term path. So far, the use of petroleum revenues has exceeded the real return on the Fund. However, the gap between the use of petroleum revenues and the real return on the Fund is expected to narrow from NOK 22 billion in 2005 to NOK 12 billion in 2006, driven by the high oil prices and the subsequent growth of capital in the Fund.

Even if oil prices are sustained at a high level, there will still be long-term budget challenges due to the future increases in pension costs in the National Insurance Scheme. A pension reform is therefore an important element in securing fiscal sustainability in the long run. At the same time, long-term challenges underline the importance of a continued prudent fiscal policy strategy. Today, the Government submits to the Storting a separate legislative proposition on the establishment of the Government Pension Fund. This fund is based on the Government Petroleum Fund and the National Insurance Scheme Fund and will help to make clear that the Government accumulates assets to finance future pension payments. The Pension Fund does not, however, represent a formal funding of pension liabilities. The Norwegian National Insurance Scheme will still be a pay-as-go system and integrated in the central government budget.

This budget includes a second year of the tax reform implementation, nearly completing the reform. The Government also aims at continuing the process of making the tax system more efficient and fair. The Government’s proposed tax changes amount to net reductions of about NOK 2.8 billion in 2006.

The Government proposes a fiscal budget for 2006 with a structural, non-oil deficit of NOK 65.9 billion, which is deemed to have a broadly neutral effect on the overall economic activity. Priority has been given to international aid, R&D, education, mental health care and to investments in public transport and infrastructure. The Government has also made room for important policy measures, such as measures against poverty and drug addiction.

Fiscal policy

The main features of fiscal policy in 2006 are:

• A structural, non-oil fiscal deficit of NOK 65.9 billion. The excess spending compared to the expected real return of the Petroleum Fund is estimated at about NOK 12 billion, down from NOK 22 billion in 2005.
• As a share of Mainland Norway trend-GDP, the structural non-oil fiscal deficit is unchanged from 2005 to 2006.
• A budget that has a broadly neutral effect on the overall activity level of the economy.
• A non-oil fiscal deficit estimated at NOK 77 billion. This deficit is covered by a transfer from the Government Petroleum Fund.
• A real underlying growth in Fiscal Budget expenditures of ¾ per cent
• Tax changes which reduce paid taxes and excises by NOK 2.8 billion from 2005 to 2006.
• A central government net cash flow from the petroleum activities of NOK 251 billion.
• A consolidated surplus in the Fiscal Budget and the Petroleum Fund, including interest and dividends, estimated at NOK 305 billion.
• The capital in the Fund at the end of 2006 is estimated at NOK 1 670 billion, corresponding to 86 per cent of GDP.

Tax policy

In March 2004, the Government passed a report to the Storting on tax reform (Report no. 29 (2003-2004)). The tax measures were planned to be implemented in the fiscal years 2005, 2006 and 2007. The main objective of the reform is to achieve a more efficient and fair tax system and reduced tax and excise levels. The main proposals for 2006 pertaining to the tax reform include:

• A reduction in the surtax rates on labour income by 5 percentage points in income bracket 1 and by 3.5 percentage points in income bracket 2, to 7 per cent and 12 per cent respectively.
• Proposal to abolish the supplementary employer’s national insurance contribution on high wage income.
• A reduction in the maximum marginal tax rate (including employer’s social security contribution) from 61.5 per cent to 54.3 per cent. Combined with the decided tax on returns above risk-free rate of interest (the shareholder model etc.), which implies a 48.2 per cent marginal tax rate on returns to individuals, this makes it possible to abolish the prevailing splitting of business income of self-employed into capital and labour income (the split model).
• An increase in the standard allowance for wage income both by a rate increase and a higher upper limit.
• A reduction of 50 per cent in the wealth tax during the course of 2006 and 2007, with an aim to a complete abolishment at a later stage.
• Certain retrenchments which will contribute to a simpler tax system and finance the tax reform.

Further tax changes in the 2006 budget, not directly linked to the tax reform, include:

• An increased rate of depreciation applicable to machinery, etc., to 25 per cent.
• A relief of the inheritance tax by doubling the amounts which trigger payment
• An introduction of tax deductibility for individuals from other EEA countries on equal footing with individuals from Norway, and a curtailment of the special standard allowance.
• Adaptation of the tax rules applicable to ship owners to the new EEA regulations.
• An increase of two percentage points in VAT on food to 13 per cent. A general rise in the lowest VAT rate from 7 to 8 per cent. The lowest VAT rate will be introduced on accommodation.
• An increase in the use of green taxes. The CO2 and SO2 tax rates on domestic aviation and sea transport will be raised to the general tax levels.
• Abolishing the base tax on disposable beverage packaging, and an expansion of the base which the environmental tax on beverage packaging applies to.

New tax measures imply a net tax reduction of about NOK 2.8 billion in 2006, amounting to close to NOK 6.7 billion on an accrued basis. During this parliamentary period and including proposals in the 2006 budget, the overall net tax relief amounts to some NOK 31 billion.

More detailed information in English on the tax proposals contained in the 2006 budget is available soon.

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 (confer Report no. 29 to Stortinget (2000-2001)). The operational target is defined as an annual increase in consumer prices of close to 2.5 per cent over time. As a general rule, it is expected that consumer price increases will fall within an interval of +/- 1 percentage point around the inflation target. 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) is currently at 2.0 per cent.

The Government Petroleum Fund

At the end of the second quarter of 2005, the market value of the Government Petroleum Fund was NOK 1 184 billion. The value is estimated to grow to NOK 1 335 billion by the end of 2005 and to NOK 1 670 billion at the end of 2006.

Under the ethical guidelines for the Petroleum Fund, established on 19 November 2004, companies manufacturing key components for particularly inhumane weapons will be excluded from the Fund. Pursuant to a recommendation from the Petroleum Fund’s Advisory Council on Ethics on 30 June 2005, the Ministry of Finance instructed Norges Bank to exclude eight companies from the Petroleum Fund pursuant to these guidelines. The disinvestment process is completed.

On 20 September 2005, The Petroleum Fund’s Advisory Council on Investment Strategy was established. The mandate of the Council is to act as a professional advisory body for the Ministry of Finance on the long-term investment strategy for the Petroleum Fund.

General Outlook

Growth in household demand, fuelled by low interest rates and a significant increase in income has been the main driving force behind the expansion of the mainland economy. Profitability in the business sector has improved, and mainland fixed business investment has also picked up. Strong growth in petroleum investment and healthy international growth has further stimulated growth in the mainland economy. Thus, the upswing has gradually become more broadly based.

The upswing of the economy is expected to continue. High growth in export prices suggests sound profitability for the mainland business sector. High capacity utilisation indicates further increases in mainland fixed business investment, and the growth in household demand is expected to continue.

Mainland GDP is expected to increase by 3¾ per cent in 2005 and by 2½ per cent in 2006.

Labour market
The situation in the labour market is improving. However, a decline in sick leave and increase in full-time employment have dampened the increase in employment. Continued economic growth is expected to result in a decline in the unemployment next year. On an annual basis, the unemployment rate (Labour Force Survey) is expected to fall from 4.5 per cent in 2005 to 4.1 per cent in 2006.

Prices and wages
The results from the central wage settlements indicate a relatively moderate wage growth in 2005. The hourly wage growth is estimated at 3¼ per cent this year and 3½ per cent next year. The introduction of a mandatory occupational pension scheme from January 2006 implies that growth in total compensation per employee will be somewhat higher than the hourly wage growth.

Consumer price inflation has increased somewhat this year from a low level, and moderate wage growth and a strong currency is expected to keep the inflation rate relatively low. The consumer prices (CPI) is expected to increase by 1½ per cent in 2005 and by 1¾ per cent in 2006. 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.

Since the beginning of the year the oil price has increased by NOK 150 per barrel, reaching more than NOK 400 by the end of September. The projection in the National Budget 2006 is based on an oil price of NOK 350 per barrel in both 2005 and 2006.

Key projections for the Norwegian economy. Percentage change from previous year

Sources: Statistics Norway and Ministry of Finance.

Key figures for the Petroleum sector

Key figures for the fiscal budget (incl. social security) and Government Petroleum Fund
Source: Ministry of Finance .

General government net lending (surplus). NOK billion
Source: Statistics Norway and Ministry of Finance.