- International Monetary Fund
- Published Date:
- March 1986
The relatively open Danish economy, where foreign trade amounts to 25 to 30 percent of GDP, was severely affected by the two oil crises and the ensuing global recession. Denmark’s heavy dependence on imported energy made it especially vulnerable; in 1973 oil imports accounted for 90 percent of its basic energy supplies.
A sudden drop in GDP growth occurred in 1974 and 1975, when GDP actually fell by about 1 percent in each year. Growth rebounded to 6½ percent in 1976, in response to a sharply expansionary policy, but in subsequent years it was sluggish and uneven. The poor growth performance during the past several years reflects not only the effect of external impulses, but also restrictive economic policies that were imposed to alleviate the persistent balance of payments problem.
Unemployment rose drastically over the period, with the rate of registered unemployed rising from less than 1 percent in 1973 to 10 percent in 1982. Although the slowdown of economic growth may have accounted for much of the rise in unemployment, increasingly generous unemployment compensations may also have contributed by undermining work incentives.
Inflation averaged more than 10 percent a year over the period, which is above the average for industrial countries. It reached high points in 1974 and 1980, 15½ percent and 12½ percent, respectively, owing largely to the oil price increases and accommodating financial policies, but the high rates have been sustained by the reliance on higher indirect taxation to curb private demand and by wage indexation mechanisms.
The external current account position was in deficit throughout the period. The deficit widened from 0.4 percent to over 3 percent of GDP between 1972 and 1974, but was halved in the following year when the domestic recession deepened and a marked fall in imports resulted. With subsequent temporary stimulus measures, the external position deteriorated sharply in 1976 when the current deficit reached 5 percent of GDP. In the remainder of the period, the current account deficit ranged between 3 percent and 5 percent of GDP. The persistent balance of payments problem has been a constant cause for concern to the authorities and has significantly shaped economic policy during the period under review.
|Real GDP, percentage changes||5.4||3.8||–0.7||–1.0||6.5||2.3||1.8||3.7||–0.4||–0.9||3.4|
|Rate of unemployment||1.4||0.9||2.1||5.1||5.3||6.4||7.3||6.1||7.0||9.2||10.0|
|Consumer prices, percentage changes||6.6||9.3||15.3||9.6||9.0||11.1||10.0||9.6||12.3||11.7||10.1|
|External current account balance as a percentage of GDP||–0.4||–1.7||–3.1||–1.5||–4.9||–4.0||–2.7||–4.7||–3.7||–3.0||–4.1|
|(as a percentage of GDP)||34.6||34.5||35.0||33.0||34.9||34.7||36.7||37.4||37.8||37.5||36.9|
|Percentages of total revenue||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0|
|Social security contributions||5.0||1.6||1.6||1.7||1.6||1.7||1.6||1.8||2.2||2.6||3.4|
|Payroll (manpower) taxes||—||—||—||—||—||—||—||—||—||—||—|
|Taxes on goods and services||41.4||41.5||38.2||40.0||41.1||44.2||44.3||45.4||44.2||44.3||43.6|
|Taxes on international trade||3.0||1.4||1.2||1.3||1.3||1.2||0.8||0.8||0.8||0.7||0.7|
|Nontax revenue and grants||8.3||10.4||11.2||14.0||16.5||14.6||15.5||15.6||16.3||16.1||16.3|
|(as a percentage of GDP)||32.0||31.0||34.4||35.0||35.2||36.0||37.0||38.1||40.6||43.7||45.2|
|Percentages of total expenditure||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0|
|Expenditure on goods and services||32.5||28.8||28.1||28.1||25.7||24.4||23.3||22.2||21.3||20.7||20.0|
|Wages and salaries||19.4||19.2||18.6||18.8||17.1||16.3||15.4||14.8||13.4||12.9||12.4|
|Subsidies and other current transfers||58.3||62.2||63.1||62.9||64.2||66.3||67.3||66.7||66.7||64.9||64.0|
|Social security funds||4.3||1.6||4.3||6.7||6.6||7.9||8.9||9.2||10.3||11.9||11.8|
|Lending minus repayments||1.4||1.5||1.5||1.3||1.2||1.0||1.2||0.7||1.1||1.2||1.2|
|(as a percentage of GDP)||2.6||3.5||0.7||–1.9||–0.4||–1.3||–0.3||–0.7||–2.7||–6.2||–8.3|
|General government expenditure and net lending/GDP||…||…||…||…||…||50.3||52.2||53.8||56.6||59.8||…|
|Central government debt outstanding/GDP||–1.6||–3.6||–1.7||4.5||8.4||13.2||18.2||24.7||33.7||45.9||59.2|
Between 1972 and 1982 central government expenditure rose as a percentage of GDP from 32 percent to 45 percent, which represents a continuation of the rapid expansion of the government sector that began in the 1960s. Expenditure on goods and services declined sharply as a proportion of total expenditure from 32½ percent to 20 percent, and within this category the share of wages and salaries in the total declined steadily from 19½ percent to 12½ percent. Measures to alleviate the unemployment problem by increasing public employment mostly affected the local government sector. Both wages and salaries and other expenditure on goods and services grew more slowly than GDP. By contrast, subsidies and other current transfers increased their share in the total from 58½ percent to 64 percent between 1972 and 1982, owing in part to increased unemployment compensations and measures to reduce costs and improve the competitiveness of enterprises.
With widening fiscal deficits in the period following the first oil crisis, interest payments on the government debt rose from 1½ percent of total expenditure in 1972 to 10 percent in 1982; there are signs that debt servicing will impose a sharply increasing burden on the budget in future years. Capital expenditure declined as a proportion of total expenditure from 6½ percent to 4½ percent between 1972 and 1982 and was a reflection of the increased reliance on cuts in investment expenditure as part of efforts to curb overall expenditure growth in the latter half of the period. Net lending has not been significant at the central level and ranged between 1 percent and 1½ percent of total expenditure over the period.
Central government revenue expressed as a ratio to GDP increased moderately from 34½ percent in 1972 to 37 percent in 1982 after having dropped to 33 percent in 1975. The share of income taxes, over 90 percent of which are personal income taxes, in total revenue rose from 39½ percent in 1972 to 45½ percent in 1974 due in part to a pay-as-you-earn (PAYE) system of income tax collection that had been introduced in 1970. The share has since dropped sharply and was less than 34 percent in 1982. The drop reflects the depressed state of economic activity and a series of tax concessions designed to stimulate private sector demand and support incomes policy.
Taxes on goods and services, on the other hand, rose as a share of total revenue from 41½ percent in 1972 to 43½ percent in 1982. Increases in indirect taxes were the major fiscal instrument used to curb private sector demand—mainly through increases in the value-added tax, which was introduced in 1967 and in 1982 accounted for 60 percent of revenue in this category. A temporary reduction in the value-added tax partly explains the drop in the ratio of total revenue to GDP in 1975–77. Other taxes in this category include various excises and motor vehicle taxes, some of which are specific and have not kept pace with nominal GDP growth. Other tax revenue taken together, that is, social security contributions, property taxes, and taxes on international trade, declined as a share in total revenue from 10½ percent in 1972 to 6½ percent in 1982, reflecting in part the elimination of customs duties on products from EC member countries during a transitional period that ended at the beginning of 1978. Nontax revenue and grants, on the other hand, increased their share in the total from 8½ percent to 16½ percent over the period. The most important revenue items in this category are property income, administrative fees and charges, and grants from the EC.
The Fiscal Balance and ITS Financing
In most years from 1960 to 1974, central government finances were in surplus. But in the mid-1970s, automatic expenditure increases and revenue shortfalls brought about by recessionary conditions led to a sharp fiscal deterioration. In 1975 a number of discretionary measures were introduced to counteract the effects of the recession, and the fiscal position shifted to a deficit amounting to 2 percent of GDP. In the following four years the deficit contracted to about or less than 1 percent—owing to fiscal restraint in view of the worsening balance of payments position and high inflation rates. However, in 1979 it widened sharply and in 1982 reached the equivalent of more than 8 percent of GDP. The renewed upsurge in oil prices, a mounting debt-servicing burden, and expansionary measures taken in 1981 were largely responsible for the widening deficit. No data on deficit financing are given in Government Finance Statistics (GFS), the basic source. There is evidence, however, that the deficit has been financed mostly by domestic sources and the external current account deficits have been financed mainly by external borrowing by the Government. The domestic financing requirement has been met by bond issues and the sale of securities to both the banking and nonbanking sectors; the latter have in recent years covered about three fifths of the gross borrowing requirement. At times, recourse has been made to the central bank. While these debt data should be interpreted cautiously, as government borrowing is also for balance of payments purposes, International Monetary Fund staff estimates indicate that total net central government debt, expressed as a proportion of GDP, rose from minus 1½ percent to 59 percent between 1972 and 1982.
The framework. The size of the local government sector is relatively larger in Denmark than in all the other countries in the group except Sweden and Norway. Of the almost 60 percent general government expenditure/GDP ratio in 1981, central government expenditure inclusive of transfers to other levels of government accounted for 44 percent. Although local governments derive approximately one half of their total revenue as transfers from the Central Government, their financial autonomy is substantial, as local councils have the right to determine the level of local income and property tax rates. As a result of a local government reform in 1970, responsibility for certain current and capital functions was transferred to the local level, while the Central Government took over a number of social security-oriented transfers.
Because of the significance of local government activity in the economy, fiscal policy issues have had to be coordinated at both levels, and a procedural framework has been developed which places emphasis on improving control over public expenditure in the medium term. Since the mid-1960s, multiyear budgeting has been gradually introduced into the budgetary process, and rolling budgets covering a three-year period beyond the next fiscal year are prepared annually and presented to Parliament with the annual central government budget.1 Later, multiyear budgeting was adopted at the local level, and the first public sector budget was published in 1979. Although the public sector budgets are not formally binding on the Government, they form a basis for the establishment of overall ceilings on expenditure. Negotiations take place between the Central Government and the association of local governments about overall ceilings on real expenditure growth. The outcome of the negotiations takes the form of recommendations from the Central Government.
While the multiyear public sector budget has a sound technical and informational basis, the effectiveness of the system of centrally fixed ceilings is limited, as it relates only to expenditure that is not fixed by specific legislation. Major expenditure categories, chiefly transfers to persons and to local governments, are based on law, and, at the central level, account for some 60 percent of total expenditure. This proportion has been growing over the period. Another factor that tends to complicate long-term public decision making and to upset a steady policy course is Denmark’s political system, which is characterized by coalitions or minority governments.
Aims and measures. Over the period, the persistent balance of payments problem had significant implications for the pursuit of fiscal policy. While external adjustment efforts relied on incomes policy and, toward the end of the period, on exchange rate adjustments, fiscal policy sought to contribute through restraining private sector demand, supporting incomes policy, and providing incentives for the transfer of resources to the export sector. Other major objectives of fiscal policy were to cushion the impact of the international recession on employment and activity and to improve social security benefits in real terms. Stabilization also became the province of fiscal policy, as monetary policy was mainly preoccupied with preserving the foreign reserve position, which entailed high interest rates to induce the capital inflows needed to finance the external deficit.
After general restraint in the early years of the period—achieved largely through a ban on new public investment projects—fiscal policy shifted in a highly expansionary direction in the wake of the first oil crisis; a number of discretionary measures to stimulate the economy were introduced in 1975. This action was prompted by rising unemployment and an easing of the balance of payments position. The improvement in the external balance proved to be short-lived, however, and with a sharply widening current external deficit in the following year, fiscal policy resumed a restrictive stance. In subsequent years, with a persistently high external deficit, fiscal restraint focused largely on increases in indirect taxes. The effectiveness of this approach, however, was severely limited by measures on the expenditure side to contain rising unemployment and by tax concessions to stimulate demand. Fiscal restraint was further stymied by actions taken as part of incomes policy to curb inflation and to support the balance of payments adjustment process, as well as other actions, at times associated with changes of government, to improve social security benefits.
The resulting deterioration in the budgetary position was aggravated by cyclical factors that automatically caused social security payments to increase and revenue growth to slow down. Also, the inflationary conditions further weakened the fiscal position. Experience suggests that expenditure was more affected by inflation than was revenue, owing to indexation of significant expenditure components, the existence of specific excise and other taxes, and indexation of tax scales and deductions.
In contrast to the policy response to the first oil crisis, the fiscal stance remained tight in the first year after the second oil shock as far as discretionary action is concerned. However, as a result of the working of automatic stabilizers and a shift of fiscal policy in an expansionary direction in 1981, the fiscal position deteriorated markedly after 1978. With a new government in 1982, fiscal policy again assumed a restrictive stance.
The pursuit of fiscal policy toward the several goals discussed above involved a variety of measures. Measures on the expenditure side to stimulate demand and employment introduced before and during the mid-1970s included public building programs, subsidization of interest costs on loans for residential construction, and relaxation of ceilings on local government investment. Among measures to support employment in these and subsequent years was a program to increase public sector employment, financed partly by the Central Government, for retraining the long-term unemployed in the local government and private sectors. Youth employment programs were also introduced. Other measures have included subsidies for energy-conserving investment in the enterprise sector and for energy-saving repair and maintenance work in residential housing. The export industry has received grants and subsidies, as well as tax concessions.
In the social security field, in addition to full indexation of pensions, benefits have been raised in real terms and their coverage extended. In 1979 an early retirement scheme was introduced to encourage wage earners in the 60–66 age group to withdraw from the labor force. A generous system of unemployment compensations has been developed to serve the high-priority social objective of relieving distress. A rapidly growing labor force in recent years, owing mainly to a rising female participation rate, has constituted growing claims on budgetary resources.
Stimulatory measures on the revenue side included a substantial reduction in the personal income tax at the beginning of 1975. This reduction followed intense controversy over the prevailing high marginal tax rates—on average, one half of each increment to money wages was being absorbed by direct taxes—which were thought to have significantly contributed to the speed of cost-inflation. The issue had important political implications; a new party placing the abolition of income tax at the top of its platform won 15 percent of the seats in Parliament in the 1973 general elections. The income tax reduction was at the same time intended to moderate wage settlements, and similarly motivated cuts were made in subsequent years. The personal income tax scales have been indexed since 1970. One stimulatory measure taken in 1975 was a reduction in the value-added tax from 15 percent to 9¼ percent, which was maintained until 1977. Company tax reductions have taken the form of increased depreciation allowances, such as a countercyclical special depreciation allowance on investment in plant and machinery. Toward the end of the period, depreciation allowances were indexed. Measures specifically designed to support incomes policy and to contribute to the balance of payments adjustment process include the already cited cuts in the personal income tax and payment by the central government of a portion of indexation compensations due to workers into blocked individual accounts with the Supplementary Labor Market Pension Fund.
As already mentioned, the restrictive stance of fiscal policy relied on increases in indirect taxation, especially the value-added tax, which after the temporary reduction during 1975–77, was raised in stages from 9¼ percent in 1977 to 22 percent in 1980. Taxes on energy use were also raised largely for conservation, and a number of specific excise duties were increased, although these hardly kept pace with GDP growth, as indicated earlier. Rapidly expanding public sector activity has long been a cause for concern to the Danish authorities, and restraint on the expenditure side has been part of the fiscal strategy since 1976. Successive governments set targets to contain public expenditure growth, but successful realization of these targets has been limited, especially at the central level. Although local governments assumed a fair amount of the burden of containing unemployment through employment-creating schemes, their expenditure has grown less than central government expenditure over the past several years, mainly because the Central Government, in connection with the local government reform in 1970, assumed responsibility for the rapidly growing social security expenditures.
Overview and implications for future policy. Owing to the openness of the economy and in particular its high dependence on imported energy sources, the impact of the two oil crises and recessionary external developments was especially strong in Denmark. These events exacerbated the country’s longstanding balance of payments problem and posed a difficult dilemma for fiscal policy, which was a major instrument of stabilization throughout the period under review. Attaining the objectives of cushioning the impact of recessionary trends and improving social security benefits in real terms without imparting undue pressure on the balance of payments has proved elusive and has been complicated by changes in policy priorities.
Official goals to contain public sector spending have not materialized, despite long-term planning that was intended to enhance public awareness of the consequences of continuing past trends for private sector activity and overall performance of the economy. Instead, the period witnessed an explosive growth of central government expenditure whose ratio to GDP expanded from 32 percent to 45 percent from 1972 to 1982, with the public expenditure/GDP ratio reaching almost 60 percent by 1981, implying a sharply widening fiscal deficit and a heavy accumulation of government debt.
The major contributor to this deterioration in the fiscal position is the generous social security system whose foundations were largely laid in more prosperous times when prospects for the economy were brighter. Unemployment benefits have been the fastest-growing element, and although they may have relieved distress, they may at the same time have generated disincentives to work. The long-term consequences of high social security expenditure are likely to inhibit the growth of the economy and employment; adjustment to the real growth prospects would seem a prime objective of future fiscal policy.
Reversing these trends was indeed a major objective of one new government. In 1982 it introduced measures to substantially reduce automaticity in expenditure determination by suspending wage and salary indexation and the indexation of certain transfers until 1985, and by limiting increases in public sector wage and salary rates during the same period. While these measures soon led to improvements in certain areas, serious external and internal imbalances remained. Despite prospects for domestic energy production and more favorable external conditions, past experience strongly suggests the need for a resolute course of fiscal policy over an extended period with a clear order of priorities, if lasting improvements are to be achieved. The effort needed is all the greater because of increasing rigidities in the fiscal system owing to indexation mechanisms, a tendency to fix expenditures by specific legislation, and a growing future debt burden.2
The Danish Budgetary System, pp. 4–5.
A substantial fiscal adjustment has taken place since 1982 owing to both revenue-raising measures and expenditure restraint. Discretionary actions include the introduction of a tax on pension funds, raising of user charges, containment of certain social security transfers in nominal terms, and a reduction in transfers to local governments. The impact of the temporary suspension of indexation mechanisms is also significant in this respect. Government expenditure other than interest payments declined as a proportion of GDP by several percentage points between 1982 and 1984. The Government has announced its intention to reduce the budget deficit annually until a balance is established by the end of this decade.