Public Finance

Public Finance

As of 1987, public-sector spending amounted to about 42 percent of GDP, below the OECD average. Austerity policies had limited real budget increases to about 1.5 percent per annum from 1980 to 1987, substantially less than the rapid growth in government spending during the 1960s and 1970s. Total taxes amounted to about 36 percent of GDP in 1987, fluctuating by a few percentage points from year to year. Because of the gap between taxes and spending, government debt grew relatively rapidly during the 1980s, reaching almost 15 percent of GDP by 1987, but it was still low by OECD standards.

Each autumn the Ministry of Finance submitted to the Eduskunta, the country's parliament, the budget for the next fiscal year (which corresponded to the calendar year), accompanied by a survey of the economic situation. Early in the following spring, while the budget was being debated, the ministry published a revised version of the survey, which estimated the overall fiscal impact on aggregate demand, income, and money supply. After parliamentary approval of the annual budget, the government often responded to changing conditions by requesting supplementary appropriations, sometimes significantly modifying the original budget.

Starting in the late 1970s, as it sought to maintain tight limits on the growth of the public sector, the government, in its fiscal policy considerations, began to analyze social security funds and local spending as parts of the overall budget. The central government regularly transferred large sums to local authorities, which accounted for about two-thirds of publicsector operations. Local administrations levied a flat tax, which had reached about 16 percent in 1986, on earned income. The central government influenced local expenditures by regulating transfers and by negotiating multiyear spending limits. Nevertheless, current local government expenditures, many of which were required by law, sometimes exceeded targets. The central government also attempted to manipulate social security taxes as an instrument of fiscal policy, a technique that Finland had pioneered. The government lowered employers' contributions for health, accident, and unemployment insurance by about 2 percent of the wage bill between 1977 and 1987 in an attempt to encourage job creation.

National taxes absorbed about 26 percent of GDP, and local taxes, roughly 16 percent, in the mid-1980s. In 1986 the government introduced reforms of business income taxes, including a reduced value-added tax on energy, designed to improve export competitiveness. In 1988 the legislature enacted a comprehensive tax reform meant to reduce marginal rates of taxation after eliminating many deductions. Policy makers expected that the 1988 reform would reduce tax-induced distortions in investment behavior and would make the tax system fairer.

Government spending had changed significantly during the postwar years. In the late 1940s and early 1950s, temporary expenditures associated with the war dominated the budget. From the early 1950s to the early 1970s, the fastest-growing sectors in the budget were education, social welfare transfers, and capital investments. By the late 1980s, current expenditures remained roughly the same as in the 1970s, but investments had fallen. In 1987, for example, debt service led expenditures (at about 17.2 percent of total outlays), followed closely by social security (17.1 percent) and education, science, and the arts (16 percent). Government operations and defense amounted to about 14.7 percent, and health, to 8 percent. Except for agriculture and forestry (which absorbed 8.3 percent) and transport (8 percent), subsidies for different branches of the economy took relatively small amounts: housing, 4.4 percent; industry, 3.4 percent; and labor, 2.5 percent.

Finland's state debt, at about 14 percent of GDP in 1987, was low by international standards, as was the debt of local governments, which stood at roughly 3 percent. Nevertheless, during the 1980s the government tried to limit the growth of state debt to avoid increased interest expenditures. As of 1987, slightly more than half the state debt was in foreign currencies. When the state sought financing abroad, it avoided crowding out private borrowers in Finland's relatively shallow capital market, but foreign debt increased foreign-exchange risk. In 1986 and 1987, however, officials took advantage of their government's high credit rating to refinance much of the debt at lower interest rates. Although policy makers would have to manage the debt carefully, most analysts believed it was unlikely that Finland's state debt would seriously constrain government operations during the late 1980s and early 1990s.

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