Government promises balanced budget while raising taxes and fees

The government’s 2027 budget proposal forecasts a balanced state budget for the first time in eight years, while also announcing tax and fee increases and greater issuance of government bonds on the domestic market, mbl.is reports.

Andri Már Rúnarsson, a fund manager at Kvika Bank, told Morgunblaðið that the plans contained a degree of inconsistency. Measures intended to support falling inflation and lower interest rates could at the same time increase inflationary pressure and put pressure on bond yields, he said.

The proposal forecasts a surplus of 4.7 billion Icelandic krónur, equivalent to 0.1% of gross domestic product. Despite this, the state’s financing needs will remain substantial.

The government plans to borrow 230 billion krónur domestically next year, while repayments on domestic loans are expected to total about 143 billion. Net issuance will therefore be about 87 billion krónur, compared with nearly 69 billion this year.

“This increased net supply will inevitably put pressure on the yields of government bonds,” Andri said. He noted that yields had risen considerably in many foreign markets this year, partly because of increased financing needs. Higher government bond yields also indirectly affect other interest rates, including mortgage rates, he said.

The proposal also includes several tax and fee increases. A number of public charges will rise by 5.2% at the start of the year, in line with estimated inflation for this year. These include the vehicle tax, carbon tax, alcohol, tobacco and nicotine duties, and the fee for operating Ríkisútvarpið, the state broadcaster.

The kilometre charge will rise by 15.9%, with the increase expected to generate an additional 4 billion krónur in state revenue.

Andri said the increases were inconsistent with the government’s stated goal of reducing the role of indexation in the economy. He said that automatically linking the government’s own revenues to last year’s inflation, while the inflation target is 2.5%, would entrench inflation and send the wrong signal about inflation expectations.

He particularly pointed to the kilometre charge, saying that its increase would directly affect the consumer price index and therefore the principal of households’ inflation-linked loans, as well as the state’s own interest expenses.

The proposal also states that the personal tax credit and the thresholds for tax brackets will rise only in line with prices next year. A productivity adjustment previously added to price changes will not be included. The change is expected to increase state revenues by more than 3 billion krónur.