FinMin: State budget to pose a challenge for new govt

State budget to pose a challenge for new govt. Photo: Sander Ilvest

Raoul Lattemae, head of the fiscal policy department at the Estonian Ministry of Finance, the government to be formed faces a serious challenge, considering the current budget situation and the need arising from the restoration of budget rules to reduce budget deficits in advance.

Lattemae added that according to the State Budget Act, the government has the task of preparing a government sector budget that is more or less balanced, taking into account the state of the economy, be it a boom or a downturn.

«If, for some reason, usually due to crises or economic recession, the budget has sunk into a deficit, this deficit must be reduced in the following years -- this is the requirement of the State Budget Act,» he said.

Last week, the Ministry of Finance gave an overview of the state of the state's finances to the political parties holding coalition talks, after which the politicians stated that three quarters of a billion euros need to be found in order to reduce the budget deficit in the coming years.

Lattemae said that, since 2020, the budget of the Estonian government sector has moved into an unusually deep deficit for Estonia, which is also planned to be quite permanent. The budget deficit planned for 2023 is -3.9 percent of the gross domestic product (GDP), and according to the current budget strategy, the government sector will also remain in deficit in the coming years: in 2024, the planned budget deficit will reach -3.3 percent, and in 2025 and 2026 -3 percent.

«Broadly speaking, two factors have led to the deficit. To a large extent, the deficit has been due to expenses due to COVID-19 and Russian aggression. But the deficit has also been partially increased by new (permanent) expenses, which had a weaker direct connection to the crises, but which were still considered politically important. The latter became possible due to the fact that due to the COVID-19 crisis, the implementation of budget rules was suspended in Europe, and it also created a legal opportunity in Estonia to postpone the reduction of the budget deficit every year from 2020. Now that the budget restrictions disappeared, there was money in the budget for this and the cuts discussed before 2020 and reform needs were overshadowed by crises,» he said.

According to Lattemae, a fundamental budget stimulus was necessary to cope with the COVID-19 crisis, while expenses have also been necessary to cope with the Russian war, but he still believes that COVID-19 and the war blurred the line between the expenses that were due to the crisis and the expenses that due to the Estonian budget practices prior to 2020 would likely not have been under discussion in this form or could not have been included in the budget without additional sources of funding.

«The suspension of the European rules made it possible. But the European rules reflect the minimum level necessary in Europe. Our region's recovery from COVID-19 was the fastest in Europe. The fact that an unrestricted fiscal policy could be planned for 2022 has been more of a 'lucky accident' for politicians. It was not due to European foresight about the outbreak of the Russian war, but rather due to the weakness of the Spanish, French and Italian economic conditions. It was a moment when Estonia's economic growth was among the highest in Europe,» he said.

All in all, according to Lattemae, the outgoing Riigikogu was able to make unusually unrestricted budgets.

«The price of the last coalition was a precedent-setting budget trajectory, because this was the wish of the majority of the parliamentary parties. The tendency to increase expenses was also noticeable in the promises made before the elections. While this time the Ministry of Finance assessed 407 expenditure promises, but only 22 revenue promises, then four years ago in the 2019 Riigikogu elections, there were also 22 revenue promises, but only 262 spending promises,» he said.

The European Commission announced on March 8 that the general escape clause of the Stability and Growth Pact, which provides for a temporary deviation from the budgetary requirements that normally apply in the event of a severe economic downturn, will be deactivated at the end of 2023. Additionally, the Commission stands ready to propose country-specific recommendations on fiscal policy for 2024 that are in line with the fiscal targets member states set out in their stability and convergence programs, so long as those targets are consistent with ensuring that the public debt ratio is put on a downward path or stays at a prudent level and that the budget deficit is below the 3 percent of GDP reference value over the medium term.

«This creates a big challenge for the new government: there is shamelessly little room to realize the spending promises made during the elections without finding additional sources of coverage, in addition to the effect of the interest rate increase on the debt burden,» Lattemae said.

At the same time, according to him, there are ongoing discussions in Europe, as a result of which it can be seen that the European budget rules will probably be loosened for countries with a low debt burden.

«From the European point of view, the idea of this step is not to call on countries to spend more, but to make the rules more specific to the countries themselves. So that the country itself takes more responsibility for its budget policy. So that the country itself takes responsibility for the performance of its budget, rather than pointing the finger at Europe, that Europe prohibits or Europe permits,» Lattemae added.

He noted that in European terms, Estonia is a country with a relatively low tax burden, which means that in most areas the Estonian state can contribute less than the European average. This, in turn, reflects the political choices of Estonian society. According to him, in terms of the share of expenses, Estonia is at the top in Europe when it comes to spending on national defense, education and culture, leisure and religion, while the areas where Estonia considers it important to contribute significantly less than the European average are social protection, healthcare and general public services, which includes both the general state apparatus as well as the interest costs for servicing the state's debt burden.

«Looking at the current budget situation, the need to start reducing budget deficits in advance due to the restoration of budget rules, and the state's current priorities in the form of both low tax burden and sectoral funding proportions, politicians face a serious challenge -- whether and what to cut, whether and what to increase. This is a political choice that can be made only by politicians who reflect the will of society in these choices,» Lattemae said.