No. 42



Challenges and Sectoral Priorities in Public Finances

09 December 2020


RiTo No. 42, 2020

  • Sven Kirsipuu

    Deputy Secretary-General for Fiscal Policy, Ministry of Finance

Historically, fiscal policy and public finances have been surrounded by many sophisticated concepts, myths and inaccurate interpretations. In the case of economic developments, it is fairly clear that four-percent growth is better than two-percent growth, while in the case of budget deficit and national debt burden the good-bad scale is insufficient and the answer generally depends on the particular situation.

In the broadest terms, the aim of fiscal policy is to balance economic development and to do so sustainably. The fiscal sustainability comparisons made before the virus outbreak showed that Estonia belonged among lower-risk countries and this depends in particular on demographic pressure on healthcare and pension costs. At the same time, financial sustainability of course tells nothing about social sustainability. According to the forecast, Estonia’s tax burden will fall from the nearly 33 per cent of GDP of the recent years to below the level of 32 per cent by 2024. Low tax burden definitely has a positive impact on the potential of economic growth and competitiveness. On the other hand, as Estonia belongs in the lower quarter among European Union countries, there is no need to wonder that if it contributes nearly the highest percentage of GDP in the European Union to education, defence and culture expenditure, its social protection sector funding fell short of the European average by 5.8 per cent of GDP in 2018, that is, by nearly 1.4 billion in the then currency.

Often the question is asked in public if the countries will ever actually have to repay the loans they have taken. In practice, there are many examples where the debt burden not only stays in place but also keeps growing over a longer period of time. Nevertheless, in the case of the majority of European countries, an attempt to reduce the debt within a certain period of time can be seen, but often the positive economic cycle is over before the debt burden can fall sufficiently low. There are indeed links between fiscal policy and economic growth, but it is important to understand that although GDP is often equalised with welfare, it is not the best indicator for it. Differently to GDP, which remains abstract for ordinary people, there are attempts to evaluate welfare with the help of various indexes, the most widespread of which is perhaps the welfare index enabling international comparison and published by the OECD (Better-Life-Index). For example, the per capita GDP of Japan and Italy is significantly higher than in Estonia when adjusted with purchasing power, amounting to 93 per cent and 95 per cent of the European Union average, respectively. At the same time, they both rank behind Estonia in the welfare ranking referred to above.

Fiscal policy challenges are often linked with the difficulty to see the whole and the long-term perspective, which is not easy to grasp or explain. This creates differences of opinion in budgetary debates both within the state sector and in the public, and understandably such debates involve arguments relating to world view. The right-wrong scale is generally too simplified for giving assessments to fiscal policy choices, extremities excluded. It is important to assess risks, to see deviations from the desired goals, to understand the impact of different decisions both in terms of macroeconomics and at the level of a business or an individual and to prioritise sufficiently in the circumstances of limited resources.