Individual indicators Estonia 2017 OECD economic survey overview

ASSESSMENT AND RECOMMENDATIONS OECD ECONOMIC SURVEYS: ESTONIA © OECD 2017 24 Fiscal and social policies could better sustain inclusive growth Using fiscal space for a more inclusive growth Fiscal policy has been tight over past years, despite economic slack. Estonia has the lowest gross public debt relative to GDP in the OECD around 13, a rough budget balance since 2010, and an estimated structural budget surplus since 2009 Figure 12. The government plans a structural deficit of 0.5 in 2018, 2019 and 0.3 of GDP in 2020. The budgetary plans include broad changes in the tax system and increased spending on infrastructure, health care, education and family benefits Box 1. The Fiscal Council and the Central Bank have raised concerns about a possible deviation of the deficit from current plans and questioned the expected increase in tax revenues. Given the current favourable borrowing conditions and the need for growth-enhancing policies, the planned easing of fiscal policy over 2017-20 is appropriate. Fiscal room should be used to increase long-term growth potential, notably for measures that increase labour supply and productivity growth. As detailed below, more needs to be done to support innovative activities in domestic firms, improving access to lifelong education, and fostering labour market participation of mothers, while reducing labour taxation. In addition, public spending should be used to reinforce social protection, which does not adequately protect the most vulnerable against poverty, notably by activating all individuals with some work capacity. Such fiscal initiatives should rely on ex ante evaluation OECD, 2016a. Cost and benefit analyses have not been systematically carried out for the infrastructure projects planned for 2018-20, and, given the already considerable levels of investment in road and rail transport, it is unlikely that such additional projects will have high positive economic returns. Furthermore, they will inevitably induce extra maintenance costs in the longer run. Ex ante evaluation should ideally be carried out by an independent advisory body tasked with reviewing long-term economic challenges and identifying priorities and synergies, as is done in a number of OECD countries including the Netherlands and Australia. A well-designed institution can improve the quality of the decision process and contribute to evidence-based policymaking Banks, 2015. There is no unique institution in charge of undertaking or commissioning the necessary research and analysis to identify the most promising growth-enhancing policies for Estonia. The authorities are considering different options to comply with the recent recommendation of the EU Council to establish productivity boards. While the national context is central in determining the optimal design, mandate, mission and governance of pro-productivity institutions, a recent OECD analysis shows that such institutions should be given sufficient resources, skills, transparency and procedural accountability to fulfil their tasks. It should consider both supply-side and demand-side policies including those proposed by the government and have policy evaluation functions Renda and Dougherty, 2017. Table 2. Possible shocks to the Estonian economy Vulnerability Possible outcome Increase in geopolitical tensions This could trigger an international financial crisis with difficult-to-project consequences for confidence and activity in Estonia. Banking crisis Sudden withdrawal of capital by Nordic parent banks could lead to a sharp credit squeeze. ASSESSMENT AND RECOMMENDATIONS OECD ECONOMIC SURVEYS: ESTONIA © OECD 2017 25 Figure 12. Fiscal policy has been prudent 1. Per cent of potential GDP. The structural balance is adjusted for the cycle and for one-offs. For more details, see Sources and Methods of the OECD Economic Outlook www.oecd.orgecosources-and-methods.htm. Source: OECD Economic Outlook 101 Database updated with information available on 1 September 2017. 1 2 http:dx.doi.org10.1787888933581163 10 20 30 40 50 60 10 20 30 40 50 60 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

C. Spending and revenue

General government, of GDP Total revenue Total expenditure -4 -3 -2 -1 1 2 3 4 -4 -3 -2 -1 1 2 3 4 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

B. Fiscal balance

General government, of GDP Fiscal balance Structural fiscal balance¹ 40 80 120 160 200 240 40 80 120 160 200 240 ES T LU X NZ L NO R CH E KO R LV A AU S CZ E DN K SW E LT U SV K IS R IS L PO L NL D FI N DE U IR L HU N SV N CA N AU T US A O ECD ES P G BR FR A BE L PR T IT A G RC JP N

A. Public debt

General government debt, of GDP, 2016 ASSESSMENT AND RECOMMENDATIONS OECD ECONOMIC SURVEYS: ESTONIA © OECD 2017 26 Improving the fiscal framework Because of its vulnerability to external shocks, it is prudent that a small open economy like Estonia keeps a relatively low level of debt and room for manoeuvre for countercyclical Box 1. Draft budget plans The new coalition government appointed in November 2016 puts emphasis on reducing inequality and fighting the population decline. Budget plans for 2018-20 consist of additional spending in education, health, social welfare and public investment that will be partly financed by raising taxes Table 3. The authorities expect the structural deficit to reach 0.5 of GDP in 2018 and progressively return to balance by 2021. Such projections are questioned by the Fiscal Council, in particular the level of tax revenues, as changes in the tax system are likely to take time to materialise and their impact is uncertain. Spending A sizeable investment plan of 1.3 of GDP has been announced and includes large-scale projects in transport infrastructure, development of the broadband distribution network, and investments in a conference centre in Tallinn, defence and public residential housing. A relatively large share of funds will be allocated to the road and railway networks 36 of the total amount. Around 35 of additional spending will be allocated to the education system. Teacher’s salaries are set to increase to 120 of the national median wage, and wages in kindergarten will be aligned to the minimum level in schools. These measures are welcome, as teacher wages were particularly low by international standards. They should improve the attractiveness of the teaching profession among young graduates. Revenues Changes in the taxation system are expected to increase revenues from corporate income tax and indirect taxation, while reducing labour taxes. ● The income tax allowance will be increased from EUR 170 to 500 per month in 2018 and decreased gradually with the income level for those earning more than EUR 1 200. ● Increases in excise duty rates on alcohol and gas will strengthen incentives to reduce alcohol consumption and achieve energy savings. ● The tax rate on distributed dividends will be cut from the current 20 to 14 for mature companies companies that pay dividends for three consecutive years. While this is expected to increase revenue in the short term by encouraging the companies to distribute profits, it will decrease it in the longer term. Table 3. Budgetary and fiscal reforms planned for 2018-20 of GDP 2018 2019 2020 Increase in spending 1.5

1.6 1.4

Education 0.3 0.5 0.5 Public investment 0.5 0.5 0.3 Increase in revenues 1.0 1.1 1.1 Personal income tax reform -0.6 -0.5 -0.5 Corporate income tax reform 0.6 0.4 0.2 Excise duty and VAT measures 0.5 0.1 0.2 Total impact on public deficit -0.5 -0.5 -0.3 Source: Ministry of Finance.