Iceland’s emergence from the 2008 economic crisis presents a unique opportunity to revisit the laws and procedures that shaped fiscal decision-making over the past decade. In the ten years before the crisis, fiscal policy in Iceland was characterized by pro-cyclicality, weak budget discipline, lack of coordination between levels of government, and inadequate surveillance and management of fiscal risks. Many of these shortcomings can be traced back to weaknesses in the legal framework for budgeting. Over the past few years, the exigencies of the crisis have compensated for some of these legal shortcomings and the government has also developed a number of good budgetary practices. However, with the pressures of the crisis abating, there is a need to develop a new organic budget law to preserve fiscal discipline, restore fiscal sustainability, and prevent a reversion to the more permissive
practices of the past.
Iceland’s Ministry of Finance (MoF) has seized this opportunity by establishing a Reference Group comprising the main stakeholders in the budget process to develop a new legal framework for budgeting.1 The Reference Group has been tasked with evaluating the strengths and weakness of the current legal framework and making recommendations on the form and content of a new organic budget law (OBL). The objectives of this new OBL are to:
- Address the gaps, loopholes, and inconsistencies in the current legal framework that contributed to fiscal indiscipline before the crisis;
- Codify the good budget practices that Iceland has developed since the crisis;
- Provide a firm legal foundation for sustainable fiscal policy going forward; and
- Put Iceland at the forefront of international budget practice.
During its two week visit from October 18-31, 2011, the mission held a series of discussions with the Reference Group and other participants in the budget process. This report and its recommendations are an initial contribution to the Group’s ongoing deliberations. In designing a new OBL, it is important to preserve the many good features of Iceland’s current legal framework for budgeting. Iceland’s current organic budget legislation, embodied primarily in the 1997 Financial Reporting Act (FRA):
Is admirably concise and clearly written, with more detailed operational guidance confined to regulations;
Is relatively comprehensive in that it applies not only to the central government’s budget but also to all of the entities and corporations it controls;
Includes a clear categorization of central government institutions for the purposes of financial management and control;
Specifies the required content of key financial documents including the annual budget and final accounts; and
Ensures that both documents are prepared according to the same accounting standards to allow for comparability between plan and outturn.
At the same time, any new OBL should address the key weaknesses in the FRA that prevent it from providing a credible, integrated framework for budgeting. Specifically:
The coverage of the FRA excludes municipalities and their corporations and focuses primarily on ex post financial accounting and reporting;
The law is completely silent on the principles and procedures for macroeconomic forecasting and fiscal policy-making and their link to the annual budget;
The law envisages a relatively unconstrained and fragmented budget formulation process in which the country’s 260 individual agencies (rather than their parent ministries) are the focus of budget discussions;
The budget execution provisions of the FRA include a number of loopholes that enable the government to overspend its budget with relative impunity; and
The FRA’s fiscal reporting provisions were ahead of the standards that existed at the time and are still ahead of most countries’ reporting practices today. However, international accounting standards have moved on and the crisis has revealed the need for more comprehensive and timely information to inform fiscal decisions.
To addresses these weaknesses and reflect the lessons from international experience with budget system laws, Iceland’s new OBL should incorporate the following reforms:
Legal Construction: the institutional coverage of the OBL should be expanded to encompass the whole public sector and incorporate an integrated timetable for the entire budget process—from fiscal policymaking through to end-of-year accounting;
Macro-fiscal Policymaking: the OBL should incorporate a set of fiscal responsibility provisions that oblige each new government to articulate and adhere to a comprehensive, legally binding, and independently monitored fiscal strategy;
Budget Formulation and Approval: the OBL should promote a more disciplined and policy-oriented approach to budget decision-making by reducing the number of appropriations, adopting a top-down sequence to budget preparation and approval, and increasing ministerial responsibility for budget management;
Budget Execution and Treasury Management: the OBL should ensure the annual budget is respected during implementation by tightening the rules around ministries’ rights to retain revenues and carryover past underspends, requiring parliamentary approval of a Supplementary Budget before an appropriation can be exceeded, and establishing a more credible array of sanctions for unauthorized overspending; and
Fiscal Reporting: the OBL should ensure the government is held to account for its fiscal performance by requiring the submission of more comprehensive and timely financial reports that are prepared according to international accounting standards.
The mission’s specific findings and recommendations in the above areas are summarized in the rest of this section and discussed in detail in the body of this report. A complete list of recommendations is provided in Appendix 1.
This technical assistance report on Iceland was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed in January 2012. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the government of Iceland or the Executive Board of the IMF.
Published: January 12, 2012.Series: Country Report No. 12/4