Holland's fragile one-seat majority government targets economic growth at the expense of fiscal sustainability
On 26 October, 225 days since the inconclusive elections in March, a new government was finally installed by King Willem-Alexander. Incumbent Prime Minister Mark Rutte was sworn in for another term, as his People’s Party of Freedom and Democracy (VVD) joined forces with the center-right Christian Democrats (CDA), the social-liberal Democrats ’66 (D’66) and the conservative Christion Union (CU). After the longest process of government formation in Dutch history, these four parties reached a deal on 10 October to form a fragile one-seat majority; the political scene in the Netherlands had been fragmented as a result of the March elections. The coalition agreement contains major reforms to the income tax system, labor market and mortgage interest rate deductions.
In contrast to the prudent stance of the previous government, which sought to improve government finances, the new coalition is set to pursue a more expansionary agenda at a time when the economy is already firing on all cylinders, sparking concerns that short-term economic gains will be prioritized at the expense of long-term fiscal sustainability. In the absence of a fully functioning government, the Dutch economy grew at one of the fastest rates in Europe in the second quarter of this year, clocking its fastest rate of expansion since 1999.
The plans laid out by the four coalition partners aim to boost economic growth by relieving the tax burden on households and reforming the labor market. Both measures will likely spur private consumption, a mainstay of the Dutch economy (2016: 44.4% of GDP). Official estimates project that the economy will grow a step quicker than previously expected under these policies. The Netherlands Bureau for Economic Policy Analysis (CPB), an independent body of the Ministry of Economic Affairs, calculated GDP will grow 0.2 percentage points quicker per year than previously estimate d. FocusEconomics panelists also see the economy growing slightly quicker than previously expected; they foresee growth of 2.1% in 2018, which is up 0.1 percentage points from the previous month’s estimate.
Plans to change income tax & mortgage interest payments
Income tax is set to decrease overall, and the current system of four tax brackets will be reduced to two. The working population and those earning the average income are expected to benefit the most, while the elderly on a state pension will likely see their incomes increased at a slower rate. Roughly one in eight pensioners could see a reduction of their disposable incomes. Overall, however, incomes are expected to increase by 0.7 percentage points per year on average during the new cabinet’s scheduled term (October 2017– March 2021) according to calculations from the CPB. Reforming the income tax system to accommodate lower taxation is costly, hence there is a need to compensate for the loss of revenue. As a result, the value-added tax (VAT), charged on essential goods such as food, will increase from 6% to 9%, so the cost of living overall will rise.
A second reform effort is linked to the maximum rate at which home owners can deduct mortgage interest payments from their tax obligations. Under the new government, the maximum rate will be lowered more quickly than previously planned, from 2020 onward. These reforms have been welcomed by the Dutch Central Bank and address concerns previously raised by the IMF, OECD and European Commission. Households in the Netherlands have the second-highest levels of indebtedness among OECD and EU members (2015: 276% of net disposable income), which is overwhelmingly due to generous tax incentives on mortgage loans. The system of tax deductions has become colloquially known as a “subsidy on debt”.
Proposed labor market reforms
Private consumption is further expected to benefit from proposed labor market reforms. Amendments to the labor market are geared towards making permanent employment less permanent and flexible employment less flexible. It will become easier for employers to dismiss their staff under permanent contracts. Meanwhile, the maximum number of years on a flexible contract, before an employer needs to offer permanent employment, is set to increase from two to three years. Towards the end of the new government’s scheduled term, unemployment is expected to be 0.4 percentage points lower than it would have been under the previous government’s policy, as calculations from the CPB showed. In addition, structural unemployment—which is not linked to economic business cycles—is likely to decrease by 0.2 percentage points more than previously anticipated; this would roughly translate into 14,000 full-time jobs.
Cuts to healthcare expenditure slated
Furthermore, the coalition is set to increase spending on defense and education, while cutting healthcare expenditure. Increased spending on education should lead to higher productivity in the long term and hence bodes well for economic growth further down the line. Slashing healthcare expenditure is, however, likely to result in decreased healthcare coverage or to lower-quality healthcare coverage, according to the CPB.
Is this fiscally sustainable?
Despite the healthcare funding cuts, analysts have raised concerns about the long-term implications of the fiscally expansionary agenda. According to the CPB, fiscal sustainability, which is a measure of the long-term sustainability of the government’s finances based on the proposed expenditure plans, is expected to decrease from plus 0.2% of GDP to minus 0.4% of GDP. This means that there will be a need for expenditure cuts or increased taxation down the line. Notwithstanding the fiscal implications, public debt as defined by the 1992 Maastricht Treaty is expected to decline further, moving away from the 60% of GDP threshold. FocusEconomics panelists expect public debt to reach 55.5% of GDP in 2018. The panel foresees public debt continuously decreasing to 49.2% of GDP in 2021, the scheduled expiration date of Mark Rutte’s third cabinet.
Looking beyond the borders
Looking over the country’s borders, two topics stand out: climate change and the EU. Despite being a center-right coalition, the four parties are seemingly stepping up efforts to comply with the Paris Agreement goals through increased taxation on products with higher CO2 emissions and increased subsidies to improve insulation of rental apartments. Secondly, the coalition has spoken out against progressive, institutional reform plans in the EU. This is another blow to French President Emanuel Macron’s reform agenda after the German elections, which will lead to complicated coalition talks that will likely see Angela Merkel oppose such reforms with more fervor. Moreover, Mark Rutte has ruled out any support for a Eurozone budget or common debt instrument, stating that any negative impact of a country’s policies cannot be shifted onto other member states.
What the future may hold
The new coalition government formally took power on 26 October, 225 days after the elections were held. The plans laid out for the next four years by the government are likely to boost an already-robust economy. However, as the government holds a fragile one-seat majority, the door has been opened slightly to the opposition parties.
The FocusEconomics Consensus Forecast panel expects the economy to grow 2.1% in 2018, which is up 0.1 percentage points from last month’s forecast, and 1.8% in 2019. Meanwhile the panel expects the fiscal balance to reach a surplus of 0.7% of GDP in 2018 but decrease to 0.6% of GDP by 2021.
Date: November 9, 2017
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