On 11 November 2015 the IMF completed its consultations with Finland under Article IV of its articles of agreement.

The economy has been in recession for three years but a slight recovery is projected for 2015 and expected to strengthen in 2016. Fiscal adjustment is needed to achieve sustainability and comply with the Stability and Growth Pact. The measures need to be balanced to protect the fragile economic recovery.

A selected issues paper was prepared by IMF staff as a background for the consultations. The report notes that the government’s Strategic Program and the related Action Plan aim to increase competitiveness by reducing the labor tax wedge and increasing unremunerated working hours. The reduction of tax on labor would be funded by increasing excise duties. Proposals for exceptional measures that could be implemented in 2016 include a reduction in private employers’ social security contributions.

To increase the availability of affordable housing in the regions and therefore remove obstacles to labor mobility the IMF selected issues paper proposes measures to increase competition in the construction sector and to increase the supply of land available for development. Tax measures could help this, for example raising property taxes on unused land zoned for development or improving the tax treatment of income from investing in property.

Referring to the tax literature the selected issues paper makes a number of suggestions in respect of taxation. One general recommendation is that there should be more of a shift from production-based taxes towards destination based taxes such as the value added tax (VAT). A reduction in social contributions paid by employers combined with an increase in VAT would be a revenue-neutral way of making this shift and thereby potentially increasing output and employment. The report suggests that a tax reform package that lowers labor and corporate tax rates by 0.75% and 0.25% respectively could be offset with a 1% increase in the VAT rate. This would improve competitiveness by affecting the cost of capital and labor. It could also increase the incentive to work and invest.

The report notes however that the room for raising the rate of VAT may be limited in Finland. The standard rate was increased to 24% from 1 January 2013 and the reduced rate applying to certain items including food, restaurants and catering was increased to 14%. Other reduced rates were increased to 10% at that time. Raising the standard rate of VAT further would be potentially a problem as there is an agreement within the EU not to raise the standard rate above a 25% maximum.

The VAT C-efficiency could however be improved. This represents the revenue from VAT divided by the product of the standard rate and aggregate private consumption. This consists of a policy gap where a 0 would indicate that a single rate is applied to all consumption and a compliance gap where a 0 would indicate that compliance is perfect. The C-efficiency of VAT in Finland is currently 61, with a compliance gap of 5 and a policy gap of 36. This policy gap reflects the extensive exemptions and the use of multiple rates. Closing half this policy gap would raise around 2.4% of GDP in additional revenue. This would need to be accompanied by increase social transfers to protect low income groups but could still raise significant extra revenue.

The report also suggests that property taxes in Finland also allow room for increases in revenue collected. Taxation on residential property has little effect on production costs and is relatively growth friendly. Property taxes as a percentage of GDP are below the EU average and could therefore be used to generate more tax revenue.