Iceland Economy

Iceland Economy

Subchapters:

  • Basic data
  • Public finances and the state budget
  • Banking system
  • Tax system

Basic data

After two challenging pandemic years, the government anticipates that the Icelandic economy will finally start to recover significantly. The great link of the Icelandic economy to income from tourism was manifested, among other things, in the fact that the Icelandic economy became the most affected of all the Nordic countries as a result of the pandemic. The expected gradual return of tourists to Iceland and the attenuation of state support to the affected sector of the economy are the two main reasons for the expected improvement in the state of Iceland’s public finances in the coming years. Iceland’s economy should record 4.4% growth this year, returning to pre-pandemic levels. Stable GDP growth is expected in the coming years as well. The inflation rate reached an average value of 4.4% in 2021. This is the highest value in the last seven years and the first time since December 2013 that since inflation exceeded the upper 4% limit set by Iceland’s central bank, which aims to keep inflation at 2.5%. The falling value of the Icelandic krona makes imports of foreign goods more expensive, but at the same time helps Icelandic exporters. At the beginning of 2022, the basic interest rate was increased from the current 2% to 2.75% in view of the deteriorating prospects for the development of inflation. After the crisis year of 2020, when it reached up to 8%, unemployment has already returned to the pre-pandemic level of around 4%. The banking sector was much better prepared for the crisis than in 2008. Banks are sufficiently capitalized and hold significantly higher foreign currency reserves. As part of economic recovery, the government intends to focus on the development of new sectors, such as hydrogen production, building data centers or new ways of using geothermal energy. Check ebizdir for economical facts of Iceland.

The traditional Icelandic economic sector is fishing, to which the aluminum industry has gradually been added thanks to the relatively low prices of electricity. Since the end of the banking crisis at the turn of 2008-09, the tourism industry has developed very rapidly. Iceland’s most important export items are fish, seafood and products thereof (42%), aluminum and products thereof (35%). All other commodities have a share of less than 3% in the export composition. The largest share of imports is electrical equipment and components (11%), road vehicles (9%), chemicals and metal compounds (8%). The Covid-19 pandemic caused a drop in the volume of international trade, however, after a slowdown during 2020, export and import volumes have almost equaled pre-pandemic values.

Pointer 2019 2020 2021 2022 2023
GDP growth (%) 1.9 -8.1 3.7 4.4 3.9
GDP/population (USD/PPP) 61,890.00 56,010.00 58,860.00 62,160.00 65,720.0
Inflation (%) 3 2.9 4.4 4 3.2
Unemployment (%) 3.9 6.4 5 4.5 3.7
Export of goods (billion USD) 5.2 5.1 6,7 7.2 7.2
Import of goods (billion USD) 6.6 3.7 8.7 9.5 10.4
Trade Balance (Billion USD) -0.9 -0.7 -1.4 -1.6 -2.4
Industrial production (% change) 4.8 -5 8.5 7 5.1
Population (millions) 0.4 0.4 0.4 0.4 0.4
Competitiveness 20/63 21/63 21/64 ON ON
OECD export risk ON ON ON ON ON

Source: EIU, OECD, IMD

Public finance and state budget

Public finance 2021
State budget balance (% of GDP) -9.7
Public debt (% of GDP) 80.8
Current account balance (billion USD) 0.2
Taxes 2022
AFTER 20%, 37.6%
F.O 17%, 23.5%, 31.8%
VAT 24% (basic tax), 11% (reduced tax)

The budget for 2022 is proposed with a deficit of ISK 168.5 billion (approx. CZK 29 billion), which is less of a deficit than the previous budget – the latter reached a deficit of ISK 288 billion (approx. CZK 49.5 billion). The government’s intention is to overcome the challenging post-pandemic period not through cuts and savings, but on the contrary by using a wide range of available fiscal instruments to stimulate economic growth. The declared goal of the government is to strengthen the financial position of households and businesses and prevent permanent job losses. This is how the government wants to ensure that Iceland emerges from the pandemic recession as a competitive country whose prosperity will be based on strong human capital and a dynamic economy. The expected gradual return of tourists to Iceland and the attenuation of state support to the affected sector of the economy are the two main reasons for the expected improvement in the state of Iceland’s public finances in the coming years. Even in 2022, the government provided limited financial compensation to households and businesses affected by the drop in income as a result of the pandemic, while at the same time refusing to increase the tax burden. At the same time, it bets on investments in infrastructure, education and research.

Looking ahead, the government wants to gradually reduce the state budget deficit (deficit budgets are, however, expected at least until 2026) and gain control over the accumulation of the rapidly growing state debt – the goal is to stop the growth of the debt ratio in relation to GDP by 2026 at the latest. Part of the state debt should be repaid by the gradual sale of the state share in Íslandsbanki (in 2021 the government sold 35% of its share). In the next two to three years, the entire remaining state share should be sold.

The income of natural persons in Iceland is subject to progressive taxation according to the amount of monthly income and municipal tax in the range of 12.44 – 14.52%. Total net income tax for the highest earners can be as high as 46%. Corporate income tax is determined according to the type of commercial entity. If it is a limited liability company, the rate is 20%. In other cases, the tax burden is 37.6%.

Banking system

The function of the central bank is performed by the Central Bank of Iceland (Seðlabanki Íslands). In connection with the deep crisis of Iceland’s banking sector, the Icelandic government gradually took control of the main banks from autumn 2008. Currently, there are (only) 3 nationwide commercial banks operating in Iceland: Arion banki (successor to Kaupþing bank), Íslandsbanki (successor to Glitnir bank) and Landsbankinn (successor to Landsbanki). Ten regional savings banks are also active in Iceland. After the nationalization of the banks, the government took a number of steps in recent years to restore the banking system. In cooperation with the International Monetary Fund, the successor banking houses underwent a fundamental restructuring, and since mid-2011 the healthy parts of the banks have been sold or (within the settlement of bankruptcy assets) the property and other holdings of these banks have been sold to cover the claims of creditors and, above all, the state that took them over. In 2018, the government sold off the state’s participation in Arion Bank, in Landsbankinn it holds 98% of the shares, but the gradual goal is to reduce the ownership share to 34-40%. The government also plans to gradually sell off its stake in Íslandsbanka and fully privatize it over the next three years (it has sold 35% of its stake so far). The government intends to use the proceeds from the sale of state shares in banks primarily to pay off the state debt and invest in infrastructure development.

Tax system

Taxes are paid by all natural and legal persons who have the status of resident, and this on all incomes from the country and abroad. A company becomes a resident at the time of registration in the commercial register, and a natural person after 183 days of legal residence in the country. Individuals and legal entities without resident status pay taxes on profits achieved by activities in Iceland. Income from real estate located on Icelandic territory is always taxed in Iceland. The tax system distinguishes between two basic forms of income: (i) general income (expenses are deducted) and (ii) personal income (income from dependent activity).

Personal income tax consists of national tax and local government tax. National tax for the year 2022 for incomes up to 370,482 ISK/month. is 17%, up to 1,040,106 ISK/month. is 23.5% and income exceeding this amount is taxed at 31.8%. Tax for local self-government is collected at a uniform rate of 14.45%. The employer also pays a social security contribution of 6.60% of the salary (7.50% for maritime professions). Mandatory contribution to the pension fund is paid directly by the employer (at least 8%) and jointly by the employee (usually 4%) from the gross salary. The usual types of legal entities (joint stock companies, limited liability companies, limited partnerships) pay a corporate income tax of 20%. To other legal entities, as well as interest communities (associations, non-profit organizations, funds), corporate income tax is set at 37.6%. The basic VAT rate is 24%. A reduced rate of 11% is applied to food, books, magazines and newspapers, television and radio receiver fees, tolls for the use of tunnels, hot (geothermal) water, electricity, heating oil, hotel accommodation, etc. They are exempt from VAT health and social services, postal services, regular scheduled passenger transport, taxi services, rental and parking payments, education and sports activities are exempt from VAT. The export of goods and services is also exempt from VAT.

Iceland Economy