Fiscal Reforms in the New Member States

1
Selected Issues in Fiscal Reform in Central
Europe and the Baltic Countries 2005
? Fiscal Challenges for the EU8
Countries? Managing Fiscal Risks in
Public-Private Partnerships? Financing
Higher Education? Controlling Health Care
Expenditures? Assessing Intergovernmental
Fiscal Relations
2
Fiscal Challenges and constrains for the EU8
Countries

• Key fiscal challenge is to improve
• sustainability
• quality of public finances
• Constrains
• Aging population
• Upgrading public infrastructure
• Fulfillment of commitments under Acquis
  Communicare (i.e. environment)
• Role of fiscal institution (fiscal and
  statistical governance)

• Fundamental importance for
• meeting SGP goals (euro Entry)
• catching up of NMS to the income levels of EU15
• delivering the Lisbon Strategy goals (greater
  social cohesion, combating poverty)
• more effective tool of short-tem
  macro-stabilization

3
Fiscal developments

• Evolution of fiscal balances
• Striking changes in fiscal policy in EU8 in the
  last 10Y
• EU8 engaged in fiscal consolidation toward the
  Maastricht criteria for euro adoption
• Fiscal consolidation complicated by
• Completion of transition process (large social
  protection system)
• EU membership (i.e. implementation of Acquis)
• Growing tax competition
• Structural nature of fiscal imbalances
• NMS coped with these pressures in different ways
  and with uneven results
• Deficits have tended to shrink
• but in most of EU8 remain away from
  surplus/close to balance target
• In last years
• Comfortably below 3 of GDP in Baltic countries,
  Slovenia
• Stubbornly high in Hungary, Poland (close to 5
  of GDP)
• Consolidation efforts have stabilized debt-to GDP
  ratio, at ease below 60 of GDP mark (except
  Hungary)

4
Fiscal developments
5
Fiscal developments

• Tax systems have been overhauled
• Tax burden has been reduced
• Notable exceptions burden higher than
• in mid-90s
• social security contributions in CZ, LT, PL
• direct and indirect taxes in SL
• Overall tax burden NOT HIGH compared to EU15
• close to EU15 in SL, HU
• substantially lower in Baltic countries
• but HIGH given NMS's income level
• Tax wedges still high, higher than in EU15,
  especially for low wage earners
• Structure of taxation has changed
• Share of direct taxes in total tax revenue
  declined, while share of social security
  contribution and indirect taxes increased
• ongoing tax reform played a role
• Composition still differs from EU15

25
30
35
40
45
2
EU15
0
CZ
LT
-2
HU
PL
-4
EE
LV
Cumulative change 1995-2004
-6
-8
-10
SK
-12
Total taxes, including social contributions,
GDP -
base year 1995
EE 2002, SL 2003
6
Fiscal developments

• Dynamics of public expenditure
• Public expenditure-to-GDP ratio have fallen
• In Baltic countries spending
• Increased in response to the Russia crisis and
  then reversed to downward trend
• Expenditure developments in V4 varied
• Degree of redistribution not higher than EU15
• exception HU and PL
• in Baltic countries among the lowest in EU
• Composition of spending has not changed much over
  last decade
• Economic/Functional classification Few EU8
  countries managed to improve structure of
  spending
• Social protection/benefits remain largest in EU8
  (still below EU15!), followed by collective
  consumption
• Gross capital consumption ( 3 of GDP), somewhat
  higher than in EU15
• Functional class. directed more toward
  efficiency-oriented programs and basic
  functions of the state than income
  redistribution

7
Quality of fiscal policy

• Long term strategy for consolidation has to
  include not only quantitative aspects but also
  issue of qualitative or structural
  consolidation.
• Successful contractions in EU8 Baltic countries
  in 2000 Slovakia 2001
• High quality fiscal adjustments in EU8

• Scale of adjustment is essential half of the
  episodes of fiscal consolidations were successful
  in reducing deficit at least by 1 of GDP

• Composition of adjustments matters
  expenditure-based cuts rather than tax-based
• nearly all episodes of large fiscal contractions
  (gt1 of GDP) were based on expenditure restrain
• HU in 2004 contraction relied mainly on revenue
  adjustment
• one half of large contractions were expenditure
  dominated (deficit/GDP gt70) Baltic states
  (2000), SK (2001, 2003), HU (2000)

• Rely on painful expenditure cuts fiscal
  contractions relied mainly on cuts in
• Gross fixed capital formation (CZ, EE, LV)
• Social benefits/other social transfers in kind
  (LT, LV, SK)
• Collective consumption

8
Quality of fiscal policy

• Growth-enhancing restructuring,
  efficiency-improving design and management of
  public expenditure/revenues - major policy
  challenge
• on the revenue side
• set up tax structures that strengthen growth
  potential
• (by promoting employment creation/investment)
• an analysis of tax expenditures (e.g. tax
  exemptions)
• on the expenditure side
• identify productive/growth-enhancing
  expenditure
• (covered by categories like RD, education and
  infrastructure investment)
• integrated cost-benefit assessment
• introduce effective institutional framework ,
  focused on policy outcome/efficiency
• Universal framework for assessing quality has not
  yet been developed
• our analysis aims to give a first hint at quality
  of fiscal policy in EU8
• EC synthetic indicator of the composition of
  public spending
• Panel Data Analysis expenditure/taxes structure
  versus growth per capita

9
Fiscal policy and growth

• There is as yet no comprehensive analysis of the
  relationship between tax/expenditure structure
  and growth in the NMS
• Results of an econometric panel analysis covering
  the period 1996-2004
• I. Constant tax/GDP ratio but change in
  structure
• Tax structure affects economic growth,
  specifically the proportion
• of tax revenue raised by direct taxes and social
  security contributions have a negative, robust
  correlation with economic growth.
• Variable reflecting expenditure structure seems
  no to be robustly correlated with growth
• Gross fixed capital formation - positive but
  fragile relationship
• Social benefits negative fragile
• II. Change in revenue/expenditure structure
• Distortionary taxes (PIT, CIT, SSC) hamper GDP
  growth (coeff. -0.4)
• Productive expenditure (including education,
  health, general public services) enhance GDP
  growth (coeff. 0.3)
• Unproductive E behaved ambiguously
• Both results are insensitive to the selection of
  the omitted variables. T coefficient more robust
  than E (non-linearity and public spending
  efficiency as potential explanations)

• preliminary results warrant cautious
  interpretation because of the limitation of the
  methodology used and quality/availability of data

10
Estimation results in detail
11
Synthetic indicator of the public spending

• Methodology (developed by EC)
• expenditure items categorized in terms of their
  efficiency effects and impact on fostering
  long-term growth
• each spending component has a range of 2 points
  between the best and the worst performer, all
  items have the same weight
• the higher the sum of scores in all categories,
  the better is the composition of public spending
  relative to other MS
• EC calculation for EU15 were supplemented with
  our own calculations for EU8

good scores in
Ranking 2002
ranking doesnt include Estonia
low scores in
12
Medium-term fiscal prospects

• Budget deficits are expected to decline
• sharpest decrease is foreseen for Hungary and
  Poland
• V4 plan to comply with the Maastricht criteria
• in 2006-2008
• Baltic countries, Slovenia envisage sustain
  deficit below 3 in period 2004-2007
• Public expenditure goes down
• total expenditure is assumed to decline on
  average
• total revenue edges up Slovakia, Lithuania and
  Poland
• Public debt remain below 60 of GDP threshold,
  EU15 average
• only Hungary has a debt-to-GDP very close to 60,
  though assumes declining trend
• In V4 debt prospect rely importantly on fiscal
  adjustments

13
Managing Fiscal Risks in Public-Private
Partnerships Context

• The EU8 have yet to narrow the distance to the
  EU15 to improve economic competitiveness and
  living standards
• However, noticeable differences are visible
  across different infrastructure sectors
• telecom sector being most advanced in CR, EST and
  PO
• no country from EU8 has road network to match
  those in EU15
• If the EU8 plus Bulgaria and Romania are to
  attain the EU15 infrastructure standards, this
  would imply sizeable investment requirements.
• The EU8 are facing a difficult challenge how to
  reduce the existing disparities in the quality
  and availability of public services while
  maintaining fiscal stability or, in some
  countries, conducting fiscal adjustment
• In this context PPP become increasingly popular
  in the EU8 countries

14
Managing Fiscal Risks in PPPs PPPs involve
fiscal risks

• FISCAL RISKS
• A. Direct, debt-like obligations
• Availability payments for the use of roads,
  schools, hospitals or prison facilities
• (UK, Australia, South Africa and many European
  countries)
• B. Explicit Contingent obligations
• State guarantees of investors returns
• Widely used in the 19th century, to promote
  railways
• Revenues and exchange-rate guarantees on toll
  roads
• (Chile, Colombia, Korea, and Spain)
• C. Implicit Contingent obligations
• taking over private debt of financially
  distressed infrastructure firms (Mexico and UK
  Railtrack)
• Implicit guarantees to PPA contracts of public
  energy utility
• (Indonesia, Philippines and Turkey)

• While PPPs can be beneficial when they increase
  efficiency, the also create fiscal obligations
  that are not captured by traditional measures of
  government debt.
• Accurate fiscal monitoring and good use and
  design of PPPs require the fiscal costs and risks
  of the major contractual obligations to be
  identified and quantified.

15
Managing Fiscal Risks in PPPs Fiscal institutions
Whether PPPs can create fiscal space depends to a
large extent on the quality of the legal and
institutional framework for fiscal management
or the quality of fiscal institutions.

• Incentives (min short-term cash expenditure vs
  reducing the future fiscal risks)
• Information (on traditional liabilities vs on
  liabilities incurred in PPPs)
• In EU8 there is only a limited information on the
  risks involved in PPPs and very little of such
  information is made publicly available. PPP
  contracts and their content are considered
  confidential, which makes it difficult for policy
  analysts to assess the long-term fiscal cost
• Capacity (may or may not allow G. to analyze
  risks in PPPs and to decide which are best borne
  by the G.)
• In EU8 capacity to actively manage government
  risk exposures arising from contingent
  liabilities and control long-term obligations has
  been limited

16
Managing Fiscal Risks in PPPs How to enhance
fiscal institutions to ensure fiscal prudence in
the use and design of PPPs?

• Promote Risk Awareness
• Impose Disclosure of Fiscal Risk
• Enhance Fiscal Planning, Accounting and Budgeting
  for Fiscal Risk
• Adopt Fiscal Risk Management
• Enhance International Mechanisms

Table. Improving Fiscal Institutions for PPPs at
a Glance
17
Managing Fiscal Risks in PPPs International
mechanisms to promote fiscal prudence in PPPs

• EU surveillance to further evolve fiscal risk
  analysis survey infrastructure risks, risk
  exposure of local governments, SOEs, financial
  institutions
• Reward disclosure and punish opacity (EU to
  adjust debt and deficit ceilings, early warning
  system, contingency reserve fund)
• Enhance international standards for disclosure,
  accounting, budgeting for PPPs
• Enhance auditing standards
• Assist in building fiscal risk management capacity

18
Financing Higher Education Trends

• Rush to mass higher education
• Increasing demand for tertiary education
• Met by
• by rapid increase in private provision (PL, LV,
  EE, HU)
• and/or public institutions increasing enrollment
• Declining resources per student - raising
  concerns about the quality of higher education
• Dual Track Fee System - affecting the equity of
  access to higher education

Evidence suggests that those who are currently
benefiting from free places are those who come
from better-off families and have had access to
better secondary education
19
Financing Higher Education Gross Enrollment
Rates in Tertiary Education
20
Financing Higher Education Directions for
further reform

• Introduce efficient and equitable allocation
  mechanisms for existing State Financing
• Because more resources are required in order to
  improve the quality and labor market relevance of
  higher education everywhere attract more private
  finance to higher education.
• Redefine the dual track system
• Charge variable fees
• Clarify Role of Government
• Tensions and Trade Offs

• Autonomy/Accountability
• Assure the autonomy of HEIs, inter alia to
  select their expenditure priorities subject to
  transparent budgeting practices
• Ensure the accountability of all public and
  private HEIs to the public interest.

21
Controlling Health Care Expenditures Problem
Statement

• The EU8 have carried out extensive health sector
  reforms but still
• have a costly health care system that does not
  control quality or excessive consumption of
  health services
• Health expenditures are not way out of line
• Key drivers of health expenditures in new member
  states
• Pharmaceuticals
• Hospital Infrastructure
• Salaries
• But in most countries the sector is in heavy
  debt, with expenditures consistently exceeding
  revenues
• Indebtedness in the health system presents a huge
  challenge for the fiscal health of these
  countries
• These countries cannot carry the health sector
  debts for long
• The pressure of expenditures appears to be
  persistent seemingly out of control
• Absorption of available and new technologies
• Ageing and changing demographics

22
Health spending in EU8 varies 8.1 of GDP in
Slovenia to 5.4 of GDP in Estonia
Controlling Health Care Expenditures Problem
Statement
Source Country Background Papers OECD 2004
23
Among a wider group of comparators, including
well performing middle-income countries, health
spending is not out of line
Controlling Health Care Expenditures Problem
Statement
24
A defining feature of the health sector in almost
all of the EU8 is the huge indebtedness
Controlling Health Care Expenditures Problem
Statement
Source Country Background Papers OECD 2004
25
Controlling Health Care Expenditures Thinking of
Solutions

• Social health insurance alone will not be able to
  bear the full costs of medical care in these
  countries
• Need a combination of stricter supply-side
  measures such as
• hospital restructuring and controlling drug costs
• and demand-side measures such as
• greater patient responsibility for own health
• and greater patient contributions, including cost
  sharing for pharmaceuticals

26
Assessing Intergovernmental Fiscal
RelationsDecentralization reforms

• EU8 countries have made remarkable progress in
  reforming their systems of intergovernmental
  fiscal relations
• Now EU8 countries have much more in common with
  the EU15 than with the Soviet-era systems
• Subnational governments have become an important
  part of the public sector, accounting for about
  1/4 of total government spending
• Higher transparency and predictability.
• High degree of redistribution in the financing of
  social services (perhaps even too much)
• Local government finances have not been a source
  of fiscal and macroeconomic instability,
  reflecting limited fiscal autonomy and strict
  borrowing constraints in most countries.
• Scope for further improvement exists EU8 need to
  encourage greater efficiency in the production of
  public services
• While the majority of the EU8 finance education
  on a capitation basis, this has not been
  sufficient to prompt the closure of
  under-enrolled classrooms or schools.
• In the health sector, efforts to encourage
  primary providers to increase the volume of
  services they provide have been thwarted by
  over-billing, and efforts to ration secondary and
  tertiary care using variants of the German points
  system have run aground for similar reasons.

27
Assessing Intergovernmental Fiscal
RelationsChallenges

• Long term sustainability of EU8
  intergovernmental fiscal arrangements will depend
  on the ability of central governments to keep
  their agreements with local governments.
• In monopolizing the tax revenues, central
  governments have arrogated to themselves the
  power to decide how much revenues local
  governments should receive, and how they should
  be spent.
• But it creates vulnerability, due to claims that
  local governments are under funded.
• In the case of sector specific financing, central
  government mandated increases in costs of service
  provision must be accompanied by increases in the
  level of financing
• In the case of funding discretionary
  expenditures, there is risk related to the annual
  negotiations between the central and local
  governments

28
Conclusions

• Fiscal policy key to long term growth
• Further public finance reforms are critical
• Shift taxation away from distortionary taxes
• toward general taxes or/and
• considering new tax sources (eg. property)
• Consolidate public finances
• Create fiscal space for productive expenditures
• address specific challenges in various sectors
• Rationalize expenditure
• Enhance efficiency
• Increasing private financing (social areas, PPPs,
  etc)