## _0598ch5pdf - 1997. With interest payments rising, noninterest expendi- ## Source details **Canonical URL:** [_0598ch5pdf - 1997. With interest payments rising, noninterest expendi-](https://www.imf.org/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/weo/weo0598/pdf/_0598ch5pdf.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/weo/weo0598/pdf/_0598ch5pdf.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/weo/weo0598/pdf/_0598ch5pdf.pdf.json) --- ### Fiscal adjustment and composition of expenditures - Noninterest expenditure fell from around 21 percent of GDP in 1994 to 14 percent in 1997 (to around 11 1/2percent if cash expenditures only are considered). - Items most affected by cuts: subsidies, transfers to the regions, and capital expenditure. - Items better maintained: wages and social transfers. - Expenditure adjustment described as partial, ad hoc, and with little support from weak institutions responsible for budget preparation, execution, and evaluation. ### Arrears, noncash settlements, and implications for budget management - Attempts to maintain expenditure commitments (as opposed to cash spending) led to sequestration, use of noncash means to settle budgetary obligations, and accumulation of payment arrears. - Federal government cleared wage arrears by the end of 1997, but this was replaced by a sizable buildup of new arrears to suppliers. - Finances of regional and local authorities and of extrabudgetary funds deteriorated; subnational governments accumulated undocumented arrears on wage payments and payments to suppliers. - Widespread resort to noncash mechanisms to settle budgetary arrears against the arrears of tax debtors undermines incentives for paying taxes in cash and hinders public expenditure on wages and other social commitments that can be satisfied only in cash. - Weak revenue collection, ad hoc expenditure cuts, and arrears reflect interlocked problems in tax policy, tax administration, and budgetary management. ### Tax system weaknesses and sectoral issues - Progress in tax reform in Russia described as inadequate. - Tax system characteristics: complex, with up to 200 types of taxes; numerous and sometimes arbitrary exemptions; narrow tax bases; and, partly as a result, high statutory tax rates on labor income. - Revenue structure relies heavily on payroll taxes that are likely to lead to distortions in the economy. - Energy sector tax regime has multiple shortcomings. - Relative tax burden of the oil and gas sectors—defined as the sectors’ shares in general revenues divided by their estimated shares in GDP—was around 1.6 in 1996, lower than in comparable oil- and gas-producing countries. - Actual revenues from the energy sector were only slightly more than half of the liability as estimated on a statutory basis. - An inappropriate tax structure, together with exemptions, is identified as one of the main reasons for low tax revenue. - To simplify the tax system, broaden the tax base, and reduce the number of exemptions, the government has submitted to parliament. ### Box 9. Russia’s Fiscal Challenges — Summary operations of the general government (1992–1997) - Federal government (in percent of GDP) - Revenue: 15.6, 13.7, 11.8, 12.2, 13.0, 11.6 - Expenditure: 26.0, 20.2, 23.2, 17.6, 22.1, 18.4 - Interest payments: 0.7, 1.9, 2.0, 3.3, 5.7, 4.4 - Transfers: 1.7, 2.8, 4.2, 2.1, 3.1, 3.8 - Balance: –10.4, –6.5, –11.4, –5.4, –9.1, –6.8 - Subnational governments (in percent of GDP) - Revenue: 13.5, 16.7, 18.0, 14.2, 14.5, 16.1 - Transfers: 1.7, 2.6, 4.1, 1.6, 2.7, 2.9 - Expenditure: 12.0, 16.1, 17.5, 14.5, 14.8, 16.9 - Balance: 1.5, 0.6, 0.5, –0.3, –0.4, –0.8 - Extrabudgetary funds (in percent of GDP) - Revenue: 10.9, 8.6, 9.1, 7.6, 7.7, 9.1 - Transfers: —, 0.2, 0.1, 0.5, 0.4, 0.9 - Expenditure: 8.4, 8.0, 8.6, 7.6, 7.7, 9.0 - Balance: 2.5, 0.6, 0.5, —, —, 0.2 - General government (in percent of GDP) - Revenue: 38.3, 36.2, 34.6, 31.9, 32.1, 33.0 - Expenditure: 44.8, 43.6, 45.1, 37.7, 41.6, 40.4 - Balance: –18.4, –9.4, –10.4, –5.8, –9.5, –7.5 - Memorandum - GDP (in trillions of old rubles): 1917, 2611, 1,630, 2,256, 2,675 ### Box 9. Tax policy, administration, and revenue challenges - Tax Code developments and expected changes - A comprehensive draft Tax Code expected to be adopted by the middle of 1998, with most provisions coming into effect on January 1, 1999. - The code will introduce on a gradual basis accrual accounting for indirect taxes other than oil and gas excises and for profit taxes; increase the share of personal income taxes in total revenue; and reform taxation of the energy sector. - Key weaknesses identified - Procedural and organizational problems: lack of coordination among tax collecting agencies, enforcement agencies, and the Ministry of Finance. - Insufficient political will manifested in tolerance of barter transactions and accumulation of concentrated tax arrears (energy sector major share). - Steps taken to improve collection (examples from 1997 onward) - Abolition of noncash tax arrangements. - Measures against large debtor enterprises announced. - Tax-collecting agents began working on the premises of major companies in gas and electricity sectors. - Proposed measures: administrative units for large taxpayers; introduction of realistic penalties for noncompliers. - Tax policy reform priorities - Strictly limit tax exemptions; unify rates within tax categories; eliminate sectoral tax treatment differences. - Extend VAT coverage (oil and gas to be subject to full tax regime); introduce mechanisms to collect natural resource rents (for example, royalties). - Reconsider tax status of small private businesses while containing marginal tax rates and overall private sector tax burden to limit incentives for informalization. ### Box 9. Budget institutions and expenditure management - Institutional weaknesses across the budget cycle - Legal framework for budget management largely unchanged since breakup of the Soviet Union and is deficient. - Preparation stage shortcomings: overoptimistic macroeconomic and revenue forecasts; lack of expenditure prioritization; complex and lengthy budget adoption procedure. - Execution stage shortcomings: budget not fully executed according to approved appropriations; ad hoc adjustments to new macro and revenue developments leading to arrears and sequestration; incomplete reports based on outdated accounting frameworks. - Auditing and evaluation virtually absent. - Government measures planned/intended for 1998 to strengthen expenditure control - Move all financial operations of federal agencies and ministries into the federal treasury. - Strengthen capacity to control and monitor expenditures. - Introduce more effective sanctions on agency heads who exceed budget spending limits. - Require preapproval of large-size contracts by the Ministry of Finance. - Establish a monthly system of reporting on payables by ministries and other agencies. - Settle outstanding expenditure arrears. - Treasury, cash management, and arrears - Extrabudgetary funds accounted for around 20 percent of government expenditure in Russia in 1996. - Practice of failing to honor payment obligations, cash-rationing, and sequestration persists (overdue payments to suppliers in Russia around 3 percent of GDP; in Ukraine arrears on wages, pensions, and benefits around 4 percent of GDP). - High priority: eliminate these practices and settle arrears through cash payment and securitization. ### Box 9. Intergovernmental fiscal relations - Rapid and ad hoc fiscal decentralization during 1992–94 - Federal budget revenues shrank from around 15 1/2 percent of GDP in 1992 to 12 percent in 1994. - Regional revenues expanded from 13 1/2 percent to 18 percent (partly because federal transfers increased from 1 1/2 percent to 4 percent). - In recent years a trend toward gradual recentralization of tax revenues and reduction in federal transfers; regions saw revenue-to-GDP decline and balances moved from small surplus in 1994 into deficit from 1995 onward. - Continuing weaknesses in intergovernmental relations - Nontransparent expenditure assignments and tax-sharing leave room for discretion, continual lobbying, and undermined fiscal accountability. - Transfers system has not effectively reduced large disparities among regions in per capita revenues or equalized per capita outlays on social safety nets, education, health. - No adequate arrangements to prevent subnational financial imbalances leading to arrears or excessive borrowing, including on international markets. ### Box 9. Debt sustainability and liquidity risks (illustrative framework and Russia implications) - Concept - Compare actual primary balance (excluding interest payments) with the primary balance needed to stabilize the debt-to-GDP ratio at its current level; difference measures additional “fiscal effort” needed. - If interest rate exceeds growth rate, a primary surplus is needed to stabilize debt-to-GDP; if growth exceeds interest, debt-to-GDP can fall without a primary surplus. - Table 20 (illustrative calculations for selected transition countries) — verbatim lines from source - Selected Countries in Transition: Scenarios for Fiscal Sustainability (In percent of GDP) - Czech Republic Hungary Russia Ukraine - Ratios of debt to GDP, end of 1997 11 7 65 0 30 - Real output growth, forecast for 1998 2.2 4.8 1.0 — - Ratio of primary balance to GDP, 1997 –0.6 3.5 –3.1 –3.8 - Primary balance (share of GDP) needed to stabilize ratio of debt to GDP for a real interest rate that exceeds the growth rate by: - 1 percent 0.1 0.7 0.5 0.3 - 3 percent 0.3 2.2 1.5 0.9 - 5 percent 0.5 3.6 2.5 1.5 - 10 percent . . . . . 5.0 3.0 - Russia-specific points on debt structure and vulnerabilities (verbatim numeric descriptors) - Total stock of debt (including all levels of government and enterprises) equals around 50 percent of GDP, with a composition of 60 percent foreign currency borrowing, 25 percent domestic currency debt with a maturity of less than one year, and the rest longer-term domestic currency debt. - The share of domestic currency short-term debt held by foreign investors is around 30 percent. - Implications - High real interest rates in Russia imply either substantial primary surpluses or sharp accelerations of growth are required to stabilize the debt-to-GDP ratio. - Liquidity risk: concentration of short maturities and foreign currency borrowing raises vulnerability to market sentiment shifts and exchange rate moves; recent episodes showed treasury bill yields spiking in Russia when judged at risk. ### Box 9. Tax administration reform: organization, systems, enforcement - Three broad areas for reform: organization of tax administration; systems and procedures; enforcement. - Organizational issues - Inadequate staffing, poor training, low wages, lack of equipment; low morale and administrative malpractices. - Need for internal control and accountability systems to detect incorrect assessments and deter corruption. - Systems and procedures - Need better identification procedures; move to self-assessment and withholding mechanisms; simplify tax forms and procedures. - Improve monitoring and follow-up, including selective audits; Russia and most former Soviet countries have made only limited progress adopting modern audit methods. - Enforcement - Require modern enforcement tools: access to bank deposits, vigorous prosecution of egregious tax fraud, appropriation of accounts receivable, seizure and sale of property in selective cases. - Rationalize interest and penalties on overdue tax payments. - Accurate and timely aggregate information on tax arrears is needed (example figures: Kazakhstan arrears exceed 2 percent of GDP; Russia mid-1997 tax arrears around 6 percent of GDP). ### Box 9. Expenditure adjustment, social spending, and safety nets - General trends - Aggregate spending shares fell in many transition countries; in countries more advanced in transition spending remained above 40 percent of GDP after initial decline. - Composition changes: subsidies and capital investment shares declined; social expenditures gained importance. - Military spending share fell in central and eastern Europe but remained broadly constant in Russia and most former Soviet countries (as share of GDP fell due to overall expenditure-to-GDP decline). - Subsidies, enterprise support, and cost recovery - Governments continue to subsidize electricity, residential heat and hot water; enterprises receive tax concessions and tolerated tax arrears. - Recommendation: spin off provision of nonwage benefits (housing, clinics, kindergartens), remove implicit subsidies, aim for full cost recovery while targeting social benefits to needy households. - Example: Lithuania achieved full cost recovery for heating and hot water and established an indirect subsidy when heating bills exceed 15 percent (hot water 5 percent) of household income; approximately 30 percent of urban households estimated eligible. - Russia plans full cost recovery by 2003. - Public investment - Public investment was sharply reduced early in transition; in several central Asian states and Ukraine public investment now very low (less than 2 percent of noninterest expenditures, around 1 percent of GDP), indicating need to raise infrastructure spending once shocks absorbed. - Social expenditures and unemployment - Share of social expenditures rose in most countries; unemployment insurance and active labor market schemes implemented but remain relatively small in Russia and most former Soviet countries. - Registered unemployment (selected Russia figures) - Russia registered unemployment: 0.4 (1992), 1.7 (1993), 2.8 (1994), 3.5 (1995), 3.4 (1997). - Poverty and targeting - World Bank-based estimates (Table 23) — select Russia figures verbatim: - Russia: Poverty headcount 44.0 (in percent of population); Average shortfall (as percent of poverty line) 38.0; Total number of poor 66.1 (in millions); Total poverty deficit 3.3 (in percent of GDP). - To bring all the poor up to the poverty level (assuming perfect targeting) would require income transfers of less than 1 percent of GDP in more advanced transition countries, but more than 3 percent in Russia and most other former Soviet Union countries. - Given imperfect targeting and administrative constraints, realistic schemes should aim at alleviating poverty, with emphasis on simplicity. - Health and education reform - Systems inherited from central planning provided wide access but suffered structural problems: centralized decision making, input-based performance metrics, overcapacity, and misalignment with emerging disease burdens. - Reforms should address inefficiencies from overstaffing and excess physical capacity while preserving broad access to basic education and health care. ### Box 10. Pension Reform in Countries in Transition — Public pension systems: trends and pressures - Pension systems faced declining numbers of contributors and weakening tax compliance, putting downward pressure on revenues. - Average replacement rates—defined as the average pension in terms of the average wage—fell by more than 10 percentage points in Albania, Croatia, and Romania during 1991–93. - In a number of countries of the former Soviet Union, benefit structures were flattened and the average pension was reduced to a little above the poverty line, converting pensions into largely category-based social safety nets. - Payroll tax rates after significant increases are now in general in excess of 30 percent, and they were as high as 52 percent in Ukraine in 1996. - Public pension payments exhibited substantial cross-country variation in 1996: - Around 10 percent of GDP in Hungary and Latvia. - As high as 14 percent of GDP in Poland. - "4!/2percent" of GDP in Russia (as reported in the source). - An average of around 15 percent in the western European economies (memorandum). - Pension funds began to run deficits across the region; pension arrears reached up to 3 percent of GDP in Moldova in 1996. - Demographic pressures: people aged over 60 are expected to exceed 25 percent of the population by 2030 in the Baltics, Bulgaria, Hungary, Russia, and Ukraine. ### Box 10. Observed fiscal outcomes, reform approaches, and recommendations - Observed short-run policy responses - Reducing the generosity of benefits (benefit compression). - Raising contribution rates. - Substantial budget transfers in some cases. - Reform approaches adopted - Piecemeal reforms to restore viability of PAYG systems (eligibility criteria, actuarial provisions, tighten rules on working pensioners). - Systemic reforms toward multipillar systems (first pillar: scaled-down PAYG; second pillar: compulsory, privately managed, fully funded individual accounts; third pillar: voluntary private schemes). - Countries that have taken concrete steps to shift to multipillar systems: Hungary, Kazakhstan, Latvia, and Poland. - Kazakhstan: reform plan became operational in January 1998. - Hungary: legislative work for the pension reform is complete and the new pension system is being introduced. - Poland: some laws regulating the private pillars still need approval; reforms scheduled to take effect at the beginning of 1999. - Policy recommendations, priorities, and constraints - Short- and medium-term priorities: introduce rules or incentives to raise the effective retirement age; tighten eligibility criteria for early retirement and disability; eliminate tax exemptions and extend the payroll tax to nonwage compensation; improve collection and tax compliance; reform the contribution base. - For countries considering a private second pillar: decide relative sizes and functions of public and private pillars; determine speed of transition. - Fiscal costs of transition: governments continue to provide benefits to existing and future pensioners while payroll-tax revenues fall when contributors shift to private accounts. - Preconditions for private pillar: fairly established financial markets and considerable regulation and supervision. ### Box 10. Key statistics (selected) - Pension arrears example: up to 3 percent of GDP in Moldova in 1996. - Payroll tax observation: in general in excess of 30 percent; Ukraine at 52 percent in 1996. - Public pension expenditure (selected country figures, percent of GDP): - Albania: 1993 = 6.5; 1996 = 6.8 - Bulgaria: 1993 = 14.1; 1996 = 9.5 - Croatia: 1993 = 6.2; 1996 = 10.2 - Czech Republic: 1993 = 7.3; 1996 = 8.4 - Hungary: 1993 = 10.6; 1996 = 9.7 - Poland: 1993 = 13.4; 1996 = 14.4 - Russia: 1993 = 6.1; 1996 = 4.5 - Ukraine: 1993 = 8.3; 1996 = 8.7 - United States (memorandum): 1993 = 4.6 (reported) ### Box 10 (concluded) — Health and Education; Intergovernmental relations; Legal reform; Fiscal outlook - Health and education - Financing reforms include transfers of assets and private provision; mixed public health insurance funded largely through payroll taxes and transfers from general revenues. - In Russia: employers make income-based contributions to health insurance funds for employees; local governments make contributions for the nonworking population; state and municipal public health costs financed directly from budget levels of the government. - Efficiency problems: overstaffing and excess capacity persist; shares of public health and education in total employment increased during transition even while expenditure on wages, supplies and materials, and maintenance and capital programs fell in real terms. - Priority reforms: address overemployment and inefficiency while avoiding relative wage erosion for public-sector workers. - Intergovernmental fiscal relations - Structural change: shift to decentralization with mostly two-tier systems; average share of subnational spending in total government spending about 30 percent among transition countries; range: 15 percent in Croatia to almost 50 percent in Russia. - Revenue sources for subnational governments limited; transfers from central government often necessary (example: Hungary transfers can be as large as almost two-thirds of recurrent expenditures of local governments). - Borrowing and fiscal risks: local and regional governments have borrowed domestically and issued Eurobonds; policy tools include administrative controls or rules-based approaches for borrowing. - Recommended reforms: increase subnational own revenue sources; introduce clear and stable assignments of expenditures, tax-sharing, and transfer arrangements; strengthen regulation and safeguards for external borrowing. - Legal reform, transparency, and accountability - Need legal frameworks covering financial operations at all levels; develop internal and external ex post audits and budget evaluation; move to transparent fiscal reporting. - Current shortcomings: fiscal statistics and reporting often use central-planning–era procedures; incomplete coverage of arrears and noncash transactions; extra-budgetary funds remain large but data incomplete. - Progress among more advanced transition countries: Croatia, Hungary, Latvia, Lithuania, Poland, and Slovenia generally meet IMF SDDS specifications for data coverage, periodicity, and timeliness. - Fiscal policy outlook and priorities - Fiscal policy contributed greatly to initial macroeconomic stabilization. - Remaining challenges: excessive deficits in some countries (including Russia) need elimination; persistent tax collection and administration problems require immediate and forceful policy responses. - Second-generation reforms should focus on: safeguarding sustainability of fiscal programs; improving performance and quality of public services; improving transparency and accountability and promoting good governance. *Source: _0598ch5pdf - 1997. With interest payments rising, noninterest expendi-* ### 1997. With interest payments rising, noninterest expendi- ### _0598ch5pdf - 1997. With interest payments rising, noninterest expendi- ### Fiscal adjustment and composition of expenditures - Noninterest expenditure fell from around 21 percent of GDP in 1994 to 14 percent in 1997 (to around 11 1/2percent if cash expenditures only are considered). - Items most affected by cuts: subsidies, transfers to the regions, and capital expenditure. - Items better maintained: wages and social transfers. - Expenditure adjustment described as partial, ad hoc, and with little support from weak institutions responsible for budget preparation, execution, and evaluation. ### Arrears, noncash settlements, and implications for budget management - Attempts to maintain expenditure commitments (as opposed to cash spending) led to sequestration, use of noncash means to settle budgetary obligations, and accumulation of payment arrears. - Federal government cleared wage arrears by the end of 1997, but this was replaced by a sizable buildup of new arrears to suppliers. - Finances of regional and local authorities and of extrabudgetary funds deteriorated; subnational governments accumulated undocumented arrears on wage payments and payments to suppliers. - Widespread resort to noncash mechanisms to settle budgetary arrears against the arrears of tax debtors undermines incentives for paying taxes in cash and hinders public expenditure on wages and other social commitments that can be satisfied only in cash. - Weak revenue collection, ad hoc expenditure cuts, and arrears reflect interlocked problems in tax policy, tax administration, and budgetary management. ### Tax system weaknesses and sectoral issues - Progress in tax reform in Russia described as inadequate. - Tax system characteristics: complex, with up to 200 types of taxes; numerous and sometimes arbitrary exemptions; narrow tax bases; and, partly as a result, high statutory tax rates on labor income. - Revenue structure relies heavily on payroll taxes that are likely to lead to distortions in the economy. - Energy sector tax regime has multiple shortcomings. - Relative tax burden of the oil and gas sectors—defined as the sectors’ shares in general revenues divided by their estimated shares in GDP—was around 1.6 in 1996, lower than in comparable oil- and gas-producing countries. - Actual revenues from the energy sector were only slightly more than half of the liability as estimated on a statutory basis. - An inappropriate tax structure, together with exemptions, is identified as one of the main reasons for low tax revenue. - To simplify the tax system, broaden the tax base, and reduce the number of exemptions, the government has submitted to parliament *Source: _0598ch5pdf - 1997. With interest payments rising, noninterest expendi-* ### Box 9.Russia’s Fiscal Challenges ### Box 9.Russia’s Fiscal Challenges ### Summary operations of the general government (1992–1997) - Federal government (in percent of GDP) - Revenue: 15.6, 13.7, 11.8, 12.2, 13.0, 11.6 - Expenditure: 26.0, 20.2, 23.2, 17.6, 22.1, 18.4 - Interest payments: 0.7, 1.9, 2.0, 3.3, 5.7, 4.4 - Transfers: 1.7, 2.8, 4.2, 2.1, 3.1, 3.8 - Balance: –10.4, –6.5, –11.4, –5.4, –9.1, –6.8 - Subnational governments (in percent of GDP) - Revenue: 13.5, 16.7, 18.0, 14.2, 14.5, 16.1 - Transfers: 1.7, 2.6, 4.1, 1.6, 2.7, 2.9 - Expenditure: 12.0, 16.1, 17.5, 14.5, 14.8, 16.9 - Balance: 1.5, 0.6, 0.5, –0.3, –0.4, –0.8 - Extrabudgetary funds (in percent of GDP) - Revenue: 10.9, 8.6, 9.1, 7.6, 7.7, 9.1 - Transfers: —, 0.2, 0.1, 0.5, 0.4, 0.9 - Expenditure: 8.4, 8.0, 8.6, 7.6, 7.7, 9.0 - Balance: 2.5, 0.6, 0.5, —, —, 0.2 - General government (in percent of GDP) - Revenue: 38.3, 36.2, 34.6, 31.9, 32.1, 33.0 - Expenditure: 44.8, 43.6, 45.1, 37.7, 41.6, 40.4 - Balance: –18.4, –9.4, –10.4, –5.8, –9.5, –7.5 - Memorandum - GDP (in trillions of old rubles): 1917, 2611, 1,630, 2,256, 2,675 ### Tax policy, administration, and revenue challenges - Tax Code developments and expected changes - A comprehensive draft Tax Code expected to be adopted by the middle of 1998, with most provisions coming into effect on January 1, 1999. - The code will introduce on a gradual basis accrual accounting for indirect taxes other than oil and gas excises and for profit taxes; increase the share of personal income taxes in total revenue; and reform taxation of the energy sector. - Key weaknesses identified - Procedural and organizational problems: lack of coordination among tax collecting agencies, enforcement agencies, and the Ministry of Finance. - Insufficient political will manifested in tolerance of barter transactions and accumulation of concentrated tax arrears (energy sector major share). - Steps taken to improve collection (examples from 1997 onward) - Abolition of noncash tax arrangements. - Measures against large debtor enterprises announced. - Tax-collecting agents began working on the premises of major companies in gas and electricity sectors. - Proposed measures: administrative units for large taxpayers; introduction of realistic penalties for noncompliers. - Tax policy reform priorities - Strictly limit tax exemptions; unify rates within tax categories; eliminate sectoral tax treatment differences. - Extend VAT coverage (oil and gas to be subject to full tax regime); introduce mechanisms to collect natural resource rents (for example, royalties). - Reconsider tax status of small private businesses while containing marginal tax rates and overall private sector tax burden to limit incentives for informalization. ### Budget institutions and expenditure management - Institutional weaknesses across the budget cycle - Legal framework for budget management largely unchanged since breakup of the Soviet Union and is deficient. - Preparation stage shortcomings: overoptimistic macroeconomic and revenue forecasts; lack of expenditure prioritization; complex and lengthy budget adoption procedure. - Execution stage shortcomings: budget not fully executed according to approved appropriations; ad hoc adjustments to new macro and revenue developments leading to arrears and sequestration; incomplete reports based on outdated accounting frameworks. - Auditing and evaluation virtually absent. - Government measures planned/intended for 1998 to strengthen expenditure control - Move all financial operations of federal agencies and ministries into the federal treasury. - Strengthen capacity to control and monitor expenditures. - Introduce more effective sanctions on agency heads who exceed budget spending limits. - Require preapproval of large-size contracts by the Ministry of Finance. - Establish a monthly system of reporting on payables by ministries and other agencies. - Settle outstanding expenditure arrears. - Treasury, cash management, and arrears - Extrabudgetary funds accounted for around 20 percent of government expenditure in Russia in 1996. - Practice of failing to honor payment obligations, cash-rationing, and sequestration persists (overdue payments to suppliers in Russia around 3 percent of GDP; in Ukraine arrears on wages, pensions, and benefits around 4 percent of GDP). - High priority: eliminate these practices and settle arrears through cash payment and securitization. ### Intergovernmental fiscal relations - Rapid and ad hoc fiscal decentralization during 1992–94 - Federal budget revenues shrank from around 15 1/2 percent of GDP in 1992 to 12 percent in 1994. - Regional revenues expanded from 13 1/2 percent to 18 percent (partly because federal transfers increased from 1 1/2 percent to 4 percent). - In recent years a trend toward gradual recentralization of tax revenues and reduction in federal transfers; regions saw revenue-to-GDP decline and balances moved from small surplus in 1994 into deficit from 1995 onward. - Continuing weaknesses in intergovernmental relations - Nontransparent expenditure assignments and tax-sharing leave room for discretion, continual lobbying, and undermined fiscal accountability. - Transfers system has not effectively reduced large disparities among regions in per capita revenues or equalized per capita outlays on social safety nets, education, health. - No adequate arrangements to prevent subnational financial imbalances leading to arrears or excessive borrowing, including on international markets. ### Debt sustainability and liquidity risks (illustrative framework and Russia implications) - Concept - Compare actual primary balance (excluding interest payments) with the primary balance needed to stabilize the debt-to-GDP ratio at its current level; difference measures additional “fiscal effort” needed. - If interest rate exceeds growth rate, a primary surplus is needed to stabilize debt-to-GDP; if growth exceeds interest, debt-to-GDP can fall without a primary surplus. - Table 20 (illustrative calculations for selected transition countries) — verbatim lines from source - Selected Countries in Transition: Scenarios for Fiscal Sustainability (In percent of GDP) - Czech Republic Hungary Russia Ukraine - Ratios of debt to GDP, end of 1997 11 7 65 0 30 - Real output growth, forecast for 1998 2.2 4.8 1.0 — - Ratio of primary balance to GDP, 1997 –0.6 3.5 –3.1 –3.8 - Primary balance (share of GDP) needed to stabilize ratio of debt to GDP for a real interest rate that exceeds the growth rate by: - 1 percent 0.1 0.7 0.5 0.3 - 3 percent 0.3 2.2 1.5 0.9 - 5 percent 0.5 3.6 2.5 1.5 - 10 percent . . . . . 5.0 3.0 - Russia-specific points on debt structure and vulnerabilities (verbatim numeric descriptors) - Total stock of debt (including all levels of government and enterprises) equals around 50 percent of GDP, with a composition of 60 percent foreign currency borrowing, 25 percent domestic currency debt with a maturity of less than one year, and the rest longer-term domestic currency debt. - The share of domestic currency short-term debt held by foreign investors is around 30 percent. - Implications - High real interest rates in Russia imply either substantial primary surpluses or sharp accelerations of growth are required to stabilize the debt-to-GDP ratio. - Liquidity risk: concentration of short maturities and foreign currency borrowing raises vulnerability to market sentiment shifts and exchange rate moves; recent episodes showed treasury bill yields spiking in Russia when judged at risk. ### Tax administration reform: organization, systems, enforcement - Three broad areas for reform: organization of tax administration; systems and procedures; enforcement. - Organizational issues - Inadequate staffing, poor training, low wages, lack of equipment; low morale and administrative malpractices. - Need for internal control and accountability systems to detect incorrect assessments and deter corruption. - Systems and procedures - Need better identification procedures; move to self-assessment and withholding mechanisms; simplify tax forms and procedures. - Improve monitoring and follow-up, including selective audits; Russia and most former Soviet countries have made only limited progress adopting modern audit methods. - Enforcement - Require modern enforcement tools: access to bank deposits, vigorous prosecution of egregious tax fraud, appropriation of accounts receivable, seizure and sale of property in selective cases. - Rationalize interest and penalties on overdue tax payments. - Accurate and timely aggregate information on tax arrears is needed (example figures: Kazakhstan arrears exceed 2 percent of GDP; Russia mid-1997 tax arrears around 6 percent of GDP). ### Expenditure adjustment, social spending, and safety nets - General trends - Aggregate spending shares fell in many transition countries; in countries more advanced in transition spending remained above 40 percent of GDP after initial decline. - Composition changes: subsidies and capital investment shares declined; social expenditures gained importance. - Military spending share fell in central and eastern Europe but remained broadly constant in Russia and most former Soviet countries (as share of GDP fell due to overall expenditure-to-GDP decline). - Subsidies, enterprise support, and cost recovery - Governments continue to subsidize electricity, residential heat and hot water; enterprises receive tax concessions and tolerated tax arrears. - Recommendation: spin off provision of nonwage benefits (housing, clinics, kindergartens), remove implicit subsidies, aim for full cost recovery while targeting social benefits to needy households. - Example: Lithuania achieved full cost recovery for heating and hot water and established an indirect subsidy when heating bills exceed 15 percent (hot water 5 percent) of household income; approximately 30 percent of urban households estimated eligible. - Russia plans full cost recovery by 2003. - Public investment - Public investment was sharply reduced early in transition; in several central Asian states and Ukraine public investment now very low (less than 2 percent of noninterest expenditures, around 1 percent of GDP), indicating need to raise infrastructure spending once shocks absorbed. - Social expenditures and unemployment - Share of social expenditures rose in most countries; unemployment insurance and active labor market schemes implemented but remain relatively small in Russia and most former Soviet countries. - Registered unemployment (selected Russia figures) - Russia registered unemployment: 0.4 (1992), 1.7 (1993), 2.8 (1994), 3.5 (1995), 3.4 (1997) — as shown in Table 22. - Poverty and targeting - World Bank-based estimates (Table 23) — select Russia figures verbatim: - Russia: Poverty headcount 44.0 (in percent of population); Average shortfall (as percent of poverty line) 38.0; Total number of poor 66.1 (in millions); Total poverty deficit 3.3 (in percent of GDP). - To bring all the poor up to the poverty level (assuming perfect targeting) would require income transfers of less than 1 percent of GDP in more advanced transition countries, but more than 3 percent in Russia and most other former Soviet Union countries. - Given imperfect targeting and administrative constraints, realistic schemes should aim at alleviating poverty, with emphasis on simplicity. - Health and education reform - Systems inherited from central planning provided wide access but suffered structural problems: centralized decision making, input-based performance metrics, overcapacity, and misalignment with emerging disease burdens. - Reforms should address inefficiencies from overstaffing and excess physical capacity while preserving broad access to basic education and health care. ### Pension reform (high-level points from the box) - Pension systems largely PAYG defined-benefit with narrow contribution bases and high statutory contribution rates; benefits based on complicated formulas and weakly linked to contributions. - System dependency ratios high and increased during transition; contribution collection weakened and payroll tax compliance declined (in some countries effective contribution rates fell below half the statutory rate). - Pension reform is a key component of social spending reform; approaches vary across countries. *Sources: Ministry of Finance; Central Bank of Russia; Goskomstat; and IMF staff calculations; text excerpts from Box 9.Russia’s Fiscal Challenges.* ### Box 10.Pension Reform in Countries in Transition ### Box 10. Pension Reform in Countries in Transition ### Public pension systems: trends and pressures - Pension systems faced declining numbers of contributors and weakening tax compliance, putting downward pressure on revenues. - Average replacement rates—defined as the average pension in terms of the average wage—fell by more than 10 percentage points in Albania, Croatia, and Romania during 1991–93. - In a number of countries of the former Soviet Union, benefit structures were flattened and the average pension was reduced to a little above the poverty line, converting pensions into largely category-based social safety nets. - Payroll tax rates after significant increases are now in general in excess of 30 percent, and they were as high as 52 percent in Ukraine in 1996. - Public pension payments exhibited substantial cross-country variation in 1996: - Around 10 percent of GDP in Hungary and Latvia. - As high as 14 percent of GDP in Poland. - "4!/2percent" of GDP in Russia (as reported in the source). - An average of around 15 percent in the western European economies (memorandum). - Pension funds began to run deficits across the region; pension arrears reached up to 3 percent of GDP in Moldova in 1996. - Demographic pressures: people aged over 60 are expected to exceed 25 percent of the population by 2030 in the Baltics, Bulgaria, Hungary, Russia, and Ukraine. ### Observed fiscal outcomes and short-run policy responses - Typical short-run responses to financial pressures included: - Reducing the generosity of benefits (benefit compression). - Raising contribution rates. - Substantial budget transfers in some cases. - These measures have not restored the financial viability of many systems. - The immediate effects of high inflation combined with ad hoc and imperfect indexation led to reductions in replacement rates in several countries; inflation adjustments generally protected the real value of the basic pension while pension supplements fared less well, leading to compression in the distribution of pensions. ### Reform approaches adopted - Two broad approaches observed: - Piecemeal reforms aimed at restoring viability of existing PAYG systems without altering basic structure. Measures include: - Changing eligibility criteria. - Introducing actuarial provisions in benefit calculations to reduce incentives for early retirement. - Reducing or eliminating benefits for working pensioners and privileged early retirement. - Reforming the contribution base and improving compliance. - Systemic reforms toward multipillar systems (as promoted by the World Bank), typically structured as: - First pillar: scaled-down PAYG focused on redistribution and a social safety net. - Second pillar: compulsory, privately managed, fully funded individual accounts to foster saving. - Third pillar: voluntary private schemes for additional saving. - Countries that have taken concrete steps to shift to multipillar systems (as reported): - Hungary, Kazakhstan, Latvia, and Poland. - Country-specific notes: - Kazakhstan: reform plan became operational in January 1998; envisages a transition toward a Chilean model where the first pillar plays a minimal role and all current and new workers immediately participate in the funded system of individual accounts. - Hungary: legislative work for the pension reform is complete and the new pension system is being introduced. - Poland: some laws regulating the private pillars still need approval; reforms are scheduled to take effect at the beginning of 1999. - In Hungary and Poland, reforms offer current workers within a certain age range the option to remain in the old system (a gradual transition). ### Policy recommendations, priorities, and constraints - Short- and medium-term priority measures (piecemeal and systemic) include: - Introduce rules or incentives to raise the effective retirement age. - Tighten eligibility criteria for early retirement and disability. - Eliminate tax exemptions and extend the payroll tax to nonwage compensation. - Improve collection and tax compliance. - Reform the contribution base. - For countries considering a private second pillar, key issues to decide: - Relative sizes and functions of the public and private pillars. - Speed of transition from PAYG to funded schemes. - Fiscal and institutional constraints: - Fiscal costs of transition arise because governments continue to provide benefits to existing and future pensioners while payroll-tax revenues that supported those benefits fall when contributors shift to private accounts; these fiscal costs increase the fiscal deficit as conventionally measured. - Systems emphasizing the private pillar offer less scope for redistribution and require a sound financial system. - Preconditions for introducing a private pillar include fairly established financial markets, and considerable regulation and supervision to avoid fraud and excessive risk taking. - Recommended sequencing: - Countries advanced in transition and in financial sector reform may move toward having the private sector provide a relatively large share of pensions in the medium term. - Countries less advanced should prioritize developing the legal and financial market environment necessary for privately managed pension funds. ### Key statistics reported (selected) - Pension arrears example: up to 3 percent of GDP in Moldova in 1996. - Payroll tax observation: in general in excess of 30 percent; Ukraine at 52 percent in 1996. - Public pension expenditure (selected country figures, percent of GDP): - Albania: 1993 = 6.5; 1996 = 6.8 - Bulgaria: 1993 = 14.1; 1996 = 9.5 - Croatia: 1993 = 6.2; 1996 = 10.2 - Czech Republic: 1993 = 7.3; 1996 = 8.4 - Hungary: 1993 = 10.6; 1996 = 9.7 - Poland: 1993 = 13.4; 1996 = 14.4 - Russia: 1993 = 6.1; 1996 = 4.5 - Ukraine: 1993 = 8.3; 1996 = 8.7 - United States (memorandum): 1993 = 4.6 (reported) - Countries explicitly named as implementing multipillar steps: Hungary, Kazakhstan, Latvia, Poland. *Source: Box 10. Pension Reform in Countries in Transition (excerpt).* ### Box 10(concluded) ### Box 10 (concluded) ### Health and Education: organization, financing, and efficiency - Organizational and financial reforms have reduced and redefined central government roles and shifted responsibilities to local authorities; financing reforms include transfers of assets and provision to the private sector. - Health care financing has moved toward a mixed system based on public health insurance funded largely through payroll taxes and transfers from general revenues. - Example: In Russia, employers make income-based contributions to health insurance funds for employees, local governments make contributions for the nonworking population, and state and municipal health systems’ public health costs continue to be financed directly from budget levels of the government. - Financing reforms have allowed maintaining or increasing spending on health and education as a percentage of total noninterest expenditures; in Russia total spending on health in real terms has returned to pre-transition levels following adoption of new financing mechanisms. - Efficiency problems remain: - Overstaffing and excess infrastructural capacity persist, partly due to government attempts to safeguard employment. - The shares of public health and education in total employment increased during transition in almost all transition countries (see Table 26), even while expenditure on wages, supplies and materials, and maintenance and capital programs fell in real terms. - Priority reforms: - Address overemployment and inefficiency while avoiding relative wage erosion for public-sector workers vis-à-vis the private sector. - Major restructuring of public health and educational sectors to improve cost-effectiveness and quality. - Table 26. Selected Countries in Transition: Shares of Education and Health in Total Employment (In percent) - Belarus - Education: 9.9, 10.2, 10.5, 11.1, 11.5 (1990 1993 1994 1995 1996) - Health: 5.2, 5.8, 6.1, 6.5, 6.9 - Czech Republic - Education: 5.9, 6.7, 6.6, 6.4, 6.4 - Health: 5.2, 5.4, 5.3, 5.2, 5.3 - Kazakhstan - Education: 11.4, 12.1, 12.0, 11.9, 10.4 - Health: 5.8, 6.2, 6.5, 6.4, 5.9 - Latvia - Education: 7.2, 7.6, 7.6, 8.7, 8.8 - Health: 4.8, 6.4, 6.1, 6.2, 6.1 - Romania - Education: 3.8, 4.3, 4.4, 4.6, . . . - Health: 3.0, 3.1, 3.3, 3.5, . . . - Russia - Education: 9.6, 10.2, 10.8, 11.0, 11.2 - Health: 5.6, 6.0, 6.4, 6.7, 7.0 - Ukraine - Education: 9.3, 9.6, 9.9, 9.5, 9.2 - Health: 5.9, 6.4, 6.5, 6.4, 6.4 - Sources: National authorities; and IMF staff estimates. ### Intergovernmental fiscal relations - Structural change: - Transition from unitary central-planning administration to decentralization with mostly two-tier systems (central government plus many relatively small local governments); some countries developing three tiers (example: Poland planning a new middle tier of about 320 governmental units). - Decentralization requires appropriately designed intergovernmental fiscal relations. - Reality and problems: - In Georgia and Ukraine local governments often act as spending agents of the central government with limited autonomy (administrative decentralization). - In many countries local governments have been given autonomous spending and taxing powers within legal criteria; Russia is evolving toward a fiscal federation with extensive regional fiscal autonomy. - Average share of subnational spending in total government spending is about 30 percent among transition countries; range: 15 percent in Croatia to almost 50 percent in Russia. - Expenditure assignment and subsidiarity: - Efficiency gains from decentralization depend on clear, consistent, and stable assignment of expenditures to government levels. - In practice, transfers of expenditure authority have proceeded by trial and error; in some cases national-level functions (for example, social safety net spending) were transferred to subnational governments. - Revenue sources for subnational governments: - Own revenues are limited; assigned taxes often include property taxes and minor “nuisance” taxes that raise a small proportion of local revenue—around 9 percent in Estonia and 6 percent in Hungary. - Shared taxes (often personal income tax) are used but tax shares often vary year to year and are negotiated. - Transfers from the central government are often necessary; in Hungary transfers can be as large as almost two-thirds of the recurrent expenditures of local governments. - Borrowing and fiscal risks: - Local and regional governments have borrowed domestically and issued Eurobonds: Prague (1994), Tallinn (1996), and several Russian cities and subnational authorities (1997). - Risks from weak subnational fiscal discipline include borrowing for inappropriate reasons, potential defaults that could force central government bailouts, and aggregate borrowing that may compromise macroeconomic stability. - Policy tools: - For unitary systems: administrative controls preventing subnational borrowing or allowing borrowing only for investment with approval. - For more federal systems: rules-based approaches for domestic borrowing may be appropriate. - Recommended reforms: - Increase subnational governments’ own revenue sources. - Introduce clear and stable assignments of expenditures, tax-sharing, and transfer arrangements. - Ensure that intergovernmental finance systems provide adequate funding for key functions such as health, education, and social welfare. - Strengthen regulation and institutional safeguards for external borrowing. ### Legal reform, transparency, and accountability - Need for legal frameworks: - Establish and implement legal frameworks covering financial operations of government at all levels so the rule of law applies to every government financial transaction. - Accountability and transparency measures: - Develop internal and external ex post audits and budget evaluation. - Move away from secrecy and central-planning–oriented data systems to transparent fiscal reporting. - Current shortcomings in fiscal statistics and reporting: - Many fiscal statistics still refer to reporting procedures and classification codes from the central-planning era. - Serious shortcomings include incomplete coverage of fiscal reporting documenting budget execution, inadequate coverage of financing flows and outstanding domestic and foreign debt, and classification codes that do not accurately distinguish economic characteristics of transactions. - Fiscal reporting weaknesses also include cash-based recording, incomplete coverage of arrears and noncash transactions, recording of privatization transactions, and quasi-fiscal operations. - Extra-budgetary funds remain large but data are incomplete. - Progress among more advanced transition countries: - Public finance statistics in Croatia, Hungary, Latvia, Lithuania, Poland, and Slovenia generally meet IMF SDDS specifications for data coverage, periodicity, and timeliness. - Fiscal rules and borrowing limits: - Countries can adopt fiscal policy rules (numerical ceilings or targets); examples include limits on central bank credit to government in the Czech and Slovak Republics. - Some countries have imposed restrictions on subnational borrowing: Estonia and (following new legislation) Russia face ceilings on both stock of debt and new borrowing. - Broader fiscal rules may be less effective given limited track records of fiscal discipline and unstable expenditure and revenue patterns in many transition countries. - Governance and public resource management: - Reforms in tax administration, audits, and publication of financial information can deter misuse of government resources and reduce discretionary decision-making and preferential treatment. - Surveys indicate countries less advanced in transition are perceived as having relatively unfair taxes, onerous regulations, and poor provision of public goods and services; governance problems are associated with slower economic growth, less foreign direct investment, and a higher share of informal and untaxed activity. ### Fiscal policy outlook and priorities - Fiscal policy has contributed greatly to initial macroeconomic stabilization. - Remaining challenges: - In some countries, including Russia and other former Soviet Union countries, excessive deficits still need elimination to protect stabilization gains. - Persistent tax collection and administration problems in less-advanced transition countries require immediate and forceful policy responses to secure stable and adequate revenues. - In more advanced transition countries, reforms to improve cost-effectiveness of social security and welfare systems and reduce overall government spending are high priorities. - Second-generation reforms should focus on: - Safeguarding sustainability of fiscal programs. - Improving the performance and quality of public services to enhance efficiency, productivity gains, and quality of life. - Improving transparency and accountability and promoting good governance across all transition countries. *Source: Box 10 (concluded), _0598ch5pdf* --- _Source: https://www.imf.org/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/weo/weo0598/pdf/_0598ch5pdf.pdf_