Transcript English

Fiscal Policy and Economic Growth:
Lessons for Eastern Europe and Central Asia
Key questions

How do broad public finance patterns and
trends affect economic growth?




Fiscal balance
Size of government
Patterns of spending and taxation
How can the efficiency of spending and
taxation be increased?






Infrastructure
Education
Health
Pensions
Flat income taxes
Labor taxes
Key messages
o
The impact of fiscal policies on growth
depends on the quality of governance.
o
o
o
In most ECA countries fiscal space needs to be
created through efficiency gains rather than
increased spending.

o
Government size and expenditure composition matter most
when governance is weak; Tax composition also matters
when governance is strong
High fiscal deficits reduce growth in both cases
There are opportunities for efficiency gains in infrastructure,
education, health, and pensions.
Recent reforms in income taxation are
welcome but do not adequately address the
high labor tax wedge.
Public Finance and Economic Growth:
Trends and Interrelationships
Growth in ECA has been rapid in recent
years after initial collapse.
Annual real GDP growth, in %
15
Low income CIS
EU3 Baltics
SE Europe
10
5
EU5 Central Europe
0
-5
Middle income CIS
-10
-15
-20
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
-25
R
ke
y
us
sia
B
Ka os
za nia
kh
st
M an
ol
d
Bu o va
lg
a
G ri a
eo
rg
Es ia
Az ton
er i a
ba
ij
Be an
la
R rus
om
a
FY S ni a
l
R ov
M en
ac
i
ed a
on
i
La a
tv
ia
Sa
Ta
M
jik
ist
Al an
ba
Li ni a
th
ua
Ar nia
m
en
C ia
ro
at
i
Sl a
ov
a
Po k
la
H nd
un
Ky g a
rg ry
yz
re
C p
ze
c
U h
kr
ai
ne
Tu
r
Fiscal balances have improved in recent
years in most ECA countries.
…but further fiscal adjustment is still needed in some settings.
Primary fiscal balance (average 2002-04, in % of GDP)
8
6
4
2
0
-2
-4
-6
-8
Successful fiscal adjustments have been
stronger than unsuccessful ones and have been
driven mainly by broad-based expenditure cuts
Characteristics of fiscal adjustments in ECA
5
4
3
successful
unsuccessful
in % of GDP
2
1
0
Composition of fiscal adjustments
-1
-2
-3
-4
-5
fiscal balance 1 fiscal balance 2
year before
years after
expenditure
cuts
revenue
increases
Growth has been higher when fiscal
adjustment has been successful…
8
7
GDP growth before, during, and after fiscal adjustment in ECA, 1996-2004, in % per
year
Successful adjustments
Unsuccessful adjustments
6
5
4
3
2
1
0
Year before
During adjustment
Over 2 years after adjustment
…and adjustments financed by “non directly
productive” expenditure cuts have had higher
growth impact
Impact on the annual growth rate of an increase in the fiscal surplus of 1% of GDP
0.5
0.48
0.46
0.44
0.42
0.4
0.38
0.36
decrease in non
productive
spending
increase in non
distorting taxes
increase in
distorting taxes
Increase in fiscal surplus financed by:
decrease in
productive
spending
Most ECA governments are larger than
in comparator high-growth countries
Primary Public Expenditures and Per capita Incomes (PPP)
(average 2000-2004)
60
Primary Exp Percent of GDP
55
Croatia
50
45
International
correlation
40
35
ECA countries
correlation
30
Spain
Ireland
25
Korea
Vietnam
20
Chile
Uganda
15
Thailand
10
6
7
8
9
LN GDP per capita, PPP
ECA countries
High growth comparator countries
10
11
Percent of GDP
Large size tends to reflect large
spending for social transfers
45
40
35
30
25
20
15
10
5
0
Other
Economic Affairs
General Public Services
Defense & Public Order
Education
Health
EU8
SEE
Turkey MIC CIS
Low
income
CIS
Social Security
Large government size is associated with
slower growth in poorly-governed countries
More Effective Governments
0
-50
-50
-25
-25
0
Economic Growth
25
25
50
50
Less Effective Governments
0
20
40
Size of Government
60
80
0
20
40
Size of Government
… but not in well-governed countries
60
80
Why might “big governments”, beyond a
certain size, adversely affect growth?

Misallocation of expenditures: Big

Low efficiency: Weak administrative capacity

High taxes: Financing of high levels of public
governments may spend more on less productive
functions
may be more of a binding constraint when public
responsibilities are large
spending requires high taxes that can distort
incentives for saving, investment, and work effort
…and the negative effect of these factors tends to
be stronger when governance is poor
The impacts on growth of public spending and
revenues also depend on the quality of governance.
Size of government and spending mix matter most when governance is poor;
Spending and revenue mix matters more when governance is good.
SPENDING
Good
governance
Poor
governance
“Unproductive”
expenditures
No measurable
impact
Negative impact
“Productive”
expenditures
Positive impact
No measurable
impact
“Distorting” taxes
Negative impact
No measurable
impact
“Non distorting”
taxes
Positive impact
No measurable
impact
TAXATION
The Challenge of Improving
Public Spending Efficiency
Few ECA countries have fiscal space
for additional spending
Infrastructure: Policy reforms are high priority
-- and maintenance, private sector participation, some new investment
Total Hidden Costs - Percentage of GDP
(2000-2005)
30
25
20
15
10
5
2000
2001
2002
2003
2004
2005
kr
ai
ne
U
Tu
rk
ey
om
an
ia
R
Po
la
nd
R
gy
z
Ky
r
G
eo
rg
ia
ro
at
ia
C
a
Ar
m
en
i
Al
ba
ni
a
0
Education and health: ECA has good
outcomes given its level of income…
…but these results come at a high cost.
KOR
1.00
CHL
0.92
THA
Example:
Input efficiency
score for life
expectancy at
birth
0.79
ALB
0.70
GEO
0.69
ARM
0.69
VNM
0.68
KGZ
0.65
UKR
0.65
UGA
0.65
TUR
0.63
ROM
0.56
POL
0.55
SVK
0.46
HRV
0.00
0.38
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0.80
0.90
1.00
Reforms can increase efficiency in
education and health
Education




Allocate financing on a per student basis
Move to more efficient (generally larger) class sizes
Reduce emphasis on expensive vocational education
Enhance private financing, particularly at tertiary level
Health




Consolidate hospitals to improve efficiency
Strengthen incentives for cost saving by providers and
consumers (e.g. co-payments, basic benefits package)
Address high out-of-pocket payments (often informal)
Improve transparency and accountability at all levels
Pensions are a particular challenge in ECA

Situation different than in comparators



Legacy of generous pension coverage
Falling employment levels (exacerbated by high labor taxes)
Aging populations
140

Share of elderly
receiving
pensions
exceeds
percentage of
working-age
population
making
contributions
% of working age contributing
120
100
IRELAND
80
SPAIN
60
UKRAINE POLAND
CHILE
KOREA
SLOVAKIA
CROATIA ROMANIA
40
THAILAND
20
ALBANIA
VIETNAM
VIETNAM
UGANDA
0
0
KYRGYZ REP
GEORGIA
TURKEY
20
40
60
80
% of elderly receving pensions
100
120
140
A two-pronged approach for pension reform?

MICs: public/private contributory systems +
means-tested social assistance

LICs: universal low-rate pension (financed
from general revenues)

All contributory systems should be entirely
self-financing

In many cases financial sustainability will
require benefits to be tightened
How can Distortions in the Tax
System be Reduced?
ECA leads the world in flat-rate income
tax reforms…
Revenue, incentive, equity, and growth effects
have generally been positive.
PIT Revenue Collections as % of GDP
8.00
7.00
6.00
5.00
4.00
3.00
2.00
1.00
0.00
Lithuania
Russian
Federation
before
1 year after
Slovakia
2 years after
Ukraine
…but complementary policies are needed to
enhance the impact of flat-income taxes




Closing tax loopholes and ad hoc
exemptions
Maintaining appropriate tax allowances
to enhance equity
Strengthening tax administration
Reforming payroll taxes and social
insurance
Labor taxes are still too high…
Tax Wedge on Labor: ECA against Selected Comparator Countries, 2006
50.0%
45.0%
40.0%
35.0%
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
ECA
Comparators
Vietnam
Korea
Ireland
USA
UK
Spain
Netherlands
Denmark
EU-15
Low-income CIS
Middle-income
CIS
SEE
EU-11
Turkey
0.0%
…and are associated with low
labor force participation in ECA
ECA countries need to streamline social benefits and
move to general revenue financing of health and
some social transfers to help spur employment
Labor Force Participation Rate by Quartiles of Tax Wedge, 2004
28 ECA countries
70
Labor force participation rate, %
69
68
67
66
65
64
63
62
bottom quartile
2nd quartile
3rd quartile
Tax Wedge
top quartile
Summing up

The impact of fiscal policies on growth
depends on the quality of governance.



In most ECA countries fiscal space needs to
be created through efficiency gains rather
than increased spending.


Government size and expenditure composition matter
most when governance is weak; Tax composition also
matters when governance is strong
High fiscal deficits reduce growth in both cases
There are opportunities for efficiency gains in
infrastructure, education, health, and pensions.
Recent reforms in income taxation are
welcome but do not adequately address the
high labor tax wedge.
Thank you.
Report available in English and Russian
at www.worldbank.org/eca/fiscal