- Vito Tanzi, and Antonis Adam
- Published Date:
- June 1992
Fiscal Policies in Economies in Transition
International Monetary Fund
© International Monetary Fund, 1992
Reprinted March 1995
Library of Congress Cataloging-in-Publication Data
Fiscal policies in economics in transition / edited by Vito Tanzi. p. cm.
Includes bibliographical references and index.
1. Fiscal policy—Europe, Eastern. 2 Post-communism—Europe, Eastern. 3. Fiscal policy—Africa. 4. Post-communism—Africa. 5. Fiscal policy—Asia. 6. Post-Communism—asia. I. Tanzi. Vito.
This book’s cover and its interior were designed by the IMF’s Graphics Section. David Driscoll of the IMF’s External Relations Department edited the book for publication.
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One of the most dramatic political and economic developments of recent years has been the realization on the part of the citizens of many centrally planned economies that central planning cannot lead to economic well-being and to democratic and open societies. The successful economic and social transformation of these countries will not be easy. It will require great effort and perseverance on the part of policymakers; it will also require the solution to many technical problems never before discussed by economists, and the creation of new institutions.
From the beginning the IMF has assisted these countries with technical advice and, where appropriate, with financial assistance. One aspect that has required particular attention is the establishment of fiscal institutions as a prerequisite to good fiscal policy. Some institutions that are essential to the proper functioning of a market economy were not needed, or were needed in very different forms, by the centrally planned economies. Until efficient fiscal institutions are fully in place, the conduct of macro-economic policy will be difficult. Many mistakes can be made in the process of creating these fiscal institutions, which could reduce the chance for a successful economic policy. Such mistakes should be avoided.
This book brings together some of the knowledge in the fiscal area accumulated by individuals who have been closely involved with this historical process of transformation. As long as this knowledge remains in confidential reports to specific countries, or in the memory of a few individuals, it will not be as useful to the community at large as it could be. Lessons learned in one country may be useful to other countries. And many individuals outside the Fund can benefit from this knowledge. I am hopeful that this book, dealing with such a topical and important subject, will help make the road to a market economy less bumpy.
International Monetary Fund
Sheetal K. Chand and Henri R. Lorie
Milka Casanegra de Jantscher, Carlos Silvani, and Charles L. Vehorn
Ved P. Gandhi and Dubravko Mihaljek
Alan A. Tait
Erik C. F. Offerdal
Ke-Young Chu and Robert Holzmann
A. Premchand and L. Garamfalvi
Daniel Hewitt and Dubravko Mihaljek
Introduction Vito Tanzi
One of the important but least-known functions of the International Monetary Fund is the provision of what is broadly and not precisely described as “technical assistance.” Technical assistance comprises many heterogeneous activities, ranging from those associated with the setting up of statistical systems and central banks to those associated with the setting up of fiscal institutions and the reform of public finances. Much of this activity is largely invisible to outsiders since it is often carried out quietly and discreetly. It rarely makes the news, even though there is growing evidence that the policymakers of the Fund’s member countries attach importance to it and that the receiving countries derive significant benefits from it. When this activity results in the writing of reports, these are written for the specific use of the most senior economic policymakers of the member countries. Because of their confidentiality, these reports are never available to the general public and are generally available to only a few key individuals.
It is natural that the individuals who are engaged in these activities often come to acquire a detailed and profound knowledge of the relevant area since they have access to information that is rarely available to others. The authors of the papers contained in this book have been deeply involved with technical assistance and, in more recent years, with technical assistance to the countries that are now generally called “economies in transition.” These authors have spent much time in these countries studying their fiscal systems and assessing possible reforms. With one exception, all the authors have been associated with the Fiscal Affairs Department of the Fund, which is the department through which the Fund provides technical assistance in the fiscal area. Since technical assistance is closely connected with the creation of institutions and with policy reform in general, it is natural that the authors of these papers have a bias for the practical over the theoretical. The papers have been written to provide guidance to the policymakers in their reform effort rather than to provide classroom material for academic discussion. Thus, there is little abstract theorizing in them. Still, they should be useful to all those who have a genuine interest in understanding what is really going on in the economies in transition and to those who want to influence that process. It is, thus, the hope of the editor that the interest in this book will extend beyond those directly involved with fiscal reform in these countries and that this book will increase the general awareness about the obstacles and the possibilities faced by these countries. Incidently, the group of economies in transition extends beyond the countries of Central and Eastern Europe and includes some from other continents. Much of the focus in this volume is, however, on the Central and Eastern European countries.
As in the past couple of years, the Fiscal Affairs Department intensified its work in the transforming of planned economies; it became evident that the amount of knowledge of the fiscal systems of these countries and of the way in which those systems might develop was very limited. This lack of knowledge was likely to lead to mistakes on the part of economists advising these countries. The institutional limitations to policy changes were likely to be ignored, and unrealistic expectations about how soon new policies could be implemented would be created. In fact, the early talk about “big bang” solutions was largely the result of ignorance of the real situation. In fiscal policy, there cannot be any big bang solution since, before new policies can be introduced, new institutions must be created. And the creation of these new institutions will require a lot of effort and time. This realization provided a strong reason to make available to a wider audience some of the knowledge accumulated by those engaged in technical assistance in the fiscal area. The Fund could provide an important service to the general public, as well as to the policymakers of the relevant countries, by making some of this material generally available. An additional reason was that those who received the technical assistance reports would often not remain in their job for long so that the benefit of this assistance might be reduced by this lack of continuity.
In a period when “planning” has lost much of its allure, it must be admitted that this is a fully planned book. The content of edited books is rarely fully planned, since the editors of these books must rely on papers already available (often those presented at conferences) and can thus only marginally influence the content and the coverage of the papers. These papers often do not provide a cohesive whole. The genesis of the present book, however, is somewhat different. All the papers were written for this volume in response to specific instructions by the editor. As a consequence, they form a homogeneous body, covering all the major facets of fiscal policy. The book is likely to provide the most comprehensive treatment of fiscal issues in economies in transition now available in print.
The book is made up of three parts. The first part, consisting of four chapters, deals with general effects of fiscal policy, including the financing of the deficit, the management of public debt, and the fiscal implications of privatization of public enterprises. The second part, consisting of seven chapters, deals with revenue aspects in general, and especially with the setting up and the reform of tax.systems. In fact, to be successful, the process of transformation of these economies must include the replacement of a revenue system that consists largely in the transfer of funds from relatively few surplus enterprises to the government to one that is based on the contribution of a very large number of taxpayers. One quick lesson learned from early work in these countries is that modern and market-economy types of tax systems have to be developed almost from scratch. The third part consists of five chapters dealing broadly with public expenditure. Once again, the lack of modern institutions in the budgetary area is highlighted.
Chapter 1, by Chand and Lorie, is a broad survey of fiscal issues in economies in transition. It is a kind of introductory overview. It covers the main feature of financial and fiscal policies under classical central planning, the consequences of partial reforms, the obstacles to market-oriented reform, and the requirements for a successful transition to a market economy.
The second chapter, by Adrienne Cheasty, covers an area that has received little, if any, attention so far, namely, the financing of growing fiscal deficits in countries that were not supposed to have deficits, that had experienced little, if any, deficits in the past, and that, as a consequence, did not have the institutions to absorb in a noninflationary way large fiscal deficits. Cheasty provides interesting data on five East European countries. She shows that it will be difficult for those countries to finance substantial deficits in noninflationary ways since central bank financing will almost inevitably have to play a large role in financing the deficits. In a way, the situation of these countries is similar to that of poorer developing countries with undeveloped capital markets and limited possibilities of placing bonds with the public. Foreign financing is also likely to be limited. Cheasty shows that the method by which budget deficits are financed will be an important determinant of the success of the stabilization efforts. Through a simulation exercise she shows the effects of financing alternatives on the fiscal deficit itself, on the inflation rate, and on the trade balance. The importance of foreign financing in reducing the cost of the transition is highlighted.
Chapter 3, by Mark Allen, also deals with a topic that has attracted almost no attention, namely, the management of the existing and growing domestic debt. He shows that, as time passes, the value of government-owned assets is becoming progressively lower while the government is nationalizing large and growing liabilities. Thus, the net worth of the public sector appears progressively lower. Examples of these liabilities are bad bank loans to the enterprise sector and bank losses arising out of housing credit extended at very low fixed interest rates. Thus, old debt is being added to newly created debt arising out of current fiscal deficits. This process is not complete so that the full extent of public debt is yet not known. The need to develop financial markets to encourage financial saving is stressed.
Chapter 4, by Richard Hemming, deals with a topic that, unlike those in Chapter 2 and 3, has received and continues to receive a lot of attention, namely, privatization. The privatization of state enterprises has been considered by many as a sine qua non for the transformation of these economies. It would generate resources for the government, it would create incentives for the enterprises to become more efficient, and it would remove from the management of those enterprises bureaucrats still ideologically committed to central planning. Without privatization it is unlikely that the public enterprises of these countries could meet the challenge of world competition. Unfortunately, so far, progress in this area has been slow. The reasons for privatization and the difficulties faced are discussed by Hemming’s chapter, which also assesses the fiscal implications of privatization.
Chapter 5, by Krister Andersson, is a kind of introductory chapter to the chapters dealing with taxation. Andersson highlights efficiency considerations in the setting up of tax systems, considerations that may be ignored owing to the preoccupation with revenue or to the temptation on the part of policymakers to pursue some sort of industrial policy or some social objectives through the tax system. The debate between broad-based systems and special incentives is addressed, and some important tax incentives issues are discussed. A key question in this chapter is the kind of tax system that would contribute to a favorable investment climate.
Chapter 6, by Milka Casanegra, Carlos Silvani, and Charles Vehorn, addresses the issue of taxation from the angle of administrative feasibility. These authors argue that fundamental changes must take place in the institutions that deal with tax administration, and they outline some of these changes. New institutions must be created; staff must be trained; new procedures must be developed; and modern techniques must be introduced. All this will take a lot of effort and much time. The possibility of making mistakes will be particularly high in this area. Without a total restructuring of the tax administration, the reform of the tax system along the lines of market economies will remain a dream. This is a chapter that should be read by all tax experts from advanced market economies who are pushing their own ideas of a proper tax system on the economies in transition. And, of course, it should prove useful to the policymakers of those countries charged with reforming the tax systems.
Chapter 7, by Ved Gandhi and Dubravko Mihaljek, is a broad introductory chapter on the need for and the scope of tax reform in economies in transition. Noting that taxation has attracted little attention on the part of those who have written on the centrally planned countries, it argues that socialist economies in transition need tax reform and need it immediately. It goes on to discuss the role of various taxes and the reforms in other sectors required to make tax reform possible. For example, there is a loose link between tax reform, price reform, financial reform, external sector reform, and factor market reforms. This chapter discusses objectives and constraints of tax reform in the short run and over the longer run.
The following three chapters—Chapters 8, 9, and 10—by Leif Muten, Alan Tait, and Van-Can Thai, discuss respectively the three groups of taxes that will play a major role especially over the next few years, namely, income taxes, value-added taxes, and foreign-trade taxes.
Chapter 8, by Leif Muten, starts by outlining the role of income taxes in centrally planned economies. These taxes were not used to redistribute income, as their objective was achieved through more direct means, but to discourage private activities. The promotion of incentives was not an objective of policy, and the concept of income and profit was vague and not in accordance with accounting or economic concepts. In market economies, these taxes should be based on objective concepts, should be efficient, and possibly, should be consistent with the achievement of new objectives, such as an improvement in income distribution. Muten discusses various questions that must be addressed in the process of reforming these taxes.
Value-added taxes are likely to play a large role in the future of the tax systems of the economies in transition because of revenue needs and, especially for the Eastern European countries, because of their desire to get closer to European tax structures. Alan Tait’s Chapter 9 is a careful evaluation of the prospects for the introduction of these taxes. He indicates that all the Eastern European countries have declared their intention to introduce value-added taxes soon and some have already done so. Tait discusses the obstacles faced in this process and outlines the structure of the tax that, in his view, is the best feasible one. Issues related to the size of the base and the structure of the rates receive careful attention. He cautions that the attempt to pursue objectives other than revenue generation through value-added taxes is bound to lead to value-added taxes that are far from efficient. Mistakes made at the time of introduction of the tax will be difficult to correct at a later time.
Foreign trade taxes play an important role in developing countries but not in industrial countries. In centrally planned economies, they did exist but their role was largely limited to insulating domestically controlled prices from variations in international prices and to obtaining trade concessions from other countries. In economies in transition, import duties may come to play roles closer to those played by these taxes in developing countries, namely, revenue generation and the protection of particular industries. The chapter by Van-Can Thai analyzes the role of foreign trade taxes in economies in transition. He reviews the recent role of tariffs in the reform of several of these countries and discusses the future role of tariffs as well as of export taxes and subsidies. Since this chapter deals with issues that have received almost no attention, it fills an important gap in the general knowledge.
The transformation of the economies of the previously centrally planned countries will be accelerated if foreign direct investment is attracted to these countries and if it brings needed capital, technology, and managerial skills. What are the factors that attract foreign direct investment? And what role can taxation play? These questions have often been raised in connection with developing countries. In Chapter 11, Erik Offerdal addresses the same questions within the context of economies in transition. He discusses the role of tax incentives, describes the current situation, and makes recommendations for further tax reform. He cautions that foreign direct investment will generate serious complications for a tax administration already strained by the changes taking place.
Chapter 12, by Ke-Young Chu and Robert Holzmann, surveys some general issues concerning public expenditure. It discusses the level of total expenditure in economies in transition as well as their structure. It shows that the level of public expenditure has been somewhat higher in these countries than in market economies owing largely to the role of transfers to families and enterprises. The transition to a market economy will require a redefinition of the role of government. The new role will almost surely be smaller. The macroeconomic situation and the probable decline in tax revenue will require a reduction in public spending, especially in tansfer payments. Over the medium run such a reduction will not be easy.
The chapter by A. Premchand and L. Garamfalvi assesses the strength of budget and accounting systems in centrally planned economies and the extent to which these fiscal institutions can be adequate during the transition to a market economy. Their conclusion is that major reform will be necessary since the institutions that prevailed under central planning will prove to be wholly inadequate in the new situation. Once again these reforms will take time. As they put it: “…the recent experience with institutional developments suggests that it is a medium-term task, more suited to long-distance running than to sprinters.” Premchand and Garamfalvi provide a careful outline of the changes that will be needed.
The question of social security in economies in transition is addressed by George Kopits in Chapter 14. He points out that “ironically, countries that have lived for decades under socialism are experiencing a social security crisis of major proportions.” It is unlikely that the fiscal resources that will be available to these countries in future years will be sufficient to finance existing social security programs. Inevitably, major reforms aimed at reducing and restricting benefits will become essential if fiscal crises are to be avoided. This chapter provides a careful analysis of the problems for various programs such as old-age pensions and health related schemes and outlines future options for reform. Kopits emphasizes that stop-gap adjustments will not provide a solution and that fundamental reforms are necessary.
The transformation of the centrally planned economies will bring about major changes in income distribution and in living standards. Some groups are likely to experience unacceptable cuts in living standards. It is thus necessary that, especially during the period of transition, social safety nets are put into place so as to protect the most vulnerable groups. Chapter 15, by Ehtisham Ahmad, addresses this important topic. It discusses various options, such as cash compensation and means testing, categorical transfers and allowances, limited rationing, and other means for protecting the vulnerable groups. The likely prospect that tax revenue will fall during the transition makes it essential that whatever option is chosen, it cannot be a fiscally expensive one.
The last chapter, by Hewitt and Mikaljek, addresses an issue of growing importance in these countries, namely, the fiscal arrangements between the central government and the local government. How will the transition to a market economy affect the existing assignments of fiscal functions and power-sharing arrangements between different levels of government? Chapter 16 addresses this question. For sure, the transition is likely to lead to an increased role for the local governments. But then, how will they get their revenues? And what precisely will be their expenditure responsibilities? Hewitt and Mikaljek provide some answers.