Transition to Market
Chapter

Chapter 5 Fundamental Fiscal Reform in Poland: Issues of Design and Implementation

Editor(s):
Vito Tanzi
Published Date:
June 1993
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Author(s)
Ved P. Gandhi

Poland was one of the first among centrally planned countries to have committed itself, as early as mid-1989, to the adoption of market-oriented economic reforms. The authorities viewed a fundamental reform of the country's fiscal structure as a major prerequisite for the transition to the new economic system. This chapter highlights the main characteristics of the country's fiscal structure prior to 1989. It then outlines what the author considers to be the major elements of a fundamental reform of the country's fiscal system that would fully support the market orientation of the economy. The paper then reports on progress made on fiscal reform to date and identifies the issues that still need to be addressed.

Pre-1989 Fiscal Structure

Fiscal Indicators

Between the state budget and extrabudgetary funds, the Polish Government appropriated almost 50 percent of GDP during most of the 1980s and, as Table 1 shows, there was little change in this proportion all through this period, despite the partial reform efforts of the Government.

Table 1.Poland: Major Budgetary Aggregates(In percent of GDP)
198219831984198519861987198819891990
State budget
Revenue43.439.139.740.439.934.235.630.833.3
Expenditure46.341.241.941.641.037.737.037.032.6
Surplus/deficit (-)-2.9-2.0-2.2-1.2-1.1-3.5-1.4-6-10.7
Extrabudgetary funds
Revenue10.011.812.613.013.816.816.617.418.3
Of which: transfers from
state budget2.62.32.42.63.13.03.25.06.0
Expenditure9.510.610.911.713014.115.218.716.2
Of which: transfers to
state budget0.20.70.713
Surplus/deficit (-)0.51.21.71.20.82.71.4-1.32.1
On transactions with
state budget2.41.61.71.33.13.03.25.06.0
On other transactions1.90.40.00.12.30.31.8-0.3-3.9
General government
Revenue49.846.847.948349.446.948.041.543.0
Expenditure52.247.648.448.249.747.748.048.939.8
Surplus/deficit (-)-2.4-0.8-0.50.1-03-0.8-7.43.1
Memorandum item:
GDP (in billions of zlotys)5,5466,9248,57610,44512,95316,94029.62996.549591,518
Sources: Various publications.
Sources: Various publications.

Selected fiscal indicators, calculated from data relating to the state budget, are given in Table 2. Several characteristics of the country's fiscal structure prior to 1989 are noteworthy.

Table 2.Poland: Fiscal Indicators(In percent)
198219831984198519861987198819891990
Revenue
Total revenue/GDP43.439.139.740.439.934.235.630.833.3
Tax revenue/GDP39.036.336.537.037.531.533.425.228.2
Taxes on income and property/GDP24.220.020.321.923.118.420.516.221.0
Individuals4.14.44.44.44.54.34.32.73.0
Enterprises19.514.914.716.417.713.415.513.618.0
Taxes on goods and services/GDP14.816.316.215.214.413.012.88.97.2
Domestic11.513.813.612.311.610.610.88.96.6
Foreign3.32.62.52.92.82.42.0_0.6
Taxes on goods and services/private
consumption25.524.623.621.823.517.1
Foreign trade taxes/value of imports16.116.916.612.910.1
Socialized enterprise income tax/profits
before taxes of socialized
enterprises61.146.945.750.949.545.647.231.837.7
Direct taxes/tax revenue62.155.155.759.161.558.661.564.773.7
Expenditure
Total expenditure/GDP46.341.241.941.641.037.737.037.032.6
Current expenditure/GDP41.435.636.735.935.232.231.633.629.9
Wages and salaries/GDP4.14.44.54.64.44.24.05.14.1
Purchases/GDP4.03.83.73.73.83.63.32.53.6
Subsidies/GDP20.616.517.316.516.315.916.012.97.3
Consumer9.17.37.57.37.98.89.08.43 9
Food5.83.42.83.03.13.44.93.70.2
Coal0.70.50.50.50.70.80.40.20.1
Housing1.02.53.22.83.13.62.52.42.8
Transportation1.50.80.90 90250.80.80.90.4
Other11.59.19.89.28.37.17.04.53.4
Export2.9.3 :3.53.63.12.52.2
Coal1.51.41.81.92.31.01.13.31.6
Agriculture1.52.01.81.81.81.41.00.1
Transfers/GDP8.26.86.56.54.24.04.26.37.7
Capital expenditure/GDP4.85.55.35.75.95.65.33.32.8
Consumer subsidies/private
consumption11.811.813.014.716.59.2
Socialized enterprises
Investment/GDP16.115.016.116.817.818.518.610.1
Investment/investment in the economy84.678.680.581.983.383.984.858.3
Gross operating surplus/GDP24.423.723.823.823.027.127.349.429.9
Turnover taxes/GDP11.714.314.012.611.210.013.913 27.1
Subsidies/GDP12.110.610.910.510.89.114.513.55,7
Profits before taxes/GDP25.019.820.821.722.526.227.855.328.3
Income tax and dividends/GDP15.39.39.511.011.211.913.135.845.3
Income tax and dividends/profits
before taxes61.146.945.750.949.545.647.235.847.0
Profits after taxes/GDP9.710.511.310.711.414.314.735.416.4
Workers' benefits/profits after taxes34.434.437.137.931.622.731.317.6
Retentions/profits after taxes65.665.662.962.168.477.368.782.386.6
Development and reserve funds/
investment36.944.139.031.133.944.243.9
Sources: Various publications.
Sources: Various publications.

On the revenue side, three trends are predominant. First, the ratio of tax revenue to GDP declined between 1982 and 1988. This was more the result of erosion owing to high inflation than of any large reduction of tax rates or excessive tax reliefs to taxpayers. Second, direct taxes contributed almost 60 percent of total tax revenue, with enterprises accounting for most of this revenue. Third, between the profits tax and the turnover tax, enterprises contributed almost 26 percent of GDP and 80 percent of total tax revenue. The profits tax and the turnover tax were therefore the most important sources of government revenue. The average burden of the enterprise profits tax was between 45 percent and 50 percent of profits before taxes of socialized enterprises, while the average burden of the turnover tax was about 23 percent of total private consumption.

On the government expenditure side, once again, three facts are apparent. First, subsidies to consumers and producers accounted for almost 45 percent of total expenditure (and were an even higher percentage in earlier years), with subsidies for food, housing, and exports being the most important. Second, wages and salaries of public sector employees absorbed unusually small proportions of total expenditure, and their share in GDP remained almost constant over time. Third, the Government's direct capital expenditure was never a significant proportion of GDP, primarily because socialized enterprises undertook most of the public sector investment.

Investment by the socialized enterprises accounted for almost 20 percent of GDP, over 80 percent of total investment, and almost 90 percent of industrial output in the economy. Based on available data, profits before taxes of the socialized enterprise sector were quite impressive (almost 28 percent of GDP in 1988). Even after paying the enterprise profits tax and dividends to the Government and various benefits to workers, in 1987 and 1988 enterprises retained 70 percent or more of their profits after taxes.

Different Roles of the State and Their Fiscal Implications

The foregoing indicators of the fiscal structure were the by-product of the very active role of the state in the Polish economy. Similar to other centrally planned economies, the state had many responsibilities, each of which had important implications for the country's fiscal structure prior to 1989.

First, in Poland the state played a dominant role as an investor and producer through socialized enterprises. This had major implications for the tax system, public expenditure policies, and the workings of the parastatal enterprises. The tax system came to be dominated by taxes on enterprises, which were frequently negotiated between the Government and each enterprise. The enterprise profits tax system therefore became more of an ex post profit-sharing system, with the Government deciding on the amount of final (tax) payments to be made by each enterprise, based on its final profits, the state-established “norms” for paying bonuses to its workers, and the investment needs of the enterprise for plant modernization and capacity expansion as determined under the plan.

As regards public expenditures, a number of economic and social functions of the Government were assigned to parastatal entities; as a result, numerous extrabudgetary funds, supported by special levies on enterprises, were established to finance the activities of these entities. This resulted in a large and complex extrabudgetary economy with serious implications for budget monitoring and expenditure control.

Many socialized enterprises grew into inefficient monopolies and enterprises that had to be supported through a variety of open subsidies (such as export subsidies) or hidden subsidies (such as credit subsidies and tax reliefs), and these subsidies came to dominate government expenditure. Moreover, as socialized enterprises had little autonomy in making their investment and financing decisions, or had little control over their depreciation or dividend policies, their finances and indebtedness became closely intertwined with the finances and indebtedness of the state budget.

Second, the state controlled the prices of most inputs and outputs. Among other things, this required the authorities to constantly monitor and in fact frequently increase or decrease the turnover tax rates applicable to individual commodities, with a view to clearing commodity markets, as well as financially supporting unprofitable sectors unable to pay legislated turnover tax rates. On the expenditure side of the budget, it called for massive outlays on consumer subsidies and subsidies to industrial and agricultural inputs.

Third, the state played an active role in incomes policy, particularly in determining wages in the socialized sector and incomes arising in the nonsocialized sector. This, too, had important implications for the fiscal structure. On the revenue side of the budget, individual income taxation played a negligible role in the government revenue structure as, for the most part, wages in the economy were tax exempt. Highly progressive and schedular income taxes were applied on incomes arising from the nonsocialized sector to discourage the development of the private sector and to reduce incomes earned in the nonsocialized sector to the levels prevailing in the socialized sector. On the expenditure side of the budget, with wages nominally fixed at low levels by the state, wages and salaries comprised a smaller proportion of expenditure, while a large proportion of the budget was devoted to price support subsidies and to financing the social welfare system.

Finally, the lack of market orientation of the economy affected macrofiscal policymaking and budgeting. For example, there was little appreciation of the effects of fiscal policies on aggregate demand, output, prices, and balance of payments. As a result, fiscal deficits, arising from the implementation of various nonfiscal government policies, were not of much concern to policymakers. These deficits were frequently monetized with little or no attention paid to external and domestic debt manageent. To cite another example, budgeting was used more as a tool of planning than of fiscal analysis and policymaking. Thus, little or no effort was made to institute appropriate budgetary controls or to develop an adequate cash management capacity in the Ministry of Finance.

Strategy of Fundamental Fiscal Reform

A major transformation from a centrally planned economy to a market-oriented economy therefore required a fundamental reform of the country's fiscal structure. This was essential, particularly because the state was about to shed its role as a major investor and producer in the economy and because most existing socialized enterprises were to be privatized and the inefficient ones among them were to be allowed to go bankrupt. In addition, most price controls were to be eliminated and wages and other factor incomes were to be determined by the market, which also implied fundamental fiscal reform. Finally, once market forces were to start determining resource allocation in the economy, macrofiscal policymaking and budgeting were going to assume their usual important roles. The need for wide-ranging structural fiscal reform thus was both immediate and urgent.

Objectives of Fiscal Reforms

Fiscal reform had three main objectives: (1) to create the conditions under which the market mechanism would exert its allocative superiority; this required a change from the Government as an active player that determined all the key economic variables to one that encouraged the appropriate economic environment and provided an adequate social safety net; (2) to disengage the Government, over time, from the responsibilities of ownership of economic means of production; and (3) to secure fiscal adjustment in the transitional period.

To support the first objective, an entirely different fiscal system had to replace the existing system. This new system was to help curtail the direct involvement of the state in the economy as a producer, a price controller, and an incomes’ regulator. Instead, it was to foster private initiative and allow market forces to allocate resources. Public expenditure policies were to be reoriented, for example, from direct investment in, or subsidization of, production and distribution to providing a social and economic infrastructure to facilitate private production and distribution. A new tax system was needed that would not thwart private initiative and enterprise, produce adequate revenue, and also be easy to administer. Further, totally different budgetary procedures and perspectives on fiscal policymaking and fiscal deficits were desirable.

In support of the second objective of fiscal reform, namely, to facilitate disengagement of the state from the socialized enterprise sector and to create healthy competitive conditions, many obvious changes had to be set in motion. Among other things, serious efforts had to be made to privatize and to institute fiscal as well as nonfiscal reforms to help make the remaining socialized enterprises economically efficient.

The final, and equally important, objective of fiscal reform was to facilitate fiscal adjustment during the transitional period. Because of institutional rigidities, the authorities had to reckon that this transition could easily last for several years. During this period, the tax system had to be made productive enough to allow the state to meet the fiscal costs of the economic and social upheaval caused by restructuring the economy.

Main Elements of Fiscal Reform Program

It was clear from the outset that a fiscal reform program for Poland entailing the development of a new fiscal system would have to be comprehensive and consist of at least five elements.

First, it would cover macrofiscal policymaking. Among other things, this would mean redefining the appropriate role of government in the future economy of Poland and instituting a fiscal strategy for domestic and external debt management.

Second, the previous tax system would have to be reformed while ensuring the adoption of taxes to raise needed budgetary revenues in as fair and nondistortionary a fashion as possible and to create an “appropriate” balance between taxation of enterprises and taxation of individuals, as well as between taxation of incomes and taxation of consumption.

Third, fiscal reform would include the reform of the income support system, reducing or eliminating consumer subsidies and reforming the social security system, including the creation of a strong social safety net.

Fourth, the entire budgetary system would need to be reformed. This would entail redefining the role of the extrabudgetary economy and rationalizing the budget organization, as well as strengthening the budgetary procedures and controls.

Finally, the reform of the socialized enterprise sector had to be a major element of the overall fiscal reform. Along with other economic policies, fiscal instruments and institutions had to be used to facilitate the restructuring of their ownership. Their investment decisions and financial behavior also needed to be urgently reformed.

These five categories of fiscal reform are described in some detail below, followed by a possible sequence in which the reforms needed to be carried out.

Reform of Macrofiscal Policies

Given the important linkages among the fiscal deficit and aggregate demand, savings-investment balance, prices, and balance of payments, policymakers needed, even in the short run, to be conscious of the macroeconomic damage that higher fiscal deficits can cause. They had to recognize that many market-oriented reforms of the economy, such as price liberalization, exchange rate adjustment, interest rate reform, and reform of wage policies, were likely to result in significant increases, as well as decreases, in government revenue or expenditure, with major uncertainties as to the “net” fiscal outcome. Policy makers, therefore, needed to be ready with contingency revenue and expenditure measures that could be put into effect to reduce large fiscal deficits.

Over the medium term, at least three fiscal issues will require the attention of policymakers:

First, the exact role of the Government in the future economy of Poland will have to be defined. The future scope and functions of the public sector will have to be carefully delineated to facilitate the reorientation of the economy. Certain functions of the Government (for example, subsidies to consumers and producers) will have to be scaled down substantially. On the other hand, various other functions (for example, investment in the social and economic infrastructure) obviously will have to be strengthened to facilitate private sector growth, while still other functions (for example, unemployment compensation and targeted social transfers) will have to be greatly extended, at least during the restructuring of the economy.

Second, the reorientation of the economy, and the changed manner in which economic resources will be allocated in the future, will have important effects on the composition of production, the use of economic resources, and the distribution of factor incomes. As a consequence, there could be major effects on budgetary aggregates and possibly on levels of fiscal deficits. In order to conduct macrofiscal policy in an orderly fashion, the tax system and expenditure policies will have to be restructured so as to take advantage of the marked shifts in the way national income in the future is likely to be produced, distributed, and used.

Third, debt management will also require closer attention from policymakers. Notwithstanding the sizable reduction in external debt, Poland might be able to negotiate debt restructuring with its external creditors, and new external borrowing should be contracted only where it can be used efficiently; besides, government guarantees will have to be strictly limited. As to the domestic indebtedness of the public sector, it will change its character and entail a direct financial cost, as the Government increasingly finances its fiscal deficits through the sale of treasury bills and bonds to nonbanking institutions and investors instead of monetizing them. A carefully considered policy of domestic debt management, therefore, will need to be established and implemented, taking into account a number of relevant factors.

Reform of Tax System

As mentioned above, the earlier tax system was out of tune with the needs of a reoriented economy. This demanded an urgent reform of the previous enterprise profits tax, personal income taxes, and the turnover tax. In reforming the tax system, the criteria of revenue productivity and elasticity, economic neutrality, equity, and ease of tax administration were most important.

Obviously, to the extent possible, the personal income tax had to be a universal and global tax with a level of exemption and a rate schedule consistent with the equity and administrative criteria. This meant that all incomes had to be aggregated and taxed equally. This also meant that the exclusion of agricultural incomes from income tax, which had been the case so far, and subjecting interest and dividends to a separate flat final tax, which was the preferred solution on incentive and administrative grounds, could run counter to the universality as well as progressivity of income taxation.

The enterprise profits tax had to be broad-based and nondistortionary. This implied that all tax preferences, both systemic and discretionary, granted to selected activities and sectors had to be eliminated. Tax holidays to future foreign investors and foreign-owned enterprises also had to be eliminated in favor of a lower tax rate generally. All interest payments had to be tax deductible. The basis for calculating depreciation allowances had to be liberalized by permitting the use of the declining-balance method, and the number of depreciation rates had to be reduced drastically. Carryforward of losses had to be permitted into the future for a given period, say, up to three years, and subject to a maximum amount, say, up to the value of the assets.

The turnover tax had to be replaced with a broad-based and more uniform-rate VAT. This tax had to be supported by selective excises on sumptuary goods and a few selected luxury products.

In designing the new tax system, thought had also to be given to the reform of customs duties and the fiscal and economic roles they should play in the short run and in the long run. To the extent possible, customs duties should play a limited fiscal role, if any, in the longer-term tax structure of the country but, in the short run, they could be retained while all possibilities for further liberalizing imports and rationalizing tariffs are being explored.

Reform of Social Programs

In order to be socially effective and fiscally efficient, social support programs, which had in the past taken the form of consumer subsidies and monetary transfers, had to be reformed. As restructuring the economy would create large unemployment and price reform would reduce the real incomes of certain households, an appropriate social safety net had to be established for the needy. Consumer subsidies, including housing subsidies, ultimately would need to be replaced with needs- and means-tested monetary transfers.

Reform of Budgetary System

In order to improve overall budgeting and to allow better fiscal analysis, the role of the extrabudgetary economy in Poland needed to be redefined. The Budget Department of the Ministry of Finance had to be reorganized along more functional lines to make it an effective fiscal institution and a new budget nomenclature had to be instituted that was based on an administrative classification of expenditures but from which economic and functional classifications could be easily derived without a lengthy process of reclassification. An administrative unit, within the Ministry of Finance, in charge of cash management of the operations of the general government had to be created in order to facilitate effective fiscal monitoring. The extrabudgetary funds had to be limited to only those few that were fiscally viable and economically justified, while all others that could not function without budgetary transfers had to be abolished.

Reform of the Socialized Enterprise Sector

In the past, socialized enterprises were in many ways indistinguishable from the general government in Poland. Therefore, enterprise reform could not be limited purely to financial flows between enterprises and the state budget but also had to encompass certain nonfiscal aspects, specifically, reform of ownership and market structure, reform of financing and investment decision making, and the elimination of most enterprise subsidies.

The divestiture of socialized enterprises and the widest possible public participation were needed. In addition, an effective antimonopoly law had to be enacted to encourage the systematic and speedy breakup of enterprises.

Politically motivated rescue operations of socialized enterprises, which were faced with hard budget constraints and market prices, had to be avoided as far as possible. Where loss-making enterprises could be rehabilitated through restructuring, this task had to include carefully crafted contractual agreements between enterprise management, workers’ councils, creditors, and others, with objective indicators of performance as well as mechanisms of periodic reviews specified in each case.

New structures had to be established so that all future decisions on the public infrastructure would be made according to criteria based on the social rate of return. Further, all government transfers to socialized enterprises, including indirect subsidies through preferential bank credits or exchange rates, would be recorded as expenditures in the state budget. These measures were essential for creating greater transparency in fiscal policy.

As is obvious from the above, a large number of time-consuming fiscal reforms had to be carried out to transform the Polish economy. However, not all of the reforms were equally important, or needed to be undertaken right away. If necessary, the reforms could be carried out in two stages, with their sequencing guided by economic necessity, institutional preparedness, and timing of their likely economic effects.

In the first stage, fiscal reforms of immediate importance that supported the adjustment effort had to be carried out. In this connection, the top priorities were securing government revenue (by broadening the bases of existing taxes, particularly consumption taxes, and capturing the emerging private sector in the tax base), protecting the unemployed and the poor (by instituting a cost-effective social safety net), and containing the fiscal deficit (by, among other things, establishing early on a cash management unit in the Ministry of Finance). The size of the extrabudgetary economy also had to be reduced significantly. Finally, the socialized enterprise sector had to be reformed, by identifying the enterprises to be privatized, initiating appropriate procedures for the privatization, closing down or starting bankruptcy proceedings against unsalvageable enterprises, and designing rehabilitation measures for the remaining (mostly loss-making) enterprises while forcing them to face market forces and to take efficient economic decisions.

In the second stage, fiscal reform aimed at putting a full-fledged new fiscal system in place and building new fiscal institutions needed to be given top priority. So as to provide a level playing field for all economic agents and to secure revenues in the most nondistortionary way, all elements of tax reform would need to be legislated and a thorough review of the tax administration capacity and procedures undertaken for instituting measures to implement new taxes. This stage should also see work initiated on tariff reform consistent with rules under the General Agreement on Tariffs and Trade and the tariff structure of the European Community, including a review of the customs administration and procedures. In order to reduce public intermediation of resources and to prevent price distortions, consumer and producer subsidies would need to be eliminated and the future scope of the functions of government would need to be defined more precisely. To make the best use of public resources, comprehensive budget reform would have to be initiated. This should include the reorganization of the Budget Department in the Ministry of Finance and the rationalization of budget classification and budgetary procedures, the establishment of a debt management unit in the Ministry of Finance, and the development of debt management policies.

Implementation of Fiscal Reform

At the end of 1989, the Polish Government faced an economic crisis. Domestic and external imbalances were widening at an alarming pace, and hyperinflation loomed. The Government, therefore, launched an economic reform program in early 1990 that focused on stabilization. After an initial devaluation of the zloty, a fixed exchange rate, together with a strict incomes policy, became nominal anchors aimed at breaking the inflation spiral. The anchors were supported by tight monetary and fiscal policies, which were remarkably successful. Inflation dropped sharply during the year, while both the fiscal and external accounts swung into surplus. But output fell by over 10 percent and has declined ever since. Efforts to stimulate a recovery have set back the stabilization effort somewhat. The early experience of Poland has shown that the mix of stabilization and structural policies has to be appropriately balanced and that systemic reform has to be accelerated to speed the transition to a market economy.

During 1990, genuine progress was made with price and trade liberalization. But, in most other areas, measures proved to be more difficult to implement, and preparation time was longer than initially envisaged. This section describes the progress that has been made with respect to the individual elements of fiscal reform to date and the problems the authorities have encountered.

Tax Reform

With the exception of adjustments to the structure and level of turnover taxes (carried out continuously since 1989) and steps toward limiting reliefs–and making their application less discretionary–under the enterprise profits tax (mainly in 1990), the tax reform effort to date has consisted of the introduction of a personal income tax (PIT), with effect from January 1, 1992, and of an enterprise income tax (EIT), since February 15, 1992, as well as preparations for the introduction of a new valueadded tax (VAT).

The PIT law, passed on July 26, 1991, legislates a progressive tax on earned income, covering wages and salaries, fringe benefits, pensions, and rental incomes. There are three tax rates (20, 30, and 40 percent) applicable to high income brackets which, in future, will be indexed to wage growth. There is a sufficiently high income exemption to keep lowincome earners outside the income tax net, and wage and salary earners enjoy a standard deduction equivalent to 3 percent of that income. Incomes from certain types of interest payments and dividends are subject to a final tax of 20 percent withheld at source. While capital gains from the sale of stocks and bonds are exempt from tax for tax years 1992 and 1993, capital gains realized from the sale of real estate are to be taxed at a reduced tax rate of 10 percent. Agricultural incomes and personal interest receipts remain exempt from tax, as are about 35 other categories of receipts. The new PIT operates as a pay-as-you-earn (PAYE) tax that is withheld at source, and the law allows joint filing of tax returns by husband and wife. Since the law is based on the French quotient system, there are some fears that it will result in a flood of income tax returns and present serious problems of income tax administration.

An EIT has also been enacted. Under this tax, a flat rate of 40 percent is to be imposed on enterprise profits. However, the tax contains numerous tax preferences, not the least of which is the complete exemption of agricultural activities. The law also permits accelerated depreciation allowances, generous reserves for bad debts, and a three-year carryforward of losses.

The VAT (called the “goods and services tax”) has been debated in parliament for a long time now. When enacted, it will be a broad-based consumption tax, with a wider coverage than the existing turnover tax. Excise duties on alcohol, tobacco, petroleum products, and 12 other items will also be levied. Three rates of VAT are expected–0, 7, and 22 percent. Unprocessed foods, financial services, and a few other services will be the notable exemptions. Exports, medicines, and some agricultural inputs will be zero rated (the last two items until the end of 1995); processed foods, building materials, and a few other items (as well as medicines and agricultural imports after the end of 1995) will be taxed at 7 percent; and all other goods and services, not specifically exempted, will be taxed at 22 percent.

While the proposed structures of the PIT, EIT, and the VAT seem broadly appropriate and in line with the strategy described above, the key to their successful implementation is administrative preparedness. In particular, the detailed design of the VAT, which will be an entirely new tax, would certainly need to be tailored to administrative capacity and adequate preparations for its implementation will need to be made.

Unfortunately, at the time of writing, the approval of the VAT law by parliament and the president has been delayed. As a result, the design of many administrative procedures necessary to implement a VAT cannot begin. Coordination among the various agencies involved in administering the VAT also has been cumbersome. Decisions on data processing remain unfinished, largely because of uncertainties surrounding computer funding and strategy, and reorganization of local tax offices too has been delayed.

Public Expenditure Policy

The principal thrust of expenditure policy so far has been a sharp reduction in subsidies, both to households and enterprises. These stood at about 16 percent of GDP in 1988, but were reduced to 13 percent of GDP in 1989, 7 percent of GDP in 1990, and less than 5 percent of GDP in 1991.

For the most part, these reductions reflect far-reaching price liberalization (only 12 percent of industrial producer prices and 17 percent of consumer prices are said to be subject to price controls in mid-1992). Subsidies on agricultural inputs and food, together with exports, have been virtually eliminated since early 1992; coal subsidy has been abolished. Housing continues to be subsidized, mostly by way of subsidies for housing construction and interest on housing loans, the latter through the banking system.

Capital expenditure has also been curtailed since 1988. It fell by 0.5 percentage point of GDP between 1988 and 1990 (see Table 2). Public investment in infrastructure development needs to be expanded, and the Government is undertaking a major review of public investment.

Much of the reduction in subsidies and capital expenditure has meant a lowering of total expenditure, but there has been some additional spending on the social safety net.

Social Programs

Between 1988 and 1991, expenditure on pensions, family benefits, and unemployment compensation and social assistance increased by about 8 percent of GDP; budget support of these programs rose by 3 percent of GDP During 1989, the rapid increase in inflation strained the state pension system and eroded significantly the real value of pensions. Since early 1990, in principle, pensions are supposed to be revalued at the end of each quarter in line with the increase in average wages in the previous quarter; in practice, this has not been the case and the real value of pensions has been allowed to erode through inadequate indexation for inflation. Also, in order to ensure a minimum benefit level, the lowest pension is set at 35 percent of the average wage.

Unemployment has risen sharply, a result of stabilization and restructuring, and the introduction of unemployment benefits has been a significant social safety reform. In March 1992, duration limits (of 12 months) and flat rate benefits (equivalent to 35 percent of wage) were established. Nevertheless, unemployment benefits continue to absorb a large part of the Labor Fund's resources. The Labor Fund also finances labor market measures, such as training and retraining benefits, intervention jobs, and credit for the creation of new jobs and activities.

Between 1990 and 1992, social assistance schemes were enlarged to provide some shelter to the most needy from the immediate effects of the macroeconomic stabilization program. Social assistance currently consists of the following: permanent cash benefits targeted to the elderly and the disabled with no pension rights; temporary cash benefits granted under special circumstances, for instance to the unemployed with no benefit rights; special credits for the disabled and for families in temporary financial difficulties; the maintenance of nursing homes; special programs for single mothers bringing up disabled children; and “quick reaction” government programs. Local authorities are responsible for all these social assistance schemes.

Budgetary System

General government in Poland consists of 49 regional governments (voivodships) and more than 2,400 communes and cities (local authorities). Previously, the voivodships and local authorities were no more than administrative subdivisions of the Central Government. While they had separate budgets, these were jointly enacted in the context of a consolidated state budget.

The structure of the state budget was changed markedly in 1991. In line with the increased autonomy being granted to local authorities, their revenue and expenditures were separated out of the state budget, with only the transfer from the budget to the local authorities recorded as an expenditure item. Local authorities have in the past been required to balance their budgets. Deficits are now permissible, although there are restrictions on access to credit and the ability to issue securities. There are, however, concerns that the financial management of local authorities will become more of a problem than in the past. Establishing mechanisms for monitoring and controlling their expenditure is therefore of high priority.

Imposing such mechanisms, of course, will be part of a wider effort to improve expenditure monitoring and control. While the integration of most of the extrabudgetary funds into the state budget–only the two social insurance funds, the Labor Fund, and a few others are still outside the budget–has provided a measure of additional influence over the expenditure of these funds, existing procedures seem to be somewhat arbitrary. Since 1990, reliance has been placed mainly on assigned cash limits on ministries' spending. With the planned reorganization of the Ministry of Finance, budget procedures may be overhauled soon. Also, it is possible that the budget nomenclature will be changed, reporting procedures will be improved, modern systems of budgetary planning and cash management will be put in place, and attention will be given to strengthening the Government's domestic and external debt management capacity.

Privatization of Socialized Enterprises

Enterprise privatization continues to lag in Poland, partly for the lack of a clear-cut approach regarding property rights. Privatization began in earnest during 1991. However, while the privatization of small-scale shops, the wholesale trade, trucking, and other services has been rapid, the privatization of larger enterprises appears to have proceeded somewhat slowly. It is estimated that there have been only about 100 buyouts by mid-1992, primarily through the transfer and leasing of the assets of the enterprise to the workers or management. The stipulation that share purchases by foreigners must be approved by the Foreign Investment Agency if the par value of the shares exceeds 10 percent of the share capital has caused many foreign investors to take a fairly cautious approach until now.

Concluding Observations

Although Poland has made substantial progress on fundamental fiscal reform, the process has been somewhat slow and uneven. Of course, this is not totally unexpected. Drafting new tax laws, in the face of a vocal and multiparty parliament, and strengthening tax administrative capacity, in the face of shortages of trained manpower, have taken time. It was perhaps easy to reduce consumer and producer subsidies, in order to contain public expenditures, but to design an appropriate social safety net or to formulate an infrastructure development plan consistent with available budgetary resources was not that easy. Shifting expenditure responsibilities on to local authorities, including many social assistance schemes, was also simple, but ensuring their financial viability has taken a lot of time and effort. Instituting a sound budget management system too has lagged, and the Government has had to make do with the imposition of “temporary” cash limits on ministry expenditures. Finally, the privatization of socialized enterprises is proving far more difficult than envisaged earlier.

To sum up, it is not for lack of willpower and effort that the Polish authorities have not—until now—succeeded in instituting the wideranging and fundamental fiscal reform described in this paper; carrying out fiscal reform in economies in transition, and doing it right, is simply a laborious and time-consuming process.

Ved P. Gandhi is Assistant Director in the Fiscal Affairs Department. This paper draws heavily on the unpublished work he carried out jointly with Laszlo Garamfalvi, Robert Holzman, and George Kopits in late 1989. Richard Hemming, Gerd Schwartz, and Charles Vehorn have also provided significant help. The author gratefully acknowledges their contributions; however, none of them is responsible for any errors and omissions that may remain.

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