Transition to Market
Chapter

Chapter 16 Transition and Transformation: Fiscal Sector Issues in Kazakhstan

Editor(s):
Vito Tanzi
Published Date:
June 1993
Share
  • ShareShare
Show Summary Details
Author(s)
Parthasarathi Shome

As in all states of the former Soviet Union, Kazakhstan, in its transformation to a market economy, is facing multiple hurdles. These reflect its geography, the structure of its economy, and the rigid institutional arrangements associated with unpredictable rules, regulations, and financial obligations typical of a command economy. There are no institutions that can provide a basis for the smooth operation of a market economy, and economic agents at present lack sufficient understanding of market systems. Transformation will have to be based on a spread of education and awareness of the rudimentary operating rules of market systems, the steady building of market-oriented institutions, the easing of rigid rules and regulations with the burden of responsibility assigned clearly, clarity and simplicity of obligations to the state, for example, in tax laws, and a reorientation of the economy from an overt dependence on the former U.S.S.R. to a trading system more open to the rest of the world.

This paper focuses on fiscal issues and assesses the structure of economic activities and the overall macroeconomic setting so as to place those fiscal issues in context. First, it describes the structure of the Kazakh economy. Then it outlines the macroeconomic setting and fiscal sector operations before and around the beginning of the transformation process. Next, the paper assesses the factors, including those that have emerged from the reform process, that can be expected to affect shortrun economic performance. This is followed by a fiscal strategy for future tax and expenditure policies and, finally, some concluding observations.

Structure of the Economy

Kazakhstan has a population of 17 million, of whom 7 percent of men and 16 percent of women were old enough to claim pensions in 1990.1

Further, the population aged 50 to 54 is currently much larger than those in the preceding or following age groups, which implies a heavier burden on the pension system in the near future.2

Kazakhstan comprises 2.7 million square kilometers and has one fifth of the arable land of the former Soviet Union. Its net material product (NMP) derives primarily from agriculture–wool, grain, meat–followed by mining and manufacturing. Table 1 compares selected states of the former U.S.S.R. representing a Central Asian state, a Baltic state, and three other economically dominant states. Kazakhstan has substantial mineral reserves of chrome, lead, copper, zinc, coal, and oil. The Tengiz oilfield–one of the largest in the world–alone has 25 billion barrels of oil, a third of which is recoverable, and is planned for exploitation over 40 years with foreign collaboration. Metallurgy, heavy machinery, and petrochemicals are major components of manufacturing. Consequently, Kazakhstan’s trade pattern indicates its specialization in mining and heavy manufacturing: half of its final goods are imported, and three fourths of its exports consist of intermediate goods and raw materials. State enterprises are responsible for 80 percent of output, and the state owns 90 percent of fixed assets. The remaining assets are divided about equally between the cooperative sector and the private sector.

Table 1.Kazakhstan: Comparative Indicators of Output and Sectoral Distribution
KazakhstanAzerbaijanBelarusLatviaRussian. Fed.Ufcra ine
(In millions of rubles)
Net material product(NMP) (1990)28,08810,58228,7008.854425,200118,000
(Percentage distribution)
Total100100100100100100
Industry283547514242
Agriculture403622222828
Construction15121781010
Transport and communications954866
Trade, supply, and other81015111414
(In percent)
NMP growth rate
1988-895.85.212.38.77.16.9
1989-90-1.3 1-7.81.416.03.08.3
Retail price index(1980 base)
1980100.0100.0100.0100.0100.0
19851 05.4104.2105.2105.0104.2
1990114.1116.3122.3113.5
1991208.8210.7231.2207.2
(In percent of GDP)
Trade balance
1987-21.68-33.6-9.5-4.5
1983-18.67.66.0-7.0-2.1
1989-20.212.52.5-5.7𠈂-4.6
Source: IMF staff estimates.

Agriculture was a positive 4.7 percent, but industry, construction, and transport were negative.

Source: IMF staff estimates.

Agriculture was a positive 4.7 percent, but industry, construction, and transport were negative.

In the transition phase, agriculture and heavy manufacturing–albeit using static technology–might be expected to continue to dominate production, but the role of energy in ensuring the smooth functioning of production and distribution is especially important. After transformation, mining, reflecting rapid exploitation of mineral resources, as well as services, reflecting the growth of market-based economic activity, may be expected to grow in importance. The crux here is the pace at which the transformation takes place and the length of the transition phase. These will determine the strategic planning of the pace of privatization of state enterprises and state assets, changes in the mechanisms and rules for revenue generation for government, and the composition of appropriate macroeconomic policies. Institution-building and structural change have to proceed hand in hand with the implementation of that strategy.

Recent Fiscal Operations

Macroeconomic Setting

Under the regime of strictly administered prices, production and trade followed a pattern guided by the Gosplan. The Union Government created and allocated credit, which helped bridge any fiscal gap of the Kazakhstan Government through substantial transfers. Under this regime, a moderate sustained rate of growth with very little inflation took place in 1985-88.

Transition has led to increased prices but has also reduced the number of administered prices across sectors. By January 1992, 80 percent of retail prices on goods and services were freed, and the prices of those that remained administered were increased threefold to fivefold. State assets, including business property, are slowly being privatized. In 1991, 380 enterprises were sold, mainly services (representing gross assets of about rub 1 billion), out of about 34,400 enterprises in Kazakhstan (total of rub 200 billion of assets). By May 1992, 1,540 enterprises (5 percent of the total) had been privatized or transformed into joint ventures. Less organized changes in contractual and other economic and financial arrangements, such as in wages and pension benefits, are bound to have taken place. The Government has felt the pressure to accommodate many of these changes with softer financial policies. In turn, the partially managed price system has continued to give mixed signals to the production and distribution systems. As a result, growth was negative beginning in 1989, inflation soared beginning in 1991, and the trade balance, which had been negative in recent years, did not improve (Table 1 presents comparative information on these aspects). In addition, widespread structural bottlenecks have appeared.

Fiscal Sector

With the increasing market orientation of the economy, and the reversal of the Union revenue-sharing mechanisms, the entire fiscal system in Kazakhstan is having to change dramatically, leading to an immediate fiscal disequilibrium. The fiscal balance of 1989 rapidly moved to a deficit of 8 percent of GDP in 1991 (Table 2), an experience similar to that in Ukraine. This reflected a fall in tax revenue from 26 percent of GDP to 19 percent even while nontax revenue and expenditure remained stable at about 9 percent and 36 percent, respectively. It is important to assess carefully the changes in tax policy instruments and in the institutions on which tax collection is based.

Table 2.Kazakhstan: Comparative Indicators of Fiscal Balance of the General Government, 1989-91(In percent of GDP)
KazakhstanAzerbaijanBelarusLatviaRussian Fed.Ukraine
1989 performance
Total revenue and grants36.622.351.828.4
Tax revenue25.018.639.9
Government expenditure36.624.451.027.9
Fiscal balance-2.00.80.5
1990 performance
Total revenue and grants34.726.438.246.127.4
Tax revenue21.921.130.437.5
Government expenditure33.431.934.744.028.0
Fiscal balance1.3-5.53.52.1-0.6
1991 performance
Total revenue and grants27.632.142.945.525.531.8
Tax revenue18.524.529.846.6
Government expenditure35.637.440.639.436.846.1
Fiscal balance-8.0-5.22.28.0-11.3-14.4
Source: IMF staff estimates.
Source: IMF staff estimates.

Revenue Sources3

As in most states of the former Soviet Union, in recent years the two largest sources of revenue in Kazakhstan have been taxes on income and profits and taxes on turnover and sales, each accounting for about a third of total revenue. Revenue from the individual income tax has accounted for about 15 percent and other taxes–mainly social security–have accounted for the remainder (Table 3).4

Table 3.Kazakhstan: Government Financial Operations(In percent of GDP)
19871988198919901991
Total revenue and grants35.635.436.634.727.6
Tax revenue27.625.225.021.918.5
Of which:
Income profits tax11.810.610.58.310.7
Of which:
Individual4.94.85.22.73.4
Corporate6.95.85.35.67.4
Social security
contributions3.93.83.73.5
Taxes on property
Taxes on production
and consumption11.710.610.69.76.8
International trade taxes
Other taxes0.20.20.20.40.9
Grants—Union transfers7.19.611.011.96.5
Total expenditure35.734.636.633.435.6
National economy18.918.820.717.711.9
Social and cultural programs14.315.813.912.715.4
Of which:
Social security4.24.24.13.94.7
Transfers to Union budget1.81.31.22.02.0
Other expenditure0.70.70.81.06.3
Revenue and
grants (-) expenditure-0.10.81.3-8.0
Memorandum item:
GDP (in millions of rubles)35,00039,00042,00051,00092,000
Source: IMF staff estimates.
Source: IMF staff estimates.

The Kazakh revenue structure reflected the characteristics of a centrally planned economy. A large portion of the budget revenue was collected through the public enterprise sector, directly in the form of profits tax, or less directly in the form of turnover tax, which might eventually be paid by households but was collected and paid by public enterprises.

Until 1990, the profits tax system was configured on centrally established “norms” for contributions to the budget, payments to workers, and the plan-determined investment needs of the enterprises. These enterprises had little autonomy in their investment and financing decisions; their finances and indebtedness were intertwined with the finances and indebtedness of the Government's budget.

The turnover tax presupposed government control over the prices of inputs and outputs. The tax resulted from the difference between producer prices and retail prices, both controlled by the Government, which constantly monitored, and frequently increased or decreased, the turnover tax rates applicable to individual commodities to clear the commodity markets and support unprofitable sectors through tax reliefs (see Tanzi (1991)).

The new market orientation of the Kazakh economy renders the old revenue system obsolete. The conventions of profits tax and turnover tax cannot exist unmodified in a market-oriented economy; the new tax system must not thwart private initiative and enterprise and must be consistent with a liberalized price system.

The Kazakh authorities launched their revenue system reforms in 1991. Effective July 1991, comprehensive income tax laws were introduced, subjecting enterprises to profits tax at proportional rates and wage earners and the self-employed to progressive income tax. Although a sales tax was levied on the consumption of commodities in 1991, much remains to be accomplished.

Expenditure System

About half of expenditure was accounted for by “expenditures for the national economy,” which included outlays for subsidies to individuals as well as for subsidies and transfers to public enterprises (see Table 3). Although it captured profits of the public enterprises as budget revenue, the Government was also forced to support this sector, burdened as it was with economically inefficient monopolies, through a variety of open or hidden subsidies and transfers, which dominated the expenditure pattern of the Government. The price controls called for large outlays on consumer subsidies and subsidies to industrial and agricultural inputs.

The “socio-cultural expenditures,” which include outlays for social security, health, education, culture, and arts, accounted for about a third of total expenditures. Social security by itself has accounted for slightly over 10 percent of total expenditures. However, most of the social security programs were–and still are–administered by such extrabudgetary funds as the pension fund, social insurance fund, and employment fund.

With the emergence of the market economy, public expenditure policies have to be reoriented from direct investment in, or subsidy of, production and distribution activities to providing social and economic infrastructure to facilitate private production and distribution. Government could play a strategic role in removing the bottlenecks to production and distribution, especially in the transition phase. In lieu of social support programs in the form of consumer subsidies and transfers to public enterprises, appropriate social safety nets have to be created for vulnerable groups.

Fiscal Relations with the Union

The Kazakh fiscal system was closely tied to the fiscal system of the former Soviet Union. Most major fiscal decisions, including those on tax legislation, were made at the Union level, and the republic simply implemented them. At that time, Kazakhstan was fiscally a net recipient of the Union subvention. Transfers from the Kazakh Republic–about 5 percent of total expenditure–which included the transfer of a certain portion of its revenue determined by the Union laws, as well as transfers related to all Union projects, were more than offset by the subvention from the Union budget. Up to 1990, any deficit in the republic's budget was covered by transfers from the Union without any interest obligations. Since 1991, the deficit has been financed through credit from the Gosbank, but at low interest rates.

Factors Affecting Future Economic Performance

Price and economic reforms should help the economy to grow over the medium to long run. In the transitional period, however, the Kazakh economy confronts difficult macroeconomic conditions since the reforms could be expected to have an unfavorable impact on the economy–high inflation, decline in output, and unemployment have occurred. These have implications for fiscal performance, on both revenues and public expenditures. The severance of fiscal ties with the Union carries important consequences. The formulation of future macroeconomic-fiscal policies would need to recognize all these factors.

Balancing the macroeconomic disequilibrium will depend on many factors, including the nature and direction of future interstate economic relations. For example, the extent of pass-through of energy pricing–applicable to the trade between Kazakhstan and the rest of the states of the former Soviet Union–could carry important consequences for the terms of trade of Kazakhstan, depending on how the relative prices of oil and coal (which Kazakhstan produces and exports) move in relation to prices of consumer goods (which Kazakhstan imports). Movements in consumer goods prices would be strongly affected by price movements in the Russian Federation. To the extent that other states fail in macroeconomic management and thus suffer from high inflation, Kazakhstan would “import” such inflation, given a continuing high incidence of trade among the states of the former Soviet Union.5

Policies within Kazakhstan would also affect the overall macroeconomic picture. Domestic output could continue to decline and remain low in the transitional period, owing, on the real side, to enterprise restructuring and subsequent liquidation and closure of firms and, on the financial side, to an adherence to prudent credit and budgetary policies to contain inflation. Given these conditions, the real income level of Kazakhstan may be expected to decline further in the short run. Enterprise profits could decline substantially, while wages could not be raised as fast as prices. Last, opening up the economy to trade and investment with the rest of the world may take considerable time since this involves the removal of many structural rigidities and developing and producing products that meet standards of international competitiveness. These factors call for extraordinary measures to arrest the decline in output. Such measures can be implemented only if the Government takes the lead in the transition phase.

The short-run impact of price reform during the transition phase can be especially stringent. On the expenditure side, the move toward free market prices results in a major reduction in the real value of subsidies to the population and enterprises because of the tendency, at least initially, for prices to rise sharply. But the reduction in real income of the population as a result of higher prices would cause increasing demands on the budget for social security outlays, especially to safeguard the position of vulnerable groups in society. The higher price level, together with pressure to increase wages, would increase budgetary expenditure for purchases of goods and services and wage payments to civil servants.

On the revenue side, the higher price level increases the nominal value of revenue from taxes on commodities. However, it is possible that a large increase in prices would change the expenditure pattern of households, forcing them to spend less on consumption items, with a possible negative impact on revenue from consumption taxes, namely, value-added tax (VAT) and excises. The higher price level would also increase the nominal value of revenue from profits and income taxes but, again, the assessment of the impact is not straightforward. An increase in energy prices and production would have a positive impact on revenue through higher tax collection and royalty payments. But if higher inflation continues to bring recessionary episodes and further declines in output and employment, it would have a serious negative impact on revenue. In addition, as a result of possible collection lags, the Tanzi effect is likely to operate in that inflation would continue to exert a negative impact on the real value of tax revenue.

We may suppose that a rearrangement of the Union system of revenue sharing could turn Kazakhstan into a net payer–from a net receiver–of economic resources to the former Soviet Union and could increase its defense and education expenditures. The pressure on expenditures would tend to increase with a breakup of the revenue-sharing mechanisms, again calling for added fiscal effort to close the fiscal gap.

Strategic Planning and Fiscal Policies

Overall Strategic Planning

Similarities between the current experience of Kazakhstan and the experiences of several East European countries during their recent transition and transformation to market economies are striking. These include starting the transition with a large government deficit and rapid inflation; a markedly different inherited tax system from that of market economies; and guarantees of social benefits at least as ample as in most of the developed market economies. Thus, some experiences–notably Poland–may help in strategic fiscal planning for Kazakhstan.

There are also many likenesses to the economic conditions faced by Japan just after World War II: a sudden decline in military-demand-led output, economic infrastructure in disrepair owing to low wartime investment, and high and rising inflation caused by low output and high debt service. At least, Kazakhstan has not suffered from a lack of natural resources or from a dramatic loss of national wealth as Japan did. Japan's strategic planning in the postwar period may provide important lessons for Kazakhstan.

A fiscal strategy has to be developed within the context of overall economic strategy because fiscal policies cannot function in the absence of other sound stabilization and structural policies. Ota and others (1992), using the Japanese postwar experience as a guide, suggest that the Government’s primary task in the initial reconstruction phase was to halt a further decline in output by embarking on a selective interventionist policy aimed at emergency economic stabilization. Such a policy would identify bottlenecks in the production-distribution chain and direct resources to sectors that would help remove them, such as infrastructure (steel), energy (petroleum), and, for social stabilization, food production.6 A strategy that includes maintaining the health of important segments of the agricultural sector is essential because of the large share of NMP accounted for by agriculture. The worst policy would be to diversify investment in an all-out manner; the authorities should be selective in the choice of leading sectors. To encourage their growth and halt output decline, the authors recommend preferential treatment in credit policy (low-interest loans),7 tax policy (tax incentives and even earmarking if needed), pricing policy (maintaining energy prices at an “appropriate” level), wage policy (maintaining higher levels of wages in priority sectors to keep workers from leaving, while granting lower-than-inflation wage increases in other sectors), and trade policy (exporting oil to import industrial facilities and equipment). Subsequently, as the picture turns around, such a priority production program could be extended sequentially to include other infrastructure and materials industries, such as electricity, railways, and fertilizers. Of course, this strategy would also affect the expenditure composition of the Government.

Regarding structural policy, Ota and others (1992) emphasize that privatization without accompanying structural measures could not capture the full benefits of a private sector economy. Thus, monopolies would have to be broken up simultaneously and equally with the development of markets. Product diversification would be encouraged to step up competition by breaking existing production patterns in which most products are produced by only a few companies. Vertical integration would have to be discouraged and new entry encouraged to promote competition among suppliers of materials and components. The breakup of vertically integrated monopolies would be called for, following the Japanese model of carefully orchestrated divisions of particular manufacturing oligarchies. Such structural reforms reflecting an interventionist style would complement price liberalization and privatization efforts aimed at generating supply-side responses.

Interventionist policies seem to have worked in other selected East Asian economies, notably Taiwan Province of China, Korea, and Singapore. In these economies the respective governments played a major role in development by providing economic and social infrastructure, for example, through differential wage policy and substantial investment in technical education, as well as by promoting economic growth through the vigorous promotion of an export-oriented strategy (see Tanzi and Shome (1992)). The importance of an active government role in the transition and transformation of the Kazakh economy to a market-based economy has to be assessed in the light of these important examples.

Fiscal Strategy

Fiscal policies form part of the Kazakh economy's overall strategic planning. From the fiscal viewpoint, strategies would have to be developed on both the revenue and expenditure sides. For example, consequences of the transition would include a decline in revenue in real terms. To offset this, the tax base would have to be expanded even as the index of economic activity declines. This can be done only if the incomes of new entities emerging as a result of economic liberalization and privatization can be successfully brought into the tax net (although revenue collections from such sources would be small at initial stages). The importance of the pace of privatization and the prevalence of right price signals to encourage private economic activity cannot be ignored. Slack in such structural transformation would necessarily imply a slowing in the conversion of macroeconomic instruments toward market-oriented credit policies as well as tax and expenditure policies.

Because of the tight fiscal constraints, social expenditure programs have to be streamlined and targeted so that social benefits are efficiently provided to the most needy. Much institution-building is necessary in all these efforts, which cannot be achieved overnight. For example, even though institutions geared toward meting out social benefits with broad coverage are in place, the establishment and activation of targeted programs that reduce net cost to the Government will involve considerable time and resources. Analyzing the experience of Hungary, Newbery (1991) points toward the considerable difficulties in setting up the necessary infrastructure for administering social safety net benefits while breaking up schemes for benefit payments (administered through public enterprises) that went primarily to the employed, middle class.8 The impact on social stability of reducing net benefits to particular groups will have to be recognized at this pivotal point in Kazakh history.

Strategy for Tax Revenue Maintenance

A strategy may be developed benefiting from the experience of Eastern Europe. The average profit rate of Polish firms jumped from 19 percent in 1988 to 46 percent in 1989, when prices exploded. In 1990, it was still high at 30 percent, but fell to 8 percent as nominal interest rates shot up with inflation and true profits were understated as a result of nominal interest deductions (Gordon (1992)). Business income tax revenue paralleled the profits path, growing moderately in real terms in 1989 and 1990 but collapsing in 1991. This experience points in the direction of correcting for inflation-induced biases in the measurement of profits for tax purposes.

Several additional strategic elements should be borne in mind. If tax incentives are to be used as a part of an interventionist strategy, these have to be extremely selective and be geared toward very few leading sectors with the revenue loss being made up from other sources. This is because experience teaches that broad use of tax incentives leads to revenue loss, inefficiences in resource allocation, and bureaucratic growth. Yet, in Kazakhstan, a major role for infrastructure sectors, such as energy, cannot be denied. Here, of course, foreign investment has to be encouraged. However, the authorities would have to design finely tuned tax structures to minimize the possibilities of foreign and joint ventures devising plans to reduce their tax liabilities by setting up lightly taxed subsidiaries, using transfer pricing, and the like. Many European countries do not tax foreign-source income, and many U.S. firms already benefit from excess credits. Thus, foreign investment would not necessarily be attracted by generating additional credit. These matters would need careful examination. It would not be prudent to consider new and untried forms of taxation, such as the cash-flow tax, with unpredictable revenue effects, at this crucial transition phase.9

The rapid incorporation of modern methods in tax administration is equally important, for example, through training of officials in acceptable accounting standards and selective auditing of firms. This is especially important given the scarcity of banks and accounting firms. Improvements in accounting and auditing are important for large firms. But improvements in tax administration with the goal of controlling newly emergent small private firms in various sectors are equally important. Otherwise, tax revenue from the private sector will certainly shrink as it did in Poland even as the number of private sector firms increased. If withholding is used to capture as many sources of income as possible within the tax base, the focus of tax administration could be laid on improving other important areas.

Foreign tax advisors must be prepared to accept radical concepts of tax bases at least in the short run. Thus, a corporate “income” tax, incorporating profits plus wages in the tax base, may have to be accepted to discourage managers of state enterprises from giving themselves high wage payments from what would otherwise be taxable profits.10 Or, a long list of excise taxes may have to suffice during the initial period of price reform and continuing need for greater revenue by government. Indeed, in the initial reform phase, high and changing tax rates may be needed to close the fiscal gap, itself fluctuating with inflation. As the economy transforms to a predominantly market economy, the focus should turn toward improving the efficiency of the tax system, for example, by more methodical implementation of nondistortive taxes such as a consumption-type VAT.11

Turnover taxes fixed in specific terms must be quickly transformed to an ad valorem basis. Otherwise their real value could fall dramatically, as it did in Poland in 1990. As high tax rates depress the incentive to invest as well as reduce consumption, it must be recognized that there is a limit to taxation, to arrest any downward spiral of economic activity.12 Here, the relief has to come from opening the economy, as rapidly as possible, to trade and foreign investment.

Strategy for Expenditure Policies

On the expenditure side, government policies have to be targeted toward reducing the net subsidies to firms and households, desisting from commandeering goods and services at below-market prices, and attracting foreign investment for investment expenditures. These objectives should be reflected in a change in the composition of government expenditure, from broad-based subsidies to enterprises to selected investment in industrial infrastructure. Thus, firms should be allowed to face market prices both on the cost and receipts sides (this should be an integral part of the price reform) and government receipts should be based on properly defined–albeit some distortionary–taxes, rather than through dictating terms to the production sector on transfers.

Households are complex entities. There is no doubt that household subsidies have to be reduced in the net to accommodate the acute need for closing the fiscal gap. However, if strong adverse reaction from households is to be successfully contained, the expenditure policy package geared toward household benefits needs to be carefully designed. This can be achieved by converting the current mix of social welfare programs to a social safety net program for the most vulnerable, including lowincome pensioners and children of low-income families. The retirement age could be raised, and contributions be required on a sound actuarial basis.13 The remaining pensioners (under a revised system) could even be accommodated at a higher real income level. Unemployment compensation can be financed through a specific program funded by the employed rather than through the general budget.14 The system of family allowances can be targeted to include only low-income families with children, comprising the most vulnerable groups. Other social expenditures, including health care, can be made subject to cost-sharing. While there seems ample room for reductions in subsidies to households, and such reductions are of paramount importance, the actual sequencing of the reduction and removal of particular programs, while replacing them with well-targeted, cost-saving programs for the vulnerable, will need to be handled with great care.

Concluding Remarks

This paper surveyed the nature of Kazakh economic and fiscal reform in its own macroeconomic setting, during its transition and transformation to a market economy. The objective was to focus attention on the best fiscal strategy. However, such a strategy has to be placed in the context of an overall economic strategy. The experiences of postwar Japan and the development process in some East Asian economies point toward the government playing a strong complementary role–through selective interventionist policies–in fostering a market economy.

Turning to the long-term goal of fiscal reform in the states of the former Soviet Union: neutral, nondistortionary taxes with a wide revenue base and low, overall tax rate structure, assuring stability in revenue productivity, have been widely written about. Certainly, a broad-based consumption-type VAT–rather than a distortionary structure that does not allow credit for capital goods and machinery–would be preferable; an appropriately defined system of selective excises–on alcoholic beverages, tobacco products, and petroleum products–in addition to the VAT, would be desirable; personal income tax cannot be ignored; and ultimately a corporate income tax has to have a sound conceptual basis, rather than hybrid definitions suited for a particular short-run revenue objective. Streamlined payroll taxes would be important in the overall tax structure.

Rather than calling into question the appropriateness and suitability of the specified tax structure, this paper has looked at the important elements of an interim strategy; it has asked what the strategic tax-expenditure policy mix is, and how it is to be differentiated from the ideal, long-run policy package. What are particular concerns that must be kept in mind by fiscal experts in formulating interim tax-expenditure policies to avoid a possible collapse of revenues or an alarming erosion of real values of government expenditures, especially in the social category? What are specific areas in which some compromises–from the long-run optimal package–might be necessary to correct negative rates of growth, rapidly rising prices, and high fiscal deficits?

In its quest for interim fiscal policies, the paper identified selected taxexpenditure measures, in view of recent experiences of Poland and Hungary. Such tax policies would at times result in the maintenance of current structures for certain taxes–albeit only in the short run–in order to prevent the collapse of revenues experienced in Poland. While a consumption-type VAT would be the least distortionary, the existing production-type VAT, which does not allow credit for capital goods and machinery, coupled with a list longer than usually recommended of excisable items, may have to be accepted in the short run for revenue considerations. This might be necessary for macroeconomic stabilization.

On the expenditure side, transition policies would have to identify ways of reducing budgetary subsidies to firms (synchronized with allowing market prices to prevail on their receipts side), while allowing for selective preferential treatment of leading (infrastructure) sectors. This has to be done notwithstanding the significant state ownership of productive assets, superimposed on a monopolistic organization of production. Expenditure policies would have to address the changing needs of households. Government would have to be aware of the possible social consequences of drastic, one-shot reductions in the prevailing subsidies to households. While the objective must be to target the most vulnerable sections of society, the less vulnerable who are more visible still have to be taken into account when making sensitive policy decisions: Hungary provides a case in point; the reductions may have to be gradual.

Finally, despite the belt-tightening measures, a fiscal gap may still remain. That can be filled with foreign financing, flowing primarily into investment activities. It is clear that the search for external resources, especially private resources, will remain an important element of strategic fiscal planning during the transition period.

    CalvoGuillermoA. and FabrizioCoricelli“Output Collapse in Eastern Europe: The Role of Credit,”IMF Working PaperNo. 92/64 (Washington: International Monetary FundAugust1992).

    GordonRogerH.“Fiscal Policy During the Transition in Eastern Europe,”paper presented at Conference on the Transition in Eastern Europe National Bureau of Economic ResearchFebruary 26-291992.

    KapurI.L.ValdiviesoS.GeadahK.WarwickA.FurtadoR.Vaez-Zadeh and X.MaretKazakhstan–Economic Review (Washington: International Monetary FundMay1992).

    MintzJesus and T.Tsiopoulos“On the Effectiveness of Corporate Tax Incentives for Foreign Investment in the Presence of Tax Crediting: An Application to Central Eastern European Countries” paper presented at Trans-Atlantic Public Economics Seminar National Bureau of Economic Research (University of MunichJune11-131992).

    NewberyDavidM.G.“An Analysis of the Hungarian Tax Reform,”Discussion Paper SeriesNo. 558 (London: Center for Economic Policy ResearchMay1991).

    OtaF.H.Tanikawa and T.Otani“Russia’s Economic Reform and Japan’s Industrial Policy,”paper presented at symposium on“Unification of Europe,”June1 and 21992Research Institute of International Trade and Industry (MITI) and Japan Industrial Policy Research Institute.

    TaitAlanA.“A Not-So-Simple Alternative to the Income Tax for Socialist Economies in Transition,”The World Bank Research ObserverVol.7No.2 (July1992) pp. 23948.

    TanziVito“Tax Reform and the Move to a Market Economy: Overview of the Issues” in The Role of Tax Reform in Central and Eastern European Economies (Paris: Organization for Economic Cooperation and Development1991).

    TanziVitoParthasarathiShome“The Role of Taxation in the Development of East Asian Economies” Chap. 2 in The Political Economy of Tax Reformed. by ItoTakatoshiand KruegerAnne O. (Chicago and London: University of Chicago Press1992).

Parthasarathi Shome is Chief of the Tax Policy Division in the Fiscal Affairs Department. The author would like to acknowledge many useful comments from his colleagues, Luis Valdivieso and Howell Zee.

Life expectancy in the former Soviet Union is 64 years for men (72 in member countries of the Organization for Economic Cooperation and Development (OECD)) and 73 for women (78 in the OECD).

In 1990 there were almost a million people between ages 50 and 54, and slightly over half a million between ages 55 and 59.

My colleague, Yuichi Ikeda, helped develop the information on revenues and expenditures.

Except for a relatively small portion, payroll tax is not included in the budget but in extrabudgetary funds set up for social security programs.

Equivalently, of course, Kazakhstan could also export the effects of its own policies to the other republics.

Unlike Kazakhstan, Japan also faced trade restrictions.

Calvo and Coricelli (1992) have also emphasized the need to maintain the real value of credit at the initial point of change, in order to prevent an “output collapse.” They suggest additional measures such as swapping public enterprise debt with government debt, the latter presumably being more acceptable as collateral for private market borrowing (provided such a market exists); and a slower removal of subsidies (provided hyperinflation is not feared) and a smoother increase in input prices so that enterprises have time to build liquidity.

Newbery (1991) rightly alludes to the political viability question in that such redistributive policies mean that social benefits will be switched from the middle class to the poor, while simultaneously allowing an entrepreneurial, upper economic class to grow rapidly to encourage quick, private capital accumulation and growth

Mintz and Tsiopoulos (1992) have demonstrated that the argument that the cash-flow tax would provide greater incentive for investment cannot be supported for U.S. corporations operating in Central and East European countries because of excess tax credits. See Tait (1992) on related issues.

A tax-based incomes policy has been introduced in Kazakhstan. It disallows exemption from calculation of corporate income tax of any amount of the wage bill over four times the minimum wage times the number of employees.

While the VAT is already on the tax statutes of Kazakhstan and other states of the former Soviet Union, focus cannot perhaps be removed entirely from the continuing interim role of a long list of excise taxes.

For methods of improving the structure of particular taxes such as the turnover tax or profits taxes, see Tanzi (1991) and Gordon (1992).

This could take time because of lack of information and of professionals who could develop appropriate contribution tables from actuarial data.

In 1991, the authorities created an Employment Fund to be financed by enterprise contributions and to be self-financing at least in the short run. They also separated the Pension Fund from the general budget. See Kapur and others (1992).

    Other Resources Citing This Publication