The fiscal impact of privatization will reflect the amount and use of the proceeds and the subsequent changes in financial flows—taxes, transfers, and dividends—to and from the budget.18 In a broader context, consideration should also be given to the impact of privatization on quasi-fiscal costs, including subsidized credit to public enterprises. There may also be impacts on the budget from the assumption of quasi-fiscal costs that were previously imposed on public enterprises by the government arising from the pursuit of public policies, such as uncompensated provision of subsidized goods and services. Privatization often takes place as part of a policy package that involves a substantial change in the macroeconomic environment, which makes it difficult to distinguish its impact from the other effects of a regime change. Moreover, data on public enterprise operations is often scanty, and the information available on the financial flows between enterprises and the government, including quasi-fiscal flows, is less than complete.19
This section examines the contemporaneous impact of privatization on the budget, and its effects over time, for the case study countries. To a substantial extent, the short-run impact depends on how the privatization receipts are used, while long-run gains reflect the microeconomic benefits from exposing the enterprises to market discipline. The empirical evidence draws on the panel econometric estimates reported in Appendix II and on a less formal review of the case study experience.20 Given the shortcomings of the data, the findings on the fiscal effects of privatization need to be considered as preliminary and interpreted with particular care.
Contemporaneous Use of Privatization Proceeds
Privatization proceeds accruing to the budget may be saved or spent, the former implying reductions in domestic or external financing and the latter higher spending or reduced taxes (see Section III). These hypotheses were tested using the case study data and panel econometric techniques. To test the robustness of the findings, the effects on saving and spending were tested independently and considered for different samples and coverage of explanatory variables. The methodology and results are reported in Appendix II, with summary findings on the impact of privatization on domestic financing presented in Table 6.
Impact of Privatization on Domestic Financing
Dependent variable is the first difference of the ratio of domestic financing to GDP.
Variables are significant at the 1 percent level; standard errors of estimates are in parentheses.
Privatization proceeds accruing to the budget.
Impact of Privatization on Domestic Financing
| Explanatory Variables1 | |||||
|---|---|---|---|---|---|
| Regression | Budgetary privatization2,3 | Overall balance2 | External financing2 | R-squared | Number of Observations |
| Full sample | −0.97 (.13) | −0.74 (.15) | — | 0.54 | 83 |
| Nontransition countries | −0.79 (.12) | −0.90 (.22) | — | 0.50 | 57 |
| Full sample | −1.19 (.19) | — | –0.65 (.20) | 0.39 | 82 |
| Nontransition countries | −1.03 (.11) | — | –0.96 (.19) | 0.58 | 52 |
Dependent variable is the first difference of the ratio of domestic financing to GDP.
Variables are significant at the 1 percent level; standard errors of estimates are in parentheses.
Privatization proceeds accruing to the budget.
Impact of Privatization on Domestic Financing
| Explanatory Variables1 | |||||
|---|---|---|---|---|---|
| Regression | Budgetary privatization2,3 | Overall balance2 | External financing2 | R-squared | Number of Observations |
| Full sample | −0.97 (.13) | −0.74 (.15) | — | 0.54 | 83 |
| Nontransition countries | −0.79 (.12) | −0.90 (.22) | — | 0.50 | 57 |
| Full sample | −1.19 (.19) | — | –0.65 (.20) | 0.39 | 82 |
| Nontransition countries | −1.03 (.11) | — | –0.96 (.19) | 0.58 | 52 |
Dependent variable is the first difference of the ratio of domestic financing to GDP.
Variables are significant at the 1 percent level; standard errors of estimates are in parentheses.
Privatization proceeds accruing to the budget.
The results suggest that privatization proceeds transferred to the budget are saved. More specifically, they are consistent with these proceeds being substantially used to substitute for other sources of domestic financing; the coefficient on privatization is always close to minus one and statistically significant. There is some weaker evidence for the nontransition economies that about one-fifth of the privatization receipts are used to reduce external financing, with the rest substituting for domestic financing.21 Regressions with the overall deficit, total expenditure, and taxation as dependent variables did not provide support for the suggestion that proceeds were generally spent.
The interpretation of this econometric evidence needs to be carefully qualified, and it is difficult to assess the general applicability of these results. First, the results are based on a select sample of countries and for a limited number of years for which data were available. Second, the evidence applies to the budget narrowly defined, because the sample only covers privatization proceeds identified as flowing to the budget; as discussed in Section III, there are examples of countries subject to liquidity constraints spending proceeds that accrue to extrabudgetary funds. Third, most of the countries in the sample had an IMF program for at least part of the period when privatization receipts were at their height.
If, however, the resources that are channeled through the budget tend to be saved, this would not support arguments that the placement of the privatization proceeds in extrabudgetary funds is necessary to prevent the misuse of the resources. Furthermore, the results would be consistent with the hypothesis that the formulation of fiscal plans under IMF programs is made on the basis of a deficit consistent with overall program objectives, and that privatization receipts are not a determining factor in the setting of fiscal targets, except at the margin (see Section VI).
Effects of Privatization on the Fiscal Accounts Over Time
Privatization may affect the fiscal accounts over time in several ways: directly, through its effect on financial flows to and from the privatized enterprise; indirectly, insofar as it influences the macroeconomic environment (see Section V); and as a result of decisions as to the initial use of the proceeds. This section presents evidence on developments in tax revenue, net transfers to public enterprises, more broadly defined public enterprise sector deficits, and public debt. The partial and piecemeal evidence is consistent with the public sector in the case study countries benefiting from privatization in a longer time perspective.
Tax Revenue
Taxes paid by privatized enterprises will reflect changes in efficiency and differences in the tax regime. Increased profitability would benefit budgetary revenue, as would any intensification of restrictions to competition that favor the new owners. The impact of differences in the tax regime when an enterprise is privatized is less certain. Revenue may increase to the extent that public enterprises have sometimes been subject to less rigorous auditing and collection efforts than private firms. However, a tax system may be more difficult to administer in an economy characterized by many smaller private firms than in one dominated by large state firms whose financial operations are, in principle, transparently available to the tax authorities. Moreover, private firms may have stronger incentives to evade or avoid taxes and may also prove more skillful in doing so. In transition economies in particular, private enterprises have often proved difficult for nascent tax administrations to capture in the tax net (see Box 2).22
At the microeconomic level, there is evidence that privatized firms have paid higher taxes compared to the preprivatization period (Galal and others, 1994). Evidence for some nontransition case study countries also suggests a similar conclusion.23 In Argentina, for example, taxes paid by five large privatized firms increased significantly following privatization (Shaikh and others, 1996; see also Larraín and Winograd, 1996), while in Mexico privatized firms became significant tax contributors after having received, on average, a small net transfer prior to privatization (La Porta and López-de-Silanes, 1997). World Bank studies for Côte d’Ivoire and Mozambique also provide evidence of substantial increases in tax revenue from privatized firms.
The Impact of Economic Transition on Tax Administration
The Previous system. State ownership of the productive sector significantly determined the basic practices and procedures of tax administrations in the transition countries. Under the previous system, the state was entitled to all of the profits from state-owned enterprises. Whether the state received this profit as tax revenue or as dividend payment, the total resources available to the state were the same. Moreover, because both the tax assessor (auditor) and the state-owned enterprise’s tax accountant were both effectively employed by the state, their relationship was less adversarial than that between a tax auditor and the representative of a private business in a market-oriented economy. Ownership also allowed the state to make discretionary ex post changes to an enterprise’s tax liabilities. In China, for example, tax authorities can still impose an adjustment tax on top of the enterprise income tax. This tax is intended to be an equalizer that compensates for differential profitability, so its rates may vary depending on the particular circumstances of each enterprise.
Another feature of state ownership is that the number of taxpayers is much smaller than in market-oriented economies. Most tax revenue is obtained from a limited number of large state-owned enterprises or collectively owned enterprises through turnover tax and profits tax. State-owned banks played a major role in monitoring the tax payments of these state-owned enterprises; for example, in some transition countries banks will still not release funds to the state-owned enterprises to pay wages until taxes due (including wage withholding) have been paid.
Changes associated with transition to a market economy. Many transition countries have continued to apply effectively the same tax assessment and collection procedures, despite the privatization of state-owned enterprises, development of a private sector, and the establishment of privately owned banks. The growing number of small enterprises, often operating outside the formal economy, has increased the burden on local tax offices considerably. For example, in Bulgaria the number of small enterprises registered by the tax administration has increased by about 100,000 each year between 1993 and 1999, In Moldova, the number of taxpayers increased from about 34,000 in 1991 to more than 350,000 in 1999, with many of the new registrants being small- and medium-sized businesses.
In all of these countries, economic transition has been a difficult challenge for tax administration. In the absence of a tax-paying culture and a willingness on the part of the tax administration to modernize procedures and systems, tax evasion and noncompliance are serious problems. Significant dollarization, continuing barter arrangements, “cash-economy” business operations, and the nascent development of the banking system have all exacerbated tax compliance problems. A number of laws, such as accounting laws, are rudimentary, complicate the work of tax administration, and increase the cost of compliance to taxpayers. Even where tax and other laws have been updated, tax officials are often poorly trained. Also, the typically low salary levels of officials in these countries may increase the risk of corruption. Finally, moribund and failing business enterprises have also created major problems for tax administration, especially when their managers give little, if any, priority to payment of taxes.
Overall government tax revenue benefits from the likely greater efficiency of the privatized firms and the concomitant impact on growth, but it may also suffer from the increased difficulty of taxing the private sector. The econometric results offer some limited evidence that privatization leads to a positive and ongoing increase in tax revenue as a share of GDP in the nontransition countries (see Appendix II). This increase could be due to several factors: higher collection rates from the privatized firms, either from improved compliance or enhanced administrative scrutiny; privatization leading to a shift in the structure of GDP toward sectors paying more taxes; or the privatization process coinciding with a general strengthening in macroeconomic management, including possible improvements in tax policy and administration. The fact that a majority of the sample observations coincide with the presence of an IMF program may be of importance in the context of the last factor.
Net Transfers to Public Enterprises
In many countries, the public enterprise sector has required substantial net resource flows from the budget over extended periods, suggesting that often the policy goals pursued through their operations are being achieved at high fiscal cost. Viewed in this way, privatization provides an opportunity to enhance the efficiency of public expenditure.
For several case study countries, gross budgetary transfers to the public enterprise sector have tended to decline with privatization (see Figure 1).24 The reductions have been particularly significant in countries such as Argentina, the Czech Republic, Mexico, Mongolia, Mozambique, and the Philippines. In addition, there may be quasi-fiscal support to public enterprises that is not captured in the budgetary data. Public enterprises may run deficits after transfers financed by various forms of non market credit, obtain “financing” in the form of insufficient investment and the corresponding deterioration of the capital stock, and benefit from government-guaranteed liabilities and tax relief.25
Gross Budgetary Transfers and Subsidies to Public Enterprises for Selected Countries
(In percent of GDP)
Sources: Data provided by the authorities; and IMF staff estimates1 Excludes Petróleos Mexicanos. Includes some decentralized government agencies.Gross Budgetary Transfers and Subsidies to Public Enterprises for Selected Countries
(In percent of GDP)
Sources: Data provided by the authorities; and IMF staff estimates1 Excludes Petróleos Mexicanos. Includes some decentralized government agencies.Gross Budgetary Transfers and Subsidies to Public Enterprises for Selected Countries
(In percent of GDP)
Sources: Data provided by the authorities; and IMF staff estimates1 Excludes Petróleos Mexicanos. Includes some decentralized government agencies.In the case study countries for which data are available, dividends paid to the budget by the public enterprise sector declined following privatization. There is often concern as to the potential negative impact on the budget of the privatization of highly profitable public enterprises. Box 3 suggests, however, that such privatization need not adversely impact the budget.
Fiscal Issues in the Privatization of Profitable Public Enterprises
Sometimes there are concerns about possible negative effects on the fiscal accounts from the privatization of profitable public enterprises. In particular, the perception that it could result in revenue losses has sometimes deterred more rapid progress in privatization. The analysis of this case involves the consideration of several issues.
Profitability and efficiency. These are distinct concepts that are sometimes confused. If the private sector can increase the efficiency of a profitable public enterprise, and the government shares in these gains through the sale price and subsequent taxation, government net worth will increase even though profitable enterprises are divested.
Efficiency of privatization procedures. If profitable public enterprises are sold for less than their true value, then concerns about possible detrimental effects of privatization on the fiscal position would be warranted, but these considerations would apply equally to loss-making public enterprises.
Ability to tax. Profitable public enterprises may be a source of sizable tax receipts to the budget, but the government may be unable to tax these enterprises effectively following privatization. However, if the sales process is competitive, in principle this should be reflected in the sale price, and the tax regime should have no bearing on the impact of privatization on government net worth. Potential buyers will incorporate information about the tax regime in their offers, bidding up the price of the enterprise up to the discounted value of net earnings after tax. In effect, the government would get the net present value of the taxes forgone due to the inability to tax effectively in the lump-sum form of a higher sale price, which in turn should contribute to a lower net interest bill in the future.
Postprivatization investment and taxation. The new buyers may need to undertake investments, which, depending on the corporate income tax regime, may entail temporary effects on income tax revenue. However, if the public enterprise remained in public hands, presumably investments would also need to be undertaken at some stage to forestall decapitalization, with effects on the overall public sector balance.
Large dividends and transfers from profitable public enterprises prior to divestiture. Sometimes, when the budget gets large revenues from certain public enterprises in the form of dividends or transfers, there is a perception that as these come to an end following privatization, budget revenue will fall resulting in a deterioration of the fiscal position. However, this is a partial analysis focused solely on the budget that fails to take into account the financial position of the consolidated public sector as a whole.
One possibility is that in order to make large transfers to the budget, the profitable public enterprise is having to borrow or is decapitalizing because of insufficient investment. These preprivatizalion factors, which affect the fiscal position of the public sector as a whole, are not captured if the analysis focuses on the budget. Following privatization, the “’borrowing” hitherto done by the public enterprise (in the form of credit or decapitalization) would just shift to the budget to make up for the loss in dividends, net of the interest that will be earned on the financial assets generated by privatization revenue.
Another possibility is that a very profitable public enterprise is able to finance large dividend and transfer payments to the budget without having to borrow or decapitalize; in the absence of such transfers, it would be building up assets. In this case, under efficient privatization mechanisms, the sale price should also reflect the enterprise’s profitability, and the loss of dividends and transfers to the budget should be made up through the return on financial assets generated by privatization revenue.
Tax and interest factors to take into account in fiscal projections. The perception of a negative fiscal effect from the privatization of profitable public enterprises could arise from the failure to include appropriate estimates of the taxes expected to be paid by the privatized public enterprises in the fiscal projections, as well as the interest that will accrue on financial assets purchased with privatization proceeds, or the reduction in interest due following debt amortization financed with the proceeds.
In many cases, the fiscal savings from privatization are larger than those arising from the elimination of budgetary transfers to public enterprises and above-the-line quasi-fiscal support. This is particularly likely to be the case if public enterprises record sustained deficits after such transfers, which are financed through various forms of voluntary and involuntary credit,26 Figure 2 presents data for four countries on the overall fiscal balance of the public enterprise sector before transfers lo and from the government, the amounts of net transfers, and the balance that remained to be financed through various forms of credit. These data are for the years before the peak privatization period and for the latest year for which data are available. For these countries, both the deficit before and after transfers declined markedly following privatization, which would suggest a lessening of the fiscal burden from these enterprises.27
Operations of the Public Enterprise Sector Before and After Privatization for Selected Countries
(In percent of GDP)
Sources: Data provided by the authorities; and IMF staff estimates.1 Excludes Petróleos Mexicanos. Includes some decentralized government agencies.2 Gross transfers less dividends.Operations of the Public Enterprise Sector Before and After Privatization for Selected Countries
(In percent of GDP)
Sources: Data provided by the authorities; and IMF staff estimates.1 Excludes Petróleos Mexicanos. Includes some decentralized government agencies.2 Gross transfers less dividends.Operations of the Public Enterprise Sector Before and After Privatization for Selected Countries
(In percent of GDP)
Sources: Data provided by the authorities; and IMF staff estimates.1 Excludes Petróleos Mexicanos. Includes some decentralized government agencies.2 Gross transfers less dividends.Public Debt and Interest Payments
A number of case study countries instituted explicit or implicit rules requiring that a part of privatization proceeds be directed to debt reduction. Four case study countries that expressed an explicit intention to use privatization proceeds for debt reduction (Argentina, Egypt, Hungary, and Mexico) had initial stock of registered public debt ranging between 40 percent and 130 percent of GDP. In each of these countries, the debt stock fell sharply between the year before the period of most active privatization and the last year of active privatization, though clearly this involved many other factors in addition to the use of the privatization proceeds (see Table 7).
In Argentina, Egypt, and Mexico, interest payments as a share of GDP felt significantly from their levels just prior to the initiation of their privatization programs. In general, where privatization proceeds were used to reduce public indebtedness, privatization contributed to the strengthening and stabilization of the economy. Thus, reductions in the interest burden are likely also to have reflected lower interest rates arising from changes in the policy regime associated with privatization. In Argentina and Mexico, significant declines in inflation rates during the period of intensive privatization also resulted in lower nominal interest rates on the domestic currency debt.
Reduction in Debt Stock and Privatization
(In percent of GDP)
Stock at end of previous year, except for Argentina, where 1990 data are used because of discrepancies in the 1989 data.
Stock at end of fiscal year of the active privatization period, except for Egypt, where debt data for 1997 are used.
Reduction in Debt Stock and Privatization
(In percent of GDP)
| Country | Start of Active Privatization Period | End of Active Privatization Period | Initial Debt Stock1 | End-year Debt Stock2 |
|---|---|---|---|---|
| Argentina | 1990 | 1995 | 40.1 | 32.0 |
| Egypt | 1993 | 1998 | 129.4 | 89.6 |
| Hungary | 1991 | 1998 | 66.3 | 60.4 |
| Mexico | 1989 | 1994 | 64.4 | 33.3 |
Stock at end of previous year, except for Argentina, where 1990 data are used because of discrepancies in the 1989 data.
Stock at end of fiscal year of the active privatization period, except for Egypt, where debt data for 1997 are used.
Reduction in Debt Stock and Privatization
(In percent of GDP)
| Country | Start of Active Privatization Period | End of Active Privatization Period | Initial Debt Stock1 | End-year Debt Stock2 |
|---|---|---|---|---|
| Argentina | 1990 | 1995 | 40.1 | 32.0 |
| Egypt | 1993 | 1998 | 129.4 | 89.6 |
| Hungary | 1991 | 1998 | 66.3 | 60.4 |
| Mexico | 1989 | 1994 | 64.4 | 33.3 |
Stock at end of previous year, except for Argentina, where 1990 data are used because of discrepancies in the 1989 data.
Stock at end of fiscal year of the active privatization period, except for Egypt, where debt data for 1997 are used.
Data Issues
Many countries have experienced difficulties even forming a clear picture of the value of the productive assets they own because of data deficiencies and problems with adequate reporting. Governments should identify clearly in their accounts the revenues collected from public enterprises, including taxes paid and dividends transferred, as well as any current or capital transfers made to the enterprises. Quasi-fiscal support to enterprises should be budgetized. Efforts are also needed to improve data pertaining to the public sector fiscal position, including more adequate reporting—along with the budgetary accounts—of the operations and financing of deficits or surpluses of the sector as a whole.
