III. Fiscal Structure and the 2000 Budget
Author: Mr. Robert J. Corker, Ms. Dawn Elizabeth Rehm, and Ms. Kristina Kostial
Language:
English
Keywords:
BOOK; budget system; right; reconstruction program; Kosovo budget; wage bill; budget support; expenditure level; budget summary; Capital spending; Budget planning and preparation; Social security contributions
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Abstract

Given Kosovo’s unique circumstances, fiscal policy currently takes a rather rudimentary form. UNMIK had to start from scratch in designing a tax system, developing a budget, and creating the institutions to implement its policies (Box 2). At present, Kosovo has a basic tax system that relies mostly on tax collection at the border (sales tax as well as customs and excises), while the structure of expenditure has yet to become fully comprehensive. In the absence of domestic financing instruments, donor grants are financing about half of the recurrent budget, as well as all capital outlays.

Given Kosovo’s unique circumstances, fiscal policy currently takes a rather rudimentary form. UNMIK had to start from scratch in designing a tax system, developing a budget, and creating the institutions to implement its policies (Box 2). At present, Kosovo has a basic tax system that relies mostly on tax collection at the border (sales tax as well as customs and excises), while the structure of expenditure has yet to become fully comprehensive. In the absence of domestic financing instruments, donor grants are financing about half of the recurrent budget, as well as all capital outlays.

Kosovo’s first budgets for the final four months of 1999 and for 2000 focused on essentials such as reestablishing the provision of basic goods and services, a minimal welfare net, and the rehabilitation of utilities. With the help of World Bank technical assistance, expenditures were drawn up on the basis of a needs assessment, although due regard was also given to resource constraints in the design of the key programs in the areas of education, health, and welfare.

At the same time, with the help of European Union (EU) and IMF technical assistance, UNMIK moved rapidly to establish border tax collection. However, it was recognized at the outset that it would take time to establish revenue streams, given limitations in administrative capacity and the many gaps between border posts. In the meantime, donor grants were to supplement local revenues for financing recurrent expenditures, with the explicit assumption that such grants would be on a declining path as the local tax base was developed. The budgets focused only on recurrent spending. The capital budget was drawn up separately, was based on reconstruction needs, and was financed in full by donors.

After initial problems, the execution of the recurrent budget has been commendable. At first, UNMIK encountered problems in both establishing the flow of tax revenue and in carrying out planned expenditures. On balance, spending shortfalls predominated, and the budget generated a cash surplus in the final months of 1999. As holes in the border were plugged (mostly by establishing border posts with Montenegro) and experience with payments and procurement procedures improved, tax and spending were brought up to planned levels during the course of 2000 (Tables 2 and 3).

The composition of revenues and expenditures has, however, diverged in places from budget plans. On the tax side, revenues have been boosted by windfall gains in car imports, which have offset generally weak customs and excises at the beginning of the year and the postponed introduction of some domestic taxes, including the income tax. On expenditures, utility subsidies have been much larger than planned in part because of bill collection difficulties as well as problems of overstaffing in the electricity company. There have also been problems in reducing staffing to budgeted levels in the education and health sectors, although the wage bill is estimated to have been below the budgeted amount. Expenditure overruns have been offset by shortfalls in procurement—in some cases compensated for by off-budget provision of goods in kind from donors, notably for pharmaceuticals and education equipment—and in spending on social assistance. Over all, required donor budget support was close to the requested amount.

Administrative Structures

The removal of Kosovo’s autonomy and centralization of public administration in Belgrade during the past decade created an institutional vacuum in Kosovo. Essential functions, such as the management of public resources, either did not exist or existed in a rudimentary form. A parallel budget system financed by voluntary contributions from the Kosovar diaspora was created in these years to ensure the provision of basic public services for the ethnic Albanian majority. However, by the summer of 1999, neither the official nor the parallel system could serve as a substitute for formal budgeting.

While initial spending had to be organized in an ad hoc fashion, UNMIK adopted at end-1999 an IMF technical assistance blueprint for the Central Fiscal Authority (CFA), which assumed the functions of a ministry of finance. Fiscal operations are also performed by municipalities and public utilities.

Central Fiscal Authority

The CFA is responsible for the financial management of the Kosovo Consolidated Budget (KCB), which consists of general government activities, municipal services, and public enterprises but excludes the UNMIK budget. The CFA formulates the overall fiscal strategy by executing its main functions:

  • budget preparation and monitoring;

  • execution of budgetary transactions through the treasury single account and their financial control, including procurement procedures;

  • design of tax policy;

  • control of tax and customs administration—the latter executed by the European Union Customs Assistance Mission in Kosovo (CAM-K); and

  • internal audit.

Municipalities

Kosovo has 30 municipalities, which currently are financed by transfers from the central government (about DM 20 million in 2000) but also by illegally levied taxes, including from the exploitation of natural resources (in particular, quarries). A recent regulation laying the groundwork for future local self-government envisages the devolution of major services such as health and education. However, while explicit in assigning expenditures, the regulation limits municipal revenue to a few instruments that would be insufficient to cover the envisaged devolution of expenditure.

Public Utilities

Kosovo Electricity Company (KEK) is currently a huge drain on public finances because of net operating losses (reflecting nonpayment of electricity bills, but also overemployment) and the need to complement domestic electricity production by imports to offset outages caused by the rehabilitation of the power stations. Budgetary subsidies are estimated at about DM 50 million in 2000 and are supplemented by additional off-budget donor support for imports of about DM 40 million. With the rehabilitation work expected to be completed in the course of the year, subsidies and import support are expected to decline to about DM 50 million in 2001. Subsidies to other utitilies are budgeted at about DM 12 million for 2001.

Table 2.

Budget Summary, 2000 and 20011

(Millions of deutsche mark)

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Does not include donor-financed reconstruction, which accounts for all capital spending.

The initial budget was revised in March to reflect new costs associated with the implementation of the Joint Interim Administrative Structure (JIAS) and a more pessimistic outlook for local revenues.

A positive sign denotes an increase in cash reserves.

Total government expenditure levels are temporarily quite high because of the large foreign-financed reconstruction program. Data on off-budget spending are less reliable than those on the spending controlled by the CFA. Nonetheless, the IMF staff estimate that capital spending in 2000 is currently some 75 percent higher than the recurrent budget (Table 4). Adding in some identified off-budget spending items pushes spending up to about 40 percent of GDP. Not included in spending are the accrued costs of servicing potentially large liabilities for existing pensions and debt service. Also not included are the cost of humanitarian aid (which should be largely exhausted by end-2000), defense (provided by NATO), and foreign assistance in running the civil administration.1

Excluding capital spending, expenditure levels in Kosovo are not high by international standards. On-budget recurrent spending in Kosovo amounts to about 14 percent of GDP, compared with an average 20-23 percent of GDP in low- and middle-income countries with which Kosovo might reasonably be compared (Table 5 and Figure 1). However, most of the difference can be accounted for by the exclusion from the Kosovo budget of defense and debt service—which make up about 6 percent of GDP in typical low- or medium-income countries. Expendi-ture-to-GDP levels are much higher in typical transition economies, including the economies in the region, but it is well known that such economies have bloated public sectors.

Of the main economic categories of expenditure, social transfers and the wage bill are on the low side by international standards. Welfare and social security spending is noticeably below that in transition countries and somewhat below that in middle-income countries—primarily because of the absence of payment of public pensions. Instead, Kosovo’s welfare system focuses on the provision of means-tested social assistance to the neediest families.2 Until now, such assistance has been augmented by sizable off-budget humanitarian assistance. The overall budget sector wage bill is low by international standards because employment levels are for the most part lean (there are some exceptions, including in health and education) and because some functions (for example, military personnel, police, judges) are not fully developed. Nonetheless, wage rates for government workers are high in comparison with those in a broad range of transition economies when they are corrected for average productivity levels in the economy (Figure 2).3 On a functional basis, spending on health and education is broadly in line with that in other countries.

Table 3.

Recurrent Budget, 1999–20011

(Millions ofdeutsche mark, unless otherwise indicated)

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Sources: United Nations Mission in Kosovo (UNMIK); and IMF staff estimates.

Does not include donor-financed reconstruction, which accounts for all capital spending.

In April 2000 a revised budget added DM 6 million for the Joint Interim Administrative Structure (JIAS), responsible for the administration of Kosovo since February 2000.

For 2000, includes DM 20.7 million for the Kosovo Protection Force.

For 2000, subsidies to the Kosovo Electricity Company (KEK) and for water/public heating increased by DM 25 million and DM 5 million, respectively. Increases reflect in part delays in reducing redundant staff.

For 2000, includes dedicated donor support of DM 17.7 million for the Kosovo Protection Corps.

Does not include support for electricity imports, estimated at about DM 40 million each in 2000 and 2001.

A positive sign denotes an increase in cash reserves.

Table 4.

Integrated Budget, 2000

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Includes changes in cash reserves.

Table 5.

Selected Countries: Government Expenditures

(Average as percent of GDP)

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Sources: IMF, Government finance Statistics yearbook (Washington, various years); and IMF staff estimates.

Budget 2000, subsidies and transfers include unallocated contingency reserves.

Barbados, Botswana, Chile, Colombia, Costa Rica, Cyprus, Dominican Republic, Egypt, El Salvador, Fiji, Hungary, Islamic Republic of Iran, Jordan, Malta, Mauritius, Morocco, Panama, Paraguay, Peru, Romania, Swaziland, Thailand, Tunisia, Turkey, Uruguay, and Zimbabwe.

Burkina Faso, Cameroon, Ghana, Kenya, Lesotho, Malawi, Mali, Sierra Leone, Sri Lanka, former Zaire, and Zambia.

Military wages included in other goods and services for Bosnia and Herzegovina in 1999.

Data unavailable for the former Yugoslav Republic of Macedonia.

Does not include lending minus repayments.

Services provided by Ministries of Agriculture, City Planning and Construction, Development, Economy, and Information, the Bureau of Statistics, and nonclassified expenditures.

Figure 1.
Figure 1.

Selected Countries: Government Expenditure

(Simple averages; percent of GDP)1

Source: IMF staff estimates.1Middle- and low-income countries based on IMF, Government Finance Statistics Yearbook (Washington, various years).2Barbados, Botswana, Chile, Colombia, Costa Rica, Cyprus, Dominican Republic, Egypt, El Salvador, Fiji, Hungary, Islamic Republic of Iran, Jordan, Malta, Mauritius, Morocco, Panama, Paraguay, Peru, Romania, Swaziland, Thailand, Tunisia, Turkey, Uruguay, and Zimbabwe.3Burkina Faso, Cameroon, Ghana, Kenya, Lesotho, Malawi, Mali, Sierra Leone, Sri Lanka, former Zaïre, and Zalaire.4Albania, Bulgaria, former Yugoslav Republic of Macedonia, and Romania.

At this stage, Kosovo’s tax base is very small by regional standards. Although the revenue-to-GDP ratio varies considerably across countries in the region, Kosovo’s ratio at 8 percent is only 40 percent of that in Albania, which stands out as a low revenue raiser (Table 6). Kosovo’s revenue base compares even more unfavorably with states of the former Socialist Federal Republic of Yugoslavia, which would have shared with Kosovo a similar tax system before the breakup of Yugoslavia began in the early 1990s. For example, Bosnia and Herzegovina—which endured a much longer conflict than Kosovo—has, at 47 percent, the highest revenue ratio in the region. Other transition countries raise between 30 and 45 percent of GDP in revenues—roughly 4-6 times more than Kosovo.

Kosovo’s weak revenue performance is to a large extent due to its rather basic tax instruments. Almost all revenues in Kosovo stem from imports, which are subject to a uniform tariff, a sales tax, and excises; the domestic economy, in contrast, escapes virtually untaxed (Box 3). Tax rates are not low, but substantial exemptions on basic consumption goods depress collections. Conspicuously absent in Kosovo are taxes on incomes, including social security contributions. These are a substantial source of revenue to fund programs such as pensions in the former Yugoslav republics, where surviving payments systems from the old regime play an important role in forcing collections: social security contributions amount to about 15 percent of GDP in Bosnia and Herzegovina, for example. In Kosovo, however, the breakdown of the payments system (which had been centralized in Belgrade) and the widespread collapse of the state sector made the collection of income tax and social security contributions initially infeasible after the conflict. Efforts to collect revenues on incomes have only restarted tentatively, with some limited presumptive taxes on businesses. Official business and income taxes have to compete with illegal “parallel”taxes collected by local administrations and extortionists. In some cases, such taxes exert a substantial burden on local businesses, and their elimination is a major challenge.

Figure 2.
Figure 2.

Selected Transition Economies: Budget Employment and Net and Gross Budget Wages1

Sources: IMF staff estimates.1The two observations for each entry denote net and gross budget wages.
Table 6.

Selected Transition Economies: Revenues as a Share of GDP1

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Sources: IMF, Government Finance Statistics Yearbook (Washington, various years); and IMF staff estimates.

Average share of GDP during 1996–98, excluding Romania (1996–97), Bosnia and Herzegovina (1998-99), and Kosovo (2000).

Tax Policy: Status and Outlook

Current Tax Structure

Kosovo has a basic tax system that collects revenues mainly from imports. Imports are subject to a 10 percent uniform tariff (with the exception of agricultural and medical products and humanitarian goods), a 15 percent sales tax (same exceptions apply), and excises on alcohol, tobacco, and petroleum goods as well as soft drinks and some electronic goods. To begin taxing the domestic economy, UNMIK introduced a 10 percent hotel, food, and beverage tax on the gross receipts of hotels and restaurants, and a presumptive tax on businesses (with a flat-rate and a second-tier tax on turnover for larger enterprises).

Tax Policy in the Future

While taking into account the practical limitations of the economic situation, Kosovo should lay the groundwork for a coherent long-term tax policy as the economy recovers and administrative capabilities increase. The following is based on technical assistance provided by the IMF and describes the main issues and next steps for improving the current system and further extending it to the domestic economy while taking into account the tax systems of neighboring countries.

Customs Duties. The major issue relating to customs duties is the treatment of trade with the former Yugoslav Republic of Macedonia (exempt under a free trade agreement) and Montenegro (exempt because this trade is considered internal trade within the Federal Republic of Yugoslavia). The best option would be to levy a uniform tariff for goods regardless of origin. However, if this option is politically not feasible, the status quo should be maintained, but customs would need to develop further its capabilities in determining the origin of imports. Alternatively, tariffs could be abolished and sales tax rates adjusted to compensate. Since the food exemption (from the customs duty and sales tax) has lost its justification with the resumption of trade after the emergency situation, the Central Fiscal Authority (CFA) has drafted a resolution to eliminate this exemption by mid-2001.

Excises. To improve compliance for excise taxes, the major excises on petroleum products, alcoholic beverages, and tobacco products will be converted from ad valorem to specific levies. Once the stock of cars is registered, UNMIK could consider an annual tax on cars since this would be easy to administer and could yield substantial revenues.

Wage Tax. A draft of a 15 percent wage tax is under review.1 This tax will ensure greater equity between employees receiving wage income (and not currently taxed) and those entrepreneurs, such as repairmen, professionals, and various service providers, who pay (or should pay) the presumptive tax and whose income is primarily labor or earned income.

Value-Added Tax. The CFA has drafted the legislative framework for a 15 percent valued-added tax (VAT) to expand the sales tax to domestic goods with a view of its implementation on July 1, 2001. A major impetus to extending the sales tax to the domestic economy is to ensure that exports are not burdened by VAT charged on imports used to produce the exports. The VAT will replace the sales tax currently paid by importers and will apply to a limited number of domestic taxpayers in order not to exceed administrative capacities.

Profit Tax. As the last pillar of Kosovo’s tax system, a profit tax should be imposed on business profits, measured by taking into account all legitimate costs of producing income. Because many Kosovar enterprises have been crippled by years of underinvestment and the recent war, the profit tax is not likely to be a major revenue raiser in the early years. Its introduction should thus have lower priority than introducing a VAT or wage tax.

1 Implementation of the wage tax has been delayed, in part because it appears that local employees of international organizations would be exempt from this tax pursuant to the UN Convention on Privileges and Immunities. The current draft excludes UN local hires, thus raising political problems of fairness of treatment.
1

The extra cost of replacing foreign administrators with locals at Kosovo budget wage levels would, however, be modest.

2

See World Bank, “Kosovo: Building Peace Through Sustained Growth”(Washington, November 1999).

3

Wage rates are also reportedly much higher in Kosovo than in the rest of the FRY.

Within Same Series

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Cover Kosovo
Kosovo
Macroeconomic Issues and Fiscal Sustainability
Author: Mr. Robert J. Corker, Ms. Dawn Elizabeth Rehm, and Ms. Kristina Kostial
ISBN:
9781589060180
Publication Date:
12 Feb 2001
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781589060180.071
Pages:
32
  • View in gallery

    Selected Countries: Government Expenditure

    (Simple averages; percent of GDP)1

  • View in gallery

    Selected Transition Economies: Budget Employment and Net and Gross Budget Wages1

Selected Countries: Government Expenditure

(Simple averages; percent of GDP)1

Selected Transition Economies: Budget Employment and Net and Gross Budget Wages1