III Fiscal Strategy, and Tax and Expenditure Systems
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

Abstract

Kosovo has made strides in building capacity and institutions for autonomous fiscal management; at the same time, an excellent tax performance has laid a strong fiscal foundation, offering a unique opportunity for fiscal policy to address Kosovo’s significant developmental challenges. However, in the context of plentiful resources and weak capacity for expenditure management, the absence of a fiscal strategy could set fiscal policy on a wasteful and unsustainable course. Lack of proper assessment of the main fiscal risks—in the presence of large government assets—raises the risk of creating unsustainable entitlements. Fiscal risks are significant as a result of uncertainties about the main parameters of fiscal solvency. Weak capacity and institutions for expenditure management increase the likelihood of significant inefficiencies.

Kosovo has made strides in building capacity and institutions for autonomous fiscal management; at the same time, an excellent tax performance has laid a strong fiscal foundation, offering a unique opportunity for fiscal policy to address Kosovo’s significant developmental challenges. However, in the context of plentiful resources and weak capacity for expenditure management, the absence of a fiscal strategy could set fiscal policy on a wasteful and unsustainable course. Lack of proper assessment of the main fiscal risks—in the presence of large government assets—raises the risk of creating unsustainable entitlements. Fiscal risks are significant as a result of uncertainties about the main parameters of fiscal solvency. Weak capacity and institutions for expenditure management increase the likelihood of significant inefficiencies.

The Main Issue: The Need for a Fiscal Strategy

Under the impetus of fast-rising tax revenues, the Kosovo General Budget (KGB) nearly tripled in 3 years and now covers most public services and all social transfers. From a large deficit, the budget swung into a sizable surplus in 2001, and a continued surge in tax revenues in 2002–03 kept the budget balance solidly positive. By 2003, the budget surplus had reached 2½ percent of GDP, with an underlying current surplus equivalent to nearly 8 percent of GDP, and government assets had reached an amount equivalent to 17 percent of GDP (see Figure III.1, and Statistical Appendix Tables 1617). A basic Organic Budget Law, promulgated in mid-2003, transferred responsibility for budget preparation and execution to the Ministry of Finance and Economy (MFE), although the Special Representative of the Secretary-General (SRSG) retains the final authority “to set the financial and policy parameters for, and to approve” the budget.1

Figure III.1.
Figure III.1.

Consolidated General Government: Revenues, Expenditures, and Cash Balances, 2000–03

(In millions of euros)

Source: Kosovo authorities.

Budgeting on a commitment basis, which served Kosovo well initially, is the main reason for the lack of progress in elaborating a fiscal strategy. Right after the end of the conflict, annual balanced budgets were built on extremely conservative revenue projections, and, to guard against the risk of making unsustainable long-term commitments, the full amount of multiyear projects were appropriated up front. In the event, revenue performance was far better than expected, and the weak administrative capacity put a constraint on actual spending. The confluence of the two practices, together with multiple and protracted budget reviews, led to large unused appropriations, which were liberally carried from one budget cycle to the next. After 4 years of such practice, the buildup of carryforward commitments has reached staggering proportions. While a nearly balanced budget was adopted at the beginning of 2004, the reappropriation of carryforward commitments resulted in total appropriations that are consistent with a deficit of 16 percent of GDP (see Table III.1). This situation has undermined the central role of the annual budget, hindered longer-term planning, and created so much opacity that it is virtually impossible for legislators and policymakers to discern fiscal policy intentions in the existing appropriations.

Table III.1

General Budget: Cash and Commitments, 2003–04

(In percent of GDP)

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Sources: Kosovo authorities; and Fund staff estimates.

Budget as of end-June 2004, including reappropriated commitments carried forward from 2003 and other augmentations to the initial budget.

Lack of progress in elaborating a fiscal strategy is also in part due to the unhealthy competition between “reserved-power” and “transferred-power” agencies. The Constitutional Framework adopted in 2001 transferred to the PISG most government functions except a few related to security and sovereignty,2 which are referred to as “reserved powers.” These functions account for one-third of the total 2004 budget and close to one-half of the central government’s budget (Statistical Appendix Table 18). In a situation where not all budget organizations are under the remit of a single body, competition among budget entities has not helped consensus building on priorities. In particular, the delegation of POEs’ supervision to a reserved-power agency has not given the PISG adequate incentive to provide the strong political backing necessary for a successful restructuring of loss-making POEs. Unaddressed losses, in turn, have left the SRSG little choice but to unilaterally appropriate resources to cover them.

Important steps are being taken in the context of the 2004 midyear review and the preparation of the 2005 budget to move to a system of budgeting on a cash basis (by lowering appropriations to the level of expected annual cash expenditures). First, the MFE has announced the elimination of the carryover principle, effective January 2005. Second, amendments to the procurement law3 no longer mandate that the full cost of multiyear projects be committed up front. Third, the MFE is putting greater emphasis on building its own capacity and that of line ministries for cash-flow forecasts and long-term planning. Another welcome development is the simplification of the 2005 budget circular to be more in line with current capacity.

Within the existing political setup, a solution to the split in the budget between reserved- and transferred-power agencies has yet to be found. Meanwhile, improving the working relationship between the MFE and the reserved-power agencies will allow the policy-formulating institutions—the Budget Commission, the PISG, the Economic and Fiscal Council, and the SRSG—to concentrate on strategic budget decisions. To avoid situations in which the SRSG is compelled to appropriate resources against the PISG’s will, the PISG and UNMIK need to reach a common understanding on economic priorities and on how these should be reflected in budget allocations.

It is hoped that reform of the budget process will enable a debate about an appropriate fiscal strategy.4 Consensus should be built on the principle that the long-term fiscal objective is sustainable, efficient, and effective public spending, financed by equitable and efficient taxes. In the pursuit of this long-term objective, the fiscal strategy in the short to medium term should be based on two pillars:

  1. Reining in the expansion of current spending to prevent waste, preserve a comfortable current budget surplus to help finance public investment, and ensure long-term sustainability. Given the weakness in expenditure management capacity, a more guarded expansion is warranted to ensure value for money and allow the budgetary process to be informed by evolving policy analysis and strategic planning. Also, a prudent expansion is needed to ensure that the increase in public spending will, ex post, be consistent with medium-term fiscal solvency, thereby avoiding policy reversals. For the time being, the main parameters of fiscal solvency remain in doubt, owing to uncertainties about the growth potential of the tax base, the cost of additional government functions to be transferred to the PISG and of needed public investment, the level of an eventual inherited debt, and the level of foreign assistance.

  2. Stepping up work on medium-term strategies for the key sectors and on a well-prioritized public investment program, with the aim of reprioritizing and increasing spending on human and physical capital. As the ability to implement investment projects improves, a level of capital expenditures higher than the current surplus should be encouraged, as long as it is consistent with a sustainable financing strategy—making prudent use of accumulated government assets and eventual borrowing, and taking into account the likely paths of foreign grants and donor-financed investment, as well as overall macroeconomic conditions.

Accordingly, the main anchor of the medium-term fiscal framework should be rolling 3-year growth rates for current expenditures, while the level of capital expenditures and, hence, the overall budget balance should be consistent with a sustainable financing strategy for a well-prioritized public investment.

The sectoral strategy for education is the most critical: unless the government gives a much higher priority to rebuilding the depleted stock of human capital, a powerful development lever will be forgone. Education achievements are very low both in quantity and quality. In the absence of reliable population statistics,5 gross enrollment rates are uncertain. However, on the basis of available information, the staff team is concerned that Kosovo may be falling short of the basic goal of universal primary education, while access to preschool and higher education is limited. The rate of enrollment in preschool is less than 20 percent compared with a European average of 80 percent; the rate of enrollment in primary and secondary schools may be less than 80 percent, and the rate of enrollment in tertiary education is about 16 percent, compared with a European average of 45 percent (see Table III.2 and Figure III.2). With most schools operating two to three shifts a day, the quality of education is also likely to be very poor. The share of spending on education in total budgetary expenditures is relatively small and declining;6 taking into account the spending made by the donor sector, the share of education in total public spending was only about 6½ percent in 2003 (Statistical Appendix Table 19).

Table III.2

Gross Enrollment Rates, 2003

(In thousands, unless otherwise specified)

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Sources: Ministry of Education and Ministry of Finance; and Fund staff estimates.

Unpublished population statistics.

Figure III.2.
Figure III.2.

Kosovo and Selected Economies: Education, Gross Enrollment Rates, 1999/2000

Sources: United Nations Educational Scientific and Cultural Organizations (UNESCO); and IMF staff estimates.

A medium-term fiscal scenario in line with the proposed fiscal strategy and consistent with the medium-term growth scenario elaborated in Chapter II is shown in Table III.3. At this stage, the scenario is only illustrative, as its development should be based on the medium-term strategies for the key sectors and the costing of related investment needs. In 2005, the proposed pay-scale reform (see below) plus the full 1-year impact of the new disability pension raise the wage bill and cost of social programs by 15 and 13 percent respectively—assuming a hiring freeze and a leveling off of the number of old-age pensioners. A 2 percent cut in spending on goods and services—to claw back some of their recent excessive increase—plus a 20 percent cut in transfers to POEs should help contain the nominal growth rate of current spending in 2005 at about 1½ percent.7 This should offset most of the revenue losses from the tariff reform (see Table III.3) and maintain the current budget surplus at about 3½ percent of GDP. In 2006, further cuts in subsidies to POEs could raise the current surplus to a level close to 4 percent of GDP. Combined with some drawdown of government assets, these measures would allow significant volumes of investment to be financed from Kosovo’s own budgetary resources. By end-2006, the government’s bank balances would have declined to slightly over €100 million, close to the level that should be retained as a cushion for liquidity and risk management.

Table III.3

Consolidated Government Budget, Illustrative Scenario, 2002–06

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Sources: Kosovo authorities; and Fund staff estimates.

Assessment of the Performance of the Tax System

Kosovo has been remarkably successful in rebuilding its tax system, surpassing initial expectations. The performance of the new tax system is perhaps the single most positive feature in all economic developments since the end of the conflict. Initial revenue projections envisaged a gradual increase to about 14 percent of GDP by 2006. In the projections, the tax-to-GDP ratio reached 29 percent in 2003, with tax revenues of €520 million, more than doubling the initial projections (see Table III.4).

Table III.4

Tax Revenues in 2003: Projections in 2000 and Actual Realization

(In millions of euros, unless otherwise indicated)

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Sources: Kosovo authorities; and Fund staff estimates.

Fund staff projections prepared in 2000.

Wage, profit, and presumptive taxes.

Other taxes, tax refunds, and adjustments.

Higher tax rates, larger tax bases, and better enforcement contributed about equally to this overperformance. First, the main excise tax rates were higher than initially envisaged, in particular those on petroleum products, which are 45–80 percent higher than envisaged, and on cigarettes, which are five times higher. Second, the base of the value-added tax (VAT), excises, and customs duties turned out to be larger, as domestic absorption as a share of GDP was larger. Also, corporate taxes yielded significant revenues against the initial expectation that years of disinvestment would depress business profits. Lastly, better tax enforcement and compliance—helped by the greater number of border crossing points, antismuggling units, and patrolling KFOR units, and the larger and more experienced staff for local tax administration—explain the remaining overperformance.

A coherent strategy is to be credited for this success. The strategy called for relying initially on border taxes and for broadening the tax base in phases as the economy stabilized and as institutional capabilities increased. The system was to remain simple and transparent and was to rely on relatively low nominal tax rates and few exemptions. The system was jump-started in August 1999 by the introduction of customs duties, sales tax, and excises on imports. In quick succession during 2000, excise taxes were extended to local production, and a hotel, food, and beverage tax was introduced, followed by a presumptive tax on businesses. Moving quickly to adopt the standard broad-based taxes on personal income and business profits, and on consumption, the authorities changed the sales tax on imported goods into a full-fledged consumption-based VAT in July 2001. In March 2002, wage withholding and profit taxes were introduced, completing the basic architecture of the system. Effective June 7, 2004, the 10 percent uniform import tariff was lowered to zero for selected capital goods, raw materials, and intermediate goods. Finally, effective September 2004, the VAT law was amended to zero-rate irrigation water and certain agricultural inputs (Appendix III presents an overview of Kosovo’s tax system).

Consistent implementation of this tax strategy led to sharp increases in revenue collections. The rapid growth in recorded imports—reflecting a sharp improvement in border controls—has been the main factor underpinning the steep increase in tax revenues during 2001–02 (Figure III.3). Increases in excise rates sustained further growth in tax revenues, even as recorded imports leveled off. The phasing in of domestic taxes boosted revenue growth further, with the total share of domestic tax revenues increasing from 5 percent in 2000 to 18 percent by 2003 (see Table III.5).

Figure III.3.
Figure III.3.

Tax Revenue and Recorded Imports, 1999–2003

(In millions of euros)

Source: Kosovo authorities.1 September–December 1999.2 Taxable commercial imports.
Table III.5

Sources of Growth in Tax Revenues, 2001–031

(In percent)

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Sources: Kosovo authorities; and Fund staff estimates.

Central government tax revenues; figures may not add up because of rounding.

Impact of higher excise rates, including cascading impact on VAT.

Kosovo’s tax-to-GDP ratio is high compared with other low-income economies, and its tax structure is sound (Statistical Appendix Table 20 and Figures III.4a and III.4b). At 29 percent of GDP, tax revenues, excluding social security contributions and payroll taxes,8 are comparable to those in the EU-15 countries. Kosovo’s greater reliance on expenditure-based taxes is mainly due to the low yield of personal income taxes, as a large share of wages fall below the equity-based exemption threshold.9 The share of corporate taxes (i.e., profit and presumptive taxes) in total revenues is well in line with corresponding ratios in other transition economies or even in more developed countries. At 14 percent, the share of import duties is in line with that in other transition economies (Statistical Appendix Table 20).

Figure III.4.
Figure III.4.

Kosovo and Selected Economies: Taxes, 20021

Sources: IMF, country desk data; and staff estimates.1 Data for Kosovo refer to 2003, EU 2001, and Poland 2000.2 For Kosovo, this consists of mandatory contributions to the fully funded “Second Pillar” pension scheme.

Close to 80 percent of taxes are collected at the border, and this is often mistakenly attributed to an inefficient domestic tax administration or an excessive tax burden on international trade. In fact, this is mainly reflective of two factors: (i) the high imports relative to domestic consumption explains most of the large share of gross border VAT in total VAT collection,10 and (ii) traditional excisable products, such as petroleum products, alcoholic beverages, and cigarettes, are produced in limited quantities, if at all. Only 17 percent of border taxes are genuine taxes on imported goods, but this is in line with the experience in other economies at a similar stage of development.

The revenue performance is all the more remarkable considering the relatively low tax rates (Statistical Appendix Table 21). Kosovo’s VAT rate is the lowest in the region, and individual income tax rates are among the lowest. The average customs tariff compares well with other transition economies, with the maximum lower than in any comparator economy. The main excise rates are also in line with rates in the region.11 Finally, employees’ and employers’ social security contributions are low, minimizing distortions in the labor market.

An otherwise sound policy has nonetheless had some shortcomings. First, the long delay in finding a solution to the adverse impact of the high customs duty on capital and intermediate goods is likely to have hurt export competitiveness and growth. Second, wage tax exemptions enjoyed by local UNMIK employees and local employees of the specialized agencies of the UN continue to distort the tax system and, probably, the labor market. The exemptions cause significant revenue losses (estimated to be in excess of €5 million annually) and post-tax wages that may divert labor resources to less productive uses. The exemptions are also inconsistent with international standards and may encourage other wage earners to evade the tax. Third, problems in the VAT refund system have imposed an extra burden on production and exports.

The strong revenue performance raises an obvious question: Is this too good to be true? To some extent, yes, as the overperformance reflects, paradoxically, the economy’s structural weaknesses and the peculiarities of foreign assistance. First, as explained in Chapter II, Kosovo’s level of economic activity is supported to the tune of 20 percent by foreign assistance. This, in turn, not only provides a commensurate indirect support to the tax base, but also directly contributes some 3 percentage points of GDP to tax revenues in the form of taxes on the implicit “exports” associated with the donor sector (Chapter II). As illustrated in Statistical Appendix Table 22, about €55 million, or more than 10 percent of total tax revenues, is attributed to the local consumption of the large community of expatriates, the KFOR soldiers, and donors’ local employees. Second, the level of economic activity is supported to the tune of 30 percent by large private inflows. These help support an unusually high level of domestic absorption compared with GDP. As illustrated in Statistical Appendix Table 23, a decrease in domestic absorption of 15 percent of GDP, which might correspond to a more steady-state level of these private inflows, would lower expenditure-based tax revenues by about 3 percent of GDP, on top of the indirect impact already being exerted by lower economic activity.

Kosovo’s tax base is, therefore, as vulnerable as the rest of the economy to its structural weaknesses. Smaller private inflows or lower levels of foreign assistance, if not offset by endogenous growth, will lead to a loss of revenues, which would be further compounded by the induced economic contraction. Additional risks to tax revenues may arise from political pressures to lower rates or grant exemptions, and from a phasing out of the peacekeeping forces’ mission, whose presence is contributing to good tax compliance at the border.

Further development of the tax system should be guided by the need to ensure cost-effectiveness to avoid the risk of poor implementation adversely affecting tax compliance. Although there remains further scope for widening the tax base, the authorities should pay close attention to cost-effectiveness. To ensure that further changes to Kosovo’s tax system will yield lasting benefits in an environment in which donor-supported technical assistance is diminishing, Kosovo’s authorities should further strengthen the capacities of tax and customs administrations to nurture a culture of tax compliance. Overly frequent changes in the tax environment increase both the burden on tax administration and compliance costs to taxpayers.

Expenditure Policy

Expenditure policy so far has been aimed to ensure a minimum coverage of basic public services, and the budget is still at a formative stage. This section discusses the main trends in budgetary expenditures on the civil service wage bill, social transfers, and subsidies and transfers.

Civil Service Wage Bill

The civil service wage bill has increased rapidly over the past 3 years and is expected to reach €175 million in 2004, 60 percent higher than in 2001. This situation reflects both a rapid expansion in hiring and generous wage increases (see Table III.6). Over the past 3 years, close to 15,000 new civil servants have been hired; meanwhile, wages for two-thirds of the civil service were raised by 20 percent in mid-2003, followed by a 33 percent increase in the minimum civil service salary in early 2004.

Table III.6

Civil Service Employment and Wage Bill, 2001–041

(Excluding salaries paid from designated donor grants)

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Sources: Kosovo authorities; and Fund staff estimates.

Assuming constant hiring speed during the year; excluding staff to be temporarily employed during elections.

Including employers’ and employees’ pension contributions, from August 2002 onward.

The wage bill divided by the average number of employees.

These developments raise concerns about the fiscal sustainability and efficiency of the wage bill. Indeed, a number of indicators suggest that the scope for further expansion of the civil service wage bill is being exhausted very rapidly, at a time when the budget has yet to assume additional responsibilities—as UNMIK’s activities are being phased out—and additional costs will be incurred through the soon-to-be-implemented pay-scale reform. The wage bill currently absorbs about 9½ percent of GDP, a level higher than in most comparator countries (see Table III.7). As a share of government revenues, the wage bill is already almost 30 percent, which is higher than in most other countries (the average in the EU countries is 23 percent). Also, the ratio of the wage bill to total general government spending is higher than in any of the comparator countries; this may be indicative of inefficiencies, although a more detailed assessment of the current input mix in each sector is needed for a proper assessment of overall effectiveness.

Table III.7

Selected Transition Economies: General Government Wage Bill, 2002

(In percent)

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Sources: Kosovo authorities; IMF, Country desk data; and Fund staff estimates.

Assuming constant hiring speed during the year so that the 2004 budget’s head-count ceiling is reached at the end of the year.

The growing size of the civil service relative to private sector employment leaves very little room for additional hiring to cover new areas of responsibility. Although the size of the civil service is not particularly high in terms of percent of total population (only 3.6 civil servants for each 100 citizens, see Table III.8), its shares in total employment (about 17 percent) and in formal employment (more than 40 percent) raise concerns about fiscal sustainability. Hence, the need to cover new areas should be met by redeploying civil servants within and across various sectors, supported by appropriate training.

Table III.8

General Government Employment, 1990s1

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Sources: World Bank, An International Survey of Government Employment and Wages, 1997; and Fund staff estimates.

Kosovo data is based on 2003 estimates; for all other countries, data are from the early 1990s.

It is assumed that total employment in Kosovo, including informal sector and subsistence agriculture, is about 415,000.

The proposed new pay and grading system would address several of the problems plaguing the current system; preparatory work should be stepped up to allow its uniform implementation as early as possible. If implemented, the new system would provide equal pay for equal work through a consistent approach to job grading and consistent rules for increasing individual pay. It would also provide a clear basis for promotions and allow recognition of the value of increased experience and performance at each job level. Moreover, it would monetize most allowances, allowing rationalization and greater transparency. Furthermore, the proposed increases in the salaries in managerial categories should help the civil service attract and retain the skills it requires.12 The new system should be phased in uniformly across all agencies as soon as all necessary preparatory work is completed, and wage increases should not be made retroactive.

The benefits of the contemplated new pay scale seem to justify the associated costs. The estimated cost of the proposed pay-scale reform amounts to 1 percent of GDP, which would raise the wage bill to 10½ percent of GDP and to 32 percent of government revenues. These costs seem to be justified in light of the benefits of the reform discussed above; however, the gains in terms of wage dispersion are rather modest, and the competitiveness of the new wages vis-à-vis private sector wages is unclear. Nevertheless, the cost of the proposed meal allowance for all civil servants is significant and unwarranted; it would undo most of the wage decompression and raise the wage bill to close to 38 percent of government revenues. The uncertainty about future government revenues and the resiliency of the economy to an eventual withdrawal of donor assistance call for utmost prudence at this time.

Pensions and Social Protection in Kosovo

The new postconflict pension system, whose basic law was promulgated in December 2001, consists of three pillars.

Pillar I is a basic old-age pension financed from general government revenues. It offers all habitual residents of Kosovo 65 years and older a flat pension whose level is tied to the price of a basic food basket. Since its introduction in mid-2002, the level has been raised to €40 per month from €28 initially.

Pillar II is a mandatory, fully funded, defined-contribution pension scheme financed by monthly payroll contributions by both employees and employers, each of which contribute 5 percent of total gross wages (each of the 5 percent mandatory contributions can be increased by voluntary contributions up to 15 percent of annual salary). Funds are managed by the Kosovo Pension Savings Trust, which is under the supervision of the Banking and Payments Authority of Kosovo (BPK). Participation in this system became mandatory for large employers, including the public sector, in August 2002 and was extended to cover all employers in August 2003. Since August 2003 Pillar II pension contributions have also been collected from the self-employed.

Pillar III is a voluntary supplemental system that can be either defined-contribution or defined-benefit schemes financed by employees and employers. Contributions are transferred to private pension providers (pension funds, insurance companies, or banks) that are licensed and supervised by the BPK. Contributors are eligible to start receiving benefits when they reach 65. At the moment, there are six supplementary pension schemes; all except one are defined-benefit plans financed by the employer.

The main social assistance programs consist of the following:

Social Assistance Program. This program pays benefits to families without resources in which no one is capable of working, or expected to be available for work (category 1), and to families with at least one child under age 5 and in which members capable of working are unemployed and meet certain additional criteria (category 2). The program was introduced in 2000 and was modified in August 2003.

War Invalid Benefits. This scheme, introduced in December 2000, provides benefits for war invalids and the next of kin of those who died as a result of the armed conflict in Kosovo.

Disability Pension. This pension provides benefits for total and permanent disability until the recipient graduates to the old-age basic pension at age 65. The level of benefit is equal to the old-age pension. The law on disability pensions was promulgated in December 2003, and the payment of benefits was set to start in mid-2004.

Pensions and Social Assistance

Another achievement in the fiscal area has been the introduction of a well-designed social safety net, which is providing adequate minimum protection to the most vulnerable citizens (Box III.1). The new three-pillar pension system strikes the right balance among long-term fiscal sustainability, the need to provide minimum protection for today’s elderly, and the need to ensure that tomorrow’s elderly enjoy higher pensions, without putting undue pressure on the cost of labor today. With the recent introduction of a disability pension scheme to complement social assistance to the poor, the social safety net is now covering all those who need income support.

Although the level of benefits is necessarily modest and many more needs can be readily identified, the authorities should resist the pressure to create unsustainable entitlements. For the social safety net to remain fiscally sound, its cost—which has reached 6 percent of GDP13—should be stabilized by keeping benefits constant in real terms and by enforcing the eligibility criteria strictly. Pressures to create general early retirement schemes should be resisted and appropriate comprehensive solutions developed to deal with labor redundancy in public sector enterprises (see Chapter V).

Subsidies to Public Enterprises

Budget transfers to POEs are necessary at present but should be phased out as soon as feasible. The lack of progress in the restructuring of POEs is reflected in the large budget subsidies to a number of loss-making POEs. The 2004 budget provides subsidies for operating losses for electric monopoly KEK, mining conglomerate TREPCA, UNMIK Railways, and POEs in the district heating, water, and waste sectors. In addition, subsidies to finance investment are provided to KEK, Trepca, and Airport.14 In the near term, operational subsidies may, in some cases, be unavoidable. However, as part of the restructuring of POEs, operational subsidies need to be phased out. Incorporating POEs and endowing them with stable and strong corporate governance will be critical to improving their financial performance and attracting the participation of much-needed private capital.

To ensure efficiency, the use of budgetary resources by public enterprises should be made more transparent and monitored more closely. The loss-making enterprises must be subjected to hard budget constraints. Greater transparency and accountability in the use of budgetary subsidies by enterprises under the responsibility of the reserved power would not only accelerate the restructuring and lighten the fiscal burden but also improve the overall budget process by eliminating potential sources of friction between the PISG and UNMIK.

1

UNMIK/REG/2001/9 On a Constitutional Framework for Provisional Self-Government in Kosovo, May 15, 2001.

2

Specifically, foreign affairs, law and order, the judiciary, the protection of minorities, and the administration of publicly and socially owned property.

3

UNMIK/REG/2004/3 On the Promulgation of the Law on Public Procurement in Kosovo, adopted by the Assembly of Kosovo (Law No. 2003/17), February 9, 2004.

4

The outline of a medium-term fiscal scenario prepared by the MFE as part of the 2005 budget process is a welcome step.

5

Population statistics are very weak and undermine the quality of the entire statistical infrastructure, as no reliable population census has been undertaken since 1981.

6

It fell from 17.3 percent in 2002 to 15.5 percent in 2003.

7

Sustainable reductions in transfers to POEs require credible restructuring (see Chapter V). Related to this, the large quasi-fiscal activities of the POEs underscore the need for closer monitoring of a broader definition of the nonfinancial public sector.

8

As explained in the following section, the second pillar of Kosovo’s pension system, the mandatory individual savings pensions, is funded by mandatory contributions from employees and employers. These pensions are fully funded, defined-contribution pensions. The basic old-age pension scheme is financed from general budget resources.

9

Because of Kosovo’s low wages, high unemployment, and the large role of subsistence agriculture, the potential base for wage taxes is relatively small.

10

In a small, open economy where both exports and imports are very high, and where the bulk of taxation falls on consumption, one should expect most of the taxes to be collected at the border, reflecting the large share of imports in total consumption.

11

For tobacco products, excises were actually much lower until recently, when, to discourage outward smuggling, the rates were increased to bring them more in line with the excise rates in neighboring countries.

12

Wage dispersion, that is, the ratio of the highest and lowest grades in the pay structure, would increase from 4.8 to 6.8.

13

Assuming that the already decided policies are fully phased in.

14

Subject to status determination by the Kosovo Trust Agency (KTA), TREPCA is still identified as an SOE.

Gearing Policies toward Growth and Development
  • View in gallery

    Consolidated General Government: Revenues, Expenditures, and Cash Balances, 2000–03

    (In millions of euros)

  • View in gallery

    Kosovo and Selected Economies: Education, Gross Enrollment Rates, 1999/2000

  • View in gallery

    Tax Revenue and Recorded Imports, 1999–2003

    (In millions of euros)

  • View in gallery

    Kosovo and Selected Economies: Taxes, 20021