Scholarly article on topic 'Public Finance Consolidation in Czech Republic and Poland – What after Crisis?'

Public Finance Consolidation in Czech Republic and Poland – What after Crisis? Academic research paper on "Economics and business"

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Abstract of research paper on Economics and business, author of scientific article — Agnieszka Jachowicz

Abstract The economic and financial crisis was the catalyst for a fiscal crisis engulfs European Union's Members. Consolidating public finances in order to address the consequences of the crisis, underlying weaknesses and also future spending pressures creates important challenges. Fiscal consolidation requires choices to be made about how much consolidation is needed, how fast it should be implemented and which instruments should be used. In this article was showed the need of public finances’ consolidation, what was exacted by European Commission and its regulations. Setting an example – Czech Republic and Poland – author described the ways of reforms in public finance. While the process in both countries was different, the result is the one – both countries need deeper, wider and long – time reforms.

Academic research paper on topic "Public Finance Consolidation in Czech Republic and Poland – What after Crisis?"

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Procedia - Social and Behavioral Sciences 220 (2016) 142 - 149

19th International Conference Enterprise and Competitive Environment 2016, ECE 2016, 10-11

March 2016, Brno, Czech Republic

Public finance consolidation in Czech Republic and Poland - what

after crisis?

Agnieszka Jachowicza'*

aUniversity of Dqbrowa Gornicza, ul. Cieplaka 1C, 41-300 Dqbrowa Gornicza, Poland

Abstract

The economic and financial crisis was the catalyst for a fiscal crisis engulfs European Union's Members. Consolidating public finances in order to address the consequences of the crisis, underlying weaknesses and also future spending pressures creates important challenges. Fiscal consolidation requires choices to be made about how much consolidation is needed, how fast it should be implemented and which instruments should be used. In this article was showed the need of public finances' consolidation, what was exacted by European Commission and its regulations. Setting an example - Czech Republic and Poland - author described the ways of reforms in public finance. While the process in both countries was different, the result is the one -both countries need deeper, wider and long - time reforms.

©2016 The Authors.Published byElsevierLtd. This is an open access article under the CC BY-NC-ND license

(http://creativecommons.Org/licenses/by-nc-nd/4.0/).

Peer-review under responsibility of the organizing committee of ECE 2016

Keywords: consolidation; crises; public finance; European Union; reform

1. Introduction

The economic and financial crisis is like catalyst for a fiscal crisis. The Stability and Growth Pact was designed to avoid budgetary free-riding and to make credible the Maastricht Treaty's "no bail-out rule", and thus to limit the extent to which budgetary developments in individual countries impinge on their neighbours. The Pact provided for enforcement of rule with a new institutional framework, which includes both an "excessive deficit procedure" with a specification of possible sanctions, and an early warning mechanism involving strengthened surveillance and coordination of economic polices via the annual review of national programmes. But the situation changed in 2008

* Corresponding author. E-mail address: ajachowicz@wsb.edu.pl

1877-0428 © 2016 The Authors. Published by Elsevier Ltd. This is an open access article under the CC BY-NC-ND license

(http://creativecommons.org/licenses/by-nc-nd/4.0/).

Peer-review under responsibility of the organizing committee of ECE 2016

doi: 10.1016/j .sbspro. 2016.05.478

when the financial crises began. The article has four sections. In the first one, the author described the meaning of consolidation and the EU's reaction for the crisis. Next, was described the economic situation in member states in 2008-2014. In third and fourth part was presented the economic situation in the Czech Republic and Poland with regard on reforms in their public finances. The aim of this article is to show how was prepared the consolidation in these two countries, that are members of EU and Visegard Group; what instruments was used in these reforms and what were the results at this moment. To achieve the aim the author used statistics from Eurostat and dates from national financial pages. The important think to further discussion is the question for how long the effects of consolidation will be stable.

2. Europe's decisions after beginning ofcrisis - consolidation

Fiscal consolidation is - we can say - an exercise in discretionary policy making. In theory purely cyclically induced budgetary impacts are self-correcting. However, in practice widespread structural imbalances and the secular rise of public debt reflect and underlying deficit bias. While the institutional reforms can be helpful in containing deficit (and pro - cyclicality) bias, including reliance the adoption of specific structural reforms to government spending programmes and revenue policy to stabilize and then reduce debt - to - GDP ratios to a prudent level. The challenge depends on balancing several trade - offs. The pace and composition of consolidation has to consider the trade-offs between maintaining support for domestic demand on the one hand while, on the other hand, not risking larger consolidation costs later due to delaying fiscal adjustment. The political economy of deficit reduction has to contend with the trade - off between equity and growth, too. A strategic approach to fiscal consolidation enables the government to anticipate distributional impacts and adopt accompanying measures to protect vulnerable member of society and to tend to other policy goals (Sutherland et al., 2012).

R. Hagemann (Hagemann, 2012) says that fiscal consolidation is a top - down process that entails in the first instance the determination of the size of the adjustment that is needed to secure a sustainable fiscal position, followed by establishing the balance between spending reductions and revenue increases. But in practice it is also bottom up process of identifying changes to specific government spending programmes and revenue policies. These specyfics constitute the "instruments" of fiscal consolidation. Given the government interventions in the economy, the aim is not to be exhaustive, but instead to examine the major spending and revenues categories that hold the most promise of contributing, both directly and indirectly, to fiscal consolidation.

In March 2011, following the 2010 European sovereign debt crisis, the EU member states adopted a new reform under the Open Method of Coordination, aiming at straightening the rules e.g. by adopting an automatic procedure for imposing of penalties in case of branches of either the deficit or the debt rules. The new "Euro Plus Pact" is designed as more stringent successor to the Stability and Growth Pact, which has not been implemented consistently. The measures are controversial not only because of the close way in with it was developed but also for the goals that is postulates. The four main broad strategic goal are (Council Agreement, 2011):

• fostering competitiveness,

• fostering employment,

• contributing to the sustainability of public finances,

• reinforcing financial stability.

The additional fifth issue is (Council Decisions, 2011) tax policy coordination. When we look at the new European economic governance framework, it seems to be in front of a „mixture" of different acts adopted at various territorial levels and characterized by a different legal nature.

The second, let's say, more "customary" EU norms contributed to the formation of the legal structure underlying the new European economic governance were:

• so called "Six-Pack": five regulations and one derective are attended to strengthening the Stability and Growth Pact (SGP). That is the rule-based framework for the coordination of national fiscal policies in the European Union. The new measures were meant to increase transparency on their budgetary decisions and stronger coordination within the 2014 budgetary cycle and to recognize the special needs ofEuro area Member States

under severe financial pressure. The Pact was signed by the 17 Member States of the Euro area andjoined by 6 EU member: Bulgaria, Denmark, Latvia, Lithuania, Poland and Romania. The goal is higher degree of convergence reinforcing social market economy;

• the "European Semester" has been introduced in 2010. It goal was to better an ex ante coordination of economic and budget policies of member state, integrating the specifications on the implmentation of the Stability and Growth Pact. The second governs fiscal discipline in the EU, with the purpose of ensuring fiscal discipline in the Union within Europe 2020. The Pact applies to all EU members;

• "the preventive arm" is part of the European Semester. In particular - every year in April, Euro area member state submit Stability Programmes, while member states outside the euro area submit Convergence Programmes. The important part of that assessment addresses compliance with the minimum annual benchmark figure set for each individual country's structure budget balance. The Commission draws up country-specific recommendations;

• the "corrective" part entails the Excessive Deficit Procedure (EDP). This procedure is triggered if a member state's budget deficit exceeds 3% of GDP. When the Council decides that the deficit is excessive, it makes recommendations to the member state concerned and sets a deadline for bringing the deficit back below the reference value (https:Stability_and_Growth_Pact).

3. SGP criteria in real economy

Unfortunatelly the growth in the EU-28's GDP (current prices) slowed substantially in 2008 and GDP contracted considerably in 2009 as a result of the global financial and economic crises. There was a recovery in the level of EU-28 GDP in 2010 and this development continued in 2011-2013, before growth accelerated again in 2014, as current price GDP increased by 3,0% (table 1).

Table 1. Real GDP growth 2008-2014 (% change compared with the previous year); Governmnt deficit/surplus (% GDP), Government Gross

Debt (% GDP)

2008 2010 2012 2014

GDP Dft* Debt GDP Dft* Debt GDP Dft* Debt GDP Dft* Debt

EU-28 0,5 -2,5 61,0 2,1 -6,4 78,4 -0,5 -4,3 83,8 1,3 -3,0 86,8

Euro area (EA-19) 0,5 -2,2 68,5 2,0 -6,2 83,8 -0,8 -3,7 89,3 0,9 -2,6 92,1

Belgium 1,0 -1,1 92,4 2,5 -4,0 99,6 0,1 -4,1 104,1 1,1 -3,1 106,7

Bulgaria 5,8 1,6 13,0 0,7 -3,2 15,5 0,5 0,6 17,6 1,7 -5,8 27,0

Czech Republic 2,7 -2,1 28,7 2,3 -4,4 38,2 -0,8 -4,0 44,7 2,0 -1,9 42,7

Denmark -0,7 3,2 33,4 1,6 -2,7 42,9 -0,7 -3,6 45,6 1,1 1,5 45,1

Germany 1,1 -0,2 65,0 4,1 -4,2 81,0 0,4 -0,1 79,7 1,6 0,3 74,9

Estonia -5,3 -2,7 4,5 2,5 0,2 6,6 4,7 -0,3 9,5 2,1 0,7 10,4

Ireland -2,6 -7,0 42,4 -0,3 -32,3 86,8 -0,3 -8,0 120,2 4,8 -3,9 107,5

Greece -0,4 -10,2 109,4 -5,4 -11,2 146,2 -6,6 -8,8 159,4 0,8 -3,9 178,6

Spain 1,1 -4,4 39,4 0,0 -9,4 60,1 -2,1 -10,4 85,4 1,4 -5,9 99,3

France 0,2 -3,2 68,1 2,0 -6,8 81,7 0,3 -4,8 89,6 0,4 -3,9 95,6

Croatia 2,1 -2,7 38,9 -1,7 -5,9 57,0 -2,2 -5,3 69,2 -0,4 -5,6 85,1

Italy -1,0 -2,7 102,3 1,7 -4,2 115,3 -2,8 -3,0 123,2 -0,4 -3,0 132,3

Cyprus 3,6 0,9 45,1 1,4 -4,8 56,3 -2,4 -5,8 79,3 -2,3 -8,9 108,2

Latvia -3,2 -4,1 18,7 -2,9 -8,5 47,5 4,8 -0,8 41,4 2,4 -1,5 40,6

Lithuania 2,6 -3,1 14,6 1,6 -6,9 36,2 3,8 -3,1 39,8 2,9 -0,7 40,7

Luxembourg 0,5 3,3 14,4 5,1 -0,5 19,6 -0,2 0,2 22,1 1,4 23,0

Hungary 0,9 -3,6 71,6 0,8 -4,5 80,6 -1,5 -2,3 78,3 3,6 -2,5 76,2

Malta 3,3 -4,2 62,7 3,5 3,2 67,6 2,5 -3,6 67,6 3,5 -2,1 68,3

Netherlands 2,1 0,2 54,5 1,1 -5,0 59,0 -1,6 -3,9 66,4 0,9 -2,4 68,2

Austria 1,5 -1,4 68,5 1,9 -4,4 82,4 0,9 -2,2 81,6 0,3 -2,7 84,2

Poland 3,9 -3,6 46,6 3,7 -7,5 53,3 1,8 -3,7 54,0 3,4 -3,3 50,4

Portugal 0,2 -3,8 71,7 1,9 -11,2 96,2 -4,0 -5,7 126,2 0,9 -7,2 130,2

Romania 8,5 -5,6 13,2 -0,8 -6,9 29,9 0,6 -3,2 37,4 2,8 -1,4 39,9

Slovenia 3,3 -1,4 21,6 1,2 -5,6 38,2 -2,6 -4,1 53,7 2,6 -5,0 80,8

Slovakia 5,4 -2,3 28,2 4,8 -7,5 40,8 1,6 -4,2 51,9 2,4 -2,8 53,5

Finland 0,7 4,2 32,7 3,0 -2,6 47,1 -1,4 -2,1 52,9 -0,1 -3,3 59,3

Sweden -0,6 2,0 36,8 6,0 0,0 37,6 -0,3 -0,9 37,2 2,1 -1,7 44,9

United Kingdom -0,3 -5,1 51,7 1,9 -9,7 76,6 0,7 -8,3 85,3 2,8 -5,7 88,2

Source: Own research on the base Eurostat (download: http://ec.europa.eu/eurostat/statistic explained/index.php/NationalaccountsandGDP,

Update: 17.12.2015) *dft - deficit

Under the terms of the EU's Stability and Growth Pact, EU Member States pledged to keep their deficit and debt below certain limits. In the EU-28 the government deficit - to -GDP ratio decreased from - 4,3% in 2012 to -3,0% in 2014. Among the 13 Member States with deficit ratios exceeding -3,0% of GDP, 11 had also reported deficits exceeding -3,0% for the each of the three previous years. The debt - to - GDP ratio increased from 83,8% at the end of 2013 to 86,8% at the end of2014. A total of 16 EU Member States reported a debt ratio above 60% of GDP in 2014. The lowest ratio were recorded in Estonia (10,4%), Luxembourg (23,6%) and Bulgaria (27,0%).

The SGP is intended to prevent EU Member States from taking policy measures which would unduly benefit their own economies at the expense of others.

4. Public finance in the Czech Republic

The public finance system in the Czech Republic is significantly centralized. The system consists of state budget (central government institutions) and budgets of local governments and municipalities, social security funds and extra budgetary funds. All transactions are reported trough central government budget and majority of public resources are redistributed through the central government institutions.

The general government expenditures averagely rose by 4% (annual change) between 1993-2015, while the absolute volume increased more than twice to the level 1,700 billion CZK (over 62 billion EUR) (Graph 1). According to the international comparison, the level of public expenditure in the Czech Republic is rather low -values are below the average of both European Union and Euro area countries. The Czech Republic - with the average value at 42% of GDP - reports the second best result behind Slovakia among V4 countries. The ratio of

mandatory expenditures on total general government expenditures is stable and very high, which lowers a possibility of the Czech public finance to react on macroeconomic shocks.

2000 1800 1600 1400 1200 1000 800 600 400 200 0

17111699L709L773L750

<& <§> # ^ d» ^ & <$>

40 30 20 10 0

billions(CZK)

■ % GDP

Graph 1. General Government Expenditures in the Czech Republic (1995-2015) in billions CZK and % GDP

The highest volume of revenues (37%) is generated by social contributions paid by both employers and employees. Taxes on production (esp. VAT and excise duties) create 32% of revenues, while income taxes generate just 17% of all revenues. The level of social contributions receivable is significantly higher in the Czech Republic than in other V4 countries. All V4 countries, except of Hungary, hold the relative level of revenues below European Union and Euro Area averages. The Czech Republic reports the second lowest numbers.

The consequence of higher expenditures is negative deficit, i.e. The increase in public debt (See Table 1). The public debt of the Czech Republic has risen rapidly in past 8 years - +14 p.p., although the level of indebtedness is the lowest one in the EU.

The real consolidation of public finance has not been implemented yet in the Czech Republic, because this country didn't sign "Six-Pact" like Poland and is not a Member of Euro Area. But the government introduced some changes in tax system. First, the CIT rate was reduced from 24% to21% in 2008, next to 20% in 2009 and to 19% in 2010. Second, the employers have to pay lower health and pension collections by 1,5% since 2009. But since 2010 have been introduced new taxes to protect environment. These taxes refer to gas, coal and power station industry and in next years the rates of taxes will be higher. According to the proposal, the budget should be planned with respect to the maximal gap between growth of real GDP and the deficit of public finance at the level 3% p.p. The prognosis of GDP would follow a colloquium of distinguished institutions from public sector (ministers, national bank), private sector (banks, consultant firms) and academia (universities), both domestic one and foreign one.

Especially between 2002 and 2007 the fiscal policy was not respecting the economic cycle. The implementation of proposed fiscal rules would lead to the surpluses during upturn of the Czech economy. Without the real consolidation of public finance, no improvement of the recent situation is possible. One hopeful way how to consolidate public finance in the Czech Republic is powerful legislative norm (Compendium Public Finance Consolidation in V4, 2015).

5. Consolidation in Poland - followed by "Six-Pact"

In Poland the fiscal consolidation comes from two legal sources: the first is the EU's corrective arm of the Stability and Growth Pact - Excessive Debt Procedure - which started in 2009 and the second - is the fiscal brake implemented in the Polish constitution. As in the other EU states Poland's budgetary situation worsened significantly in 2009 as a result of the global economic crisis, leading to the European Commission's decision to start the Excessive Deficit Procedure (Graph 2). An interesting think was that the deterioration of the fiscal situation in Poland in 2009 was accompanied by positive (but much weaker) economic growth.

■ General Government Balance ■ Structural Balance

Graph 2. Fiscal balance in Poland in 2008-2015 (% GDP)

The global economic crisis affected even the fiscal stability. The general government balance deteriorated from around 3,7% of GDP, in 2008, to 7,5% in 2010 (See Table 1). It was a result of decreasing of revenues with the stable expenses. The structural deficit during 2009-2010 exceeded even 8% of GPD.

The pre-consolidation situation in Poland was relatively difficult and determined the design of the strategy to decrease the excessive deficit. In 2009, around 72% of public expenses were fixed-most of them were determined by other regulations than the budget law, including the pension system, subsidies to the local administration authorities, military spending. The consolidation effect in 2010-2014 could be done on the revenue side as well as the expenses side (Gajewski & Skiba, 2010).

Looking at expenses: the government adopted a comprehensive set of measures. The earliest ones included the modification of fiscal rules for local administration units. The new regulation in 2011 introduced a new rule concerning the budget balance for local units, changed into individual debt limits ratio in2013.

In 2011, the government introduced new rule limiting the pace of growth expenses by 1% a year and froze remunerations in public administration. Another important reform is linked with the pension and social security system. The retirement age was changed: from 60 to 67 for women and from 65 to 67 for men.

Starting in 2009, the government froze the PIT thresholds (18%/32%) in nominal terms. This also applied to tax free earnings in Poland, currently amounting around 736€. Regarding the VAT, in 2011, the government temporarily changed the rates: a reduced rate from 3% to 5% for food, books and press; a reduced rate from 7% to 8% and regular rate from 22% to 23% foe services. In the same time government put efforts on the tax base, broadening and simplifying the taxation. Another important change was the transfer of specific assets (mainly public debt securities) from the private obligatory pension funds to the public one.

There is moderate awareness of the public finance issue in Poland. It should be stronger. As the data showed a correlation between a perception of debt as a problem and debt level - the bigger awareness the lower debt.

In May 2015 the Commission ended the EDP in Poland, which on one hand is positive information. On the other hand still a substantial part of Polish expenses are fixed. The government should reduce this share to better accommodate the external shocks requiring sharp cuts in spending on the national level and local level. The same applied to revenues side of consolidation - it seems to introduces new ones but not hamper the economic growth (Toporowski, 2015).

6. Summary

The situation of the last crisis was difficult. The levels of deficits were higher and higher, so countries, in our case the Czech Republic and Poland, had to introduce reforms to remit fiscal balance.

The external pressure from the European Commission played a crucial role in stabilizing their public finances after the crises hit their economies in 2009. Poland has signed the "Six-Pact" not being a member of Euro Area. Czech Republic has not done it.

In analyzed time Poland has higher deficit (over 3%) but debt never exceeded 60% of GDP. The GDP growth was over 3%, except 2012 when the GDP was 1,8%. This situation allowed to make consolidation reforms. The implemented consolidation measures included increase in the retirement age, increase in VAT taxes, temporary freezing of public workers' salaries and cuts in several social benefits. The substantial reduction of the public debt was achieved by one - off measures transferring assets from the private to the public scheme which will, however, increase public expenditure on pensions in the long term.

The Czech Republic only in 2010-2012 has exceeded deficit level, In 2014 deficit was 1,9% of GDP. It is one reason why this county has not signed "Six Pact". But the GDP growth was always lower than in Poland, even in 2012 was -0,8%. The Czech government decided for changing in tax system, too. The changes were not so wide like in Poland. Economy needs impulse in the form of public expenditures, public investments and higher number of public procurements. Without the real consolidation of public finance, no improvement of the recent situation is possible. The only way to consolidate public finance in the Czech Republic is a powerful legislative norm, which bans spontaneous enlargement of public finance, i.e. of public sector.

7. Results

The one positive effect of reforms is lower deficit, both in the Czech Republic and Poland. The GPD growth is better than in EU-28 member states. But the debt is still growing, what means, that states have more and more obligations, that will charge next generations.

On the one hand Poland made big success in reducing deficit and debt using traditional fiscal instruments. But on the other side - the effects are for short time. We don't know how long the deficit and debt will be stable because the situation on the financial markets is still unsafe. Poland still needs to bring down the fix expenses i.e. numerous privileges.

The Czech Republic has bigger debt, too, but not so high like Poland or EU member states. It is unknown how the new taxes in industry change the situation in public finance. What consequences bring for citizens and for sustainable fiscal position.

To sum up, the author thinks that these changes in public finances, special in Poland, won't have longer effect. It is doubtful that higher tax rates secure the sustainable fiscal position. The spending reduction could bring negative effects for the equity and growth, especially when the debt is still growing.

According to presented situation, the author regards that the initiating consolidation in public finances in both countries is the beginning of process of changes. The governments should think what kind of instruments will use and for how long. The most important thing is that the changes should not be harmful for economy in long time and for next generations, who have to pay our debts.

References

Barrios, S., Langedijk, S., Pench, L., (2010), EU fiscal consolidation after the financial crisis. Lessons from past-experience, European Union.

Compendium ofCountry- Specific Analyses, Public Finance Consolidation in V4, (2015), p. 27-33.

Gajewski, P., Skiba, L., (2010). Problemy polityki fiskalnej w Polsce na drodze do strefy euro w kontekscie uwarunkowan i doswiadczen innych panstw. NBP, Warsaw, November.

Hagemann, R. P, (2012). Fiscal Consolidation: part 6. What are the best Policy Instruments for Fisca; Consolidation?. Economics Department Working Paper No 937, (p. 5-7), OECD.

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Sutherland, D., Hoeller, P., Merola R., (2012). Fiscal consolidation: How much, how fast and by what means?. An Economic outlook Report, (p. 6), no 1, OECD.