Analysis of the Ukrainian draft state budget for 2017 – need to review cost-effectiveness remains

Analysis of the draft state budget for 2017 conducted by experts from the Centre for Economic Strategy (CES) shows that this document provides for introduction of some positive changes including support for structural changes required to simplify tax administration and reduce ineffective tax incentives, as well as efforts to improve the effectiveness of public spending. However, the draft contains some risks. According to the consolidated budget for 2017, public revenue is to moderately grow, while the level of expenditures is to remain at the level of 43% of GDP (consolidated budget with social funds). According to the CES research[1], this rate of distribution is high and considering the low cost-effectiveness of expenditures and insufficient institutional capacity of the state, it can suppress Ukraine’s economic growth.

Concerning the risks of budget execution, falling short of the estimated amount of revenues is possible. This risk particularly relates to revenues from privatization, special confiscation, and from some types of taxes. Cumulatively, this can result in a greater budget deficit and require more borrowings.

Our general recommendations remain unchanged: in order to ensure fiscal stability, it is required to review budget expenditures and implement medium-term planning.

The government plans to increase revenues through improving tax administration, increasing excise rates, and cancelling the special taxation treatment. At the same time, there are some issues concerning the feasibility of planned non-tax revenues: namely confiscated property (UAH 10.5 bn), privatisation revenues (UAH 17.1 bn), and NBU transfers (which might be UAH 10 bn less). Thus, there is a risk of a revenue shortfall of at least 1.4% of GDP in 2017. It is also possible there will be some shortage of tax revenues in case of slower economic growth in comparison to the state forecast, in which case budget expenditures will require adjustment.

As for the structure of outgoings, it is practically the same in 2017 as it was in 2016.  An increase is planned in expenditures on economic activity from 3.3% to 4.1% of GDP through decreasing the share of education, social protection, and public health care. In comparison with the structure of costs in European Union countries (see pic. 1), the most underfunded directions in 2016 were public health care (particularly the expenses for medical supplies and equipment), economic activity and national functions (except for debt service). According to the 2017 proposal, outgoings on economic activity are approaching the European level, however, the expenses for public health care and national functions are lower as a proportion of GDP.

However, outgoings for law enforcement and civil order continue to be high, and we can see potential for improvement in this regard. Expenses for higher education can also be optimised; it is possible to achieve some savings in social expenses in the long-term perspective if pension reform and means testing are implemented.

In general, the state budget proposal for 2017 sends a number of positive signals: it supports structural changes required for making tax administration simple and reducing tax incentives and it strives to improve the effectiveness of public expenditures. Yet there is still room for improvement since the budget shows rather high inertia (the structure of both income and expenses is not undergoing any considerable changes, apart from some exceptions) and contains risks of a shortfall in planned revenues, and thus of increasing the deficit.

Pic. 1. Public expenditure in selected sectors in Ukraine and their difference versus expenditures in the new EU member states

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* Grey markers highlight the planned expenditures in Budget 2016 with amendments; blue markers highlight those in the Budget Proposal for 2017

** Such categories as “Social Protection and Pension Provision”, “Defence”, and “Debt Service” have been removed because of relatively high levels of deviation from respective rates in new EU member states

Sources: State Treasury Service, web-portal of the Verkhovna Rada, Eurostat

“In order to ensure real cost-effectiveness and actually achieve the goals of budget programmes, it is required to implement full-bodied medium-term budgetary planning. This will enable to fund measures and plan activities for a couple of years ahead, which better fits the duration of projects targeting large-scale social and economic transformations. This does not mean that it won’t be possible to adjust budgets during upcoming periods, but it means a far better approach to spending funds and setting goals in the public sector”, comments Maria Repko, CES Deputy Director.

 

 

[1] According to CES estimates, if the share of public sector costs is reduced in GDP down to 37%, it is possible to boost annual average economic growth in Ukraine by 0.9-3.5 p.p. of GDP. Source: http://ces.org.ua/en/021115/

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