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Budget Declaration. Second Attempt

8 June 2021
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Recently, the Government approved the Budget Declaration for 2022-2024 and submitted it to the Verkhovna Rada. Without exaggeration, this marks an important milestone in the development of Ukraine’s public finances, as well as the formal beginning of medium-term budgetary planning in Ukraine.

The Budget Declaration serves to ensure transparent fiscal policy and predictable financing for various sectors in line with the medium-term budget deficit targets. This, in turn, should contribute to the sustainability of public finances, and hence to economic stability and development.

But will this document help improve the quality of the national budgetary planning? What are the strengths and weaknesses of the first Budget Declaration approved by the Government?

What is the Budget Declaration, and why is it needed?

The Budget Declaration is a strategic document outlining the Government’s consolidated approach to fiscal policy for the next 3 (in some countries – 5) years. The document should determine the fiscal policy both in terms of revenues and spending.     

Adopting the medium-term Budget Declaration is in line with international best practice in public finance management that is widely used in other countries (even though the documents can have different names, e.g. New Zealand‘s Budget Policy Statement and South Africa‘s Medium Term Budget Policy Statement).  

Ukraine’s  Budget Declaration for 2022-2024 is the first officially approved attempt to implement such an approach. However, it is the second attempt to draw up such a declaration based on the new legislation on medium-term budgetary frameworks passed in December 2018. The first Declaration was produced by the Ministry of Finance under Oksana Markarova in 2019, but it was not approved by the Volodymyr Groysman government due to political reasons (a new president was elected, there were negotiations to form a new government and discussions to call an early parliamentary election).      

In 2020, the Government refused to prepare the Budget Declaration amid uncertainty over the COVID-19 pandemic. However, the incumbent Government’s second attempt was more successful. On May 14, the Ministry of Finance submitted the Declaration to the Government, which then approved it on May 31.

Clash of the forecasts

Already after adopting the Declaration, the Ministry of Economy made public the government-approved Forecast of Economic and Social Development of Ukraine for 2022-2024, based on which the Declaration was drawn up. This reverse sequence of the Government’s actions directly affected the preparation of the document – between the Declaration’s being submitted to the Cabinet of Ministers and being made public, GDP forecast for 2022-2024 was updated (with budget revenue figures remaining the same). 

One probable reason for this is the divergent views of the Ministry of Finance and the Ministry of Economy of how fast the minimum wage should increase. 

The Declaration is based on the assumption that in 2022, the minimum wage will be UAH 6,500 from January 1 and UAH 6,700 from October 1. Thus, the weighted average minimum wage will be UAH 6,550. However, according to the Ministry of Economy’s comments to the draft Declaration contained in the accompanying documents, the Ministry’s macro forecast, on which the Declaration was based, had initially estimated an increase in the weighted average minimum wage of UAH 6,700 in 2022. Thus, budget revenue estimates in the Declaration were actually based on a higher minimum wage, while spending was based on its lower level. Such inconsistencies could lead to a hidden budget deficit. 

Accordingly, the macro forecast that served as a basis for the draft Declaration had to be revisited at the last moment, which was reflected in GDP forecasts.

What’s in the Declaration?

The Declaration is reminiscent of the traditional “explanatory note” accompanying each draft state budget law for the next year. Much of the document describes the macroeconomic environment, key macro forecast figures and budgetary performance. But, unlike annual budgets, this document deals with a three-year budgetary planning cycle.   

It is a document of nearly 170 pages, of which about 50 are a textual description of the Government’s budgetary policy for the next three years. The remaining pages are given to appendices that define the Government’s policy objectives and key performance measures for these targets, as well as maximum spending for each budget manager. 

In line with best international practice, the Ministry of Finance also included in the Budget Declaration the so-called “fiscal space”, i.e. a budget reserve to ensure the state’s ability to withstand fiscal risks (a possible unforeseen decrease in revenues or an increase in spending not included in the Declaration), which can be allotted closer to the beginning of the new fiscal year.

Specifically, the “fiscal space” is UAH 24.6 billion for 2022, UAH 24.7 billion for 2023; and UAH 48.9 billion for 2024 (this does not include an additional UAH 34 billion, which can be available to the Government in the event of additional tax initiatives). These funds will be allocated during the preparation of the law on the state budget for the relevant year – primarily for planned capital expenditures, public administration reform, etc.

Table 1. Key indicators of the Budget Declaration for 2022-2024.

Indicator 2021 2022 2023 2024
Nominal GDP, UAH billion 4,808.5 5,368.7 5,993.9  6,651.0 
Consumer price index,% 108.9 106.2 105.3 105.0
Budget deficits, % of GDP 5.1 3.5 3.0 2.7
Maximum amount of public debt, % of GDP 53.3  50.8 48.5 47
State-guaranteed debt, % of GDP 7.3 5.1 4.8 4.3
Average annual hryvnia exchange rate to the US dollar, UAH 28.0 28.6 28.8 29.2
NBU discount rate, % 7.5 7.0 5.5 5.2

We saw several problems in the Declaration. 

Possible tax changes

The first problem is the approach to defining the tax base. One of the Declaration’s tasks is to give taxpayers an understanding of medium-term taxation. This requires that the Government form and coordinate, at all levels, a consolidated approach to defining taxation rules.

However, according to the Declaration, the budgets’ revenue base rests on the current tax rates (excluding the tax on tobacco products), in particular, on the current extraction rates for oil, gas condensate, iron ore and natural gas. Also, the budget was based on the assumption of “no indexation of tax rates defined in absolute terms”, as well as excise, environmental taxes and rent. 

Assessing the financial resource of the 2022-2024 budgets, only the following significant tax changes are taken into account:

  • indexing normative monetary valuation of agricultural lands, from 2024;          
  • applying regular rates until 2023 instead of preferential rates for production from new wells operating since January 1, 2018.          

According to the Declaration, the lack of indexation of tax rates in absolute terms, as well as lower contributions to the budget from the National Bank will reduce the level of redistribution of GDP through the state budget from 22.5% of GDP in 2022 to 21.6% in 2024.

At the same time, Parliament is currently considering amendments to the TCU submitted by the Government, including those contained in the National Economic Strategy until 2030 approved in March 2020, as well as other initiatives submitted by MPs. If adopted, these changes carry significant implications for future tax revenues.

It is stated in the Declaration that the Government proposes to Parliament a number of changes to tax legislation that, starting from 2022, will increase budget revenues by about UAH 34.1 billion, in addition to the resource already provided for in the Declaration. These are the following changes:

  • indexing excise tax rates on alcoholic beverages, environmental taxes and rent in absolute values;          
  • prohibiting public sector enterprises from independently forming reserves for future spending and doubtful debts;          
  • increasing the pre-tax financial result of state-owned enterprises in the amount of the non-refundable assistance provided to related parties;          
  • restricting the transfer of losses of previous periods to 50%, for large taxpayers;          
  • restricting budget VAT refunds for intermediary payers in case of purchasing/importing goods to be supplied on the territory of Ukraine;          
  • abolishing VAT exemptions for taxpayers selling housing on the secondary market;          
  • restricting tax invoices drawn up more than 6 months from the date of the transaction from being included in the tax credit;
  • introducing a minimum tax liability for 1 hectare of agricultural land;          
  • introducing an electronic tax audit.            

The Declaration thus does not provide a final understanding of what the Government’s tax policy will be and what financial resources it will have.

This caution is understandable as other tax changes under active discussion in Parliament could lead to a decrease in tax revenue. These are primarily the proposal to extend the VAT rate of 14% to a number of socially important products; new tax benefits to support scientific and technical activities (exemption from VAT for state research institutions and higher education institutions importing equipment for their needs) and the catering industries (reduction of VAT rate to 7% on transactions in the restaurant business and catering services).

Spending is not prioritized

Another significant problem is the lack of a unified stance of the members of the Government on the expenditure budget, which is evident both from the number of various government bodies’ comments and complaints that the Ministry of Finance did not include all their proposals in the document, and from the amount of budget requests sent by the Ministries.

Preparing a Budget Declaration is a non-trivial task for the Ministry of Finance. After all, it needs to get government bodies accustomed to the fact that budget resources are scarce, and that each Ministry needs to plan its spending in advance based on an understanding of policy priorities.

The task is complicated by the fact that the Government needs to reduce the state budget deficit to ensure the country’s financial stability. There are plans to reduce it from 5.5% of GDP for 2021 to 2.7% of GDP at the end of 2024, i.e. by more than half. 

This means a significant slowdown in spending compared to what the Government has become “used to” over the COVID-19 period of 2020-2021. Specifically, according to the document, spending should grow by an average of 6.5 percent annually in the next three years, while projected revenue will grow by an average of 9.8 percent. 

To achieve this goal, the Government must clearly prioritize its spending. However, it failed to do so. So as before, many budget managers will additionally receive a little bit from the budget pie as before. 

The Budget Declaration does not contain a list of national priorities. It has 5-10 paths of action in each area under the Government’s care. Such a list is largely in line with the Government’s earlier plans (see the Box). 

However, the Government’s budgetary constraint we talked about earlier is noticeable almost everywhere in the Declaration. For example, the Government maintains the current level of state support in absolute terms for some industries. This means that it will decrease as a share of the budgetary expenditure.

For example, the Ministry of Finance foresees an annual increase in the minimum wage and subsistence level, but it will be slower than the Ministry of Economy’s macroeconomic forecast estimates. After an increase in the minimum wage to UAH 6,500 from December 1, 2021, the next 3% increase to UAH 6,700 is planned for October 1, 2022. From January 1, 2023, the minimum wage will increase by 7% (to UAH 7,176), and from January 1, 2024, by nearly 7%, to UAH 7,665.  

The subsistence level will increase at a rate exceeding the forecast inflation rate for 2022-2024 by 2 percentage points. Specifically, the subsistence level for able-bodied individuals is defined as follows:

  • UAH 2,481  from January 1, 2022    
  • UAH 2,600  from July 1, 2022
  • UAH 2,684  from December 1, 2022

It is easy to predict that a moderate increase in these indicators will arouse considerable criticism of the document. But the Ministry of Finance should be paid a compliment for doing it in order to curb the budget deficit.

At the same time, the Government promises to reform the system of social supports and pension provision, which will make it possible to move from “passively adapting social policy to the country’s limited financial and material resources” to provide truly effective support to those who need it. However, there is no detail of this approach in the document.

The Government also plans on increasing (again, without details) the motivation of those receiving benefits and housing subsidies to economically use housing and communal services and implement energy efficiency measures.

The Government also has plans to change its approach to the formation of the wage and the amount of remuneration for public sector, government agency and court employees, and to untie their salaries from the subsistence level for able-bodied persons. 

It will be recalled that the size of more than 150 different types of payments from (and to) the budget depending on the subsistence level is a considerable issue for the budget today. Therefore, each step towards increasing this indicator means an additional increase in spending on a wide range of budget payments.

Budgetary expenditures in 2022-2024, by sector

 Social spending: 

  • UAH 35.2 billion a year in subsidies for citizens to pay for housing and communal services (the 2021 level)       
  • UAH 3.1 billion in assistance to IDPs (the 2021 level)       
  • UAH 1.4 billion a year in financial assistance to veterans (the 2021 level)       
  • UAH 2.6 billion a year in social assistance to Chernobyl victims (the 2021 level)       
  • Salaries for public sector employees and judges (the 2021 level)       
  • Indexing pensions from March 1, 2022-2024       
  • Continuing to pay a monthly allowance of UAH 500 to 80-year-old pensioners, and UAH 400 to pensioners aged 75-79       
  • UAH 195.3 billion in budgetary spending on the Pension Fund in 2022-2024 (= target in 2021). No increase in spending is expected due to the planned growth of USC proceeds, which will make up for growing spending on pension indexation        

Social policy: 

  • Establishing 270 support services for those affected by domestic violence       
  • Developing family and other forms of upbringing for orphans and children deprived of parental care       

Educational policy: 

  • UAH 1.4 billion in 2022 to continue developing the NUS (the 2021 level)       
  • Continuing to implement the State Standard of Basic Secondary Education: providing new equipment for 260 school classrooms and further training for 33.1 thousand teachers and their assistants       
  • UAH 108 billion in teacher salaries in 2022 (UAH 20.6 billion in 2021)       
  • UAH 0.5 billion for inclusive education: this will cover 42,000 children with inclusive services (the 2021 level)       
  • Streamlining the small schools network        

Science:

  • Increasing spending on the National Research Foundation: UAH 822 million or 8.1% of the total amount of financial support for science from the state budget in 2022; UAH 953 million or 8.6% in 2023; and UAH 1.039 billion or 8.9% in 2024 (UAH 732.8 million in 2021)

Medicine:

  • Additional spending on the Medical Guarantees Program (cf. UAH 126.7 billion in 2021). However, there are no details on this area, it only concerns ensuring transparency in use of budget funds by taking into account all the healthcare services provided and medicines paid for under the Medical Guarantees Program. The reason for such vague wording (according to the explanatory documents to the Budget Declaration) is that the proposals to the Declaration submitted by the Ministry of Health were of poor quality, and so they were not taken into consideration due to errors and inconsistencies. 

Culture:

  • UAH 650 million in support for domestic cinema in 2022 (UAH 621.1 million in 2021)       
  • UAH 300 million for construction of cultural facilities of national importance (UAH 600 million in 2021)       

Digitization:

  • UAH 135.6 million to create infrastructure to automate interactions between executive bodies, as well as with legal entities and individuals based on information and telecommunication technologies, for 2022-2024       
  • converting the most popular public services into electronic form       
  • introducing monitoring of the system of electronic services and assessing the quality of their provision       
  • streamlining registers and providing digital interaction between them       
  • developing Internet access networks, ensuring access to high-speed Internet  for social institutions, local self-government bodies and citizens 
  • creating conditions for the development of IT businesses       

Infrastructure:

  • Target: renovating and refurbishing 43 thousand km of roads of national significance and 119 thousand km of roads of local significance       

Spending, UAH billion:

  2021 2022 2023 2024
Developing and maintaining a network of roads of national significance 31 38.4 40.1 40.8
Roads of local significance 18.1 22.4 23.4 23.8
Road safety no 3.2 3.3 3.4
Total 49.1 64 66.8 68

Agro-industrial complex: 

  • UAH 4.5 billion a year to support agricultural producers during 2022-2024 (UAH 0 in 2021)       
  • stimulating the livestock industry       
  • supporting farms and their access to financial resources       
  • providing partial compensation of the cost of agricultural machinery and equipment       
  • preferential lending to agricultural producers, in particular farms       
  • stimulating the establishment of permanent cropping       

State investment projects: UAH 2.7 billion annually

Environmental protection, UAH billion:  

  2021 2022 2023 2024
Water industry 5.3 6 6.6 6.9
Ecological safety 3 2.9 3 3
Nature reserve fund 0.5 0.8 0.9 0.9
Environmental protection measures 0.2 0.1 0.1 0.1
Total 9 9.8 10.6 10.9

State policy regarding the coal industry (spending is not specified):

  • approving the Concept of Reforming the Coal Industry       
  • liquidating unpromising coal enterprises after bringing them to a safe state (UAH 1 billion in 2021)       
  • providing social protection for the employees of state-owned mines through job creation and employment of mine workers; promoting the voluntary resettlement of the miners’ families; developing SMEs in the mining regions       

SME support and development (spending is not specified):

  • continuing with the “5-7-9” program (UAH 2 billion allocated for the Entrepreneurship Development Fund in 2021)       
  • program for providing portfolio guarantees       

Cooperation with international financial institutions (IFIs):

  • attracting long-term soft loans for development projects in the amount of: UAH 25.5 billion in 2022, UAH 26.5 billion in 2023, UAH 27.5 billion in 2024

Judiciary: 

  • streamlining the justice system
  • introducing a jury trial
  • enhancing the functional and procedural capacity of the Supreme Court
  • launching an IP court; introducing a full-fledged electronic court

Desires beyond possibility 

The Ministry of Finance’s caution in planning the spending has already met with opposition from nearly every Ministry. According to the SCMU’s conclusions to the draft Budget Declaration, the budget managers asked the Ministry of Finance for the amount that is 60% more than the Government could afford, going far beyond the managers’ spending “limits”.

But is it about the Ministry of Finance or is it more about the adequacy of requests made by the government bodies? 

One of the key elements in preparing the Budget Declaration is informing the government agencies (main budget managers) about the so-called “budget ceilings”, i.e. the funding amounts that each of them can reasonably count on in the medium term in line with the budget capacity. 

Keeping within such “ceilings” is a powerful tool for training government officials to exercise restraint and prioritize spending. The Ministries need to decide on which spending areas are of more importance to them in order to allocate resources more rationally.

To this end, some countries even use punitive tools for those government agencies whose requests exceed the ceiling (Table 2).

Table 2. “Budget ceilings” and the government bodies’ responsibility for violating them during the preparation of spending requests, 2019.

Country Budget ceilings of line ministry Characteristics of ceilings If spending requests are higher than ceilings
No Overall/total  Program / sector Agency /
organization
Australia x          
Austria   x     relevant line ministry no penalty
Belgium     X     mandatory reduction (in line with budget ceiling)
Canada     x X   no penalty
Chile   x     relevant line ministry no penalty
Czech Republic         made public no penalty
Denmark   x x     no penalty
Estonia   x     within the government no penalty
Finland   x     made public no penalty
France x          
Germany   x     within the government no penalty
Greece   x     made public mandatory reduction (in line with budget ceiling)
Hungary x          
Iceland     x   made public no penalty
Ireland   x     made public no penalty
Israel   x     made public  
Italy         made public no penalty
Japan   x x   made public spending request  cannot exceed ceiling
Korea   x       penalties
Latvia   x     made public  
Luxembourg     x X within the government no penalty
Mexico   x     within the government  
Netherlands   x     made public mandatory reduction (in line with budget ceiling)
Norway   x     within the government mandatory reduction (in line with budget ceiling)
Poland   x     relevant line ministry no penalty
Portugal     x   made public no penalty
Slovakia   x     relevant line ministry  
Slovenia   x x   made public mandatory reduction (in line with budget ceiling)
Spain   x     relevant line ministry no penalty
Sweden x          
Switzerland   x        
Turkey       X made public no penalty
United Kingdom   x     within the government  
Total 4 21 8 3    

Source: Budgeting and Public Expenditures in OECD Countries 2019 

Ukraine is still very far from such a consciousness of budget managers. How so? 

For starters, because some Ministries’ staff (and even their heads) still do not think in terms of policy-making, proposing that the Finance Ministry simply fund spending in the same way it has done for years (regardless of whether such spending is needed to meet their objectives or whether it is worth being funded at taxpayers’ expense).

Therefore, most government bodies propose that funding be allocated not to achieve specific objectives, but simply to support their own (often very outdated) infrastructure.

Secondly, even if some spending is indeed needed, there is almost always room for increasing its effectiveness through rightsizing, efficiency, digitization of processes, etc. Just like what any regular organization does in a limited budget situation. But the appendices to the Declaration show that such streamlining does not always take center stage for government officials. And the failed experience of conducting expenditure reviews shows that improving spending efficiency is not important for budget managers.

We estimate that less than half of the 55 budget managers (excluding 24 regional state administrations) who submitted their requests to the Budget Declaration plan their spending based on policy objectives. The others ask for money to keep going with the status quo. 

How should one plan expenditures?

How should that work? For example, the goal of the Ministry of Agrarian Policy and Food of Ukraine is to create conditions for food security and sustainable development of agriculture. Therefore, spending the stated amount of money could result in increasing the share of Ukrainian products in the domestic market, developing farming, etc. Instead, the Ministry of Agriculture states in the Budget Declaration that in order for this goal to be achieved, the share of household spending on groceries in the overall expenditure should remain stable at 60% over the next 3 years (!), whereas this figure is typical for poorer countries (it was 47% for Ukraine in 2019). 

One of the policy goals of the Ministry of Regional Development is to create and develop its own documentary and information resources, modern information and communication technologies, and a high-quality library service in order to enhance the scientific and technical sector capacity. But the performance indicator for this goal is “number of users of the State Scientific-Technical Library”, which according to the Ministry should see an annual increase of 115 people on average.

And it is clear from the policy objectives of the State Judicial Administration that there are no plans to increase the level of trust in the judiciary: it should remain at 40% over the next three years. And the share of unresolved cases should even increase to 80% (although there is hope that it is just an error made by those setting the goals). Instead, protecting the cases of the judges themselves is SJA’s number one concern (the level of enforcement of court decisions made in favor of the judges and court employees should be 100%), which once again underlines the need for judicial reform, where “being a judge” does not mean having advantages in exercising the right to a fair trial. 

And while some of these indicators help the Government keep track of what government agencies spend their money on, it in no way helps to understand whether such spending will contribute to a real change for the better in each of the policy objectives.

In addition, according to the appendices to the Declaration, government bodies often measure their own performance (requesting additional funding from the Ministry of Finance) based on such outdated and meaningless indicators as:

  • number of incoming/outgoing calls of employees,       
  • number of draft regulations drawn up,       
  • number of management decisions made,       
  • number of meetings/conferences held,       
  • number of completed orders,       
  • number of opinions on legislative acts provided, etc.

To remedy this problem and base budget spending on policy needs, rather than simply provide funding “because it’s always been this way”, the Ministry of Finance has been trying for years to launch “expenditure reviews” – an important tool for creating an effective budgetary planning system. The purpose of such reviews is to ensure a direct link between budgetary spending and achieving policy objectives.

But expenditure reviews are currently facing significant problems. The Government planned on carrying out expenditure reviews in 5 Ministries in 9 areas in 2019 and in 11 main budget managers and in 15 areas in 2020. But most of these reviews have not resulted in any action so far.

Conclusions

Despite all these shortcomings, we would like to congratulate the Cabinet of Ministers on adopting an important document – the medium-term Budget Declaration. It is always hard at the beginning, but it is important to start implementing best international practice in the field of public finance management.

In the years to come, we would like to see the goals being correctly defined by the budget managers, as well as a clear and predictable budget policy framework. The Government should also learn to identify several important development priorities for the country, to which additional funding should be directed in the first place, actively working in other areas to improve the efficiency of budgetary spending to achieve better results for the same money.

But already this year, the Government must show that the Budget Declaration is not a declarative document, but one of genuine importance. To this end, the draft State Budget for 2021 should be based on the policies and indicators contained in the Declaration. Any deviations will need to be justified in an explanatory note to the Budget.

Authors

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The authors do not work for, consult to, own shares in or receive funding from any company or organization that would benefit from this article, and have no relevant affiliations