The Parliament of Georgia is currently discussing the 2015 draft state budget. Here, we examine the draft budget’s priorities as well as planned income and spending. In the present analysis, attention is drawn to the problems in the first ten months of the 2014 budget execution related to income as well as spending and what lessons these problems might suggest.

1. General Assessment

• The 2015 state budget plans to increase income by GEL 771 million, a 10.5% increase compared with 2014. Spending will increase by GEL 465.8 million, a 6.17% increase compared with 2014;
• The state’s priorities in 2015 include health and social affairs, regional development and infrastructure, and education and science;
• The Ministry of Health and Social Affair’s financing will increase by GEL 127 million. The Ministry of Infrastructure and Regional Development’s financing will increase by GEL 125 million, and the Ministry of Education and Science’s financing will increase by GEL 99.6 million;
• The 2015 draft budget plans an increase of GEL 358.5 million in central government salaries, compared with 2012. Compared with 2014, central government salaries will increase by GEL 89.6 million;
• Social affairs spending will increase by GEL 69.93 million and will largely be directed towards pensions;
• According to the 2015 draft budget, spending on administrative expenditures will significantly increase for a number of spending agencies, compared with 2014. The Ministry of Energy will spend GEL 18.9 million more than in 2014, while the government administration will spend GEL 12.5 million more than in 2014. The Ministry of Education will spend GEL 5 million more than in 2014;
• As in previous years, the Ministry of Internal Affairs and Ministry of Defense’s administrative costs cannot be calculated from the 2015 state budget;
• The 2015 state budget will finance the Georgian Solidarity Fund to the sum of GEL 260,000;
• The budget plans that income will increase by GEL 780 million (by 11.44%) despite the fact that there have been serious problems in relation to tax collection in the last three years. Tax evasion and the black market continue to be serious problems for the government;
• Some program funding has increased without grounds being given for the increases;
• Since 2013 other income has been in decline, and this trend will continue in 2015. Other income will decline by GEL 80 million (29%) compared with 2014;
• Government debt has clearly been increasing and has reached a record level compared to GDP.

2. Priorities and new developments

The 2015 state budget has three distinct priorities: 1) health and social affairs, 2) regional development and infrastructure, and 3) education and science. Compared with the previous year, financing for the Ministry of Labour, Health and Social Affairs will increase by GEL 127 million. Financing for the Ministry of Regional Development and Infrastructure budget will increase by GEL 125 million, and financing for the Ministry of Education and Science will increase by GEL 99.6 million.

Social affairs spending will mainly increase on pensions, while increased spending on health programs is directed towards country doctors (a 236.49% increase compared with 2014), dialysis and kidney transplants (a 19.28% increase compared with 2014), and first responders and medical transportation (a 203% increase compared with 2014). Notably, spending on universal health care will decrease by 1.73%.

Increased spending on education and science is mainly directed towards general education assistance programs (a 13.34% increase compared with 2014) and support for science and scientific research (a 21.71% increase compared with 2014).

Increased spending on regional development and infrastructure is mainly directed towards road construction and maintenance (a 26.53% increase compared with 2014), highway construction (a 30.55% increase compared with 2014), and regional and municipal infrastructure rehabilitation (a 20.64% increase compared with 2014).

Increased spending on agriculture is mainly directed towards agricultural assistance and development programs (a 164% increase compared with 2014). An agricultural equipment loan and lease reduction program (GEL 21 million) and an agricultural insurance program (GEL 10 million) will start in 2015.

Spending on accommodation and internally displaced persons will increase by GEL 22 million, even though in reality, spending will decrease in this area by approximately GEL 25 million, because funding for the Ministry of Regional Development and Infrastructure’s subprogram which supports internally displaced persons will decrease from GEL 50.12 million to GEL 3.5 million.

The 2015 state budget will finance the non-profit legal entity, the Georgian Solidarity Fund, which will receive GEL 260,000 from the budget.

Figure 1. Increases in ministry funding, compared with 2014 (in thousands of GEL)

It should be seen as a step forward that the 2015 draft budget presented more details on the costs associated with legal entities of public law than the 2014 state budget. Significantly, it is planned to decrease the budget deficit to 3% in 2015 and 2.5% in 2016.

3. Problems

3.1. Excessive social spending

While in the original version of the 2015 budget, spending on health and social affairs increased by GEL 35 million, spending is set to increase by GEL 127 million (by 4.77%) compared with 2014. Spending on health and social affairs will account for approximately 35% of the 2015 budget. Spending on social programs to the degree present in the 2015 budget is unjustified for the following reasons:

• The budget’s socially oriented spending decreases government spending on capital expenditures, which inhibits economic growth;
• Financing of social projects disregards the fact that average income earners are prepared to finance their own healthcare, which would significantly reduce government expenses;
• The fact that average income earners are willing to finance their own healthcare is a resource, which should be put to use. Ignoring this resource is a completely irrational approach to budgeting. Adjusting policy and spending to account for average income earner’s willingness to finance their own healthcare would free up resources which could be directed towards the socially disadvantaged population. Notably, this population generally requires more healthcare services;
• Due to the irrational approach to financing social programs, the government loses the opportunity to finance infrastructure rehabilitation, which is important for economic development.

3.2. Growth in public sector remuneration

In 2015, central government salaries will increase by GEL 358.5 million, an increase of 34.16% compared with 2012 and 6.79% compared with 2014. Notably, central government salaries increased by GEL 89.6 million in 2015 compared with 2014 and by GEL 130.74 million in 2014 compared with 2013 (an 11% increase).

As was noted in the blog post Budget execution in quarter 1-2 of 2014: underspending of public funds remains a serious problem, public sector salaries have not reached the threshold, whereat increasing them would be ill-advised. Salary increases are fully justified if motivated by the desire to create a fully professional public sector. While increased salaries stimulate consumer spending, the increases raise the question of whether a public good is being created through the GEL 358.5 million increases in salaries.

It is true that in the present writing, only the state budget and not the consolidated budget is under consideration, but in connection to salary increases it should be noted that there are even more significant developments in the municipalities. In the municipalities, a large number of non-profit legal entities and LTDs have been created which are fully owned by the municipalities. These entities have significantly inflated staffs. Administrative expenses continued to grow in municipal divisions where additional non-profit legal entities were created. On 28 November, 2014 when amendments to the self-governance code came into force, the number of civil servants in local government increased by more than 20%.

Figure 2. Central government salaries, 2012-2015 (in millions of GEL)

3.3. Tax collection

Despite the fact that the government has experienced significant problems with tax collection in the last three years, the 2015 state budget projects a GEL 780 million increase (11.44%) in income. In the first ten months of 2014, the government has collected 81.9% of taxes planned, while in 2013 the state budget experienced a shortfall of GEL 632.3 million from income tax alone.

Without discouraging tax evasion, even with an increase in the rate of economic growth, the government will experience significant difficulties executing the 2015 budget, because compared with the 2013 state budget, expenses in the 2015 state budget have increased by nearly GEL 1.5 billion.  Tax evasion and the black market remain serious problems for the government. It is inconceivable how GEL 780 million more than in 2014 will be collected without improvements in the tax administration, especially when income tax evasion, particularly in the service sector, is such a widespread practice.

3.4. Growth in administrative spending by the Ministries

According to the 2015 draft budget, administrative costs will increase in a number of ministries. It should be noted that it is not possible to calculate the administrative expenditures of the Ministry of Internal Affairs and Ministry of Defense from the budget, whereas in every other Ministry, this is generally possible.

Figure 3. Central Administrative spending increases in a number of spending agencies in 2015 (compared with 2014, in thousands of GEL).

1. Unsubstantiated spending and the risk of corruption

As is noted in the Auditor General's report on the 2015 draft state budget, it is unclear why financing for specific programs and subprograms is increasing when planned program activities have not changed, e.g.:

This situation is not only a problem with the program budget, but rather presents a clear risk of corruption. In 2015, financing for secondary schools increased by GEL 50 million, but program activities remained exactly the same. The village doctor subprogram’s appropriation increased by GEL 17.8 million even though the subprogram contains the same activities as in 2014. Consequently, it is incomprehensible why in one instance GEL 50 million is required while in the second GEL 17.8 million is needed. As is noted in the figure above, similar increases are planned for other subprograms.

3.6. Other income

Other income began to and have continued to decline since 2013. Other income will decrease in 2015 by 29% compared with 2014 (by GEL 80 million). Other income mainly consists of nontax revenue, income from property, the sale of goods and services, and income from fines and penalties among other sources. Considering that in 2014, other income was GEL 180 million lower than in 2012, the government should analyze the reasons why other income continue to decline.

3.7. Government debt

The limit on government debt set by the budget law for 2015 is GEL 11.315 billion. This is GEL 941.5 higher than in 2014. Government debt is 35.7% of GDP, a similar level to 2014. While this is less than the amount the organic law On Economic Freedom defines as the limit, it should be kept in mind that there is a clear tendency towards rising government debt. As was correctly noted in the Auditor General’s report on the 2015 draft budget, government debt has reached a historical high.

4. Lessons to be learned for 2015 from the execution of the 2014 budget

4.1. The problem of underspending

Ten months into the execution of the 2014 budget, underspending remains the most significant problem with budget. In ten months, the government has executed 81.9% of the budget. In the first ten months of 2014, the government has spent nearly GEL 2 billion less than planned, equaling 29.72% of planned expenditures.

There are two primary reasons for underspending:

• Inappropriate work of spending agencies: In the first ten months of 2014, the Ministry of Labour, Health and Social Affairs failed to spend GEL 502.69 million. The Ministry of Regional Development and Infrastructure failed to spend GEL 285.62 million. The Ministry of Education and Science failed to spend GEL 208.14 million, and the Ministry of Agriculture failed to spend GEL 36.78 million. In total, these ministries have failed to spend more than GEL 1 billion or nearly half of the unspent GEL 2.08 billion.

• Inappropriate budgetary planning: The remaining billion lari in unspent resources comes from a variety of spending agencies. These agencies request more resources than they can spend. As a result, the resources can no longer be spent and those unspent resources cannot be used by others until the end of the year. Inappropriate budgetary planning is a problem, because it prevents the spending of resources. Although this started in 2013 and continues today, underspending at the present level is unprecedented in Georgia.

In this regard, there is a serious risk that underspending, which in 2013 and 2014 was one of the main problems with the state budget, will continue in 2015 unless the government takes forceful measures to fix the problem. While underspending clearly has a negative impact on economic growth, compensating for underspending in Q 1-2 with  feverish spending in Q 3-4 presents a clear inflationary risk. At the same time, the government should not forget that a large share of deficit spending for the 2015 budget is financed through loans. In 2015 the majority of loans were investment loans.

Figure 4. 2011-2014 Unspent funds (10 months into 2014)

5. Recommendations

Given the above, we believe that:

1. The government should take into account the experience of 2013-2014 to prevent underspending through timely responses and adequate policy changes. The government should tackle the causes of underspending which led to hundreds of millions of lari not being spent on infrastructure projects in 2013-2014
2. The government should consider tax collection a complex problem that demands a complex solution including a higher rate of economic growth, which among other factors is connected to government policy (political stability, the building of democratic institutions, legislative initiatives, etc.). Besides these factors, it is important that the tax administration improves significantly. Improvement is contingent on the effectiveness of the government;
3. The government should analyze what is causing the continued decline in other income;
4. The government should substantiate the need for the GEL 358.5 million increase in public sector remuneration;
5. The Ministry of Finance in consultation with other ministries should provide a description of how program activities have changed for programs that have received more financing as discussed above in section 3.5.