Budget execution in quarter 1-2 of 2014: underspending of public funds remains a serious problem
The Parliament of Georgia is now reviewing the state budget execution report covering the first six months of 2014. Below, we analyze the implementation of the budget, problems with implementation of the 2013 budget, and tendencies as well as problems within the period currently under examination. The current analysis will also present comparisons with the analogous period in 2013 and recommendations for the government.
In the current assessment, we identify problems as well as positive changes. These specifically include:
- The majority of problems present in the first six months of 2014, as in the previous year, mainly concern the spending of resources. In the first six months of 2014, the government spent approximately GEL 401.5 million (9.22%) less than had been planned. The Ministry of Regional Development and Infrastructure failed to disburse more than GEL 114 million;
- There is a serious problem with the spending of grants and credits from international organizations and foreign governments. Most of these funds have been received in connection to infrastructure projects. Over GEL 150 million was not disbursed in the first and second quarters of 2014 (37.48% of projected appropriations);
- In light of the fact that disbursements were not made, it is incomprehensible why a budgetary deficit has been planned;
- During the reporting period, 91.8% of projected profit tax and 106.1% of projected income tax was collected. Still, there are important breaches in collection including: (1) 78.9% of other income was collected. Other income mainly consists of non-tax revenues i.e. revenues from property, the provision of goods and services, fines/penalties etc. (2) 53% of grants and 46.8% of preferential credits for infrastructure projects from foreign governments and organizations were not disbursed due to delays in project implementation;
- The nearly one billion GEL increase in expenditures, in comparison to 2012, requires the tax administration to make significant improvements;
- Compared with the first six months of 2013, compensation of employees at state agencies has risen by 12.5% (GEL 70 million);
- Approximately GEL 5 million from the contingency fund was secretly spent. Unfortunately, it is not known what use these funds were put to;
- In comparison to recent years, the 2014 state budget’s execution report has improved significantly. For example, the portion of the report concerning health and social protection programs includes the number of beneficiaries, which, as a rule, had not been indicated in the report in the years up to and including 2013. The next step in this regard should be to identify program assignments based on the number of beneficiaries.
1. Execution of the budget in the first six months of 2014: Lessons still to be learned from the execution of the 2013 budget
From the outset, it must be noted that it is not possible to determine what the status of the budgetary execution will be for the year from the execution of the budget in the first six months of 2014. Nevertheless, taking into consideration the experience of the 2013 budget, we believe the government must take immediate proactive measures. At the start of the third quarter of 2013, there were no shortfalls in revenues, but in the fourth quarter of 2013, tax revenues began to decline as is discussed in detail in Government spending priorities in 2012-2014: Analysis and recommendations.
In the first six months of 2014, 100.4% of state budget revenues were collected, even though spending remained a serious problem as discussed in detail below.
In the first six months of 2014, the Revenues Service collected GEL 423.21 million in profit tax (91.8% of the projection) and GEL 802.88 million in income tax (106.1% of the projection). Due to the fact that profit tax is characterized by a significantly greater cyclicality than income tax, the lower than projected collection of tax on profits in the first six months of 2014 is not a cause for significant concern. While 100.2% of the projected tax on profit was collected in the first six months of 2013, by the end of the year the shortfall was about 13% (87.3% of the projection). According to the results of the first six months of 2014, the non-fulfilled collection of projected profit tax should not be a cause for alarm, and the collection of more income tax than projected should not be treated as a promising development.
Figure 1: Percentage of tax revenues collected in Q1-2 2014 against projected collection (in GEL million)
Unfortunately, the Ministry of Finance has not addressed any of the problems, which we discussed in a previous publication, in its report on the execution of the budget in the first six months of 2014. If the Ministry of Finance does not critically assess the problems, it is clear that they will not be able to solve these problems.
Figure 2: Unspent Funds Q1-2, 2011-2014 (in GEL million)
2.1. Problems with underspending the government budget: The majority of problems with the execution of the state budget in the first six months of 2013 are once again related to underspending. The government underspent its budget by about GEL 401.54 million less than it had planned for in the first six months of 2014, which is, 9.22% of planned Q1-2 payments. The underspend in the first six months of 2013 was only 4.71% of planned Q1-2 payments.
This underspending has two primary causes:
- Administrative barriers and the inappropriate working of spending agencies:
To give several examples, the Ministry of Regional Development and Infrastructure in the first and second quarters of 2014 underspent its budget by GEL 114.12 million, the Ministry of Education and Science underspent its budget by GEL 70.56 million, while the the Ministry of Agriculture underspent its budget by GEL 24.08 million. The underspending by these three ministries totals GEL 208.78 million, which is 52% of unspent budgetary resources (of a total of GEL 401.54 million).
- Incorrect budgetary planning: The remaining GEL 192.76 million in unspent funds come from a variety of spending agencies: these agencies have requested more money than they could spend, and as a result, they are no longer able spend these funds. Moreover, the resources which remain unspent are not available to be spent by other agencies until the end of the year. Funds are underspent as a result of improper budget planning. Of course, the first six months of 2014 are not the first time that this has occurred, but nonetheless, it is certain that the first six months of 2014 are unprecedented in terms of underspending in comparison to budgets from the same period in different years.
In 2013, the Government of Georgia spent half a billion GEL less than planned, which clearly had a negative impact on the economy. It should be noted that the government in 2012 was unable to spend approximately GEL 213.7 million, while in 2011 the government was unable to spend GEL 31 million. In 2013, the Ministry of Regional Development and Infrastructure was responsible for nearly 45% (GEL 220 million) of GEL 455 million the government left unspent. The government’s failure to spend nearly half a billion GEL indicates poor management as well as inappropriate budgetary planning. Hence, underspending, which was one of the main problems in 2013, remains an acute problem. The government’s plan to spend fewer resources negatively impacts economic growth, while compensating for underspending in the first and second quarters with rapid spending in the third and fourth quarters clearly presents the risk of inflation.
Figure 3: The largest failures in budgetary spending (by spending agency, in GEL million)
2.1.1 Spending of foreign grants and credits: A still more serious problem is in the spending of grants and credits received from foreign governments and international institutions, most of which go to infrastructure projects. In the first six months of 2014, the planned GEL 402.33 million was underspent by GEL 151.05 million (37.48%).
In the first six months of 2014, only GEL 47.09 million (47%) of the projected GEL 100.12 million in grants from foreign governments and organizations was received by the Government of Georgia. Only GEL 146.92 million (53.2%) of the planned GEL 276.27 million in long-term preferential investment credits were received.
A large share of grants and long-term preferential investment credits not received were intended for infrastructure projects. Receipt of credits and grants for infrastructure projects is dependent on progress in the specific infrastructure project implementation, and unfortunately, tangible progress has not been made in this regard.
If the current problems in budgetary spending persist, it is incomprehensible why the budget deficit compared with 2012 has risen by 781.5%, or by 95.7% in comparison with 2013. The 2014 budget deficit has reached an unprecedented GEL 874.73 million. At the same time, we should not forget that 52.6% of the deficit is financed through loans.
2.2. Tax administration: Despite the fact that in 2013 compared with 2012 an increase of GEL 165.64 million was planned in income tax revenues, there was virtually no shortfall in income tax collection (99.6% collection rate). In 2014 GEL 133.6 million more was planned in increased income tax revenue as compared to 2012. In the first six months of 2014, the planned increase in income tax revenue had already been exceeded. Despite the fact that a tax exempt minimum income was introduced in 2014, the scale of income tax evasion in Georgia is such that if the tax administration were to improve there is a clear potential for growth in revenues from income tax, which is the most attractive tax to evade in Georgia, as in other countries.
In light of the above and when considering that the rate of economic growth declined in 2013 compared with 2012, and the Revenue Service was able to execute 99.6% of its income tax plan, which contained an increase of GEL 165.64 million in revenue, it is possible that this can be explained by increased salaries in 2013 in both the public and private sectors. While the rise in salaries continued in 2014, in comparison to 2013, GEL 32 million less was planned to be received in income tax revenue.
Despite the increase in the rate of economic growth, the government needs to further reduce the incidence of tax evasion to meet the 2014 state budget execution, because 2014 state budget expenditures are nearly one billion GEL more than in 2012. Failure to comply with the 2013 budget was due to the fact that taxes could not be mobilized. Tax evasion and the share of the country’s economy in the black market remain the greatest cause of economic problems for the government, which, unfortunately, the Government of Georgia’s international partners and donors no longer mention.
2.2. Other revenue streams: There are significant declines in the collection of other revenues (78.9%). Other revenues mainly include non-tax revenues, revenues from property, from the sale of goods and services, and from fines/penalties among other areas. The decline in other revenues does not indicate that there are problems in the economy, although other revenues have declined by GEL 180 million in 2014 compared to 2012. The government must analyze the causes of the continued decrease in other revenues.
2.3. Government employee compensation: It is worth noting that in the first six months of 2014, the Government of Georgia spent approximately 12.5% (GEL 70 million) more on employee compensation in comparison with the first six months of 2013. This obviously raises the question of what is the added value of the additional GEL 70 million spent on employee compensation in the first six months of 2014. It is noteworthy that while this increase in expenditures of GEL 70 million occurred in the first six months of 2014, in 2013 compensation of government employees had already risen by 13.6% (GEL 138.14 million) compared to 2012.
Taking into consideration that in the government sector salaries have not reached the threshold above which growth in compensation would be unwise , increased compensation would be fully justified if the rise in compensation is motivated by the desire to create a better-paid, professional civil service. Still, due to a lack of statistics, it is impossible to say whether the rise in public sector compensation is caused by a rise in the number of public servants or their salaries.
Figure 5: Civil service compensation in Q1-2, 2013-2014 (in GEL million)
2.4 Concealment of budgetary information: In the first five months of 2014, the spending of approximately GEL 5 million from the regional projects fund and the government’s contingency fund was not disclosed on projects implemented in the regions by order of the Prime Minister and governmental decrees. Although we asked both the State Chancellery and the Ministry of Finance for the information we have not heard from them in connection with these expenditures. As such, both have disregarded the state secrets act by which the government must indicate in which sphere and for what purpose concealed funds are spent.
2.5 The regional development fund: Despite the fact that from its inception in February of 2013 the Regional Development Fund was established to define the criteria and procedures by which local self-government and regional development projects were to be selected and financed, of which accountability was an import factor, certain projects being implemented by the Regional Development Fund have nothing in common with this goal, e.g. the renovation/rehabilitation of the Writer’s House, which was partially financed through this fund.
3. Positive changes
3.1. Optimistic budget planning: As we noted in Government spending priorities in 2012-2014: Analysis and recommendations, in 2014 compared with 2012, the government’s tax revenue increased by approximately half a billion GEL, while planned expenditures have increased by approximately one billion GEL. This indicates that the current government is more optimistic in planning the budget than the previous government. In Government spending priorities in 2012-2014: Analysis and recommendations, we welcomed this transition from pessimistic to optimistic budget planning. This being said, it is problematic that a large portion of the execution of the 2014 optimistic plan will be implemented through deficit spending, which will result in a 95.7% rise in budget deficit spending compared with 2013 budget deficit levels. Hopefully, the cause of the optimistic budget planning in 2013-2014 is not only the fulfillment of pre-electoral promises, but rather an intended improvement in the tax administration, and as a result, a decline in the level of tax evasion. We welcome optimistic planning of the executive’s budget even when this may result in a shortfall.
3.2. Improved budget execution reporting: 2014 saw a significant improvement of budget execution reporting by the Ministry of Finance, e.g., the section on the execution of health and social affairs programs gives the number of beneficiaries, which up to and including 2013 had not normally been the case. The next step must be public spenders requesting funds for their programs based on the number of beneficiaries. The fact that public spenders have consistently failed to base their fund requests on the number of beneficiaries has caused the country’s budget system to malfunction on numerous occasions.
1. The government should take into account its experience with the 2013 budget as well as the costs of delays in spending and should react in a timely manner with adequate policy changes. For example the government should: (1) eliminate the causes which led to GEL 114.12 million not being spent on infrastructure projects in the first and second quarters of 2014. (2) if, for example, from the beginning of Quarter 3, the government begins to notice that it is underspending the universal health care appropriation, an adequate response would be the government taking on more costs by co-funding more of patients’ out-of-pocket expenses or including more diseases and medical conditions in the program;
2. The government should examine the causes of the continuing tendency towards decline in non-tax revenues;
3. The government must ascertain which spending agencies (which infrastructure projects) are responsible for the halt in grants and credits from international organizations and governments to ensure that a similar situation does not recur in the future. For example, it was not possible to spend the full GEL 189 million on infrastructure projects in 2013, and it was not possible to spend GEL 151.05 million (37.48%) of the GEL 402.33 million in grants and credits intended for infrastructure projects in the first six months of 2014;
4. The government should pay particular attention to discouraging tax evasion in the private sector;
The Ministry of Regional Development and Infrastructure should take into account the causes which led it to its failure to spend GEL 114.12 million in the first and second quarters of 2014.
By analogy with marginal product of labor (MPL), we mean an upward change in performance of the public administration that results from an increase in compensation. To attract better skills, the government can increase compensation in the public sector to a point when the marginal product of the increase equals zero.