Lead Author: Pablo Saavedra February 2008 The Programmatic Public Finance Review (PFR) (in two phases) has the objective of addressing key issues in public finance that face Ukraine today and recommending options for reform within a consistent, and pro-growth, macro-fiscal framework. The PFR covers the following selected areas and issues: (i) the identification of options for broadening the tax base and improving compliance to allow gradually reducing the tax burden; (ii) the identification of options for achieving expenditure savings in selected areas of the budget; (iii) the estimation of the likely fiscal impact of key reforms to the pension system; (iv) the identification of weaknesses in the process of capital budgeting and the provision of options for its strengthening; (v) the identification of weaknesses (and incomplete reforms) in the intergovernmental fiscal framework and of options for its improvement; (vi) the identification of options for achieving higher levels of efficiency in public spending on health and education; and (vii) the evaluation of the process of local capital budgeting. The first four objectives were covered in PFR Phase I, and the latter three are covered in this report (PFR Phase II).
1. THE NEED FOR IMPROVING INTERGOVERNMENTAL FISCAL RELATIONS AND REFORMING SERVICE DELIVERY: SETTING THE SCENE
Ukraine’s macroeconomic performance in recent years has been solid, with growth around 7.5 percent per annum on average between 2000 and 2007. This performance has been supported by three factors: (i) the level of utilization with excess capacity, which acts as a productivity reserve despite significant obstacles to private sector investment and rising real wage costs; (ii) the positive external environment, with metal prices that are well above their historical averages, a significant appetite among international investors for emerging market risks, and a strong regional business cycle driven by the sustained expansion in both Russia and the new EU member states; (iii) the gradual progress made in structural reform, in particular the stabilization efforts in 2000 combined with increasing transparency in the corporate sector since 2005, and a development vision (despite political volatility) that includes closer integration with Europe as its key policy direction.
2. IMPROVING INTERGOVERNMENTAL FISCAL RELATIONS IN UKRAINE
Ukraine is a unitary state with, broadly, three tiers of local government, namely (i) oblasts, (ii) rayons and cities, and (iii) villages and settlements. Local budgets are funneling close to 40 percent of the consolidated budget, and in some categories of spending such as wages and fixed investments, more than half of the consolidated budget (see Chapter 1). However, this is not an indication of the true level of fiscal decentralization or local spending autonomy in Ukraine, as this chapter demonstrates.
3. OVERCOMING FISCAL, EFFICIENCY, AND EQUITY CHALLENGES IN PUBLIC HEALTH SPENDING
Although several health indicators have been improving over the last five years (e.g., infant mortality, maternal mortality), others have remained stagnant or have deteriorated (e.g., mortality of males aged 25-39, incidence of tuberculosis and HIV). Moreover, Ukraine continues to face challenges with regard to broader health system outputs and outcomes such as improving efficiency in service provision, reversing the decline in life expectancy, reducing the incidence of catastrophic health expenditures, and reducing inequities in access to effective health care coverage. On balance, most of the indicators for Ukraine under-perform those for the new EU member countries (referred to in this report as the EU-10).
4. OVERCOMING FISCAL, EFFICIENCY, AND EQUITY CHALLENGES IN PUBLIC EDUCATION SPENDING
In Ukraine, the state is the main provider of education services at all levels and private participation is negligible. In recent years public expenditures on education have grown rapidly in real terms and absorb a high proportion of public expenditures. However, this growth is coupled with worrisome (and increasing) levels of inefficiency in education provision (at all levels). At the same time, the quality enhancing inputs and investments necessary to modernizing the system and to making it more responsive to market needs are under-provided. The inefficiency arises from a variety of sources, particularly in relation to financing, administration and intergovernmental fiscal relations (the bulk of public education spending takes place through local budgets). In parallel, inequalities are surfacing owing to increasing out-of-pocket payments (OOP) and structural governance issues of the system.
5. STRENGTHENING CAPITAL BUDGETING IN LOCAL GOVERNMENTS
Local governments have a large role in infrastructure investments in Ukraine. One-third of the total capital expenditures are made through local budgets, and more than half of the resources intended exclusively for (fixed) capital investments are spent at the local level. Investments in the housing and communal sector (which includes heating, water, and sanitation) and in the health care and education sectors are made mostly through local budgets. In addition, other important sectors such as transport (mainly roads), social assistance, and agriculture also depend significantly on local government budgets. Moreover, investment needs at the local level are estimated to be large over the next 10 years (on the order of US$25 billion).
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