Afghanistan has an unusual fiscal structure reflecting its history of conflict and current reconstruction efforts. Public expenditures are extraordinarily high (57% of GDP in 2004/05). Domestic revenues are among the lowest in the world at 5% of GDP, and the country’s fiscal deficit is entirely financed by foreign aid. In this context, Afghanistan’s development depends on building an effective and self sufficient public finance system. This report recommends an agenda for establishing a fiscal framework that supports the development of a legitimate, effective State that facilitates growth, adequate service delivery and poverty reduction.
A review of Afghanistan’s development strategy and recent economic performance sets the stage to assess how management of public finances contributed to achieving recent economic progress. The chapter outlines some key public finance issues that need urgent attention, including extremely low domestic revenues, poor service delivery, and the fact that most public spending occurs outside government channels. Three quarters of public expenditure in 2004/05 was carried out by donors. The chapter also makes the case for the importance of public finance management for Afghanistan’s development.
An assessment of Afghanistan’s PFM conducted in June 2005 reveals a public sector where financial resources are, by and large, being used for their intended purposes, with government expenditures reported regularly. At the same time, inefficiencies regarding spending allocations across sectors were found. Weaknesses in procurement and the accountability framework are also identified.
Currently, domestic revenues cover less than half of Afghanistan’s recurrent budgetary expenditures. In addition, large amounts of recurrent expenditures are directly spent by donors. While this gives Afghanistan an opportunity to temporarily soften its budget constraint, a medium-term framework to ensure fiscal sustainability is crucial. The main drivers of Afghanistan’s public expenditures are discussed, and financing options considered. Several illustrative medium-term fiscal scenarios are presented.
A tax gap is the difference between taxes actually paid and what should be paid. With a tax gap in the order of 60%, Afghanistan needs to adopt a comprehensive strategy to improve compliance, including revamping the tax administration. An outline of Afghanistan’s existing revenue base is followed by a summary of key issues to improve tax policy and a discussion on revenue collection prospects.
With Afghanistan facing immense needs in most sectors, prioritization is crucial. An analysis of expenditure patterns and trends precedes a discussion on how to determine priority expenditures across and within sectors. Key questions are addressed, such as “What is the right sequencing between competing priorities? And what are the most effective interventions?” Another key issue is the need to ensure appropriate financing to operate and maintain new investments.
The budget is a political and strategic development tool. It is a key instrument to implement policies, prioritize public spending and manage external aid. Obstacles to making this a reality in Afghanistan include the dominant share of donor financed expenditures outside government systems, lack of a medium-term fiscal strategy, and limited capacity in line ministries. More participation of lower levels of government in the budget process is also needed.
For the quality of spending to improve, Afghanistan needs to ensure that funds reach service delivery units, a serious weakness in most sectors. The new Procurement and Public Expenditure and Financial Management Laws need to be implemented, and the audit function must be strengthened. This will also help increase trust in the budget process among the Afghan people, private sector, and donors. The chapter also outlines issues and priorities for reducing corruption.
Analysis of different modes of service delivery yields some lessons for Afghanistan. Performance-based contracts in the health sector appear to be an effective mechanism to deliver services. Private sector participation has stimulated growth in telecommunication services. There are less positive experiences such as the failure to provide non-salary budgets to schools. Lessons for organizing effective service delivery are summarized, and issues related to sub-national levels of government administration are discussed from a service delivery perspective.
The trade off between the need for quick fixes to deliver effective public services and the longer-term goal of developing national institutions is at the core of this chapter’s discussion. An agenda to develop the government’s capacity is outlined, followed by a review of reforms at the Ministry of Finance and the challenge of building capacity to manage public finances in line ministries, provinces, and municipalities.
The main challenges discussed throughout the report are summarized here. A five-point agenda to strengthen and reform the PFM system is put forward. For efforts to be successful, the Government first needs to develop and reach agreement on its national development strategy, which would then be translated each year into annual plans to facilitate implementation.
Volume 1: Managing Public Finances for Development
Volume 2: Improving Public Financial Management and Procurement
Volume 3: Improving Public Financial Management: Key Cross-Cutting Issues
Volume 4: Improving Public Financial Management: Case Studies of Selected Sectors
Volume 5: Improving Public Financial Management in the Security Sector
World Bank Program
Website maintained by the World Bank Office in Kabul, a launching pad to all information on World Bank activities in the country (strategy, projects, publications, etc.)
A wide range of social and economic measures on Afghanistan, including links to the World Bank's most important online development databases.
Analysis and Research
Compilation of all the World Bank's publications on Afghanistan, with 'search' options and links to analysis and research on other South Asian countries.
World Bank Program in South Asia
Launching pad to all information on World Bank activities in Afghanistan, Bhutan, Bangladesh, India, Maldives, Nepal, Pakistan, and Sri Lanka.
Interview with the Author
World Bank report co-author William Byrd speaks about the report's main findings.
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