99559 M croeconomics & Fisc l M n ement Glob l Pr ctice GEORGIA PUBLIC EXPENDITURE REVIEW Selected Fisc l Issues GeorGiA Public Expenditure Review seLected FiscAL issUes Macroeconomics and Fiscal Management Europe and Central Asia Region Abbreviations and Acronyms AA Association Agreement MIGA Multi-Lateral Guarantee Agency APMA Agriculture Projects Management MDF Municipal Development Fund Agency MIP Medical Insurance Program CEQ Commitment to Equity MOF Ministry of Finance CIPR Center for Inter-American Policy and MRDI Ministry of Regional Development and Research Infrastructure CIS Commonwealth of Independent States NQF National Qualification Framework CIT Corporate Income Tax OECD Organization for Economic Cooperation DCFTA Deep and Comprehensive Free Trade Area and Development ECA Europe and Central Asia PER Public Expenditure Review EU European Union PIT Personal Income Tax FDI Foreign Direct Investment PP Percentage Points GDP Gross Domestic Product PPP Public Private Partnership GEL Georgian Lari RPIF Regional Projects Implementation Fund Geostat State Department of Statistics of SSA Social Services Agency Georgia TSA Targeted Social Assistance IMF International Monetary Fund VAT Value Added Tax LEPLs Legal Entities of Public Law VSP Village Support Program M&E Monitoring and Evaluation UHC Universal Healthcare System Abbreviations and Acronyms iii GEORGIA—GOVERNMENT FISCAL YEAR January 1–December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective as May 11, 2015) Currency Unit 5 Georgian Lari (GEL) US$1.00 5 2.3338 GEL Vice President: Laura Tuck Country Director: Henry G. Kerali Senior Director: Marcelo Giugale Director: Satu K. Kahkonen Sector Manager: Miria A. Pigato Program Leader: Rashmi Shankar Task Team Leader: Congyan Tan, Mariam Dolidze iv Georgia Public Expenditure Review Contents Acknowledgements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . x A. Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . x B. Key Findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi Chapter 1: Macroeconomic and Fiscal Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 A. Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 B. Recent Macroeconomic Developments and Vulnerabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 C. Fiscal Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 D. Spending Benchmarked . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 E. The Way Forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Chapter 2: Enhancing Equity with Fiscal Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 A. Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 B. Revenue and Expenditure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 C. Explaining the Redistributive Effect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 D. Redistributive Effect: Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 E. Redistributive Effect: Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 F. Impact of Fiscal Activities on Inequality and Poverty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 G. The Way Forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Chapter 3: Evaluating Agriculture Programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 A. Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 B. Agriculture in Georgia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 C. The Agriculture Card Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 D. The Agro Credit Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 E. Evaluation of Programs and Areas for Improvements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 F. The Way Forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Chapter 4: Subnational Expenditure Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 A. Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 B. Institutional Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 C. Subnational Expenditure Trends and Composition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 D. Subnational Capital Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 E. Preschool Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 F. The Way Forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Contents v List of Tables Table E.1: Distributional Impact of Fiscal Policies in GEL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi Table E.2: Policy Options for Consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xii Table 1.1: Macroeconomic Trends and Projections, 2010–18 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Table 1.2: Medium Term Consolidated Fiscal Framework, 2010–18 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Table 1.3: Selected Social Programs Introduced or Scaled-Up in 2013–15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Table 1.4: Debt Sustainability Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Table 2.1: General Government Revenues in Georgia, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Table 2.2: General Government Expenditures in Georgia, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Table 2.3: Explaining Tax Progressivity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Table 2.4: Regressivity of Indirect Taxes, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Table 2.5: Explaining Spending Progressivity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Table 2.6: Distributional Impact of Fiscal Policies in GEL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Table 2.7: Poverty and Inequality Indicators at Each Income Concept . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Table 2.8: Gini Coefficient for Each Income Concept Compared across CEQ Countries . . . . . . . . . . . . . . . . . . . . . 22 Table 2.9: US$2.5/Day Poverty in Percentage for Each Income Concept, CEQ Countries . . . . . . . . . . . . . . . . . . . 23 Table 3.1: Card Program Benefits 2013–15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Table 3.2: Summary of Card Program Expenses and Beneficiaries 2013–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Table 3.3: Components of the Credit Program, 2013–15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Table 3.4: Products Purchased with Agro Cards, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Table 3.5: Lending Activities under the Credit Program, 2013–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Table 4.1: Local Government Characteristics and Spending (in GEL), 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Table 4.2: The Composition of Preschool Education Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Table 4.3: Additional Fiscal Cost of Eliminating Preschool Fees, Million GEL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 List of Figures Figure 1.1: Drivers of Growth, 2008–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Figure 1.2: Growth Projections for ECA Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Figure 1.3: Revenues, Expenditures and Fiscal Deficits, 2008–15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Figure 1.4: Economic Classification of Consolidated Government Expenditures, 2009–14 . . . . . . . . . . . . . . . . . 4 Figure 1.5: Functional Classification of Central Government Expenditures, 2009–14 . . . . . . . . . . . . . . . . . . . . . . 4 Figure 1.6: Budget Execution, 2009–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Figure 1.7: Realignment from Capital to Social Spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Figure 1.8: Social Spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Figure 1.9: Government Expenditures and GDP per Capita, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Figure 1.10: Social Spending across Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Figure 1.11: Efficiency Scores for Social Protection Spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Figure 1.12: Efficiency Scores for Health Spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Figure 2.1: Composition of Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Figure 2.2: Social Spending and Subsidies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Figure 2.3: Concentration Curves for Progressive and Regressive Transfers and Taxes . . . . . . . . . . . . . . . . . . . . 14 Figure 2.4: Definitions of Income Underpinning the CEQ Fiscal Incidence Analysis . . . . . . . . . . . . . . . . . . . . . . . . 14 vi Georgia Public Expenditure Review Figure 2.5: Kakwani Progressivity Coefficients for Direct Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Figure 2.6: Labor Income Tax and Exemptions, as Share of Disposable Income by Decile . . . . . . . . . . . . . . . . . . 15 Figure 2.7: Labor Income Tax, Exemptions, and Direct Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Figure 2.8: Indirect Taxes as Share of Disposable Income by Decile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Figure 2.9: VAT and Exemptions, as Share of Disposable Income by Decile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Figure 2.10: Indirect Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Figure 2.11: Tax Collection by Deciles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Figure 2.12: Tax System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Figure 2.13: Social Spending, as Share of Disposable Income by Decile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Figure 2.14: Social Spending, Concentration Curves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Figure 2.15: Direct Transfers Progressivity, International Comparison . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Figure 2.16: In-Kind Transfers: Education . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Figure 2.17: In-Kind Transfers: Health . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Figure 2.18: Distribution of TSA Spending by Deciles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Figure 2.19: Concentration Curves for MIP, UHC, and Consolidated UHC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Figure 2.20: Social Spending, Concentration Coefficients . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Figure 2.21: Efficiency of Direct Transfers, Change in Poverty Headcount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Figure 2.22: Efficiency of Direct Transfers, Change in Gini . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Figure 2.23: Efficiency of Direct Transfers, by Poverty Reduction per Billion GELs Spent . . . . . . . . . . . . . . . . . . 24 Figure 2.24: Efficiency of Direct Transfers, by Gini Reduction per Billion GELs Spent . . . . . . . . . . . . . . . . . . . . . . 24 Figure 2.25: Simulated Property Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Figure 3.1: Agriculture Sector Output, 2006–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Figure 3.2: Sown Areas by Region, 2010–13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Figure 3.3: Agriculture Sector GDP and Land Plowed, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Figure 3.4: Imports of Inputs to Agriculture, 2009–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Figure 3.5: Total Loans Outstanding to the Agriculture Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Figure 3.6: New Agricultural Loans as Percentage of Total New Commercial Loans . . . . . . . . . . . . . . . . . . . . . . . . 33 Figure 3.7: Average Monthly Interest Rates and Spreads . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Figure 3.8: Food-Processing Agribusiness Output . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Figure 4.1: Local and Central Government Spending by Function, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Figure 4.2: Local and Central Government Spending by Function, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Figure 4.3: Local Government Capital Expenditures, 2012–15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Figure 4.4: Revenue Sources of Local Governments, 2012–15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Figure 4.5: Share of Wages in Total Expenditures by Local Governments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Figure 4.6: Share of Wages in Total Expenditures by Local Governments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 Figure 4.7: Local Government Capital Spending Variances, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Figure 4.8: Population and Capital Spending per Capita, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Figure 4.9: Local Government Populations, Socially Vulnerable Populations and Spending, 2013 . . . . . . . . . . 44 Figure 4.10: RPIF Spending, 2013 and 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 Figure 4.11: MDF Spending by Recipient Population, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 Figure 4.12: Preschool Education Spending, Shares and Population, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 Figure 4.13: Education Spending, Million GEL, and Share of LSG Spending, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Figure 4.14: Fiscal Impact of Parental Fee Elimination by Region . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 Contents vii List of Boxes Box 2.1: How Progressive Will the New TSA and UHC Become? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Box 2.2: How Georgia’s Tax System Could Do More for the Poor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Box 2.3: The Use of the BOOST Tool for Fiscal Incidence Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Box 4.1: Temporary Norms under the New Self-Governance Code . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 Box 4.2: Guidelines for Public Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Box 4.3: Accountability Mechanisms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 viii Georgia Public Expenditure Review Acknowledgements This Public Expenditure Review was prepared by a team led by Congyan Tan and Mariam Dolidze, and consisting of Anton Dobronogov, Peter Goodman, Cesar A. Cancho, Elena Bondarenko, Tigran Kostanyan, Irina Capita, Hirut Wolde, Rachel L. Jiang, Lidia Ceriani, Vincent Morabito, and Xavier Jaravel, with a much appreciated support from Zakia Nekaien-Nowrouz and Sarah Nankya Babirye. The team is grateful for comments and advice from Mona Prasad, Gabriela Inchauste, Nora Lustig, Nistha Sinha, Lili Liu, William Dillinger, and Julian A. Lampietti. The team is grateful for overall guidance provided by Henry G. Kerali, Satu K. Kahkonen, Miria A. Pigato, Ivailo V. Izvorski, and Rashmi Shankar. The team gratefully acknowledges the excellent collaboration of the Georgian authorities, development partners, as well as the support and guidance of peer reviewers Sebastian Eckardt, David M. Gould, and Blanca Moreno-Dodson. The Georgia BOOST database was constructed with financial support from the BOOST Public Expenditure Trust Fund under the ECA Public Financial Management Multi Donor Trust Fund and the Gates Trust Fund which is gratefully acknowledged. Acknowledgements ix Executive Summary A. OVERVIEW government needs to consolidate spending on less productive programs while increasing the effective- Georgia has an impressive growth record but social ness of spending. In this respect the Government of vulnerabilities persist. Georgia is a lower middle Georgia has requested the Bank to inform and provide income country with a per capita GDP of US$3,681 recommendations on public spending, in particular on (2014). Following intense pro-market reforms, the selected government programs. economy registered fast growth averaging nearly 6 percent during the past decade. Poverty developments This programmatic Public Expenditure Review have been encouraging. The poverty rate at US$2.5/ (PER) assesses the alignment of selected fiscal day fell from 47 percent in 2010 to 36 percent in 2013 programs with the government’s social objectives. and 35 percent (projected) in 2014. The reduction in Building on the analysis and recommendations of poverty is mainly attributable to government trans- the 2014 PER, this PER analyzes the impact of recent fers, food disinflation and increased earnings. Despite reforms including the social programs that were either the reduction in poverty, large urban-rural disparities introduced or scaled up in 2013. It gives an overview persist with rural poverty being nearly double that of of the recent macroeconomic and fiscal developments, the urban areas. The current government has there- including the fiscal implications of the social pro- fore made spending on social sectors and agriculture grams (Chapter 1). As requested by the government, a high priority and has launched a decentralization it addresses three questions in the rest of the report: reform to support regional inclusive growth.. (1) has the realignment of spending toward social sec- tors resulted in better distributional outcomes; (2) have It remains a challenge to tackle social vulnerabili- the agriculture support programs been targeted at pro- ties within a sustained macroeconomic frame- ductivity growth to support real incomes in poor rural work. The government has intensified its efforts regions; and (3) what is the fiscal and equity impact of to reduce social vulnerability, as evidenced by the the ongoing decentralization process? The first ques- increase in social spending from 7.1 percent of GDP tion is addressed by combining micro household survey in 2012, to 9.6 percent in 2014. As a result, the fis- data with administrative fiscal data to analyze the dis- cal deficit widened from 2.8 percent of GDP in 2012 tributional impact of both taxes and government spend- to 3.0 percent in 2014. The increase in the deficit in ing on poverty and inequality in Georgia (Chapter  2). 2014 was also driven by a larger wage bill and elec- The second question is addressed by comparing the tion related local government spending. GDP growth cost of new agriculture programs with their estimated recovered to 4.8 percent in 2014 largely supported impact on agricultural productivity (Chapter 3). Finally, by policy certainty and the signing of the Association the issue of regional inequalities is partially addressed Agreement (AA) with the European Union (EU) which in this report by discussing three different aspects of led to an increase in private investment and public the current decentralization process: the expected fis- consumption. The spillover effects from the slowdown cal impact of decentralization, the need to rationalize in Russia and anemic growth in the EU adversely current capital grant programs to make public invest- impacted Georgia in the fourth quarter of 2014 and ment more effective, and the implications of introduc- this trend is likely to continue in 2015. In response ing free preschool education administered at the local to the widening fiscal deficit and slowing growth, the government level (Chapter 4). x Georgia Public Expenditure Review Table E.1: Distributional impact of fiscal policies in GEL Quintiles Poorest II III IV Richest All Number of People 734,948 735,013 735,050 734,317 735,748 3,675,077 Market Income Per Capita 425 1,055 1,822 2,926 6,924 2,631 All Taxes (–) 159 193 299 512 1,234 480  Indirect Taxes 157 177 230 297 495 272  Direct Taxes 2 16 69 215 738 208 All Transfers (+) 693 630 533 488 378 545  Direct Transfers 546 492 400 363 270 414  In-kind Transfers 147 138 133 125 108 130 Indirect Subsidies (+) 1 3 5 10 24 9 Final Income Per Capita 965 1,495 2,061 2,913 6,092 2,706 Source: Staff calculations based on IHS (2013). Note: This table illustrates how the fiscal interventions in Georgia impact different quintiles of the income distribution in terms of GELs. The market income is the income before fiscal interventions and the final income is the income after. Fiscal interventions in general are equalizing in Georgia: the per capita income of the bottom 60 percent increased moving from market to final income, in particular the income per capita of the poorest 20 percent more than doubled, while the income of the top 40 percent was reduced. B. KEY FINDINGS poorest. Social benefits, such as Tbilisi city benefits, are not well-targeted to the poor. From an equity per- The fiscal incidence analysis shows that overall fis- spective, it would be preferable to consider reforms to cal policy in Georgia contributes to reducing pov- make indirect taxes more equalizing. Moreover, since erty and improving equity. The burden of taxes falls the TSA targets the poor very well and has signifi- on the richest and social spending has resulted in a siz- cantly reduced poverty and inequality, it would also be able increase in the incomes of the poor (Table E1). In advisable for other pro-poor programs to incorporate other words, taxation, especially the personal income TSA’s targeting mechanism. In-kind transfers such as tax (PIT), and social spending are overall progressive. healthcare and preschool services are also less equal- Furthermore, fiscal policy in Georgia has commendably izing than other programs. In this case inducing the reduced income inequality and poverty—reductions rich to use private healthcare and preschool services that in fact are the largest ever achieved in the devel- could make these programs more equalizing. oping countries so far included in the CEQ project.1 The main driver of this success is the system of direct The agriculture programs have generated ben- transfers, led by the Targeted Social Assistance (TSA) efits as expected. The Agriculture Card Program for program. Yet even though overall fiscal policy in gen- farmers introduced in 2013 has contributed to an eral has been equalizing, the burden of Georgia’s indi- expansion of cultivated land, an increase in yields, rect tax system (VAT and excise taxes) falls more on the and growth in agricultural GDP. Other benefits have poorest than it does to other CEQ countries. Current included more investment in inputs and machinery VAT exemptions also do not make the tax more equal- and a closer relationship of farmers with input suppli- izing. Furthermore, not all social benefits reached the ers. While this program will be completed at the end of 2015, the experience has generated valuable lessons, including a recognition of the need for better target- 1 Led by Nora Lustig since 2008, the Commitment to Equity ing, a clearer timeline and a monitoring and evaluation (CEQ) project is an initiative of the Center for Inter-American system. The large number of loans supported by the Policy and Research (CIPR) and the Department of Econom- Credit Program contributed to a substantial increase ics at Tulane University, the Center for Global Development and the Inter-American Dialogue. For more details visit www in agricultural loans. The key benefit has been a bet- .commitmentoequity.org. ter access to finance due to a reduction in banks’ risks Executive Summary xi and lower interest rate charges. Additional benefits helping them to choose and execute public investments, have included the opportunity for farmers to establish within a phased time frame. The rules on capital expen- a credit history with a bank and the opportunity for ditures in the new Self Governance Code is expected to banks to build their own agricultural lending experi- stimulate a budgeted increase of capital spending in the ence. Although the government used this tool to stim- largest cities. This may exacerbate regional spending ulate commercial bank lending to support growth in inequality, since the largest cities have more own-source the agriculture sector, subsidizing interests has the revenues. In addition, under the new Budget Code that unintended consequence of distorting the agricultural became effective in late 2014, the envisioned sharing lending market; in the future, policies could move of income taxes between local and center is estimated from lowering financing costs to addressing the fun- to add to local government own-source revenues an damental risks that agriculture is exposed to. Finally, amount equivalent to 13 percent of the current income these agriculture programs led to a surge in agricul- tax revenues. The introduction of free preschool educa- ture spending, which so far accounted for a small part tion has brought more equity in access to education but of the budget. has generated additional costs for local governments. More importantly, given the differences in capacity The decentralization reform has significant impli- across municipalities and cities, fee removal could pos- cations for subnational fiscal policies. As most of the sibly exacerbate preschool inequalities. The temporary poor live in rural areas and regional disparities are high, norms for the number of local government employ- regional development and fiscal decentralization have ees and spending on wages and salaries are expected come to be viewed as useful mechanisms for supporting to bridge some of the gaps in hiring and spending on inclusive growth. Capital grants allocated from the cen- wages, but they are likely to introduce uneven fiscal ter have traditionally had a prominent role in regional adjustments across local governments. development. However, with more fiscal resources and responsibilities delegated to local governments, there is Table E.2 summarizes the key recommendations a need to gradually build local government capacities, of the three chapters of the report. Table E.2: Policy options for consideration Policy Area Option for Consideration Likely Impact Enhancing n Revisit and reduce the list of VAT exemptions to focus more on equity. n More equalizing tax system. equity with n Utilize the targeting mechanism from the Target-ed Social Assistance n Improved targeting and effectiveness fiscal policies (TSA) program to enhance targeting and poverty reduction. of pro-poor programs. n Introduce incentives for wider use of private services rather than n More pro-poor in-kind services. public services for more affluent population, such as healthcare. Improving n Institutionalize a monitoring and evaluation (M&E) component. n Improved evaluation mechanism. agriculture n Develop information management system via the National Agency of n Improved targeting of the programs. programs Public Registry (NAPR) cadaster. n Improved overall targeting and n Design future agriculture support programs with improved targeting, performance of agricultural programs. high quality input, clear timeline, complementary advisory services, n Reduced agricultural risks. and M&E components. n Develop agricultural insurance to address agricultural risks. Strengthening n Develop guidelines for the selection and implementation of n More responsibility and higher subnational investment projects, gradually decentralizing decision-making on capacity of the local governments expenditures project selection and funding allocation, develop accountability in selection and implementation of mechanisms, and capacity building in relevant skills for local officials. projects. n Develop national standards for quality and spending per child for n More equitable preschool education preschool and put in place mechanisms to secure equitable preschool across local governments. funding using conditional grants, mandating specific budget provision, or both. xii Georgia Public Expenditure Review CHAPTER 1 Macroeconomic and Fiscal Challenges A. Overview B. Recent Macroeconomic Georgia is now facing the challenge to sustain its Developments and good performance in growth and poverty reduc- Vulnerabilities tion after it made significant progress in 2010–13. In Georgia enjoyed a period of stellar growth in 2013 the economic growth slowed due to policy uncer- 2010–12 after a fiscal stimulus was put in place tainty that followed the transition of government. In the to counter the global financial crisis in 2009. After first three quarters of 2014 growth picked up, but it came FDI inflow slowed down and the economy contracted under pressure in the fourth quarter as the regional eco- by 3.8 percent in 2009, the authorities responded with nomic environment severely deteriorated. Since Russia’s countercyclical fiscal measures, financed by a large slowdown affected Georgia’s remittance inflows, and the international crisis assistance package. Aided by high terms of trade worsened against its trading partners, public investment bolstering the recovery, GDP growth both Georgia’s exports and remittances started to fall, averaged 6.6 percent a year for 2010–12 (Table 1.1). leading to a much lower growth projection in 2015. As a Total investment more than doubled in 2009–12, dur- result, the pace of poverty reduction is also likely to slow. ing which high public spending bolstered the recovery, Georgia’s economy is still vulnerable to future shocks, and private investment, exports, tourism, and bank which underscores the need for fiscal buffers. lending picked up (Figure 1.1). Fiscal pressures are emerging as spending on In 2013, economic growth moderated to 3.3 per- social programs increases and needs for capital cent due to government transition. The transition investment continue. The government prioritized of government was associated with considerable social programs and introduced a range of new pro- uncertainty, which translated into subdued economic grams and policies, such as universal health care growth. In late 2012 the new government was elected and agriculture programs. It also raised pension and but election of the president did not take place till social assistance benefits, abolished parental pre- October 2013. The new prime minister resigned at school fees, and partially exempted low-income work- that time, just one year after he was elected, and the ers from income taxes. All of these programs came current prime minister was appointed in November. In into full operation in 2014, generating a significant 2013 investment contracted by 14.5 percent, and the fiscal impact. Meanwhile there seems to have been a fall was more acute for government financed invest- realignment from capital to social spending. It is vital ment. Meanwhile, private consumption was noticeably to sustain the progress of continued spending in capi- resilient, thanks to falling inflation, growing wages, tal, health and education to enhance long-run growth and expanding consumer lending. and address Georgia’s pending infrastructure needs while ensuring job creation for poverty reduction. In 2014, as private investment and government spending recovered, output expanded by 4.8 per- This chapter is structured as follows: The next sec- cent. Greater policy certainty and Georgia’s signing of tion sets out the macroeconomic challenges. Section C the Association Agreement (AA) with the European discusses fiscal development and the fiscal impact of Union (EU) supported this recovery. Gross invest- the new programs and policies, and Section D pre- ment recovered from 24.8 percent of GDP in 2013 to sents spending benchmarks to assess their cost and 29.8 percent in 2014, driven by significant growth in efficiency. Section E outlines policy recommendations. Macroeconomic and Fiscal Challenges 1 Table 1.1: Macroeconomic trends and projections, 2010–18 2010 2011 2012 2013 2014e 2015p 2016p 2017p 2018p Actuals Projections   (Percent change, unless otherwise indicated) National Accounts GDP nominal (in billion GEL) 20.7 24.3 26.2 26.8 29.1 31.2 33.8 37.1 40.8 Real GDP growth 6.2 7.2 6.4 3.3 4.8 2.0 3.0 4.5 5.0 Consumer price index 7.1 8.5 –0.9 –0.5 3.1 5.0 4.5 4.0 4.0 GDP per capita (in U.S. dollars) 2,623 3,231 3,523 3,600 3,681 3,073 3,223  3,434 3,711 Gross investment (in percent of GDP) 21.6 26.2 28.9 24.8 25.9 20.6 22.0 23.7 24.8 Gross national saving (in percent of GDP) 11.3 13.9 17.3 19.0 16.2 12.2 12.7 15.1 17.2   (In percent of GDP, unless otherwise indicated) General Government Operations Revenues and grants 28.3 28.2 28.9 27.7 27.9 27.6 27.8 27.9 27.9  Tax revenues 23.5 25.2 25.5 24.8 25.1 24.8 25.0 25.1 25.3 Expenditure and net lending 34.8 31.8 31.7 30.2 30.9 31.2 31.1 30.8 30.6  Current expenditure 26.4 22.9 24.9 24.1 25.4 25.3 25.1 24.7 24.4 Capital expenditure and net lending   8.4 8.8 6.8 6.1 5.5 5.9 6.0 6.1 6.3 Overall fiscal balance –6.5 –3.6 –2.8 –2.6 –3.0 –3.6 –3.3 –3.0 –2.8 Total public debt 38.7 33.6 32.3 32.2 33.4 37.3 37.4 36.7 36.0   (In percent of GDP, unless otherwise indicated) External Sector Current account balance –10.3 –12.3 –11.7 –5.8 –9.7 –8.5 –9.3 –8.6 –7.5 Exports of goods and services   34.9 36.4 38.2 44.7 42.9 46.0 47.2 49.4 51.7 Imports of goods and services   52.7 55.5 57.8 57.6 60.4 63.0 64.7 65.7 66.8 FDI (net) 5.8 6.2 3.9 5.1 6.5 7.2 7.3 7.3 7.4 Foreign exchange reserves 4.4 4.3 3.8 3.6 3.7 3.2 3.3 3.4 3.5 (Months imports of goods and services) (In millions of dollars) 2,264 2,818 2,873 2,823 2,694 2,492 2,760 3,173 3,449 Source: Georgian authorities; and Bank staff estimates and projections. private investment, particularly in construction. Capi- from Russia, and exports to Russia had become a tal spending by the government also improved slightly major driver of export growth since the Russian mar- from 5.0 percent of GDP in 2013 to 5.5 percent. Mean- ket reopened in 2013. Between November 2014 and while government spending expanded by 4.7 percent, February 2015, the Georgian lari appreciated against as the government started to scale up social programs. the currencies of its main trading partners: namely the Russian ruble, the Ukrainian hryvnia, the Azer- However, a steep deterioration in the external baijan manat, and the Turkish lira. Remittances from environment poses significant downside risks to and exports to Russia dropped in the fourth quarter growth. Growth of the region’s largest economy, Rus- of 2014, lowering quarterly growth to 1.8  percent, sia, stagnated in 2014 and in the fourth quarter of year-on-year. 2014 the ruble depreciated sharply as a result of lower oil prices and sanctions. This exposed Georgia to both With projected growth below trend and high demand and terms-of-trade shocks, since Georgia macro risks, fiscal policy needs to remain pru- traditionally received about half of its remittances dent while supporting growth. Georgia’s economy is 2 Georgia Public Expenditure Review Figure 1.1: Drivers of growth, 2008–14 Figure 1.2: Growth projections for ECA countries (Percent) (Percent) 15% 10.0 10% 8.0 6.0 5% 4.0 0% 2.0 –5% 0 B M E H R R O Z Z DA B KD M S R R RU KG KA AZ AL UZ BG BL TU UK GE BI AR RO –2.0 M M –10% –4.0 –15% –6.0 –20% –8.0 2008 2009 2010 2011 2012 2013 2014f 2014e 2015f GDP Final consumption Gross ϐixed capital formation Source: Bank staff calculations. Change in inventories Net export GNFS Statistical discrepancy Figure 1.3: Revenues, expenditures and fiscal deficits, 2008–15 Source: Estimates based on Geostat statistics. 40 10 20 8 expected to grow by 2 percent in 2015 and 3 percent in 2016. Pressures on the external sector are likely to 0 6 continue for the next year or so. Political uncertainty –20 4 could re-emerge as the 2016 parliamentary elections are approaching. Over the medium-term, improved –40 2 economic ties with the EU and the reforms outlined in –60 0 the government’s development strategy are expected 2008 2009 2010 2011 2012 2013 2014e 2015p to support economic growth. In such an environment Revenues of political and external uncertainties, fiscal policy Expenditures and net lending Fiscal deϐicit, right axis must remain tight while supporting growth and main- taining macroeconomic stability. Source: MOF and staff calculations. Act came into effect which bans any new state tax or C. Fiscal Developments rate increase without a referendum, exception for Since 2011 VAT, income tax, profit tax and excises excises. In addition, the government also allowed tax have accounted for about 24–25 percent of GDP. exemptions for low-income earners. In 2015 the gov- VAT was the largest single source of revenues in 2014 ernment has budgeted a higher rate for excise taxes at 46 percent of the total; income tax contributed to on cigarettes and alcohol, and added a new excise on 27 percent, profit tax to 12 percent and excises 11 per- international calls. As a result, a 5  percent increase cent. The shares of these taxes in total revenues have in tax revenues is budgeted for 2015 and in the first largely been stable over time. A new amendment of the quarter, collections outperformed the target. tax code allowed a certain amount of income tax to be On the spending side, after a large stimulus in exempt for low-income workers.2 In 2014, the Liberty 2009, the government successfully consolidated recurrent spending in 2010–12 which reduced the 2 Employees pay a flat income tax rate of 20 percent in Georgia. fiscal deficit from 9.2 percent of GDP in 2009 to 2.8 Individuals not earning more than GEL6,000 in taxable income percent in 2012. The fiscal stimulus in response to in salary within a year are entitled to make a GEL1,800 deduc- tion from employment income and claim a tax refund by means the 2008-09 crises led to a fiscal deficit of 9.2 percent of filing a tax return to the Georgian tax authorities. of GDP in 2009. During 2010–12, growth rebounded, Macroeconomic and Fiscal Challenges 3 revenues grew, and the government undertook fiscal in 2013, since the cost of the new programs budgeted consolidation to restore fiscal buffers. By 2012, the for the first time were not well-known before execu- deficit was reduced to 2.8 percent of GDP. As shares tion, both recurrent and capital spending were largely of GDP, the general government consolidated spend- under-executed, the former by 7 percent and the latter ing on wages by 0.8 percentage points (pp), goods by 14 percent (Figure 1.6). This was in effect a spend- and services by 0.5  pp, and social benefits by 0.7 pp ing consolidation equivalent to 2.2 percent of GDP, respectively from 2010–12 (Figure 1.4). In the central reducing the fiscal deficit to 2.6 percent of GDP. government, spending on general administration fell The policy changes introduced in 2013 came into mostly by 1.6 percent of GDP, mainly because of lower full effect in 2014, contributing to an increase in transfers from the central government to subnational recurrent spending and widening in fiscal deficit. governments (Figure 1.5). With the government transition in 2012 came a shift in fiscal policy to scale up social assistance. Figure 1.5: Functional classification of central government expenditures, 2009–14 The government elected in 2012 made spending on social programs a major priority. In February 2013, 40% a noncontributory Universal Health Care (UHC) pro- 6.9 30% gram was introduced and gradually rolled out through 2.6 6.2 5.9 6.2 7.4 the year. TSA benefits went up in mid-2013, and in Sep- 1.8 4.3 2.4 2.0 2.3 2.5 6.8 20% 2.5 2.5 tember pension benefits were raised by 20 percent. 4.7 3.7 1.5 3.7 1.4 3.7 1.8 2.2 4.0 3.4 3.4 That year the Agriculture Card program also went 10% 4.8 3.2 3.5 3.3 3.2 3.1 2.9 2.7 2.3 into operation, distributing grants to small farmers to 8.8 8.7 7.5 7.1 2.2 6.4 6.1 fund agricultural inputs and machinery services (see 0% Chapter 3). The personal income tax (PIT) exemption 2009 2010 2011 2012 2013 2014 to refund tax to low-income taxpayers was announced. General Administration Healthcare Although most new programs began in the middle of Defense Recreation, culture the year and did not make full impact in 2013, the Public Safety and religion Education increase in social spending was already visible as it Economic affairs Environmental protection Social protection rose from 7.1 percent of GDP to 8.5 percent. However, Housing and community amenities Source: Ministry of Finance. Figure 1.4: Economic classification of consolidated government expenditures, 2009–14 40% Figure 1.6: Budget execution, 2009–14 35% 100% 5.8 30% 6.4 5.3 4.7 3.8 3.3 80% 25% 5.3 4.8 4.5 4.8 4.3 5.2 20% 8.4 60% 7.8 9.6 15% 6.8 7.1 8.5 3.4 1.8 1.7 2.0 40% 10% 2.0 2.2 6.1 5.5 5.0 5.0 3.8 3.9 5% 20% 5.8 5.4 4.7 4.6 5.2 5.2 0% 2009 2010 2011 2012 2013 2014 0% 2009 2010 2011 2012 2013 2014 Net acquisition of NFA Other expenses Current expenditures Capital expenditures Social beneϐits Grants Subsidies Interest Source: MOF and BOOST.3 Goods and services Wage bill Source: Ministry of Finance. 3 The Georgia BOOST database is a micro fiscal public expendi- Note: Net acquisition of NFA 5 purchase of NFA-sale of NFA. ture database developed by the World Bank. 4 Georgia Public Expenditure Review Table 1.2: Medium term consolidated fiscal framework, 2010–18 2006 2007 2008 2009 2010 2011 2012 2013 2014e 2015p 2016p 2017p 2018p (% of GDP) Revenues and Grants 26.7 29.2 30.7 29.3 28.3 28.2 28.9 27.5 27.9 27.6 27.8 27.9 27.9  Tax Revenues 22.9 25.8 24.9 24.4 23.5 25.2 25.5 24.8 25.1 24.8 25.0 25.1 25.3  Grants 1.2 0.6 3.2 2.2 2.3 0.9 1.0 0.8 1.0 1.1 1.0 0.9 2.6 Other Revenues   2.6 2.8 2.5 2.7 2.5 2.1 2.4 2.1 1.8 1.7 1.9 1.8 2.6 Total Expenditure 29.7 33.9 37.1 38.5 34.8 31.7 31.7 30.1 30.9 31.2 31.1 30.8 30.6 Current Expenditure   20.7 25.0 28.3 30.1 26.4 23.0 23.2 24.3 25.4 25.3 25.1 24.7 24.4 Compensation of    4.1 4.0 5.3 5.8 5.4 4.7 4.6 4.7 5.2 4.8 5.0 5.0 5.0 Employees Purchases of Goods    5.6 9.3 8.5 6.1 5.5 5.0 5.0 3.8 3.9 5.9 6.1 6.1 6.1 and Services   Interests 0.8 0.6 0.6 1.0 1.0 1.2 1.0 0.9 0.9 1.0 0.9 0.7 0.6   Subsidies 2.8 2.3 2.7 2.3 1.8 1.8 2.0 2.1 2.1 1.7 1.6 1.5 1.4   Grants 0.0 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1   Social Benefits 5.1 5.0 7.2 8.4 7.8 6.8 7.1 8.4 9.6 9.6 9.3 9.3 9.2   Other Expense 2.3 3.7 3.9 5.2 4.8 3.5 3.6 4.3 3.6 2.2 2.0 2.0 2.0  Capital Expenditure 9.0 8.9 8.8 8.4 8.4 8.8 8.4 6.0 5.5 5.9 6.0 6.1 6.3   Capital 7.8 8.6 8.0 8.0 7.4 7.7 7.3 5.1 5.1 5.7 5.9 5.9 6.1   Net Lending 1.2 0.3 0.8 0.4 1.0 1.1 1.1 0.9 0.4 0.2 0.1 0.2 0.2 Overall Fiscal Deficit –3.0 –4.7 –6.4 –9.2 –6.5 –3.5 –2.8 –2.6 –3.0 –3.6 –3.3 –2.9 –2.8 Real 2008 Lari, Million Revenues and Grants 4,431 5,444 5,854 5,372 5,515 5,902 6,412 6,303 6,697 6,823 7,078 7,424 7,781  Tax Revenues 3,800 4,810 4,753 4,479 4,576 5,267 5,658 5,684 6,025 6,131 6,366 6,679 7,068  Grants 199 112 617 397 444 192 230 177 240 272 255 239 726  Other Revenues 431 522 484 497 495 443 524 484 432 420 484 479 726 Total Expenditure 4,929 6,320 7,081 7,067 6,790 6,635 7,029 6,899 7,418 7,713 7,919 8,195 8,549  Current Expenditure 3,435 4,661 5,396 5,525 5,155 4,802 5,155 5,570 6,097 6,254 6,391 6,572 6,817 Compensation of    680 746 1,008 1,070 1,053 976 1,020 1,077 1,248 1,187 1,273 1,330 1,397 Employees Purchases of Goods    929 1,734 1,614 1,128 1,070 1,040 1,101 871 936 1,459 1,553 1,623 1,704 and Services   Interests 133 112 121 175 194 247 215 206 216 247 229 186 168   Subsidies 465 429 512 429 357 366 436 489 504 420 407 399 391   Grants — 19 12 15 12 11 14 13 24 25 25 27 28   Social Benefits 846 932 1,379 1,537 1,526 1,421 1,575 1,925 2,304 2,373 2,368 2,475 2,570   Other Expense 382 690 750 963 941 741 794 986 864 544 509 532 559  Capital Expenditure 1,494 1,659 1,685 1,542 1,635 1,833 1,874 1,368 1,320 1,459 1,528 1,623 1,760   Capital 1,294 1,603 1,524 1,468 1,448 1,605 1,625 1,169 1,224 1,421 1,493 1,578 1,713   Net Lending 199 56 161 73 187 228 249 199 96 38 34 45 47 Overall Fiscal Deficit –498 –876 –1,227 –1,694 –1,275 –733 –617 –596 –720 –890 –840 –772 –768 Source: MOF data and staff calculations. Macroeconomic and Fiscal Challenges 5 Fiscal deficit rebounded to 3.0 percent of GDP in 2014. are expected to rise: a 12 percent increase is bud- Total state spending grew by 12 percent. The UHC geted for healthcare expenditures in 2015, driven by program represented 2 percent of GDP and the new higher drug coverage; pension benefits are expected agriculture card and credit programs amounted to to rise again, leading to a 4 percent increase, but that nearly 0.4 percent of GDP (Table 1.3). The income is smaller than a year ago; there will be a major revi- tax rebate for low-income workers was estimated to sion to improve the targeting and coverage of the TSA reduce 2014 revenues by 0.4 percent of GDP. Spending program but the total cost will go up only slightly. For on existing programs also went up significantly: pen- agriculture, the budgeted costs for the card and credit sion spending registered a GEL186 million increase, programs are not expected to rise, and a new insur- reflecting the full-year impact of the September 2013 ance program was designed that has a smaller budget benefit increase, equivalent to 0.7  percent of 2013 (GEL10 million). Spending on general education is also GDP. Higher TSA benefits contributed to a 30 per- expected to rise by 14 percent because higher salaries cent increase in spending on social programs other are viewed as an integral component of the envisioned than pensions (0.5 percent of 2013 GDP). Moreover, reform to improve teacher quality. after parental fees were removed, local governments The major increase in social spending did not lead faced a 19 percent increase in preschool spending.4 All to a widening of fiscal deficit as capital spending these changes led to a spending increase equivalent to moderated. In 2010–12 capital expenditures aver- 2.9 percent of 2013 GDP. aged 8 percent of GDP. In 2013–14 as social spending The high level of social spending will be sus- expanded, capital spending contracted by 2.7 pp of tained in 2015. Spending on a number of programs GDP (Figure 1.7). Not only were central government capital expenditures lower, but capital transfers to 4 The projected increase for 2015 also reflects the wage increase local governments also declined. In the 2015 budget, of kindergarten teachers in Tbilisi. capital spending will stay below 6 percent of GDP and Table 1.3: Selected social programs introduced or scaled-up in 2013–15 (In GEL million and percent of GDP) 2014 2015 (Budgeted) 2012 2013 In Percent In Percent Million GEL Million GEL Million GEL of GDP Million GEL of GDP Total Expenditure, State 7,668 7,313 8,178 28.0 8,302 26.1 Budget Programs Initiated and 1,805 2,197 2,965 10.2 2,984 9.4 Scaled Up from 2013: Health Care Programs 333 436 588 2.0 656 2.1 Tax Subsidies to Low- 127 0.4 N/A N/A income Population Agro Credit Program 7 64 0.2 30 0.1 (Interest Subsidies) Agriculture Card Program 50 0.2 50 0.2 Agriculture Insurance 0 0.0 10 0.0 Pensions 1,068 1,149 1,335 4.6 1,390 4.4 Social Programs other than 330 490 636 2.2 651 2.0 Pensions (incl. Assistance) Preschool (Kindergartens) 74 115 165 0.6 197 0.6 Note: General Education 372 469 436 1.5 498 1.6 Source: MOF and staff calculations. 6 Georgia Public Expenditure Review Figure 1.7: Realignment from capital to social spending Figure 1.8: Social spending (Percent of GDP) (Percent of GDP) 9.1 7.7 8.0 0.72 7.1 1.05 2.00 6.1 5.3 1.63 1.95 0.94 4.11 4.43 Social spending Social spending Capital expenditures 2010–12 average 2013–14 average excluding health including health and net lending Pension (old age) Social assistance 2010–12 average 2013–14 average Health Other social Source: Ministry of Finance. Source: Ministry of Finance. over the medium term the government envisions that public debt is highly concessional, interest payments it will be in the range of 5–6 percent. average only about 1  percent of GDP a year. Interest Over the medium term the government is expected rates on nearly 75 percent of external public debt are to expand revenue sources and cut back on recur- fixed, which reduces the interest rate risk. In addition, rent spending. The government is committed to fis- the government is increasing the share of domestic cal consolidation. The Liberty Act limited the fiscal borrowing in total lending. The 2014 Debt Sustainabil- deficit on government operations (current spending) ity Analysis (DSA) confirmed that debt indicators are to 3 percent of GDP and total expenditures to below within prudent thresholds (Table 1.4). 30 percent. Under this act, the government also cannot easily increase tax rates, so spending needs to be cur- tailed in future. The government plan is to consolidate D. Spending Benchmarked spending by making spending on social benefits more Compared to other governments in ECA, the Gov- efficient, reforming management of public investment, ernment of Georgia has a relatively small budget and limiting administrative expenses, while keeping envelope. Its spending constitutes a smaller share capital spending at 5–6 percent of GDP. The deficit is of GDP than that of most other countries in the ECA expected to come down to 2.8 percent of GDP by 2018 region and, than the average for shares of countries in from 3.6 percent in 2015. Fiscal consolidation is cen- Africa (AFR), Latin America and the Caribbean (LAC), tral to the International Monetary Fund (IMF) Stand- East Asia and the Pacific (EAP); it is less than two- By Arrangement and the continuing Development thirds of the average shares of spending in GDP of the Policy Operation with Georgia. To achieve the desired Organization for Economic Cooperation and Develop- outcomes, it will be crucial to make social spending ment (OECD) countries. With a small budget it is more more effective and support the government in build- important for the government to allocate resources ing institutions and capacity to conduct the programs. efficiently to address Georgia’s priorities. Georgia’s public debt remains low and sustainable. But Georgia’s surging social spending equals that In 2014 about 80 percent of public debt was external. of richer countries. Though still much lower than the Given the steep depreciation of the lari against the OECD average, Georgia’s social spending in GDP, 9.6 U.S. dollar and the need to finance a larger deficit in percent in 2014, has reached the level of richer coun- 2015, total public debt is likely to go up from 33.4 per- tries such as Korea (Figure 1.10). In general there is cent of GDP in 2014 to 37.3 percent in 2015. However, a positive association between social spending and spending on interest is likely to go up only slightly and the level of development—more developed countries repayment risk will remain low, since the country’s contribute a larger proportion of spending on social external debt is dominated by long-term multilateral objectives. Given its small spending envelope, Geor- (70 percent) and bilateral (20 percent) debt. Since gia allocated an even bigger part of its total spending Macroeconomic and Fiscal Challenges 7 Table 1.4: Debt sustainability analysis 2011 2012 2013 2014p 2015p 2016p 2017p 2018p Actuals Projections (Percent of GDP) Total Public Sector Debt 33.6 32.3 32.2 33.4 37.3 37.4 36.7 36.0  External Public Sector Debt 29.1 27.5 29.5 26.9 30.9 31.5 31.2 30.4  Domestic Public Sector Debt 4.5 4.8 2.7 6.5 6.4 5.9 5.5 5.6 Gross External Debt (including 77.8 82.2 81.8 83.3 95.0 91.6 87.3 81.7 Inter-company Loans) Source: Georgian authorities; Bank staff estimates and projections. Figure 1.9: Government expenditures and GDP Figure 1.10: Social spending across countries per capita, 2013 (Percent of GDP) 60 25 SVN Total government expenditures to GDP 20 50 UKR BIH HUN SRB HRV 15 MNE BLR CZE OECD MDA EAP POL 40 AZE TUR LVA EST 10 KGZ MKD BGR SVK AFR ALB ROU RUS LTU 30 TJK 5 UVK LAC ARM GEO 0 20 KAZ 14 a Tu l ey ile gi ea 20 ico 2 CD a a a i ric in di ni –1 az r rk Ch So 20 OE x to In Ch Ge Ko Br 10 Af e Es M a h ut or a 10 gi or Ge 0 Pension (old age) 0 5000 10000 15000 20000 25000 30000 35000 40000 Health GDP per capita, PPP Other social spending incl. income support Source: IMF WEO. Source: OECD Social Expenditure Database and staff calculations. compared to richer countries to reach the current level for TSA’s fiscal incidence analysis). However, with its of social spending. In this case, taking into account efficiency more than 35 percent behind the best there GDP per capita, Georgia spent more on social than its is still room for improvement, based on the Data Enve- developing country peers. And compared to the others lope Analysis (DEA) (Figure 1.11).5 And Georgia lags with similar shares of social spending, Georgia spent behind EU countries on health spending outcome relatively more on noncontributory pensions and less indicators in 2012. Countries that are most efficient in on health. Benchmarking shows that Georgia’s spending on 5 In the DEA analysis, government’s expenditures in a certain activity (e.g., TSA) are identified as “input” and performance social assistance is among the most efficient, how- measures of this activity (e.g., poverty) are identified as “out- ever its health spending could improve. Based on put.” Efficiencies are measured comparing outputs with inputs: 2013 social spending and the poverty reduction results, DEA picks “frontier” countries that are most efficient at produc- Georgia’s social assistance stands out as the most effi- ing outputs from given inputs, and measures the efficiency of other observed countries by comparing them to this frontier. cient in the region in reducing poverty. This result is The resulting efficiency scores give a gauge of how countries are largely consistent with micro analysis (see Chapter 2 performing relative to their peers. 8 Georgia Public Expenditure Review Figure 1.11: Efficiency scores for social protection spending Single input-multiple output DEA: Input 5 social protection spending; output 5 poverty head count and Gini MKD MNE MDA ARM HUN GEO ROU UKR BGR KAZ ALB BLR POL SRB KGZ LTU EST LVA TJK 0.63 0.20 0.21 0.24 0.24 0.27 0.27 0.28 0.31 0.32 0.32 0.35 0.36 0.38 0.39 0.53 0.64 0.93 1.00 Least efϐicient Most efϐicient Source: Bank staff estimates based on the World Bank’s SPEED databased. Figure 1.12: Efficiency scores for health spending Multiple input-output DEA: Input 5 total health spending (2012); output = “infant mortality rate,” “health adjusted life expectancy (HALE)” and “incidence of tuberculosis” MDA ROM ARM HUN SWE DNK UKR DEU NLD HRV AUT GBR BGR GEO FRA GRC SVN BLR POL PRT KGZ BEL SVK LUX LTU CZE EST ESP LVA FIN TJK IRL ITA 0.40 0.55 0.58 0.60 0.62 0.62 0.63 0.64 0.69 0.69 0.69 0.70 0.71 0.73 0.78 0.78 0.79 0.80 0.82 0.84 0.84 0.85 0.87 0.95 0.95 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Least efϐicient Most efϐicient Source: Bank staff estimates based onWDI and BOOST databases. health spending would achieve the same level of health The government needs to maintain the level of sector performance with only 55–66 percent of Geor- productive spending, in particular capital invest- gia’s current spending (Figure 1.12). Georgia’s spend- ment, even when more resources are being used ing is primarily driven by high out-of-pocket private to fund social programs. Georgia still has many seri- spending on health. However, with the government ous infrastructure needs, especially after signing the rolling out its UHC program, out-of-pocket spending Association Agreements including the agreement on is likely to drop in coming years, which is expected to Deep and Comprehensive Free Trade Area (DCFTA). improve health spending efficiency. The government needs a clear rule that keeps capital investment higher than 5 percent of GDP, to sustain its good past progress in improving infrastructure. E. The Way Forward There is room to make spending more efficient as There are stiff headwinds to Georgia’s growth and government expenditures expand. This is particu- a challenging regional environment, making it larly important given the government’s limited fiscal particularly important to build up fiscal buffers space. The government can begin by continuing its against shocks. The recent surge in social spend- reform of public investment management and setting ing and slower growth has limited Georgia’s fiscal limits on administrative spending. space, making the economy more vulnerable to future shocks. Although the current level of capital spending allows some flexibility to respond to shocks, it is desir- able to further increase fiscal buffers. Macroeconomic and Fiscal Challenges 9 CHAPTER 2 Enhancing Equity with Fiscal Policies6 A. Overview benefits, the Gini coefficient improved from 0.48 to 0.37. Direct taxes reduced Gini by only 0.015 points, This chapter presents a fiscal incidence analysis and cash transfers pushed Gini further down by to identify the beneficiaries of government expen- another 0.07 points. Poverty at the US$2.5/day line7 ditures when the government spends and the fell from 20.3 to 7.7 percent after direct taxes slightly distribution of tax burden when the government increased poverty, but direct transfers reduced it by imposes taxes. The aim is to obtain a comprehensive more than 13 percentage points. view of the redistributive effect of taxes and spending items. We used the response to Integrated Household The best candidate for tackling the challenge of Survey of 2013, and the 2013 budgetary data. The poverty reduction and inequality from the spend- central questions are (1) How much redistribution ing side of the budget would be the Targeted and poverty reduction is accomplished through taxes, Social Assistance (TSA) program. Normalized by social transfers and subsidies? (2) How progressive the amount of spending, Georgia’s direct transfers led are revenue collection and government spending? the rate of reduction in poverty and inequality in the and (3) Within the limits of fiscal sustainability, what group of countries for which fiscal incidence analy- changes in taxation and spending could increase redis- sis was done. TSA is also one of the programs that tribution and poverty reduction? best target the poorest. Simulations reveal that the expected revisions of TSA benefit rule assignment will A wide range of fiscal activities were analyzed. make the program better targeted. Since TSA is very Among them are taxes (personal income, property, cost-effective, the government could consider utilize value-added, and excise taxes), direct transfers (pen- some of the existing TSA mechanism to improve the sions and social assistance programs), in-kind transfers targeting of other programs, especially the less well- (preschool, general, and tertiary education, UHC, and targeted benefit programs. It is also important to targeted medical insurance), the Agricultural Card pro- recognize, however, the important role that pensions gram, and Tbilisi city benefits and subsidies. The impact have in reducing poverty, in spite of not being the most of government programs on poverty and inequality var- efficient one. Pensions are responsible for two thirds ies. The TSA best targets the poorest Georgians; bene- of the observed reduction due to direct transfers. fits of other pro-poor measures such as the low income tax exemption, and Tbilisi benefits and subsidies are In what follows, the next section lays out the taxes more widely distributed across population. and expenditure line items for the fiscal incidence analysis. Section C explains the methodologies and In Georgia poverty and inequality have been con- tools used. Section D assesses fiscal activities in terms siderably reduced by fiscal activities. Comparing of redistribution. Section E discusses the impact of fis- poverty rates and Gini before and after the fiscal inter- cal activities on poverty and inequality. Section F links ventions of taxes, direct and in-kind transfers, and poverty reduction with program costs to assess effi- ciency, and Section G outlines policy recommendations. 6 Led by Nora Lustig since 2008, the Commitment to Equity (CEQ) project is an initiative of the Center for Inter-American Policy and Research (CIPR) and the Department of Economics at Tulane Uni- 7 Estimates based on per-adult equivalent consumption. They dif- versity, the Center for Global Development and the Inter-American fer from ECAPOV estimates based on consumption per capita Dialogue. For more details visit www.commitmentoequity.org. (36 percent in 2013). 10 Georgia Public Expenditure Review B. Revenue and Expenditure Table 2.1: General government revenues in Georgia, 2013 Georgia’s total revenues amount to 28 percent of (Percent of GDP) GDP; 60 percent are from VAT and personal income Included in tax revenues. Tax revenue represents about 25 per- Incidence cent of GDP. VAT accounts for 10.6 percent of GDP and 2013 Analysis personal income tax (PIT) for 7.2 percent. There are six Total General Government 27.7 21.0 taxes in Georgia, of which five (PIT, corporate income Revenue tax (CIT), VAT, excise tax, and import tax) are nation-  Tax Revenue 24.8 21.0 wide and one (property tax) is local. Georgia imposes no   Direct Taxes 11.1 7.9 capital gains,8 inheritance, gift, wealth (except for prop- Personal Income Tax     7.2 7.9 erty), property transfer, social, branch remittance, or Corporate Income Tax     3.0 ... other taxes. The Liberty Act of 2011 bans introduction Other Direct Taxes:     0.9 0.03 of new state taxes or increases in existing taxes without Property Taxes a nationwide referendum, except for the excise tax. This   Indirect Taxes 13.6 13.1 institutional restriction along with smaller average rev-    VAT 10.6 11.5 enue than its ECA peers limits the government’s ability Specific Excise Duties     2.7 1.6 to affect the distribution of income.9    Customs Duty 0.3 ... Based on available data in the household survey,   Other Taxes 0.1 ... the analysis looks primarily at four major taxes—  Non-tax Revenue 2.9 ... PIT, property tax, VAT and excise duties on alcohol, Sources: Treasury, Ministry of Finance of Georgia, Geostat, and tobacco and fuel. Together they make up about 86.2 staff calculations. percent of total general government tax revenues. The CIT, other non-classified taxes, and revenues from 8 Capital gains used in the analysis are tax exempt, but some capi- other sources that are not captured by the household tal gains are subject to tax, please refer to the Tax Code of Geor- survey are not part of the analysis. Nor are social con- gia for more information. tributions, because Georgia does not have a contribu- 9 Average general government revenue in middle-income ECA countries amounted to 34.9 percent of GDP in 2013, based on tory pension system. Customs duty is omitted because ECA Regional Tables (2014). it is not possible to identify whether a purchase was Figure 2.1: Composition of taxes (Percent of GDP, ranked by GNI per capita) 30% 16000 14000 GNI per capita Share of GDP 25% 12000 20% 10000 15% 8000 10% 6000 4000 5% 2000 0% 0 ad (20 ) ( 3) El or (20 ) ne (2 ) (2 1) 2) ( n Br (2 ) ug l (2 ) M ay ( 09) (2 9) 0) em (2 ) 0 Ge ala 09 1 ca 10 Ur azi 010 at ia 11 a Sa gia 1 1 In en 201 si 01 01 ic 00 01 Co fric Jord 0 Ri 20 0 Gu liv 20 ex 2 Bo ia ( Am r do a a st a o o i op u hi A lv a Et h ut So Direct Tax* Indirect Tax GNI per capita (2011 PPP, right axis) *Direct taxes include Corporate Income Tax collections in addition to PIT. Sources: Armenia (Younger et al., 2014), Bolivia (Paz et al., 2014), Brazil (Higgins and Pereira, 2014), Ethiopia (Hill et al., 2014), Indonesia (Jellema et al., 2014), Mexico (Scott, 2014), Peru (Jaramillo, 2014), Uruguay (Bucheli et al., 2014), and South Africa (Inchauste et al., 2014). Georgia (GNI: HDRO calculations based on data from World Bank (2014), IMF (2014) and United Nations Statistics Division (2014) and own estimations). Enhancing Equity with Fiscal Policies 11 Figure 2.2: Social spending and subsidies (Percent of GDP, ranked by GNI per capita) 16% 16000 14% 14000 12% 12000 GNI per capita Share of GDP 10% 10000 8% 8000 6% 6000 4% 4000 2% 2000 0% 0 (2 ) 3) Ge la ( 9) 1) 1) 2) st a (2 ) 0) Ur zil ( 0) M y (2 ) (2 ) 0) ) 10 0 09 9 11 ad 01 01 0 en 01 1 So ord 201 1 Ri 01 1 00 20 em 20 ne 20 Af (20 Br (20 20 Bo (20 2 at a ( Am r ( do ia ( ( Sa ia a ca o an ia o ua Gu livi si Co ic ic a rg op a r ex ug o hi lv a J Et h ut In El Direct Transfer Education Health Subsidies GNI per capita (2011 PPP, right axis) Sources: Armenia (Younger et al., 2014), Bolivia (Paz et al., 2014), Brazil (Higgins and Pereira, 2014), Ethiopia (Hill et al., 2014), Indonesia (Jellema et al., 2014), Mexico (Scott, 2014), Peru (Jaramillo, 2014), Uruguay (Bucheli et al., 2014), and South Africa (Inchauste et al., 2014). Georgia (GNI: HDRO calculations based on data from World Bank (2014), IMF (2014) and United Nations Statistics Division (2014) and own estimations. an import; moreover, duties represent only a small the sample. Most of its poverty reduction in the past share of government revenues. two years was attributable to its social assistance. General spending of the government is also Most transfers are included in the analysis, small compared to the average for middle-income based on data from the survey and administrative ECA countries, amounting to about 29  percent sources. Government social benefits are included of GDP in 2013.10 However, spending on direct and will be used to gauge the impact of direct trans- cash transfers (e.g., pensions) and on in-kind trans- fer payments on poverty and inequality.12 The analy- fers tend to be uneven. Social spending in Georgia sis also covers all in-kind transfers associated with is among the highest in the region, accounting for public provision of education. Major health pro- 12 percent of GDP,11 because in 2013 the government grams, namely Targeted Medical Insurance (MIP) and made social expenditures a priority and increased the UHC, are also analyzed; the health care expendi- pension and TSA benefits. Georgia’s social protec- ture data in the survey will be complemented with tion system is financed entirely out of general rev- the eligibility requirements for each health program enues and accounts for about 42 percent of total outlined by Social Service Agency (SSA) of Georgia.13 public spending; social benefits, especially spending on pensions, are the largest component. Compared to 12 The survey reports the following government transfers: old age the largest “spenders”—Bolivia, South Africa, Costa pension, disability pension, loss of bread-winner pensions, tem- Rica and Brazil—identified in the CEQ analysis, Geor- porary disability benefits (due to illness, childbirth), assistance gia spends twice as much on direct transfers but only for socially vulnerable families (TSA), pensions of disabled vet- about half as much on education and health. Geor- erans, and participants in a war, or pensions with equal status and other special pensions, household assistance for single gia’s subsidy spending is also among the highest in pensioners and disabled persons, and assistance for internally displaced people (IDPs). 10 Average general government expenditure in middle-income 13 The survey reports the following expenditures on health care: ECA countries accounted for 36.6 percent of GDP in 2013. ECA outpatient treatment for chronic or disabled patients, outpa- Regional Tables (2014). tient treatment for any disease (other than chronic), impatient 11 The definition of social spending is based on CEQ methodology treatment, maternal and child health, dental services, preven- to ensure comparability across countries. tive inspection, therapeutic appliances, and equipment. 12 Georgia Public Expenditure Review Table 2.2: General government expenditures in Georgia, 2013 (Percent of GDP) Included in 2013 Incidence Analysis Total General Government Expenditure 28.80 11.2  Primary Government Spending 27.90 11.2   Social Spending 12.11 10.0    Total Cash Transfers 6.11 5.1     Old Age Pension (Non-contributory) 4.28 4.3     Social Security of Sick and Disabled Individuals 0.01 0.01     Targeted Social Assistance 1.77 0.8    In-kind Transfers 5.19 4.0     Education 2.80 2.5     Health 1.83 1.50      Targeted Medical Insurance (Mip) 0.9 0.9      Universal Health Care (Uhc) 0.3 0.6     Housing and Urban 0.56 ...    Other Social Spending 0.82 1.0   Non-social Spending (incl. Public Sector Pensions) 15.80 1.08    Agricultural Cards 0.71 0.7    Program of Communal Subsidies 0.14 0.14    Subsidized Public Transportation 0.24 0.25 Sources: BOOST database based on Ministry of Finance data and staff calculations. These items together account for 11.5 percent of GDP and the Kakwani index—to measure the degree of pro- and 40 percent of total government spending. gressivity,14 and uses concentration curves to present that graphically (Figure 2.3). C. Explaining the Income concepts are developed to estimate the inci- Redistributive Effect dence of every tax and benefit. The analysis follows the methodology described in Lustig and Higgins (2013) to Fiscal incidence analysis studies how fiscal mea- estimate the income before fiscal intervention—market sures (taxes, transfers, etc.) shape income distribu- income and compare it with net market, disposable, tion within an economy. In general, fiscal measures post-fiscal and final incomes (Figure 2.4). These mea- that improve equity are considered progressive and sures generate different income distributions, which those that reduce equity are considered regressive. By makes it possible to estimate headcount poverty rates definition, a transfer that gives poorer people higher before and after each fiscal intervention. This in turn benefits is progressive and one that gives lower ben- makes it possible to judge at each stage how equitably efits is regressive, in absolute terms. A transfer that distributed household income is relative to situations gives poorer people a higher benefit as a share of their where public interference is absent. income is progressive and one that gives lower bene- fits as a share of income is regressive, in relative terms. Similarly, a tax that charges poorer people less as a 14 The concentration coefficient is positive when it is larger than the shares of their income is progressive and one that market income Gini. The Kakwani index, defined for taxes as the charges them more is regressive. The analysis also tax concentration coefficient minus the market income Gini, will looks at two indicators—concentration coefficients be positive if a tax is progressive and negative if it is regressive. Enhancing Equity with Fiscal Policies 13 Figure 2.3: Concentration curves for progressive and regressive transfers and taxes Transfer progressive in absolute terms Cumulative proportion of beneϐits, taxes or income 45 degree line; population share. Transfer: neutral in absolute terms Tax: upper bound of regressive Transfer: progressive in relative terms; Tax: regressive Transfer: regressive; Market Income Lorenz curve; Transfer or tax: neutral in relative terms if on this line 0 Cumulative proportion of population (ordered by market income) 1 Source: Lustig and Higgins (2013). Figure 2.4: Definitions of income underpinning the CEQ fiscal incidence analysis Market Income ‫ ؍‬Im TRANSFERS Wages and salaries, income from capital, and TAXES properties, private transfers; imputed rent, value of self-consumption before government taxes and transfers ؊ Direct Taxes: personal income taxes (PIT), property and capital taxes. Net Market Income ϭ In Direct transfers: pensions, social assistance, ؉ scholarships, other minor transfers, agricultural vouchers Disposable Income ϭ Id Indirect subsidies: ؊ Indirect taxes: ؉ Tbilisi transportation and VAT, excise taxes utilities Post-ϐiscal Income ϭ Ipf In-kind transfers: free or subsidized ؉ government services in education and health Final Income ϭ If Source: World Bank staff elaboration based on Lustig and Higgins (2013). 14 Georgia Public Expenditure Review D. Redistributive Effect: Taxes are concentrated at the bottom rather than spread evenly (Figure 2.6). Wage earners with salaries less Georgia’s direct tax is progressive, but less so than than GEL6,000 are entitled to deduct GEL1,800 from most countries in the CEQ sample. Direct taxes in the their taxable income and to receive a refund. Labor incidence analysis include taxes on labor income, profit income taxes also contain exemptions for specific and property. Among these taxes, labor income tax is socio-demographic groups such as single mothers and the largest component. The Kakwani index covering persons with disability. Without the exemptions, labor progressivity shows that although Georgia’s direct tax income tax would still be progressive but less so. is progressive, it is less progressive than all the other countries in the CEQ group except South Africa (Fig- Georgia’s indirect tax system is more regressive than ure 2.5). This is largely driven by the fact that the Geor- those of its CEQ peers. For both VAT and excises, effec- gia’s labor income tax is design as a flat tax (with a rate tive rates were estimated using declared consumption.15 of 20 percent). In addition, household surveys usually Although VAT, excise taxes, and indirect taxes overall are do not capture the top of the income distribution well, more concentrated in the highest deciles, their distri- where property tax, capital tax, and property income bution is less disproportionate than disposable income tax payments are concentrated. Since taxes paid are (Table 2.4), so that the poor tend to spend more on concentrated in the top of the income distribution, labor income tax, and direct taxes as a group, are progressive. 15 For VAT, the analysis considers the VAT exemptions defined in the Tax Code, including health and educational services, books, finan- The income tax exemption for low-income earners cial services, and agricultural produce. Excises are estimated for enhanced progressivity of income tax. Exemptions consumption of mobile phone services, fuel, alcohol, and tobacco. Table 2.3: Explaining tax progressivity Progressive Regressive Neutral payment payment Taxes income higher for richer people income higher for poorer people Same distribution as the income Concentration Coefficient (CC) CC . 0, CC . income Gini CC . 0, CC , income Gini CC 5 income Gini Kakwani Index (KI) 5 KI . 0 KI , 0 KI 5 0 CC-Market Gini Everywhere below the income Everywhere above the income Concentration Curve On the income line curve curve Note: Income denotes market income. Figure 2.5: Kakwani progressivity coefficients Figure 2.6: Labor income tax and exemptions, as share for direct taxes of disposable income by decile (By country) 500 Peru (2009) 0.43 400 Millions GEL Mexico (2010) 0.30 300 Ethiopia (2011) 0.28 Brazil (2009) 0.27 200 Uruguay (2009) 0.25 100 Armenia (2011) 0.23 Georgia (2013) 0.19 0 South Africa (2010) 0.13 Labor Income Exemptions Labor 0.00 0.10 0.20 0.30 0.40 0.50 Tax (No Labor Income exemptions) Income Tax Sources: Armenia (Younger et al., 2014), Bolivia (Paz et al., 2014), Brazil (Higgins and Pereira, 2014), Ethiopia (Hill et al., 2014), Source: Staff calculations based on IHS (2013). Indonesia (Jellema et al., 2014), Mexico (Scott, 2014), Peru (Jaramillo, 2014), Uruguay (Bucheli et al., 2014), and South Africa (Inchauste et al., 2014). Georgia (GNI: HDRO calculations based on data from World Bank (2014), IMF (2014) and United Nations Statistics Division (2014) and own estimations). Enhancing Equity with Fiscal Policies 15 Figure 2.7: Labor income tax, exemptions, and direct taxes itself, with no impact on progressivity. Although 100% the Liberty Act mandates no tax rate increase without a referendum, there is still room to impose or remove Cumulative proportion of disposable income/tax 80% a tax exemption. Since currently a fairly wide range of 60% goods and services are VAT-exempt, from agriculture produce to imported goods and financial services, the 40% impact of VAT exemption is unlikely to be confined to 20% a specific income category. The exemption in value terms benefits the upper side of the income distribu- 0% 0 10 20 30 40 50 60 70 80 90 100 tion more (Figure 2.9), and relative to market income Cumulative proportion of the population does not quite improve the progressivity of the VAT. 45 degrees Excises are more regressive than VAT. They are dis- Market Income tributed more evenly than the VAT (Figure 2.10). Since Labor Income (No exemptions) excise is the only tax government can levy under the Exemptions Labor Income Liberty Act without a referendum, it is of particular Labor Income Tax interest to our analysis. However due to its regressive Source: Staff calculations based on IHS (2013). nature, a universal increase of tax rates would make the poor bear a heavier burden, but not levying high indirect taxes as shares of income than the rich. Hence, excise taxes on specific items that are consumed heav- these taxes are regressive. Compared to other CEQ coun- ily by the poor can make the excise tax less regressive. tries, Georgia shows similar levels of indirect tax shares The Georgian tax system as a whole is regressive. with respect to disposable income (Figure 2.8), but the There is a stark contrast between direct and indirect distribution is considerably more regressive than in other taxes in distributional effect: direct taxes concentrate countries with data available, with a much larger share in more in the top deciles, indirect taxes are more evenly the lowest decile (26 percent). Only Bolivia shows a simi- distributed (Figure 2.11). Together the result is a regres- lar pattern of concentration across income deciles. sive tax system. It is regressive for the lowest deciles of VAT exemptions are distributed across the income the income distribution, but almost neutral for the top distribution in almost the same way as the VAT deciles based on market income (Figure 2.12). Table 2.4: Regressivity of indirect taxes, 2013 Disposable Income and Concentration Cumulative Disposable Income and Concentration Shares, Percent Shares, Percent Disposable Indirect Disposable Indirect Decile Income VAT Excise Tax Taxes Income VAT Excise Tax Taxes 1 1.99 5.10 7.59 5.48 1.99 5.10 7.59 5.48 2 3.56 5.62 7.20 5.86 5.56 10.73 14.79 11.35 3 4.69 6.10 8.51 6.47 10.25 16.83 23.30 17.82 4 5.85 6.82 6.88 6.83 16.10 23.65 30.18 24.65 5 7.06 7.67 7.90 7.71 23.16 31.33 38.09 32.36 6 8.35 9.03 9.74 9.14 31.51 40.36 47.83 41.49 7 9.90 10.25 10.04 10.22 41.41 50.60 57.87 51.71 8 12.08 11.83 12.13 11.88 53.49 62.43 70.00 63.59 9 15.47 13.82 12.86 13.67 68.96 76.25 82.86 77.26 10 31.04 23.75 17.14 22.74 100.00 100.00 100.00 100.00 Source: Staff calculations based on 2013 IHS. Note: The distribution of disposable income and tax concentration shares for the population are ordered by disposable income deciles. 16 Georgia Public Expenditure Review Figure 2.8: Indirect taxes as share of disposable income by decile 40% 20% Share of disposable Share of GDP income 20% 10% 0% 0% Bolivia Brazil Indonesia Mexico South Africa Georgia Poorest decile Richest decile Share of GDP Sources: Bolivia (Paz et al., 2014), Brazil (Higgins and Pereira, 2014), Indonesia (Jellema et al., 2014), Mexico (Scott, 2014), South Africa (Inchauste, Lustig, Maboshe, Purfield and Woolard (2014) based on IES 2010/11, and own estimates for Georgia based on IHS (2013)). Please note, deciles are ranked by disposable income. Figure 2.9: VAT and exemptions, as share of disposable Figure 2.11: Tax collection by deciles income by decile 400 Total Tax Collection (Million GEL) 300 350 250 300 250 200 Million GEL 200 150 150 100 100 50 50 0 t 2 3 4 5 6 7 8 9 t es es 0 w ch Lo Ri VAT (No Exemptions VAT exemptions) VAT Indirect Taxes Direct Taxes Source: Staff calculations based on IHS (2013). Source: Staff calculations based on IHS (2013). Figure 2.10: Indirect taxes Figure 2.12: Tax system 100% 100% Cumulative proportion of Cumulative proportion of disposable income/tax disposable income/tax 80% 80% 60% 60% 40% 40% 20% 20% 0% 0% 0 10 20 30 40 50 60 70 80 90 100 0 10 20 30 40 50 60 70 80 90 100 Cumulative proportion of the population Cumulative proportion of the population 45 degrees All Taxes Disposable Income Indirect Taxes VAT Direct Taxes Excises Market Income Indirect Taxes 45 Degree Line Source: Staff calculations based on IHS (2013). Source: Staff calculations based on IHS (2013). Enhancing Equity with Fiscal Policies 17 E. Redistributive Effect: monetary benefits are progressive in relative terms, Expenditures but regressive in absolute terms, being distributed more at the top of the income distribution, but not as Direct transfers in Georgia are in general progres- regressive as market income. This result is not surpris- sive. The major components are the TSA, the old-age ing considering that Tbilisi is the region in the country pension, and the Agriculture Card Program.16 Other with the highest living standards, and even the poorest important components of direct transfers are the dis- in the city can be better off in relative terms than those ability pensions reported in the household survey. in other regions. Overall, the direct transfers are pro- Smaller transfers such as IDP and temporal disability gressive in absolute terms (Figure 2.13). Figure 2.15 were also analyzed, such as the Tbilisi monetary bene- shows how much incomes of the poor increased due fit distributed as a top-up to TSA household recipients to cash transfers. The left scale measures the share of during winter months. The TSA is clearly progressive, transfers in the initial market income, therefore shares concentrating on the bottom deciles of the distribu- above 100 percent imply that disposable income is at tion. The Agriculture Card Program and the old-age least double the amount of market income. Transfers pensions are progressive in absolute terms. Tbilisi help to triple original market income of those in the bottom decile in Georgia. This is larger than in other 16 Agricultural cards are in a strict sense transfers for specific countries, with the exception of South Africa. uses (inputs for agricultural production), but are included here because they better fit the definition of a direct transfer than an In-kind transfers—free public services valued at in-kind one. cost—are also progressive as a group but results Figure 2.13: Social spending, as share of disposable income by decile (Million GEL) 250 200 150 100 50 0 All Direct TSA Old Age Agricultural Tbilisi Transfers Pensions Cards Monetary Beneϐits Source: Staff calculations based on IHS (2013). Table 2.5: Explaining spending progressivity Progressive Absolute Relative Regressive Neutral benefit benefit Benefit received in value income higher  for poorer income higher  for richer Same distribution as the Spending/Transfer higher for poorer people people people income Concentration CC . 0, CC . 0, CC , 0 CC 5 income Gini Coefficient (CC) CC , income Gini CC . income Gini Kakwani Index (KI) 5 KI . 0, KI . income Gini KI . 0 KI , 0 KI 5 0 Market Gini-CC Everywhere above Between the income curve Everywhere below the Concentration Curve On the income line 45 degree line and the 45 degree line income curve Note: Income denotes as market income. 18 Georgia Public Expenditure Review Figure 2.14: Social spending, concentration curves Figure 2.16: In-kind transfers: education 100% (Million GEL) 40 Cumulative proportion of market income/transfer 80% 35 30 60% 25 20 40% 15 10 5 20% 0 Pre-school General Vocational Higher In-kind 0% 0 10 20 30 40 50 60 70 80 90 100 Education Cumulative proportion of the population Source: Staff calculations based on IHS (2013). 45 degrees line Market Income Figure 2.17: In-kind transfers: health All Direct Transfers (Million GEL) TSA Old Age Pensions 25 Agricultural Cards 20 Tbilisi Monetary Beneϐits 15 Source: Staff calculations based on IHS (2013). 10 Figure 2.15: Direct transfers progressivity, 5 international comparison 0 500% 1312% MIP UHC (In- UHC (Out- In-kind 6.0% Share of Market Income Decile 450% patient) patient) Health 400% 5.0% 350% Source: Staff calculations based on IHS (2013). 4.0% 300% 250% 3.0% 200% 150% 2.0% market income than the other levels but is still consis- 100% 1.0% tently above it. This last result is consistent with inter- 50% 0% 0.0% national evidence that higher education is accessible only for the middle and upper sections of the income ) ) ) 0) 1) ) ) 09 09 09 10 13 01 01 distribution. The level of government transfers is con- 20 20 20 20 20 (2 (2 a( y( il ( a( a( o ia ua az tin gi ric ic en centrated more heavily in the upper sections but not ex or Br Af ug n m Ge ge M Ur Ar h ut Ar as heavily as market income itself. Overall, education So in-kind transfers are progressive in absolute terms. Poorest decile Richest decile Health in-kind transfers are also progressive in Share of GDP (right axis) absolute terms, but different components show different degrees of progressivity. The Targeted Sources: Armenia (Younger et al., 2014), Bolivia (Paz et al., 2014), Brazil (Higgins and Pereira, 2014), Mexico (Scott, 2014), Uruguay Medical Insurance Program (MIP) is progressive (Bucheli et al., 2014), and South Africa (Inchauste et al., 2014). in absolute terms—not surprising in that it covers Georgia: Staff calculations based on IHS (2013). mainly TSA beneficiaries (Figure 2.17). UHC, which was introduced in the middle of 2013, to provide med- for its components differ. General education, which ical coverage to large segments of the population with- comprises primary and secondary levels, is progres- out any health insurance, is more concentrated in the sive in absolute terms. Preschool education is also upper deciles of the distribution but to a lesser degree progressive, although it is slightly more concentrated than market income. Consolidating all these programs in the upper deciles of the income distribution (Fig- results in a progressive concentration curve, largely ure 2.16). Finally, higher education is much closer to driven by the effect of the MIP (see Box 2.1). Enhancing Equity with Fiscal Policies 19 Social spending in Georgia is progressive in abso- F. Impact of Fiscal Activities lute terms. This result is driven by the progressivity of on Inequality and Poverty direct and in-kind transfers. The analysis also covered indirect subsidies, which are utility and transportation The overall fiscal system in Georgia contributes to subsidies provided in Tbilisi to TSA recipients and retir- reducing poverty and improving equity. Table 2.6 ees. Indirect subsidies are the only regressive transfer; illustrates how fiscal interventions in Georgia impact the beneficiaries are households that can afford to use different quintiles of the income distribution in terms transportation and utilities services and so are unlikely of GELs: the income of the bottom 60 increased moving to be at the bottom of the income distribution. More- from market to final income, in particular the income over, the subsidies considered in this analysis are only of the poorest 20 percent more than doubled, while the given in Tbilisi, which does not represent the bottom income of the top 40 was reduced. Georgia’s Gini falls of the national income distribution. In comparing the by more than 0.10 points moving from market to final values of the concentration coefficients, TSA again is income (0.483 to 0.374; Table 2.7). The effects of differ- noticeable for the scope of its concentration coefficient, ent taxes and transfers are different in sign and magni- which is much more progressive than that of any other tude. Direct taxes reduce the Gini only by 0.015 points, Georgian transfer (Figure 2.20). Pensions, however, but cash transfers push it down by another 0.07 points. play an important role at diminishing poverty, given it Indirect taxes, which have been shown to be regressive, magnitude. Pensions are responsible for two thirds of increase inequality by almost 0.02 points. Finally, in-kind the observed reductions assigned to direct transfers. transfers and subsidies reduce the Gini by 0.04 points. Box 2.1: How Progressive Will the New TSA and UHC Become? Important revisions of the rules for two government programs will soon materialize. First, rules for assign- ing TSA benefits are changing: benefits will be the same amount for every member of the household, the size of the transfer will depend on distance to the beneficiary threshold, and the score formula will be changed. The resulting distribution of the proposed TSA is slightly more progressive than the current one, as can be seen in Figures 2.18 and 2.19. The second change is the consolidation of MIP and UHC programs into a single UHC. Using the data on usage of health services by MIP beneficiaries, a consolidated program was simulated to analyze its progressivity. As expected, the consolidated program is located between the two original ones, gaining progressivity compared to the original UHC because it incorporates both TSA and MIP beneficiaries. Figure 2.18: Distribution of TSA spending by deciles Figure 2.19: Concentration curves for MIP, UHC, and 0.30 consolidated UHC 100% Share of TSA spending by market income decile 0.25 90% 80% 0.20 70% 60% 0.15 50% 40% 0.10 30% 20% 0.05 10% 0% 0 1 2 3 4 5 6 7 8 9 10 11 t 2 3 4 5 6 7 8 9 t es es w ch 45 degrees UHC Lo Ri Market Income All Health TSA New TSA MIP New Source: Staff calculations based on IHS (2013). Source: Staff calculations based on IHS (2013). 20 Georgia Public Expenditure Review Figure 2.20: Social spending, concentration coefficients TSA –0.56 Disability pension –0.27 MIP –0.18 Agricultural cards –0.14 All direct transfers –0.14 Vocational education –0.14 In-kind health –0.13 In-kind and direct transfers –0.12 General education –0.11 All pensions –0.09 Old-age pension –0.07 In-kind education –0.04 Other direct transfers 0.01 Pre-school 0.03 UHC 0.15 Tbilisi monetary beneϐit 0.30 Higher education 0.31 Market Income Gini 0.48 Tbilisi indirect subsidies 0.51 –0.80 –0.60 –0.40 –0.20 0.00 0.20 0.40 0.60 Source: Staff calculations based on IHS (2013). Table 2.6: Distributional impact of fiscal policies in GEL Quintiles   Poorest II III IV Richest All Number of People 734,948 735,013 735,050 734,317 735,748 3,675,077 Market Income Per Capita 425 1,055 1,822 2,926 6,924 2,631 All Taxes (–) 159 193 299 512 1,234 480  Indirect Taxes 157 177 230 297 495 272  Direct Taxes 2 16 69 215 738 208 All Transfers (+) 693 630 533 488 378 545  Direct Transfers 546 492 400 363 270 414  In-kind Transfers 147 138 133 125 108 130 Indirect Subsidies (+) 1 3 5 10 24 9 Final Income Per Capita 965 1,495 2,061 2,913 6,092 2,706 Source: Staff calculations based on IHS (2013). Table 2.7: Poverty and inequality indicators at each income concept Net Market Disposable Post-fiscal Market Income Income Income Income Final Income (1) (2) (3) (4) (5) 3 5 2 1 Cash 4532 5541   2 5 1 2 Direct Taxes  Transfers Indirect Taxes In-kind Transfers Inequality Indicator  Gini Coefficient 0.483 0.467 0.394 0.413 0.374 Headcount Poverty Indicators  US $2.50 PPP per day (%) 20.3 20.5  7.7 11.7 –  US $5.0 PPP per day (%) 42.3 43.7 29.1 34.9 – Source: Staff calculations based on IHS (2013). Note: Per adult equivalent measures reported. Enhancing Equity with Fiscal Policies 21 Poverty rates are also considerably affected by taxes rise to almost 2.5 times the initial market income. More- and transfers. Poverty at the US$2.5/day poverty line over, the net cash position of the bottom 60 percent of falls from 20.3 to 7.7 percent when moving from market the distribution is positive. Compared to other coun- to post-fiscal income (Table 2.6). Direct taxes increase tries, Georgia is almost at the same level as the leader, poverty slightly, but direct transfers reduce it consid- South Africa, in terms of the share of the population erably, by 13 pps. Indirect taxes partially counterbal- that has seen its income rise. By incorporating in-kind ance this effect, increasing poverty by more than 4 pps. transfers, the post-fiscal income of the bottom decile The US$5/day poverty estimations reported follow the triples its market income, and the net cash position of same pattern, with direct taxes having minimal nega- the bottom 70 percent is also positive. tive effect, direct transfers largely diminishing poverty, Cost-effective analyses show that Georgia’s direct and indirect taxes partially offsetting this effect. transfers have the most effect on both poverty and In the CEQ sample, Georgia reduced poverty the Gini reduction.17 While the reported changes in pov- most. For all the other countries, poverty reduction erty and Gini are similar to South Africa’s, and not far from market to disposable income is only a few per- centage points, while Georgia’s reduction was a solid 17 How effective are direct transfers in reducing poverty and 14 pps, similar to South Africa’s. For most countries inequality given the amount spent? Effectiveness is measured (Table 2.7). Indirect taxes counterbalance the reduc- as the impact on poverty or inequality of the taxes or transfers being analyzed divided by their size relative to GDP (Lustig tions observed in poverty, except for Mexico and Indo- and Higgins, 2013). For example, for direct transfers, the nesia. However, Georgia also ranks among the highest effectiveness indicator (EI) for direct transfers is defined as: n d ( x (l ) − x (l )) for increases in poverty rate between disposable and El = D n x (l ) , where X(I j ) is the inequality or poverty mea- s post-fiscal income due to indirect taxes. GDP sure of interest (e.g., the Gini coefficient or headcount index), which is defined at each income concept (market income, net Social spending has raised the incomes of the poor market income, disposable income, post-fiscal income and final considerably in Georgia. Comparing post-fiscal to income). S D is total public spending on the direct transfer pro- grams analyzed. This formulation makes it possible to compare market income, which accounts for direct and indirect across different programs, as well as to compare Georgian pro- taxes and transfers, the bottom decile saw its income grams to other developing countries. Table 2.8: Gini coefficient for each income concept compared across CEQ countries Market Income Net Market Income Disposable Income Post-fiscal Income Final Income (1) (2) (3) (4) (5) (2) 5 (1) 2 Direct (3) 5 (2) 1 Cash (4) 5 (3) 2 Indirect (5) 5 (4) 1 Taxes Transfers Taxes In-kind Transfers Ethiopia (2011) 0.323 0.316 0.305 0.302 0.299 Indonesia (2012) 0.394 0.394 0.390 0.391 0.368 Armenia (2011) 0.403 0.393 0.373 0.374 0.357 El Salvador (2011) 0.440 0.436 0.430 0.429 0.404 Uruguay (2009) 0.492 0.478 0.457 0.459 0.393 Georgia (2013) 0.494 0.479 0.410 0.428 0.389 Bolivia (2009) 0.503 0.503 0.493 0.503 0.446 Peru (2009) 0.504 0.498 0.494 0.492 0.466 Costa Rica (2010) 0.508 0.500 0.489 0.486 0.393 Mexico (2010) 0.511 0.497 0.488 0.481 0.429 Guatemala ( 2010) 0.551 0.550 0.546 0.551 0.523 Brazil (2009) 0.579 0.565 0.544 0.546 0.439 South Africa (2010) 0.771 0.750 0.694 0.695 0.596 Sources: Armenia (Younger et al., 2014), Bolivia (Paz et al., 2014), Brazil (Higgins and Pereira, 2014), Mexico (Scott, 2014), Uruguay (Bucheli et al., 2014), and South Africa (Inchauste et al., 2014). Georgia: Staff calculations based on IHS (2013). Note: Per capita measures reported. 22 Georgia Public Expenditure Review Table 2.9: US$2.5/day poverty in percentage for each income concept, CEQ countries Market Income Net Market Income Disposable Income Post-fiscal Income (1) (2) (3) (4) (2) 5 (1) 2 Direct (3) 5 (2) 1 Cash (4) 5 (3) 2 Indirect Taxes Transfers Taxes Uruguay (2009) 5.1 5.1 1.5 2.3 Costa Rica (2010) 5.4 5.7 3.9 4.2 Mexico (2010) 12.6 12.6 10.7 10.7 El Salvador (2011) 14.7 15.1 12.9 14.4 Brazil (2009) 15.1 15.7 11.2 16.3 Peru (2009) 15.2 15.2 14.0 14.5 Bolivia (2009) 19.6 19.6 17.6 20.2 Armenia (2011) 31.3 32.0 28.9 34.9 Georgia (2013) 31.8 32.5 18.0 23.0 Guatemala ( 2010) 35.9 36.2 34.6 36.5 South Africa (2010) 46.2 46.4 33.4 39.0 Indonesia (2012) 56.4 56.4 55.9 54.8 Sources: Armenia (Younger et al., 2014), Bolivia (Paz et al., 2014), Brazil (Higgins and Pereira, 2014), Mexico (Scott, 2014), Uruguay (Bucheli et al., 2014), and South Africa (Inchauste et al., 2014). Georgia: Staff calculations based on IHS (2013). Note: Per capita measures reported. from Argentina’s, when taking into account the cost of (Figures 2.21 and 2.22). Figures 2.23 and 2.24 show direct transfers, Georgia stands out clearly, because its adapted indicators of effectiveness created to mea- effectiveness is more than twice that observed in other sure effectiveness among the different programs. The countries for poverty reductions and is still consider- numerator is the change in poverty or Gini from net ably more effective than the rest for Gini reduction market income (assuming labor tax does not have any Figure 2.21: Efficiency of direct transfers, change in Figure 2.22: Efficiency of direct transfers, change poverty headcount in Gini –16% 9.0 –0.08 3.0 Change in US$2.50-a-day –14% 8.0 –0.07 Poverty Headcount 2.5 –12% 7.0 –0.06 Change in Gini –10% 6.0 –0.05 2.0 5.0 –8% –0.04 1.5 4.0 –6% 3.0 –0.03 1.0 –4% 2.0 –0.02 –2% –0.01 0.5 1.0 0% 0.0 0.00 0.0 do il (2 ) 3) ) 3) 9) (2 ) ) ) Ge y (2 ) 9) 9) (2 ) 0) Ur ca ( 9) Ge y (2 ) 9) 09 09 2 10 ric 009 ua 010 2 10 01 01 00 01 00 00 ex 201 Pe 01 0 00 Br (20 Br (20 0 Af (20 20 (2 (2 (2 2 2 (2 ( Ur a ( ( a a a a a o ut eru In azil a o ru tin gi tin gi ua si si ic ic z ri a ne ne ex or or P ug ug Af en en M M do g g h h Ar Ar ut In So So Change in Poverty Rate Change in Gini from Direct Transfers Effectiveness Indicator Effectiveness Indicator (a) (b) Sources: Bolivia (Paz et al., 2014), Brazil (Higgins and Pereira, 2014), Indonesia (Jellema et al., 2014), Mexico (Scott, 2014), South Africa (Inchauste, Lustig, Maboshe, Purfield and Woolard (2014)) based on IES 2010/11, and own estimates for Georgia based on IHS (2013). Enhancing Equity with Fiscal Policies 23 Figure 2.23: Efficiency of direct transfers, by poverty property tax. From an equity perspective, giving direct reduction per billion GELs spent taxes a bigger role will make the tax system more 25.0 21.8 progressive.18 Although the Liberty Act rules out the 20.0 possibility of raising PIT or property tax rates with- 15.0 out referendum, there is still space to enhance both. 10.0 7.8 8.0 The government could intensify tax collection efforts 4.6 5.4 5.0 to broaden the PIT tax base, especially to collect taxes 0.5 0.5 0.0 evaded by those better-off. The excise tax was the only flexible instrument left after the Liberty Act restricted T tio e n A ns d er s ie VA mp om ar io TS sf io id ex n pt lc an raising rates on other taxes, but the analysis shows that ns e c bs em ex r in ra tr Pe su tu si bo ul it is quite regressive. The government has been using si ili La ili ric Tb Tb Ag excises but in future it could consider using them only Source: Own estimates based on IHS (2013). to levy taxes on items not heavily consumed by the poor. For the VAT, it is advised from an equity stand- Figure 2.24: Efficiency of direct transfers, by Gini point that exemptions that are not pro-poor could be reduction per billion GELs spent eliminated to improve its progressivity (Box 2.2). 0.12 0.10 Since Georgia’s TSA program is very efficient, the 0.10 other programs could improve their targeting on 0.08 0.06 0.07 poverty and inequality by adopting the targeting 0.04 0.03 0.04 mechanism of TSA. Although the TSA has been very 0.02 0.02 0.01 successful in reducing poverty recently, it already 0.00 –0.01 takes considerable resources from the budget. How- -0.02 ever many of the other programs are not as well- T tio e n A s rd er s targeted. For instance, the current income tax exemp- on ie VA mp om io TS sf ca id ex n pt si an e c bs l n em ex r in ra tion for low-income workers is at least partially tr Pe su tu si bo ul si ili La ili ric intended to reduce poverty and the Tbilisi benefit pro- Tb Tb Ag gram and other transfer programs (e.g., IDP) also have Source: Own estimates based on IHS (2013). pro-poor components, but poverty reductions from these programs are less effective. The government exemptions), and the denominator is the total program could consider utilize some of the existing TSA mecha- cost in GEL. The indicator reports, then, how much nism to improve the targeting of other programs. poverty or Gini falls by billion GELs spent. As can be seen in Figure 2.23, TSA is the most effective, followed Georgia also has a range of large in-kind transfers by agricultural cards and pensions. Tbilisi subsidies that could be redesigned to be more pro-poor. To and transfers are the least cost-effective. This rank- make the in-kind transfers more progressive, special ing does not change for the Gini reduction efficiency, attention could be given to the most disadvantaged with TSA the most effective, and Tbilisi subsidies not population such as the poorest households. In addi- improving equality. tion, the government could take measures to encour- age more affluent Georgians to use private services. G. The Way Forward Given how progressive direct taxes are, the gov- 18 This chapter does not address tax efficiency, and measures ernment could consider enhancing the PIT and introduced could leads to change in efficiency. 24 Georgia Public Expenditure Review Box 2.2: How Georgia’s Tax System Could Do More for the Poor The progressivity of direct and the regressitivity Figure 2.25: Simulated property tax of indirect taxes raise the question of the extent to 100% which direct taxes might effectively replace indirect, Cumulative proportion of 80% market income/tax thus making the tax collection system as a whole more progressive. A natural step in this direction 60% would be to collect more labor income tax, which 40% is quite progressive at the present. Another alterna- tive, especially useful for Georgia, where tax rates 20% cannot easily be raised, is to lower the threshold for 0% paying property taxes, currently set at 40,000 GEL 1 2 3 4 5 6 7 8 9 10 11 Cumulative proportion of the population of annual income. Moving the threshold down to 12,000 GEL/year results in collections equivalent to 45 degrees VAT (Alt.) Market Income Property Tax (Alt.) 0.25 percent of the effective VAT rate. The resulting VAT property tax is still progressive (Figure 2.25). How- ever, decreasing the VAT rate across the board by Source: Staff calculations based on IHS (2013). just 0.25 percent does not make it much less regres- sive. Therefore, instead of reducing the VAT rate, the government could consider using additional resource levied from the property tax to compensate for eliminating specific VAT exemptions on goods that are not consumed heavily by the poorest, which could result in making the VAT less regressive. Box 2.3: The Use of the BOOST Tool for Fiscal Incidence Analysis The BOOST (initiated by the World Bank in early 2010) is a tool to enhance the transparency and efficiency of public spending across the globe by structuring and improving access to government expenditure data and linking spending to relevant results. BOOST is also useful for carrying out fiscal incidence analysis. The analysis of public spending is based on both macro (fiscal accounts) and micro (household survey) data. Expenditure data is linked to household information to identify the recipients of cash and in-kind transfers and the amounts allocated to each household. BOOST data is used to (1) construct estimates of government expenditures that are transferred to households that are not readily available in the household survey (e.g., to calculate per student or per household transfers for public school expenses); and (2)  cross-reference estimates obtained from the household survey to validate calculations and methodology (e.g., comparing the amount of government spending on the Agriculture Card Program from BOOST with total amounts of cards aggregated from the household survey data). In other words, BOOST provides a comprehensive pic- ture of total government spending that is easy to use as a benchmark for construction of different spending categories and the resulting household income concepts. Enhancing Equity with Fiscal Policies 25 CHAPTER 3 Evaluating Agriculture Programs A. Overview The Card Program has generated significant ben- efits for farmers as expected. The primary benefits A robust agriculture sector is central if Georgia is of the Card Program so far are increased land area cul- to achieve its growth and poverty reduction goals. tivated and higher yields. Among the secondary ben- More than half of Georgia’s work force is employed in efits for farmers are more investment in inputs and rural areas and about two-thirds of the country’s poor machinery, and better understanding of them, and a live there. For most of them, agriculture provides the closer relationship with the input vendors who may only source of income. However, while Georgia’s eco- have been introduced to them through the program, nomic growth has generally been stellar in the past which in the long run helps to heighten agricultural decade, agricultural growth has been sluggish. So far productivity. The program also increased sales for pro- there has not been a productive transformation of viders of inputs and machinery services. This program the agriculture sector: it is mainly characterized by will terminate at the end of 2015, but it has offered family-based subsistence farming and agribusiness is valuable experiences and lessons to draw on for future minimal. The low welfare of a large share of the popu- programs. lation and high rural poverty underscore the impor- tance of promoting a more productive agricultural The Credit program has also generated benefits. sector. The large amounts of loans issued under this program contributed to a substantial increase in total agricul- The government initiated the Agriculture Card tural loans in Georgia.19 The primary benefits have and the Agro Credit programs in order to stimulate mainly been more access of farmers to finance due agricultural productivity. Though previous develop- to lower risks to banks and lower charges because of ment of agriculture has not been a priority, the admin- interest rate caps. Secondary benefits have been the istration that took charge in 2012 has moved to boost opportunity for farmers to establish a credit history agricultural growth. For instance, an Agriculture and and the opportunity for banks to build their agricul- Economic Development Fund (the Agriculture Fund) tural lending experience. However, subsidizing interest was established to stimulate investment and produc- on loans may have had the unintended consequence of tivity. Under this fund, the government introduced the distorting the agricultural lending market; to get past Assistance to Small Farmers during Spring Work pro- this problem will require a shift in focus from lowering gram (the Card Program) and the Concessional Agro financing cost to addressing fundamental risks in the Credit Program (the Credit Program). The intent of agriculture sector. these programs is to: The new agriculture programs led to a surge in ■■ Provide direct financing to smallholder farmers to spending on agriculture, but that it is unlikely to increase their use of agricultural inputs and machin- pose any significant fiscal risks in future. In its first ery services. ■■ Provide principal guarantees, matching grants, and interest rate subsidies to promote new investment in 19 This includes the state program “Produce in Georgia,” which capital expansion of active agricultural producers supports the agro-processing via financial support, infrastruc- and processors and to attract new ventures. ture, and technical assistance. 26 Georgia Public Expenditure Review year, 2013, the Card Program recorded the highest Agriculture growth has rebounded recently spending of all programs, but at the time it was funded with the help of more government support and by private sources. In 2014, the Card Program incurred improved market conditions. After years of contrac- a total cost of about GEL70 million, which GEL50 mil- tion, growth of agriculture recovered to 8.5 percent in lion (0.17 percent of GDP) came from the government 2011 and achieved 11.3 percent in 2013, the highest budget. As the Card Program phases out, total spend- since 2005, partly because of a substantial increase ing in 2015 is estimated to be GEL59 million. Spending in public spending on agriculture and the easing of on the Credit Program, after it became fully operative trade relations with Russia in 2012. Growth in 2014 in 2014, amounted to about GEL43 million (0.15 per- was sustained at 1.5 percent. Spending on agricul- cent of GDP) and in 2015 its cost is budgeted at about ture accounted for 8.9 percent of total government GEL47 million. spending in 2009, but after 2012 it surged, reaching 21.6  percent of total spending in 2014. Starting in In what follows, the next section gives a broad over- 2013 the Agricultural Fund was set up to finance the view of the country’s agriculture sector. Section C Card Program and the Credit Program, both of which discusses the program design and fiscal impacts of the were designed to boost productivity. The 2013 Card Card Program. Section D reviews the Credit Program. Program transferred some GEL183 million to farm- Section E evaluates the performance of both programs ers for plowing and agricultural inputs, and the Credit and identifies some challenges. Section F offers some Program leveraged GEL242 million in loans at subsi- policy recommendations. dized interest rates. The Card Program was entirely financed by private funding in 2013, when it began. B. Agriculture in Georgia However, in 2014 the program was largely financed by GEL50 million from the state budget. In terms of employment and poverty reduction, agriculture remains Georgia’s most important sector. For most of the 1990s, agriculture was the C. The Agriculture Card Program largest sector and contributed more than 30 per- The Card Program was introduced in February cent to GDP. In the past 15 years, through pro-market 2013 to improve the livelihoods of the rural pop- reform, Georgia has transitioned into a market econ- ulation by enhancing agricultural productivity. omy, unleashing growth in the industry and service The program offers direct financing to smallholder sectors. During this period, while Georgia’s economy farmers to promote use of agricultural crop inputs grew by 5.8 percent a year, agricultural growth stag- and machinery services. It gives the farmers two nated. In 2006, agricultural growth affected by the debit cards: a Plow Card to buy plowing and other Russian embargo; public investment was minimal, mechanized services, and an Agro Card to buy fertil- and public services such as extension and veterinary izers, agrochemicals, seeds, and other supplies. Plow services were dismantled, leading to declines in both Cards were distributed through the representatives total sown area and crop yields from 2006 through of local municipalities. Farmers submitted the Plow 2014. Nonetheless, the importance of agriculture Cards to pay for plowing services, which were pro- has not diminished: In 2013, 54 percent of Georgia’s vided by both private firms and the state-owned workers were employed in rural areas, and income Mechanizatori. Plow Cards expire on August  1st of from agriculture is an important lifeline for many the year in which they are issued. Agro Cards were of Georgia’s poor—nearly 66 percent of whom lived distributed to farmers by commercial banks through in rural areas in 2012. In addition, agricultural pro- their branch offices. Based on the size of the farm- duction accounted for 45 percent of rural household er’s acreage, cards accrue different GEL values to incomes and subsistence agriculture for 73 percent be exchanged for agricultural inputs from suppliers of rural employment in 2012. Food products are also (Table 3.1). the country’s main exports, accounting for 38 of total merchandise exports in 2013. The Card Program started as a GEL183 million pro- gram and is designed to be phased out by the end Evaluating Agriculture Programs 27 Table 3.1: Card program benefits 2013–15 2013 2014 2015 GEL GEL GEL Plot Size (ha) Plowing Inputs Plowing Inputs Plowing Inputs 0–0.25 100 50 50 0.25–1.25 Arable 210 per ha 300 per ha 140 per ha 50 140 per ha 0.25–1.25 Perennial 510 per ha 50 + 140 per ha 140 per ha 1.25–5 640 Sources: MOA and ISET. of 2015. The government envisioned that the program that the total number of 2015 beneficiaries will be close would stimulate increased utilization of major agricul- to that of 2014. Currently there is no plan to extend the tural inputs over a brief time horizon of three years. The program beyond 2015. program was to be phased out over the three years to allow the private sector to move in and replace it. Thus D. The Agro Credit Program total spending declined from GEL182.7 million in 2013 to GEL69.5 million in 2014 and is budgeted at GEL59.1 The Agro Credit Program is designed to pro- million in 2015 (Table 3.2). The Agro Card accounted vide subsidized credit for farmers and agribusi- for over 90 percent of total expenditures in the first ness, who have traditionally had little access to year and over 70 percent in 2014. The initial target financing. To improve financial access and provide beneficiaries were smallholder farmers with land hold- favorable interest rates in order to promote private ings of up to 5 hectares for 2013. In 2014 the program investment in agriculture, the Ministry of Agriculture focus was then restricted to farmers with 1.5 hectares initiated the Credit Program, which was introduced by or less. In 2013, on average each beneficiary received the Agriculture Projects Management Agency (APMA) GEL39 from the Plow Card program and GEL594 from in March 2013. Through the program, the government the Agro Card program. In 2014, despite the stricter eli- subsidized interest rates for qualified loans approved gibility requirements and less funding, the total num- by banks on loans for financing eight components: ber of beneficiaries went up from 710,479 to 757,145, (1)  agricultural inputs, (2) working capital, (3) fixed though average spending per family fell. Over 60 per- capital, (4) agro-leasing, (5) grape inventories, (6) cit- cent of beneficiary families benefited from the Plow rus, apple and peach inventories, (7) co-financing of Card and nearly 40 percent the Agro Card. It is planned agro-processing enterprises, (8) Produce in Georgia20 (new ventures). In 2013, the program started with Table 3.2: Summary of card program expenses components 1–3 and 5–6, and in 2014 offered all eight and beneficiaries 2013–14 components (Table 3.3). Component 7 has a 40 percent grant element for agro-processors in economically less Year Plow Card Agro Card Total active areas. Components 2 and 8 guarantee one-third Cost in GEL of the principal for the first four years. The program 2013 16,628,346 166,065,264 182,693,610 will be revised in 2015 to focus its offerings on com- 2014 18,059,387 51,895,536 69,954,923 ponents 2–4 and 8. Although some components target Number of Beneficiaries individual sectors, such as Components 5 for grape 2013 430,978 279,501 710,479 2014 473,716 283,429 757,145 20 “Produce in Georgia” was launched in 2014 to support new Sources: APMA and World Bank staff calculation. competitive companies in industrial production and agro pro- Note: The number of beneficiaries presents a simple sum of cessing as well as development in existing businesses. Other beneficiaries from the two program, notwithstanding large than providing financing support, it also provided infrastruc- overlap between the two cohorts of beneficiaries. These numbers tural support such as state owned real estate with investment exclude the financing of land disk harrowing (GEL7,432,386). obligations, and advisory services for beneficiaries such as sup- port in introducing new technologies. 28 Georgia Public Expenditure Review Table 3.3: Components of the Credit Program, 2013–1521 Maturity Component Credit Type Market Segment Credit Interest Cap Cap Loan 1 n Inputs credit/installments Small farmers Up to GEL5,000 0% 6 months (excluding fertilizers) from vendors Loan, with a 1/3 principle guarantee for the first four years n Primarily Working Capital (including crops sowing and planting materials, pesticides, fertilizers, non-breeding and young livestock, poultry, fish Medium and large 17% with 9% and fish-food, beehives and bees, established farmers subsidized, Vet Drugs purchase, labor resources, GEL5,000 to 2 (with the majority of plus provision 18 months agricultural machinery and rental 100,000 income deriving from of 33% second vehicles, different types of material) agriculture activities) order collateral n Partially Fixed Assets (including the purchase of breeding and productive livestock, poultry, and fish, and the construction of greenhouses and irrigation systems) Loan n Fixed assets and long-term technology financing, including post-harvest (storage, warehouse, Agricultural enterprises packaging, cold storage and 15% with 12% 3 (at least 60 new US$30k to 600k 84 months processing facilities) subsidized ventures) n Infrastructure (modern farms, greenhouse farms, irrigation systems) Agricultural processors development of value- Lease Up to 15% with 12% 4 added infrastructure for 84 months n Fixed Assets US$600,000 subsidized agricultural products (equipment financing) Loan Grape processors (for Up to GEL10 15% with 12% 5 15 months n Inventory grape purchases) million subsidized Citrus, apple and Loan Up to 15% with 9% 6 n Inventory peach exporters and 12 months GEL10,000,000 subsidized processors Agricultural processor Loan—50% US$100k to 14% with 2% 7 (only in “economically 120 months Grant—40% US$500k subsidized less active” districts) 12% cap for Grace Period: amount up to working US$1m or 11% Loan, with a 1/3 principal guarantee “Produce in Georgia” US$600,000 to capital— 8 cap for US$1– for the first 4 years (new ventures) US$2,000,000 18 months; 2m after 10% fixed capital— subsidized (for 24 months 24 months) Sources: APMA and World Bank staff calculation. 21 Starting from 2015 the number of components is limited to only 4: the fixed assets component, working capital component, concessional leasing component and “Produce in Georgia” component. Evaluating Agriculture Programs 29 5 for grape processors and 6 for citrus exporters There was not much change in the total land area of and processors, the program covers a broad range of crops sown between 2009 and 2012, but in 2013 land market segments from smallholder farmers’ needs area sown expanded by 20 percent. The total area of for working capital to large corporate investments. agricultural land covered by the Plow Card Program Credit applicants must be individuals or private legal amounted to 207,296 hectares in 2013 and 217,405 entities, satisfy commercial bank and leasing com- hectares in 2014—nearly two-thirds of Georgia’s total pany requirements, and must have business plans, sown area. There are two categories of land area cov- project budgets, and revenue forecasts that meet the ered by the program: (1)  land plowed and paid for standard credit analysis of financial institutions. with the Plow Cards, and (2) the land plowed but not paid for with the Plow Cards. With regard to the sec- Spending on the Credit Program picked up in 2014 ond category, the program’s rules allow farmers who as it was scaled up. When it was initiated in 2013, can demonstrate that they have already plowed their the APMA spent only GEL4.1 million on loan subsi- land without using the Plow Card, to turn in the Plow dies. In 2014 as it covered more components spending Cards and transfer the outstanding balance to Agro surged to GEL29.3 million. Spending on the program is Cards. In 2013–14 about 42 percent of Plow Card ben- expected to reach GEL46.5 million in 2015. The Credit eficiaries returned the cards (Figure 3.2). In terms of Program costs much less than the Card Program. Sub- sidies for loans for working capital and fixed assets constituted a substantial part of the total cost. Figure 3.1: Agriculture sector output, 2006–14 4,000 E. Evaluation of Programs and 3,500 Areas for Improvements 3,000 Total output of agriculture products surged in GEL million 2,500 2013–14 after the agricultural programs came into 2,000 operation. Total output grew by 5 percent a year from 1,500 2006 through 2012. In 2013 after the agriculture pro- 1,000 grams were launched, output accelerated by 10 per- cent a year in 2013 and 2014. In particular, yields of 500 cereals, crops, fruits, nuts, beverages, and vegetables 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 shot up from 3 percent a year in 2006–12 to 17 per- cent in 2013–14. Agriculture services also grew from Plant growing an average of 11 percent in 2006–12 to 21 percent Animal husbandry thereafter, driven by the use of mechanized plowing Agricultural services services. Additional evidence based on cross-regional Sources: Geostat and World Bank staff calculations. data shows a robust correlation between lands plowed under the Card Program and agriculture sector GDP: the regions that benefited more from the Card Pro- Figure 3.2: Sown areas by region, 2010–13, thousand hectares gram by having more land plowed had higher agricul- ture GDP in 2013. Other than the immediate effect on 350 Samtskhe-Javakheti outputs, these programs also introduced farmers to 300 Thousand hectares Kvemo Kartli the benefits of modern agricultural technology and 250 Kakheti offered them learning-by-doing opportunities that 200 Shida Kartli should encourage future usage of machinery services 150 Samegrelo and and agricultural inputs and improve agricultural pro- 100 Zemo Svaneti ductivity over the long term. 50 Imereti 0 The Plow Card program substantially increased 2010 2011 2012 2013 Other Regions the area of crops sown in Georgia in 2013 and 2014. Sources: Geostat and World Bank staff calculations. 30 Georgia Public Expenditure Review regions, Kakheti, Imereti, and Samegrelo benefited (Figure 3.4). This program was carried out by 536 sup- the most from the Plow Card Program, accounting for pliers with 780 sales outlets throughout the country. about 56 percent of total lands covered by the pro- The Agro Card program did not have a large impact gram in 2013 and 2014; the Racha-Lechkhumi, Adjara, on input prices because the government set maximum and Mtskheta-Mtianeti regions gained the least. For prices on inputs sold through shops registered with 2013–14, about 70 percent of the lands were plowed the program. by Mechanizatori and the rest by 105 independent Some issues that emerged as the card programs machinery service providers. got underway are related to targeting, quality, and The Agro Card Program led to a significant increase transfers. Reportedly the quality of inputs bought in the use of agricultural inputs in 2013. Through with Agro Cards varied, with some being of low qual- the program, Georgian farmers were able to purchase ity. In addition, wholesalers and retailers reported products such as fertilizers, agrochemicals (pesticides that 20–30 percent of Agro Card beneficiaries trans- and herbicides), seeds, equipment and tools, and vet- ferred their card benefits to third parties. Though erinary preparations. In 2013 most of the spending this does not imply that less agricultural inputs were went to fertilizers and agricultural equipment, which used for production, it does suggest that a significant together accounted for 76 percent of total Agro Card number of the beneficiaries do not need or are not spending (Table 3.4). Products on which the least was able to use the card (e.g., urban households that do spent were veterinary preparations and seeds. Since not engage in agricultural activities). This seems to be most agricultural inputs are imported, there was also a 31 percent increase in imports of agricultural inputs in 2013 after a 35  percent increase in 2012, Figure 3.3: Agriculture sector GDP and land plowed, when most importers and wholesalers began build- 2013 ing their inventories in anticipation of the program Agriculture sector GDP (million GEL) 450 400 Imereti & Racha-Lechkhumi Kvemo Kakheti Table 3.4: Products purchased with Agro cards, 2013 350 Kartli Samegrelo 300 Products GEL Percent 250 Shida Kartli & Fertilizer 72,269,836 43.50 Mtskheta- 200 Samtskhe-Javakheti Mtianneti Agro-Chemicals 33,112,604 19.90 150 Guria Seed Material 6,742,085 4.10 100 Adjara 50 Agricultural Equipment 53,704,193 32.30 0 Veterinary Preparations 232,486 0.10 0 10 20 30 40 50 Total 166,061,204 100 Land plowed under the program (thousand hectares) Sources: APMA and World Bank staff calculations. Sources: Geostat, APMA and World Bank staff calculations. Figure 3.4: Imports of inputs to agriculture, 2009–14 60,000 54,141 52,298 50,000 41,311 40,000 USD ’000 30,607 30,000 19,756 20,000 16,898 10,000 — 2009 2010 2011 2012 2013 2014* Sprayers and Tools 1,577 1,558 3,855 7,326 6,437 4,822 Agro-chemicals 13,046 9,819 13,246 15,781 22,935 21,754 Fertilizers 2,951 4,219 7,914 13,027 20,170 20,831 Seeds 2,182 1,302 5,592 5,177 4,599 4,892 Source: Geostat. *estimated. Evaluating Agriculture Programs 31 an issue of program design not being entirely tailored percentage of this impact to the Credit Program, espe- to farmer needs, as well as a lack of monitoring and cially since the government and donor-funded grant evaluation and of internal controls. Lack of a complete programs leveraged this program’s credit offerings land cadaster and ownership information also made it to move their own programs forward. In 2009–12, more difficult to identify precisely which families were before the Credit Program, loans to agriculture held in need. In 2013, based upon the program’s product steady at an average of GEL51.1 million a year22 (Fig- sales criteria, beneficiaries were able to purchase a ure 3.5). The launch of the program marked the start significant number of nonagricultural electric tools, of an uptick in agriculture lending in the first half of but that was quickly fixed through restrictions on eli- 2013, followed by rapid growth that raised the stock gible products, again highlighting the importance of of loans to the agricultural sector by 157 percent in monitoring and evaluation. 2013 and 103 percent in 2014. In absolute terms, this section of the loan portfolio grew from GEL55.5 mil- Large amounts of agricultural loans were issued lion to GEL289.2 million between December 2012 under the Agro Credit Program. In 2012 before the and December 2014. In terms of total new issuance, Credit Program began, total agricultural loans issued the proportion of agriculture loans rose from just 1.2 were less than GEL60 million. Once the Agro Credit percent to 3.8 percent from the beginning of 2012 to Program came into effect, commercial banks loaned the end of 2014. Interest rates also started to fall in GEL242.4 million in 2013 and GEL474.7 million in early 2013 when the Credit Program started. Although 2014 (Table 3.5). Credit issued for Components 2 and the policy rate has also been declining, the narrowing 3 dominated, accounting for 79.1 percent of total loans spread between the agricultural loan interest rate and in 2013 and 76.6 percent in 2014. The lowest volumes the policy rate indicates that the Credit Program and of new credits were for Components 1, 4, 6 and 7. As of its interest rate ceilings has been effective in lowering March 30, 2015, credits issued within the Credit Pro- the financing cost of agricultural loans. gram amounted to GEL816.6 million, with 96.5 percent of all loans being issued for working capital (38.3 per- cent) and financing fixed assets (58.3 percent). The Credit Program stimulated a great deal of new 22 The National Bank of Georgia’s statistical grouping of economic lending for the agriculture sector and a drop in activities combines forestry and fishery with agricultural activi- ties. Given the comparatively small size of forestry and fishery, interest rates in 2013–14. Although several agricul- the vast majority of the loans can be assumed to be for agricul- tural development programs were operating contem- tural activities, and the aggregate total is used as a proxy for poraneously, it seems reasonable to attribute a large agricultural loans only. Table 3.5: Lending activities under the credit program, 2013–14 2013 2014 Mean Mean No. of Total Loan Percent of Maturity No. of Total Loan Percent of Maturity Component Loans Value (GEL) Total Loans (months) Loans Value (GEL) Total Loans (months) 1 2,685 1,106,478 0.50 12 2,763 1,093,341 0.20 12 2 5,755 113,384,623 46.80 36 15,049 257,628,899 54.30 36 3 382 78,324,115 32.30 60 426 106,051,680 22.30 60 4 n.a. n.a. n.a. n.a. 2 167,497 0.04 n.a. 5 43 49,085,349 20.30 15 75 86,132,747 18.10 15 6 2 450,000 0.20 4 7 2,230,000 0.50 6 7 n.a. n.a. n.a. n.a. 2 836,160 0.20 84 8 n.a. n.a. n.a. n.a. 9 20,533,592 4.30 84 Total 8,867 242,350,565 100 127 18,333 474,673,916 100 297 Source: APMA. 32 Georgia Public Expenditure Review Figure 3.5: Total bank loans outstanding to the agriculture sector 350 300 250 Million GEL 200 150 100 50 0 01/01/09 01/04/09 01/07/09 01/10/09 01/01/10 01/04/10 01/07/10 01/10/10 01/01/11 01/04/11 01/07/11 01/10/11 01/01/12 01/04/12 01/07/12 01/10/12 01/01/13 01/04/13 01/07/13 01/10/13 01/01/14 01/04/14 01/07/14 01/10/14 Source: NBG. Note: This does not include microfinance loans. By 2014 loans from the microfinance organizations amounted to GEL170 million. Figure 3.6: New agricultural loans as percentage Figure 3.7: Average monthly interest rates and spreads of total new commercial loans (Percent) 7.5% 20% 6.0% 15% 4.5% 10% 3.0% 5% 1.5% 0% 0.0% Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Interest Rates on Agricultural Loans % of Total Loan Portfolio Monetary Policy Rate Trend Spread Source: NBG. Source: NBG. However, the impact of the Credit Program on the decelerated, from 16 percent in 2006–12 to 1 percent food processing industry is still yet to be seen. in 2013–14, which could partly be explained by the Food processing is the largest agribusiness in Geor- restrictions to finance grain mill and pastry within the gia. From 2006–12, it grew by an average of 9 percent; Credit Program. At the same time, it is difficult to dis- in 2013, the growth rate was 10 percent, close to the entangle the impact of the lift of the Russian embargo trend in previous years. Growth drivers for food pro- on wine exports with the impact of the Credit Program, cessing have been agribusinesses that process meat and currently there is little evidence that agribusiness and fish products, which managed to grow by 13 per- has leveraged the lower financing cost for much more cent in 2013–14 after a gradual decline in 2006–12, capital investment. plus the alcoholic beverage business, which grew by Moreover, in the longer term, subsidizing interest 31 percent in 2013, much above the 10 percent seen rates has several negative aspects: (1) The program in 2006–12 (Figure 3.8). However, growth of the pro- addresses a demand rather than a supply constraint in cessing of grain mill and starch products and prepared the credit market. That is, it assumes there is a lack of animal feeds slowed from 16 percent in 2006–12 to demand at commercial interest rates, when in many 3 percent in 2013–14, and agribusinesses process- cases the constraint is on supply, because lenders are ing bread, pastry, biscuits, and preserved food also Evaluating Agriculture Programs 33 Figure 3.8: Food-processing agribusiness output 50.0 40.0 30.0 Billion GEL 20.0 10.0 0.0 2006 2007 2008 2009 2010 2011 2012 2013 2014* Other food products Alcoholic beverages Dairy products and ice cream Meat and meat products; processed and preserved fish and fish products Bread, fresh pastry goods and cakes; rusks and biscuits; preserved pastry goods and cakes Grain mill products, starches and starch products; prepared animal feeds Source: Geostat. *estimated. not willing to lend to high-risk investments that are not Since the Card Program will be completed at the supported by good collateral. (2) There are investments end of 2015, there is little opportunity to improve in projects that would not be financially viable at com- it; however, it offers valuable lessons for future mercial interest rates. While a project may be initiated programs: with working capital borrowed at subsidized interest (i) Creating a Stable Policy Environment: Defin- rates, it may not be viable after the subsidy is with- ing a timetable for program phase-out, com- drawn. (3) The Agro Credit program is likely distorting municating it to farmers and service providers, the allocation of credit resources between agriculture and adhering to it are important so that ben- and other sectors, which could impede the structural eficiaries have accurate information on which transformation of the economy. (4) It will be politically to base investment decisions. The Agriculture difficult to terminate the program, particularly when Card program was announced as a three-year the subsidy covers a high percentage of the subsidy cost program and it is important to stick to that. The as is the case for Georgia where some components of change in target beneficiaries during the pro- the program cover 80 percent of interest costs. gram, although justified to improve targeting, will have created uncertainty, which should be F. The Way Forward avoided in future. Although both programs have generated benefits, (ii) Targeting of Beneficiaries: Defining the right they provide only temporary assistance to the sec- group of beneficiaries and achieving accurate tor. This does not diminish the need for public invest- targeting is difficult, and socioeconomic profil- ment in essential public services and infrastructure ing beneficiaries could help to identify potential (such as roads and utilities, rehabilitation of irrigation beneficiaries who are least likely to benefit from infrastructure, veterinary and food safety services, an agro-card program. Analysis of the profile of research, education, and advisory services) which help beneficiaries who traded their vouchers would to address the fundamental causes of limited access to be particularly informative in designing future credit, inputs, and machinery as a priority for public farm support programs. They may, for example, spending.23 include land-holders living in urban areas, who have kept their land as a long-term investment 23 Some advisory services are considered under the state program but have other sources of income and little of “Produce in Georgia.” interest in farming. 34 Georgia Public Expenditure Review (iii) Type and Quality of Inputs: The program funding the provision of advisory services to would be an opportunity to demonstrate the as many as possible of the farmers that partici- benefits of investing in good-quality inputs and pated in the program (outreach to 20 percent of to encourage the supply of a more diverse range them would be an excellent achievement). Since of inputs, such as compound fertilizers,24 which the objective of introducing farmers to modern many farmers have had no experience in using. inputs and agricultural technology has now Suppliers are required to stock inputs that meet been largely achieved, it becomes more impor- national standards25 but the program would be tant to facilitate training and continued usage of an opportunity to monitor this and would pro- inputs and modern agricultural technology. vide an incentive for suppliers to adhere to the (vi) Information Management: An improved standards. Providing a sufficient diversity of management information system (MIS) would inputs could be an additional requirement for help to improve the design, management, and participation in the program, as long as this was evaluation of the impact of such programs. not too restrictive. (a)  Completion of registration of land owner- (iv) Timeliness of Delivery: Timely provision of ship rights in the National Agency of Public information to traders and farmers about the Registry (NAPR) cadaster would provide a very Agro Card programs and timely issuance of important foundation for such an MIS, since the agro-card vouchers are critical to effectiveness. area owned by each land title holder would be Many farm support programs suffer from poor clearly defined and electronic information on timeliness even in well-developed economies. it would be available. (b) The agency manag- Focus group discussions conducted for this ing the program should add a monitoring and study indicate that this was a problem in some evaluation (M&E) component to it and integrate cases with the agro-card program. Having bet- it into an electronic platform that tracks specific ter information about beneficiaries’ eligibility performance data points. Any future programs in advance would help to ensure timely pro- should consider analyzing activities generated gram delivery. by the electronic cards to track purchases, rev- enues per supplier, location of purchases, and (v) Complementary Advisory Services: (a)  Ser- products purchased. vices to advise on basic crop husbandry, soil and water management (including use of seeds, Regarding the Agro Credit Program, the govern- fertilizers, and pesticides provided through the ment should consider the following issues in program) should be financed in parallel by the developing the program in future: Ministry of Agriculture, preferably as a com- (i) Creating a stable policy environment: Defin- bined package of inputs, machinery services, ing the life of the interest rate subsidy program, and advisory services. Initially, given the limited communicating this to farmer and service pro- outreach of the advisory services it would not be viders and adhering to it is important so that possible to cover all farmers. Experience from beneficiaries have accurate information on Bank projects in Central Asia demonstrates that which to base their investment decisions. This providing provision in combination with advice is particularly important in the case of interest on crop husbandry is more effective than pro- rate subsidies because they rely on subsidized viding inputs alone. (b) If the Card Program is interest rates to stimulate long-term invest- terminated as planned in 2015, the benefits of ments which may collapse once the subsidy is the program could be maximized by publicly withdrawn. (ii) Information Management: An improved man- 24 Compounds containing a mix of nitrogen, phosphate, and phos- agement information system would help to phorus, for example. improve the design, management and the impact 25 List of approved pesticides, for example. evaluation of similar programs. The program Evaluating Agriculture Programs 35 implementation agency should institutionalize (iv) Public spending should focus on addressing a monitoring and evaluation (M&E) component the fundamental causes of risk in the agricul- to their program. As with the Card Program, an tural sector which include: (i) production risks M&E component should be put in place, which caused by climatic shocks including drought and would be integrated with an electronic platform flood damage which can be addressed through that tracks specific performance data, including investment in infrastructure, better informa- through electronic databases generated from tion, and advisory services; (ii) production the online application and its banking platform. risks caused by animal and crop disease which can be addressed through disease monitor- (iii) Provide training to banks to help them eval- ing, research, advisory services and veterinary uate risks in agriculture. Training bank loan services; (iii)  market risks which can be officers on assessment and monitoring of agri- addressed through investment in the develop- cultural loans, as well as improving their under- ment of market-based risk mitigation measures standing of climatic and production risks and such as commodity-linked finance. measures to mitigate such risks, would contrib- ute to improved loan performance. 36 Georgia Public Expenditure Review CHAPTER 4 Subnational Expenditure Review A. Overview and spending. Under the Self-Governance Code that took effect immediately after local elections in mid- According to the government’s decentralization 2014, temporary norms were instituted to regulate reform aimed at reducing regional inequality and the number of local government employees, spending poverty, local governments are to take on more on wages and salaries, and local government capital responsibilities for subnational public finance. expenditures. The new norms for the first two are Despite significant progress in growth and poverty expected to bridge some gaps in hiring and spend- reduction in general, results at regional level have ing on wages spending, but the adjustments are likely largely been uneven. The decentralization reform is to introduce uneven, in some cases drastic, changes designed to improve the allocative efficiency and equity across local governments. Meanwhile, the norm on of the public spending at local government levels: by capital expenditures appears to have stimulated a allowing those closest to the needs of community make budgeted increase of capital spending in the largest the decisions on spending. Traditionally Georgia’s cen- cities. Under the Budget Code that became effective in tral government has been the main source of financing late-2014, it is estimated that the sharing of income for local governments and making the decisions about taxes envisioned will add to local government own- subnational expenditures, but the new Self-Governance source revenues an amount equivalent to 3 percent of Law and local elections in 2014 marked a major step total subnational revenues. toward decentralization. Fiscal decentralization will fol- low starting from 2016, as envisioned in the new Budget Capital grants have been important in financ- Code, under which local governments will be sharing ing capital projects but the allocation scheme income tax revenues for greater fiscal autonomy. needs to be modified. Local government capital spending accounted for a significant one-fifth of This chapter continues the discussion on sub- total subnational spending. Capital grants from three national expenditure issues in the last Public centrally-administered funds—the Regional Projects Expenditure Review, focusing on issues related to Implementation Fund (RPIF), the Municipal Develop- decentralization, subnational capital expenditures, ment Fund (MDF), and the Village Support Program and expenditures for preschools. Chapter 4 of the (VSP)—financed about half of all subnational capital last PER (World Bank 2014) provided a comprehensive projects. However, with deeper fiscal decentralization overview of the intergovernmental fiscal system that in sight and more fiscal resources and responsibili- laid a solid foundation for this analysis. This chapter ties expected to be delegated to local governments, analyzes subnational spending in 2013–14 based on substantial benefits are likely to accrue from gradu- three specific questions: (1) what is the fiscal impact ally building the capacities of local governments and of the recent decentralization reform, in particular empowering them to choose and carry out public the temporary norms under the new Self-Governance investments, within a phased time frame. Code; (2) how are capital grants allocated and could this be done better; and (3) how does the abolition of pre- Abolishing the preschool parental will have a large school parental fees affect local government spending? fiscal impact that will be distributed unevenly across local governments. Preschool education is The current decentralization reform has signifi- a major responsibility of subnational governments. cant fiscal implications for subnational revenues Subnational Expenditure Review 37 Despite the need for equal opportunity in early child- (kindergarten); the central government is responsible hood education, local governments differ widely in for the more resource-intensive services like general preschool education services, spending per child, education and health. parental fees, and enrollment rates. Elimination of The Self-Governance Code and the 2014 local preschool parental fees in 2013 incurred an additional elections were major steps in the decentraliza- cost for all local governments estimated at about tion agenda. The Code, enacted in July 2014, out- GEL30-40 million (0.10–0.14 percent of GDP); how- lined the decentralization of local self-government ever, given the differences across municipalities and bodies by increasing their scope and financial inde- cities, the fee removal might well exacerbate inequal- pendence and providing normative acts to regulate ity in preschool services. From an equity perspective, local governance. Seven new self-governing cities addressing this issue would require reforms to the were established, and the mayors of the cities were allocation scheme for securing equitable funding and elected in 2014 local elections. The system of local strengthening preschool service delivery. self-governments (LSGs) now comprises 12 cities, In what follows: Section B discusses the institutional 59  municipalities, and 2 autonomous republics. framework of subnational governments in Geor- Before the new code and the elections, the capital city gia. Section C looks at the importance of subnational Tbilisi was the only city where direct local elections expenditures for the country and recent developments were allowed. The election in 2014 of all the cities’ related to the decentralization reform. Section D hones mayors was the first in Georgian history. Governors in on capital expenditures, capital grants, and alloca- (gamgebeli) of municipalities are also elected. This tion schemes. Section E analyzes local government introduced more public accountability and wider rep- preschool spending and the fiscal impact of the elimi- resentation in local government. nation of the parental fees. Section  F lays out policy With greater decentralization, the municipalities recommendations. have also been given greater  fiscal  autonomy. The Budget Code passed in December 2014 envisioned that B. Institutional Framework from January 1, 2016 forward, the LSGs and the central government will share income taxes. According to the Traditionally subnational governments in Georgia new code income taxes in a number of categories will relied heavily on transfers from the central gov- add to local government revenues. The central govern- ernment. These transfers accounted for two-thirds ment will still collect all income taxes but those in the of local government income for 2011–13. Local gov- following categories of income will be transferred to ernments received two types of grants: (1) a formula- local governments in their entirety: (1) income gener- based equalization grant to close local government ated through business activity; (2) non-resident income revenue and spending gaps; and (2) a special purpose generated from selling property in the local govern- grant used largely to finance capital projects, which ment; (3) individual income as additional value received will be elaborated on later. Own revenue sources from selling tangible assets; (4) individual income gen- include property taxes and nontax revenues, such erated from a gift; (5) income from an inheritance; and as rents, fines, penalties, and sale of goods and ser- (6) individual income from rent. vices.26 The primary spending responsibilities of local governments are the provision of housing, utilities Temporary measures were imposed to regulate and communal services,27 and preschool education LSG expenditures. In the coming year LSGs will soon have bigger budgets to execute at their discretion, but there remains great disparity in LSG planning and 26 With the exception of the Autonomous Republic of Adjara, which budgeting. The central government therefore insti- retains all its income tax collections. tuted some short-term rules in the Self-Governance 27 Despite reductions in spending of utility, housing and commu- nal services in recent years, it still accounted for 17 percent of Code enacted in July 2014 to encourage more capital local spending in 2014. investment, and set norms to discourage excessive 38 Georgia Public Expenditure Review hiring and spending on wages. In particular, lower There is also a lower bound on the share of increase in and upper bounds of the number of employees in local nonfinancial assets (capital expenditures) in the total governments were set based on the number and size outlays of the municipality budget, which is set at the of local administrative units, and salaries of public ser- average of the shares over the previous three years vants shall not exceed 25 percent of the expenditures. (see Box 4.1 for details). Box 4.1: Temporary Norms under the New Self-Governance Code The norms, effective from November 2014 to January 2019, are imposed to regulate local government capi- tal spending, the number of public employees, and spending on salaries. This article does not apply to Tbilisi and occupied municipalities. a) Rule on the increase in nonfinancial assets (article 155) The share of “increase in nonfinancial assets” in the total outlay of the municipality budget should not be lower than the average of the shares over the previous 3 years. b) Rule on the number of public servants in self-governing entities (article 156) The number of public servants in governor’s (gamgebeli)/mayor’s office and apparatus of councils (sakre- bulos) shall not be less than 30. In the municipalities where the number of voters is less than 45,000, the following formula governs the ceiling on the number of public servants that shall be hired: y ⌺ = 30 + 3.2x + 450 , Where x is the number of majoritarian districts in 2014 local council elections and y is the number of voters in the municipality. The number of public servants shall not exceed the minimum number of public servants (30) plus the number of majoritarian districts in the 2014 local council elections multiplied by a coefficient of 3.2 plus 1 public servant per 450 registered voters in the self-governing entity. In the municipalities where the number of voters is more than 45,000, the following formula governs the ceiling on the number of public servants that shall be hired: y ⌺ = 30 + 2.3x + 500 , Where x is the number of majoritarian districts in 2014 local council elections and y is the number of voters in the municipality. The number of public servants shall not exceed the minimum number of public servants (30) plus the number of majoritarian districts in 2014 local council elections multiplied by a coefficient of 2.3 plus 1 public servant per 500 registered voters in the self-governing entity. The number of contracted (non-staff) units in a municipality shall not exceed 10 percent of the number of public servants in governor’s (gamgebeli)/mayor’s office and apparatus of councils (sakrebulos). If the 10 percent corresponds to a number less than 5, the self-governing entities are allowed to increase the number of contracted units up to 5. The amount of salary of public servants in governor’s (gamgebeli)/mayor’s office and apparatus of councils (sakrebulos) shall not exceed 25 percent of the expenditures foreseen by the municipal budget. Subnational Expenditure Review 39 C. Subnational Expenditure Figure 4.2: Local and central government spending by function, 2014 Trends and Composition (Million GEL) Subnational expenditures, on average 18 percent 3,000 2014 10,000 of consolidated expenditures, have seen notable 2,000 changes in 2012–14. Among ECA countries, the 5,000 share of subnational expenditures in Georgia’s con- 1,000 solidated expenditures is in the middle range (World 0 0 Bank 2014). Although total subnational spending Or De es e uc e al ac ty nm s Ut nt He s Cu th n vi itie tie Ed tur on er enc io ci ic afe al e ic was largely unchanged in value in 2012–14, there has at So ili rv l En tiv f s se om & ro been a significant realignment from capital to recur- l ra Ec d ne Ge rent spending. Local government spending declined slightly, from GEL1.8 billion to GEL1.7 billion, while Central (left axis) Local (left axis) central government spending expanded by 10 per- Total central (right axis) Total local (right axis) cent each year. Between 2012 and 2014, the central government cut back capital grant allocations to Source: Ministry of Finance. local governments, which led to a 44 percent drop in LSG capital spending, from GEL650 million to GEL364 a number of income tax categories starting in 2016. In million (Figures 4.1 and 4.2). Meanwhile, recurrent 2014, income taxes from these categories amounted spending grew by 19 percent, from GEL1.1 billion to 13 percent of total income taxes and 3 percent of to GEL1.7 billion. Local government social spending total revenues—a significant addition to the local bud- went up 36 percent a year mirroring the increase in get. Based on 2014 statistics, LSG revenues as a share central government social spending, in response to the in total government revenues is expected to rise from current administration’s social priorities. Subnational 7 percent to 10 percent. education spending grew by a substantial 36 percent a year for 2012–14, driven by the increase in preschool The continuing decentralization reform has stimu- spending after the service became free in 2013. lated movements in capital spending. Before the new Self-Governance Code was adopted in 2014, there was Decentralization will expand local governments’ a substantial fall in local government capital spending spending envelopes from 2016 on. Under the new largely driven by consolidation of capital grants. From Budget Code, LSGs will keep revenues collected from 2012–14, spending on infrastructure projects in cities and municipalities was cut drastically, by 66 percent in Figure 4.1: Local and central government spending by Tbilisi, 62 percent in self-governing cities, and 37 per- function, 2012 cent in rural municipalities (Figure 4.4). With the new (Million GEL) code becoming fully operational in the second half of 3,000 2012 10,000 2014, there have been noticeable changes in local gov- ernment budgeting for capital expenditures in 2015: 2,000 5,000 Tbilisi planned a near tripling of capital spending; the 1,000 four largest self-governing cities—Batumi, Kutaisi, Rustavi, and Poti—in total budgeted a 40 percent 0 0 increase; while rural municipalities and new cities are Or De es om & s e ty nm s Ut nt He s Cu h uc e al n vi itie tie Ed ltur on er enc t io ci likely to spend less on capital investment.28 ic afe al e ic at So ili rv En ctiv f se ro a l ra The decentralization reform is expected to bridge Ec d ne Ge the gaps in hiring and unit wage spending across Central (left axis) Local (left axis) Total central (right axis) Total local (right axis) 28 New cities are Telavi, Zugdidi, Gori, Akhaltsikhe, Ozurgeti, Source: Ministry of Finance. Mtskheta, and Ambrolauri. 40 Georgia Public Expenditure Review Figure 4.3: Local government capital expenditures, Figure 4.5: Share of wages in total expenditures by 2012–15 local governments (Million GEL) (Percent) 350 25 300 20 250 million GEL 200 15 150 10 100 50 5 – 0 2012 2013 2014 2015 2011 2012 2013 2014 2015 (budgeted) (budgeted) Tbilisi Municipalities Four largest cities* New cities New self-governing cities Tbilisi Self-governing cities Ajara Source: Ministry of Finance. Municipalities Note: Budgeted allocation of capital grants for 2015 is not available. New cities are Telavi, Zugdidi, Gori, Akhaltsikhe, Source: Ministry of Finance. Ozurgeti, Mtskheta, and Ambrolauri. to fall. For example, after the Akhaltsikhe municipality Figure 4.4: Revenue sources of local governments, 2012–15 was split to a city and a municipality under the New Gov- (Million GEL) ernance Code, the number of employees is budgeted to 800 almost double in 2015 over 2013.29 On the other hand, 700 employment in the Ambrolauri municipality fell after 600 its split, most likely to meet the new thresholds on 500 400 staffing. In Adjara and Batumi employees of the Legal 300 Entities of Public Law (LEPLs) were excluded from 200 100 the staff count, but now the Single Treasury Account 0 reform has mandated local governments to consider Tbilisi Municipalities Tbilisi Municipalities Tbilisi Municipalities New cities Tbilisi Municipalities New cities 4 largest cities 4 largest cities 4 largest cities 4 largest cities LEPL employees as public employees. As a result the number of public employees more than quadrupled. The shares of spending on wages and salaries in total expenditures (Figure 4.5) are generally higher in small 2012 2013 2014 2015 local administrative units (about 22 percent) than in (budgeted) large cities (10 percent) and Tbilisi (7 percent). The Own collections Equalization grant Other grants average wage per public employee also varies widely: Source: Ministry of Finance. labor unit cost in Mtskheta in 2015 is about GEL2,000 a Note: Budgeted allocation of capital grants for 2015 is not year, while in Poti it reaches GEL18,000. The disparity available. New cities are Telavi, Zugdidi, Gori, Akhaltsikhe, is largely explained by the number of public servants Ozurgeti, Mtskheta, and Ambrolauri. per 1,000 population: nearly 20 in Mtskheta and only 3 in Poti (Figure 4.6). The Self-Governance Code nor- local governments. Subnational governments employ mative measures are expected to close such large gaps about 25,000 public employees, about 1.5  percent of in time, but this is not likely reflected in 2015 budgets. total employment in Georgia and over 9 percent of pub- lic servants. In some municipalities the decentralization reform and the new code is likely to boost local govern- 29 Since the new code was enacted in July 2014, it was a transition ment hiring; in others public employment is expected year and is not a proper benchmark. Subnational Expenditure Review 41 Figure 4.6: Share of wages in total expenditures by local governments (GEL, number of employees) 19.8 20.0 18.0 16.0 15.8 16.0 14.0 13.0 12.8 13.4 12.0 10.0 6.8 7.2 7.5 8.0 6.0 6.3 5.3 6.0 4.2 3.8 3.2 3.4 3.6 4.0 3.1 3.2 2.6 2.8 2.6 2.1 2.2 2.9 1.8 2.0 0 Kharagauli Ozurgeti Poti Mestia Kutaisi Tbilisi Khashuri Gardabani Rustavi Kaspi Ambrolauri Akhaltsikhe Zugdidi Dusheti Chokhatauri Keda Kvareli Kobuleti Sagarejo Aspindza Oni Batumi Gori Mtskheta Zestaponi Tsalka 2013 unit cost 2015 unit cost No. of employees per 1000 population Source: Ministry of Finance. D. Subnational Capital vulnerable30 (Table 4.1). As of 2013, population of Expenditures Georgian local governments range from 5,000 to 178,000 in municipalities and from 48,000 to 1.2 mil- Capital spending represents a substantial portion lion in cities. A reported wide disparity in institutional of local government spending. In 2013, local gov- capacity is not surprising: large subnational govern- ernments devoted an average of 30 percent of their ments like Tbilisi can plan and execute capital budgets spending on public investments, or GEL100 per cap- effectively but small municipalities lack that capacity. ita. This is about 40 percent of Georgia’s total capital The level and composition of total public spending, spending and 2.5 percent of its GDP. However, the high and the capital grants invested by various funds and shares mask major variance across local governments: programs (described later) also vary tremendously, the share of capital in total spending ranges from less with high coefficients of variation. The high degree of than 1 percent to more than 60 percent (Figure 4.7). variation in spending patterns reflects the differences Capital spending also represents a smaller share of the in economic development and institutional capacity. spending of larger municipalities (Figure 4.8). This is On average, large municipalities or cities tend to be in part due to economies of scale, which drive down more developed and have more institutional capacity; the share of public spending devoted to the capital they are also characterized by, a lower share of socially investments of larger local governments (World Bank vulnerable people, higher capital spending and more 2014). Larger municipalities also have on average funding from the RPIF, more spending on culture, edu- fewer budget constraints and are therefore able to cation, and social services and less on general public spend on a wider range of activities out of their self- services such as law and order (Figure 4.9).31 sourced revenues. 30 “Socially vulnerable” people are individuals receiving benefits There is a high degree of variation in capital from social security, administered by the central government. spending by local governments, which reflects the 31 The best-fit line (red) is estimated with OLS. Since Tbilisi is an difference in economic development and institu- outlier in terms of population, it is excluded from the graph but tional capacity. Local governments differ in size and the pattern is robust to its inclusion and to changes in the num- ber of local governments grouped together. The figures in the economic development, as evidenced by the heteroge- rest of this section are constructed following the same logic and neity of their populations and the share of the socially are robust to similar changes. 42 Georgia Public Expenditure Review Figure 4.7: Local government capital spending Figure 4.8: Population and capital spending per capita, variances, 2013 2013 .06 400 350 Capital Expenditures 300 .04 250 Density per Capita 200 .02 150 100 50 0 0 20 40 60 80 0 Share of Capital Expenditures in Total 0 50000 100000 150000 200000 250000 Expenditures across Local Governments Population Sources: 2013 BOOST database and staff calculations. Sources: 2013 BOOST database and staff calculations. Table 4.1: Local government characteristics and spending (in GEL), 2013 Standard Mean Deviation 10th pc 25th pc 50th pc 75th pc 90th pc Population 70,294 145,537 14,597 28,605 43,097 67,359 122,453 Percent of Socially Vulnerable People 13.7 8.4 3.9 7.3 12.1 18.6 28.1 Amount Spent by . . . Municipal Development Fund 793,582 1,360,506 0 0 412,242 618,290 2,388,555 Regional Projects Implementation 1,746,436 1,892,842 0 0 1,560,622 2,369,199 3,523,424 Fund Village Support Program 632,833 511,640 0 0 626,692 983,435 1,338,553 Share of Local Expenditures Devoted to . . . Capital Expenditures 32.6 15.5 10.7 24.9 32.5 43.8 50.6 General Public Services 26.3 13.5 15.5 18.4 23.2 29.8 36.8 Defense 1 0.5 0.5 0.7 0.9 1.2 2 Economic Affairs 25.76 14.8 1 18.1 24.5 35.6 52.1 Environment Protection 5 3.9 0.1 2.4 4.4 7.4 11.2 Health Care 0.9 0.6 0.4 0.6 0.8 1.1 1.8 Housing 12.1 8.9 1.7 5.1 10.1 17.6 25.2 Public Order and Safety 3.32 1.51 2 2.6 3.1 3.8 5.5 Social Protection 5.4 3.5 2.3 3.1 4.5 6.4 9.4 Sources: 2013 BOOST database and Bank staff calculations. On the revenue side, the central government plays For 2013–14, the special purpose grants accounted a key role in financing capital projects. In general, for 17 percent of total local government revenues local governments have three sources of financing for and financed nearly 80 percent of subnational capital capital projects—its own collections (property tax, user spending equivalent to 22 percent of total subnational fees, etc.), the equalization grants, and special purpose spending; the rest was financed by equalization grants grants, which tend to be earmarked for capital projects. and local governments’ own sources. Subnational Expenditure Review 43 Figure 4.9: Local government populations, socially vulnerable populations and spending, 2013 40 30 Level of Capital Expenditures 35 Social Vulnerable Share 25 30 (million GEL) 25 20 20 15 15 10 10 5 5 0 –5 0 0 50000 100000 150000 200000 250000 0 50000 100000 150000 200000 250000 Population Population Share of Defense and General 40 50 35 45 Share of Culture, Religion, Environment, Housing 40 and Social Protection 30 Public Services 25 35 30 20 25 15 20 10 15 5 10 0 5 –5 0 0 50000 100000 150000 200000 250000 0 50000 100000 150000 200000 250000 Population Population Sources: 2013 BOOST database and Bank staff calculation. Local governments finance capital projects projects in 70 percent of Georgia’s municipalities and through special purpose capital grants from the cities; the total amount represented nearly 30 per- RPIF, the MDF, and the VSP. The RPIF, administered cent of total local government investment. Although by Georgia’s Ministry of Finance (MOF) and the Min- allocations are based on projects, not on areas of istry of Regional Development and Infrastructure local governments, RPIF spending across local gov- (MRDI), provides funding to improve access to such ernments shows persistence over time (Figure 4.10). public services as sewerage system, kindergarten, The MDF program, which allocates funding municipal- natural gas, water supply, hospitals, and roads. Funds ity by municipality, has been growing in importance; are allocated project by project: projects are submit- in 2013 it assisted 50  percent of local governments, ted to the MRDI and selected according to criteria disproportionately benefiting small cities and munici- defined by the central government. The RPIF has also palities (Figure  4.11). It financed nearly 70 projects, set funding ceilings for each municipality based on accounting for 13 percent of total local government population. The MDF is a public legal entity that helps local governments to prepare, finance, and construct investment projects. It helps build up the institutional Figure 4:10: RPIF spending, 2013 and 2014 and financial capacity of local governments by issu- 10 9 ing loans or grants to implement projects to improve Share in 2014 Regional Funding Investments 8 public infrastructure related to, e.g., from water sup- 7 ply, sewerage, solid waste collection, and road repair. 6 5 The VSP, which is also administered by the MOF and 4 MRDI, provides funding for small-scale projects (e.g. 3 rehabilitating a small road). 2 1 Capital grants from the RPIF, MDF and VSP are 0 centrally administered; local governments have 0 2 4 6 8 Share in 2013 Regional Funding Investments limited discretion to select or carry through infrastructure projects. In 2013 the RPIF financed Sources: 2013 BOOST database and Bank staff calculation. 44 Georgia Public Expenditure Review Figure 4:11: MDF spending by recipient population, and establish fees for parents. In general, preschools 2013 are largely financed through equalization grants, like 8 most other local government services. 7 Georgia’s local governments spend a notable Amount Invested by MDF in 6 amount on preschool education. In 2013 preschool 2013, million Gel 5 4 spending averaged 7.9 percent, with a standard devia- 3 tion of 3.5 percent. Variable costs, especially salaries 2 and food, constitute the bulk of preschool expendi- 1 tures. Specifically, in the 2011–12 academic year sala- 0 ries accounted for an average of 59 percent, and food 0 50000 100000 150000 200000 250000 for 25 percent. The shares of preschool spending show Population wide disparity, but almost all municipalities spend Sources: 2013 BOOST database and Bank staff calculation. more than 5 percent of total spending on preschools expenditures. In general, larger local governments tend to spend larger shares of their budget on educa- investment. In 2013, the VSP provided funding for tion, but the preschool spending shares of the biggest most municipalities and cities but only accounted for cities are not as high as those of medium-sized local 6 percent of total local government capital spending. governments (Figure 4.12). Total preschool education Gradually increasing the discretion of local gov- spending in Georgia accounts for about 0.3 percent of ernments to choose their public investments may GDP32 and in recent years has held steady as a share have substantial benefits. Capitalizing on local of GDP. knowledge and expertise to select and manage proj- Elimination of preschool parental fees in Septem- ects has the potential to heighten the quality of public ber 2013 has driven up local government spend- infrastructure. However, decentralizing infrastructure ing on education. The majority of local governments investment decisions may be premature for LSGs spending on education goes to preschools, so the where institutional capacity to identify and realize change in education spending very much reflects the projects is low. Figure 4.12: Preschool education spending, shares E. Preschool Expenditures and population, 2013 Preschool is a major responsibility of local govern- 18 ments. Preschool education is central to the devel- 16 Share of Education in Total 14 opment of an individual’s human capital. In Georgia, Expenditures 12 preschool institutions are not-for-profit entities. 10 According to the Georgian Constitution, unlike gen- 8 eral education, which is mandatory, the state is not 6 responsible for providing every child with funding and 4 access to preschool. Responsibility for supervising 2 0 and financing preschool education was delegated to 0 50000 100000 150000 200000 250000 local self-governing units in 2005. The role of the cen- Population tral government has since been limited to drafting and Source: 2013 BOOST database. approving curricula and other programs for preschool institutions, and supporting their application through the Ministry of Education and Science. Most local gov- 32 Based on the WMS survey, 2011 preschool spending is known ernments have specialized agencies (“preschool care with great accuracy. Preschool spending in 2013 was inferred from local governments budgeting for education that year. In unions”) to coordinate and monitor public preschools, both 2011 and 2013, the share of preschool education spending provide methodological guidance and assure quality, in total GDP was about 0.3 percent. Subnational Expenditure Review 45 change in preschool spending. Before the change in Figure 4.13: Education spending, million GEL, 2012, spending on education by local governments and share of LSG spending, 2013 did not change much; in 2012 it was almost the same 250 14% as in 2010 (Figure 4.13). However, since parental fees 12% were eliminated, there have been upticks in both local 200 10% government education spending and the shares of 150 8% education spending in total outlays. Local government spending on education grew by 36 percent in 2013 100 6% and another 35 percent in 2014. By the end of 2014, 4% local government spending on education was nearly 50 2% twice what was spent in 2012. 0 0% 2010 2011 2012 2013 2014 The heightened cost after parental fees were elimi- nated is expected to vary significantly across Geor- Education spending in million GEL (left axis) gia due to differences in preschool spending per Education spending as percent of total LSG spending (right axis) child, parental contributions, and preschool enroll- ment rates before the policy change. According to Source: 2013 BOOST database. the 2011 welfare monitoring survey, average monthly spending per child ranged from GEL48 in Kakheti to GEL136 in Adjara (Table 4.2). This reflects differences 63 percent in Tbilisi. The parental fee contribution as in both the efficiency and quality of preschool ser- a share of total preschool spending also varied, from vices. For instance, teachers and caregivers in Tbilisi less than 10 percent in Guria to more than 35 percent preschools are typically much better trained than in in Tbilisi. Hence the fiscal impact of the 2013 reform the rest of Georgia. Preschool enrollment rates also eliminating parental fees would differ considerably vary widely, from 21 percent in Samtskhe-Javakheti to by region and it is expected to be closely related to Table 4.2: The composition of preschool education expenditures (As percent of total preschool expenditures) Total Percentage Total Preschool of Preschool Average Total Preschool Spending Spending Preschool Monthly Average Preschool Spending (% of Covered by Enrollment Expenditures Wage of Spending (% of total equalization Parent Fees Rate per Child Care Givers Region (% of GDP) transfers) transfers) (%) (%) (2011 GEL) (2011 GEL) Adjara A.R. 0.0295 48.4 – 29.0 28 135.7 279 Guria 0.00769 6.59 19.2 8.2 52 82.9 212 Imereti 0.0363 9.64 17.1 13.2 55 71.7 200 Kakheti 0.0147 8.01 17.8 11.6 57 48.3 162 Kvemo Kartli 0.016 8.8 21.4 38.8 22 58.2 219 Mtskheta-Mtianeti 0.00584 8.17 30.7 11.3 58 73.5 149 Racha-Lechkhumi and 0.00188 2.93 6.6 5.7 45 84.4 149 Kvemo Svaneti Samegrelo-Zemo Svaneti 0.0167 6.85 16.4 18.7 33 60.5 171 Samtskhe-Javakheti 0.00472 4.35 11.7 29.4 21 53.1 163 Shida Kartli 0.0104 7.19 12.8 20.1 36 52.2 172 Tbilisi 0.129 9.94 9.96 37.6 63 96.2 314 Total 0.272 8.81 12.6 28.5 44 80.0 235 Sources: 2011 WMS and staff calculations. 46 Georgia Public Expenditure Review pre-reform preschool spending, parental contribution available are totally filled. In that scenario enrollment in preschool spending, and preschool enrollment. will increase by about 10 percent to max out preschool capacity, leading to a higher cost of GEL33 million. Making preschool education free will also encour- Scenario 3 corresponds to the case where enrollment age enrollment, which will raise the costs for increases up to the average enrollment rate for house- local governments. Before the fees were eliminated, holds in the top three quintiles of  the consumption enrollment rates were much higher among rich than distribution. In that case, enrollment will increase by among poor households, ranging from 30 percent in 4.3 percent, at a cost of GEL27 million. In Scenario 4, the poorest households to more than 50 percent in the enrollment is assumed to increase up to the average richest. Without fees enrollment rates for less well-off enrollment rate for households in the top quintile of families are expected to rise and enrollment rate gaps the consumption distribution, bringing a 19 percent are likely to diminish. Regions more heavily reliant on increase in enrollment and a much larger fiscal cost of parental fees as a source of preschool funding are gen- GEL39 million. erally associated with lower enrollments, except for Tbilisi. This means that with parental fees eliminated, Inter-regional differences in spending are likely to regions that were more reliant on parental fees will be exacerbate inequality in the provision of preschool confronted by a more acute increase in costs because services. For some regions the implied fiscal impact of two shocks: (1) higher preschool spending to com- is much heavier than for others, driven by differences pensate for the higher parental fee, and (2) a bigger in parental fees, enrollment rates, and per child pre- increase in enrollment due to the lower enrollment school spending (Figure 4.14). Before the parental fee rate before the change. was eliminated there was already a large disparity in the quality of preschool services: for instance, Tbilisi In different scenarios the immediate increase in provides much better preschool services and its cost preschool spending after the parental fee elimina- per child is nearly 30 percent higher than the rest of tion is estimated to total GEL24–39 million. Four the local governments. After the fee exemption, more scenarios are considered (Table 4.3). In Scenario 1 developed local governments like Tbilisi are likely to enrollment remains the same as pre-reform and the be in a better position to curb the fiscal impact; others central government compensates for the amount used where parental contributions were high and enroll- to be paid in fees by parents. In this scenario the cost of ment rates low may not be able to fully compensate the reform will be GEL24 million. In Scenario 2, enroll- for the amounts parents used to pay. This will lead to ment increases so that preschool places currently further deterioration of the quality of preschool edu- cation in these localities and result in more unequal preschool services across the country. Table 4.3: Additional fiscal cost of eliminating preschool fees, million GEL F. The Way Forward Estimated Fiscal As they gain more fiscal autonomy, local govern- Scenarios Impact ments need to build up their institutional capaci- Fee Reform Scenario 1 ties and align their spending priorities to the Fixed Enrollment 24 needs of their constituents. Institutional capaci- Fee Reform Scenario 2 ties differ considerably across local governments and Fixed Supply 33 inadequate capacity for planning, selecting, and exe- Fee Reform Scenario 3 cuting budget items could make it harder for them to Enrollment Equal to Average in Top Three 27 serve the local population. It is therefore important to Consumption Quintiles draft technical guidelines and put in place account- Fee Reform Scenario 4 ability mechanisms, especially for such sophisticated Enrollment Equal to Average in Top 39 spending activities as capital investment. Technical Consumption Quintile guidelines can inform local governments as they sub- Source: Staff calculations. mit or select and conduct public investment projects Subnational Expenditure Review 47 Figure 4.14: Fiscal impact of parental fee elimination by region (Additional cost as percent of GDP) Tbilisi Shida Kartli Samtskhe-Javakheti Samegrelo-Zemo Svaneti Racha-Lechkhumi and Kvemo Svaneti Mtskheta-Mtianeti Kvemo Kartli Kakhei Imereti Guria Adjara A.R. 0 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 Enrollment Equal to Average in Top Consumption Quintile Enrollment Equal to Average in Top Three Consumption Quintiles Fixed Supply Fixed Enrollment Sources: 2011 WMS and staff calculations. (see Box 4.2). Equally important is the creation of capacity through learning by doing. This scheme could top-down and bottom-up accountability systems (see then later be gradually applied to other local govern- Box 4.3). The central government has also developed ments. Moreover, by associating local citizens with the temporary norms on subnational spending that are decision-making process of local governments and sensible measures to guide local government spend- introducing audit procedures controlled by the cen- ing as fiscal decentralization gets started. However, tral government, the reform also has the potential to the government needs to be careful not to formulate address persistent issues of inefficient local govern- rules in ways that could possibly cause distortion in ment spending. local government spending behavior. Besides setting The national government needs to institute mea- spending floors and ceilings, transfers or rewards sures to prevent a large divergence in local govern- could be used to motivate local governments to meet ment preschool spending per child. Such divergence fiscal targets. in early childhood education would undermine equity As part of the decentralization agenda, the mecha- in human capital formation and equality of opportunity. nism by which RPIF allocates funds could be modi- A variety of measures have successfully address this fied to give local governments more discretion in problem: (1) Canada and Chile use conditional grants selecting and executing their public investment to fund local government preschool services, and the projects. A possible approach is to identify a group central governments set the level of per child spend- of municipalities and cities with relatively high insti- ing and define national standards for service, such as tutional capacities and, within this pilot group, allo- access, coverage and quality. (2) Poland sets spending cate resources for public investment municipality by standards per child, mandates that specified tax rev- municipality, rather than on project by project, dele- enues be used explicitly for preschool, and fill in the gating selection and execution of projects to the discre- funding gap with conditional grants if the local govern- tion of the local governments. This reform offers a way ment does not have sufficient own-source funds. (3) to gradually shift responsibilities to local centers of The United Kingdom combines financing of services decision-making. It will give local governments more through local revenues and a general equalization grant incentives to take into account the needs and pref- from the central government, with national standards erences of local populations and build institutional of service enforced by administrative means. 48 Georgia Public Expenditure Review Box 4.2: Guidelines for Public Investment Six basic principles can help governments avoid the recurrent problems associated with appraisal and exe- cution of public infrastructure projects that have been documented in many international studies. 1. Investment Guidance and Preliminary Screening. Investment choices should always be justified as a welfare-improving public policy. They should not be affected by political considerations or aim to gener- ate private benefits for any individual. 2. Formal Project Selection and Appraisal. Projects that pass preliminary screening must still undergo rigorous scrutiny of their costs and benefits. The emphasis should be on the following basic elements: (a) the need for the project is well justified; (b) project objectives are clearly specified; (c) broad alter- native options to meet the project’s objectives are identified and comparatively examined; (d) the most promising option is subject to detailed analysis; (e) project costs are fully and accurately estimated; and (e) project benefits are assessed qualitatively as likely to justify the costs. It is helpful to maintain a portfolio of appraised projects. That can help not only in tracking how many projects have been selected but also in revisiting rejected projects should project circumstances change so that they become likely to generate net positive benefits. Hence, all appraised projects should be recorded in a project database ranked by priority for budget consideration. 3. Project Budgeting. It is vital to ensure that there is recurrent funding to operate and maintain the assets created by a project. This is especially important for donor-funded projects that create assets but operation and maintenance costs are assumed to be borne by the local or central government. More generally, after a project is selected, it is important to double-check that the project is accurately costed and can be tendered and implemented (a “ready-to-go” check). This reduces the risk of delays due to belated procurement planning—a surprisingly common problem. 4. Project Implementation. Projects that have been objectively appraised and selected for investment should be scrutinized for execution realism. Project design should set out clear organizational arrange- ments and a realistic timetable. 5. Facility Operation. Once a project is completed, there should be a process to ensure that the facility is ready for operation and that services can be delivered. This process requires adequate budget funding of service delivery agencies to operate and maintain assets. 6. Basic Completion Review and Evaluation. Finally, there should be a basic completion review and ex- post evaluation of finished projects. Basic completion review should apply systematically to all projects: it consists of an examination of (a) whether the project was finished within the original or amended budget and time frame, and (b) whether the outputs were delivered as specified. Ex-post project evalua- tion should focus on a comparison of whether project outputs and outcomes realize the objectives of the project design. It should be carried out no earlier than two to three years after project completion. This is a way to ensure that there is learning and feedback from projects that will create a positive dynamic for systemic improvement over time. If the evaluation shows that procurement processes, for example, led to costly delays, it should help address that upstream problem as a systemic corrective. Applying these principles should help avoid “white elephant” projects. White elephant projects are high-capital-cost projects with grossly negative social rates of return, such as excess-capacity infrastruc- tures (e.g., a road or airport where there is little or no traffic demand), capital investment that is never completed and is abandoned (e.g., incomplete bridges, houses, buildings), or capital investment that is com- pleted but for which little or no operation and maintenance funding is available. Such projects should be screened out as early as possible. They often arise due to corrupt access to contract funds, which account- ability mechanisms can mitigate. Subnational Expenditure Review 49 Box 4.3: Accountability Mechanisms The guidelines in Box 4.2 constitute a useful public accountability mechanism. They safeguard against abuse of discretion in project selection by forcing central and local governments to explain publicly, fully and fairly, how they are conducting their responsibilities in selecting public investment projects. The central government could be in charge of auditing the selection and execution of projects by local governments with discretion (upward accountability), and an independent commission may be created to introduce checks and balances and audit the selection and execution of projects by the central government itself (horizontal accountability). In addition, social (downward) accountability mechanisms can complement public accountability mechanisms in three ways. (1) Citizens could participate in project selection and execution through neigh- borhood or community councils. For instance, the local governments could organize town-hall meetings before selecting projects or submitting them to the central government, in order to get information from the local community to assess which projects would be most useful. Similarly, they could organize town-hall meetings once projects have been selected and planned, in order to get feedback about efficient implemen- tation. (2) A complaint system should be put in place where citizens can report any abuse at any point while a project is underway. This could be done by setting up an independent commission within Georgia’s Min- istry of Regional Development and Infrastructure, which would collect and address complaints. (3) Surveys should be conducted and meetings organized after projects are completed to assess citizen satisfaction with them. Surveys might be conducted during a town-hall meeting organized at the completion of the project to discuss its outcomes. Social accountability mechanisms could be put in place both in the group of local governments that have dis- cretion over public infrastructure investments and in the group where projects are submitted to the central government and citizens have an important role to play in terms of nominating projects. 50 Georgia Public Expenditure Review References Bucheli, Marisa; Lustig, Nora; Rossi, Maximo; Amabile, Florencia (2014). “Social Spending, Taxes and Income Redistribution in Uruguay,” in Lustig, N., C. Pessino and J. Scott (eds.), The Redistributive Impact of Taxes and Social Spending in Latin America. Special Issue. Public Finance Review, Vol. 42, Issue 3, May. Cancho, Cesar; Bondarenko, Elena (2015). Fiscal Incidence Analysis in Georgia, Working Paper. Higgins, Sean; Lustig, Nora (2013). Measuring Impoverishment: An Overlooked Dimension of Fiscal Incidence. Tulane University Economics Working Paper 1315. 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