How to improve public investment efficiency in Ukraine?

Public investment can both serve socially useful purposes and be growth enhancing, if sufficient levels are allocated efficiently and if budgeting is managed properly. Public investment in Ukraine has recently risen from low to sufficient levels. Private participation in investment for socially useful purposes, such as road construction and other infrastructure investment, is still small. Activities with doubtful rationale for long-term state intervention (economic activities, utilities) receive one third of all public capital expenditure. More than half of this is aid in form of capital transfers to public enterprises, allocated in long bargaining processes. Public investment budgeting rules suffer from a lack of integrated treatment with respect to decision-making bodies, components of capital expenditures, and planning horizons. At current public investment levels, the impact on the economy can nevertheless be increased. • Socially useful investment can be boosted by more private sector involvement in the financing of roads and other infrastructure, including utilities, by concession schemes. • Improved investment budgeting requires o transparent priorities and rules-based selection criteria (cost-benefit analysis); o smoother integration of capital expenditures in the budgeting process; capital and maintenance budgeting can be harmonized by multi-year controls. o Resource ceilings in project selection should be set early, to minimize demand for public funds and to avoid long bargaining processes for public aid. • In the medium term, state aid in form of capital transfers to public enterprises can be re-allocated towards core public activities, education, and health.

Institutional reforms versus selective targeting? Comments on the draft law `On state support of investment and encouraging investment activity' drafted by the Ministry of Economy

Elements of the institutional framework, i.e., the rules and regulations of the economy and the institutions that enforce them, are the main long-run criteria for private investment decisions. In particular, it is openness to trade and transparency that increase the chances of enhancing domestic investment and increasing FDI. Against the background of Ukraine’s still rather poor institutional framework, specifically targeted investment incentives for pre-defined sectors, regions, and/or types of investment, can be both costly and ineffective. Leaning towards selective targeting, the draft law does not sufficiently serve to sustainably enhance private investment in the long run. We recommend to consistently re-draft the law to represent Ukraine’s Guidelines for Public Support of Private Investment, in line with private investor preferences and international experience. Compared to the first draft, we specifically suggest: to focus on improvements of the institutional framework and eliminate all specific targeting elements from the law; to eliminate all references to public investment from this draft law, which should concentrate on public support for private domestic and foreign investment; not to revert to state aid in order to support private investment activity; to expand the final provisions of the draft law and explicitly mention supplementary legislation necessary to improve the institutional framework for investment in Ukraine. In particular, we recommend to focus on the adjustment of the tax legislation according to international standards, employment standards, and provisions that define property rights, to improve law enforcement, the transparency of the public sector, and the efficiency of public spending by cutting state aid. This would serve to demonstrate that institutional framework reforms need a broad and concerted effort from all sources of legislative action.

Fiscal Decentralization in Centralized States : The Case of Central Asia

The resource-based Central Asian countries Kazakhstan, Turkmenistan, and Uzbekistan constitute a special case for fiscal decentralization. Political and administrative centralization is accompanied by the centralized administration of resource rents and weak governance structures on local levels. Following best practices, fiscal decentralization is on the reform agenda in all three transition countries. As advocated in economic literature and indicated in empirical evidence, policymakers expect positive results on macroeconomic outcomes as well as on overall state governance. But the mechanism for the positive effects of fiscal decentralization is the creation of appropriate incentives by transferring information rights and authority to the local levels. How do the centralized states of Central Asia apply fiscal decentralization and what are the outcomes of their policies? To answer this question, we analyze the progress of fiscal decentralization in Kazakhstan, Uzbekistan, and Turkmenistan since independence. In all three countries we observe high levels of fiscal decentralization. The de-facto institutional design of fiscal decentralization, however, is not appropriate to make incentive mechanisms work. Fiscal autonomy at the revenue and expenditure side is almost absent, and the transfer system lacks transparency and predictability. Administrative and political centralization are the drivers of this institutional design and create obstacles for the merits of fiscal decentralisation to materialize.

VAT replacement or better administration?

VAT revenues in Ukraine are undermined by numerous privileges and low tax compliance due to manipulations and/or outright fraud causing inadequate tax collection and high tax refunds claims. Besides, there are both strong concerns about the vulnerability of the VAT system to corruption and complaints from businesses about delays in refunding. Feasible options to overcome the low VAT revenue problem include replacing VAT, e.g., with a general sales tax (GST), or improving VAT administration. We argue that a VAT is superior to a GST in Ukraine. However, VAT administration can be significantly improved. Especially, we recommend to introduce VAT accounts tied to supporting measures such as the cash method and automatic refunding of VAT; to increase spending on tax administration combined with a reform of the tax administration body (STA), simplify legislation, and favor law enforcement. We argue that the problems of tax evasion and privileges are closely related. A reduction of tax privileges potentially pushes firms towards more fraud. Better administration (such as due to VAT accounts) makes fraud schemes more expensive such that firms may be inclined to lobby for privileges. Therefore, we argue in favor of further and sustainable reductions of VAT privileges, in particular sector-specific privileges, as a necessary complement to improved tax administration. In this respect, we recommend to re-draft and to enforce the Law on State Aid and to include an assessment of all different forms of direct and implicit subsidies, including tax expenditures, in the regular reports of the Anti-Monopoly Committee to Verhovna Rada. Resulting higher tax compliance due to better administration and a growing tax base due to diminished privileges might then justify reducing the VAT rate.

Comment on the Expenditure Side of the Draft Budget of Ukraine for 2004

The paper comments on the composition of the expenditure side of the central state budget of Ukraine for 2004. It takes a closer look at possible expenditure risks contained, the priorities which are reflected in the expenditure changes for ndividual items, and the transparency and accountability of the budget.