Report No. 96451-YF Republic of Serbia PUBLIC FINANCE REVIEW 2015 Republic of Serbia Report No. Public Finance Review 96451-YF Toward a Sustainable and Efficient Fiscal Policy July 24, 2015 Document of the World Bank Macroeconomics & Fiscal Management CURRENCY EQUIVALENTS Exchange Rate Effective June 27, 2015 Currency Unit: RSD RSD 107.59=US$ 1 Fiscal Year January 1 – December 31 Abbreviations and Acronyms ALMPs Active Labor Market Policies IMF International Monetary Fund AOFI Export Credit and Insurance Agency IPARD Instrument for Pre-Accession Assistance in Rural BEEPs Business Environment and Enterprise Surveys Development CA Child Allowances JSCs Joint Stock Companies CAD Current Account Deficit LLCs Limited Liability Companies CAP Common Agricultural Policy LTO Large Taxpayer Office CSL Civil Servants Law MoF Ministry of Finance CSWs Centers for Social Work MLESP Ministry of Labor, Employment and Social Policy DILS Delivery of Improved Local Services NARD National Agency for Regional Development DZ Dom Zdravlja NCDs Noncommunicable Diseases EBRD European Bank for Reconstruction and Development OECD Organization for Economic Co-operation and EC European Commission Development ECA Europe and Central Asia PEs Public Enterprises ECD Early Childhood Development SIEPA Serbian Investment and Exports Promotion Agency EU European Union SILC Survey on Income and Living Conditions FDI Foreign Direct Investment SMEs Small and Medium Enterprises FSA Financial Social Assistance SOEs State-Owned Enterprises FREN Foundation for the Advancement of Economics STS Serbian Taxpayer Survey GIZ German Agency for International Cooperation TIMSS Trends in International Mathematics and Science HBS Household Budget Survey Study HIF Health Insurance Fund UNESCO United Nations Educational, Scientific and Cultural IBRD International Bank for Reconstruction and Organization Development UNICEF United Nations Children's Fund HTA Health Technology Assessments USAID U.S. Agency for International Development ICT Information and Communications Technology Regional Vice President: Laura Tuck Country Director: Ellen Goldstein Senior Director: Marcelo Giugale Director: Satu Kähkönen Practice Manager: Ivailo Izvorski Task Team Leaders: Abebe Adugna and Lazar Šestović TABLE OF CONTENTS Executive Summary.......................................................................................................................................................................... I I. Introduction and Country Context................................................................................................................................. 1 Chapter 1........................................................................................................................................................................................................ 3 The Need for Fiscal Consolidation............................................................................................................................................ 3 A. Country Context................................................................................................................................................................................ 3 B. Fiscal Sustainability under Alternative Scenarios ........................................................................................................ 7 C. How the Report is Organized...................................................................................................................................................10 II. Opportunities and Options for Fiscal Consolidation......................................................................................11 Chapter 2.....................................................................................................................................................................................................13 Revenue and Tax Administration.............................................................................................................................................13 A. Revenue Performance..................................................................................................................................................................13 B. Current Weaknesses in Tax Administration ...................................................................................................................14 C. Tax Administration as a Business Constraint ................................................................................................................17 D. Tax Strategies to Combat Serbia’s Shadow Economy .............................................................................................19 E. Conclusions and Recommendations.................................................................................................................................. 20 Chapter 3..................................................................................................................................................................................................... 23 Wage Bill and Staffing in Public Administration........................................................................................................ 23 A. Introduction..................................................................................................................................................................................... 23 B. The Need for Wage Reform and Right-sizing................................................................................................................ 23 C. Lack of Control and Oversight................................................................................................................................................ 27 D. Government Reforms Underway.......................................................................................................................................... 28 E. Conclusions and Recommendations................................................................................................................................... 30 Chapter 4.................................................................................................................................................................................................... 31 Pension Reform: Medium to Longer Term Issues........................................................................................................ 31 A. Current State of the Pension System................................................................................................................................. 31 B. Design of the Pension System before the 2014 Changes...................................................................................... 33 C. Reforms Enacted in 2014 and Their Impact.................................................................................................................. 37 D. Issues Going Forward................................................................................................................................................................. 38 E. Conclusions and Recommendations................................................................................................................................... 42 Chapter 5..................................................................................................................................................................................................... 43 Subsidies and State Support to the Economy............................................................................................................... 43 A. State Support to SOEs................................................................................................................................................................ 44 B. State Support to Agriculture .................................................................................................................................................. 48 C. State Support to the Private Sector.................................................................................................................................... 53 D. Conclusions and Recommendations.................................................................................................................................. 54 III. Opportunities for Improving the Efficiency and Equity of Public Spending in Social Sectors .......................................................................................................................... 55 Chapter 6.................................................................................................................................................................................................... 57 Education ................................................................................................................................................................................................. 57 A. Quality of and Access to Education in Serbia............................................................................................................... 57 B. Financing Education: Where Does the Money Go?.................................................................................................... 60 C. Opportunities for Enhancing Efficiency........................................................................................................................... 62 D. Conclusions and Recommendations.................................................................................................................................. 67 Chapter 7.................................................................................................................................................................................................... 69 Health ......................................................................................................................................................................................................... 69 A. Overview............................................................................................................................................................................................. 69 B. Health Outcomes........................................................................................................................................................................... 69 C. Coverage and Quality of Health Services........................................................................................................................ 70 D. Health Financing and Expenditure: Trends and Composition............................................................................. 72 E. Efficiency of Public Health Spending................................................................................................................................. 77 F. Financial Protection..................................................................................................................................................................... 80 G. Conclusions and Recommendations.................................................................................................................................. 82 Chapter 8..................................................................................................................................................................................................... 83 Social Assistance ................................................................................................................................................................................ 83 A. Social Protection in Serbia....................................................................................................................................................... 83 B. How Effective are Social Assistance Programs............................................................................................................. 88 C. Performance of Categorical (Non-Targeted) Benefits ............................................................................................ 90 D. Performance of Poverty-Targeted Programs .................................................................................................................92 E. Conclusions and Recommendations....................................................................................................................................93 IV. Distributional Impact of Fiscal Consolidation in Serbia............................................................................. 95 Chapter 9..................................................................................................................................................................................................... 97 Distributional Impact of Fiscal Consolidation Measures .................................................................................... 97 A. Serbia’s Poverty and Labor Market Profile in Brief ................................................................................................... 97 B. Public Sector Wage Bill Reforms........................................................................................................................................... 98 C. Pension Reforms............................................................................................................................................................................. 99 D. Reduced State Support to Public Enterprises..............................................................................................................101 E. Electricity Tariff Adjustment................................................................................................................................................. 102 References..............................................................................................................................................................................................105 Annex 1: Strategies to Combat the Shadow Economy: Examples from around the World.....................107 Annex 2: Public and Private Sector Salaries by Occupation ...................................................................................... 119 TABLES Table 1: Summary of Policy Recommendations............................................................................................................. X Table 2: Estimated Fiscal Impact of Additional Identified Reforms Relative to Baseline ............... XIII Table 1.1: General Government Expenditure by Function, Pre- and Post-crisis ............................................... 6 Table 1.2: General Government Fiscal Operations............................................................................................................ 8 Table 1.3: General Government Fiscal Operations, January-June 2014 and 2015......................................... 9 Table 2.1: Serbia Tax Revenues 2008–14 ............................................................................................................................14 Table 2.2: VAT Audit Performance, 2011–13 .....................................................................................................................15 Table 2.3: Planned vs Ordered Audits.....................................................................................................................................15 Table 2.4: Tax Arrears, 2012–14.................................................................................................................................................16 Table 2.5: Tax Evasion by Mode and Questioning Technique (pooled sample) ............................................18 Table 2.6: Cash payments Made and Received, by Firm Size....................................................................................18 Table 2.7: Factors that Complicate Paying Taxes, by Firm Size ..............................................................................18 Table 3.1: The Importance of the Wage Bill as a Source of Fiscal Consolidation Savings...................... 25 Table 3.2: Categories of Public Employment, 2013....................................................................................................... 26 Table 5.1: General Government Support to Economy, 2014..................................................................................... 43 Table 5.2: The Nonfinancial SOE Sector, 2013 unless Otherwise Indicated.................................................... 44 Table 5.3: Public Spending for the Agri-Food Sector in Rural Areas .................................................................... 48 Table 5.4: Budget Support for Crops, Fuel, and Insurance by Region, 2013.................................................... 50 Table B5.3.1: How EU Agricultural Support will be Used................................................................................................... 52 Table 6.1: Gross Enrollment Rates, Serbia and Comparator Countries............................................................... 60 Table 6.2: Public Expenditures on Education in the Republic of Serbia, 2010–12 .......................................61 Table 6.3: Primary and Secondary Student-Teacher Ratios by Region, Serbia, 2009–12 ...................... 64 Table 7.1: HIF Revenue and Expenditures, 2008–14 ...................................................................................................74 Table 7.2: Spending on the top 5 Patented Hospital Drugs, 2013........................................................................ 80 Table 8.1: FSA Spending and Beneficiaries, 2005–13.................................................................................................. 87 Table 9.1: At-risk-of-poverty Rate by Age and Labor Market Status ................................................................... 98 Table 9.2: Labor Force Statistics by Income Group, aged 18–65........................................................................... 98 Table 9.3: Old Age Pension Beneficiaries by Type and Pension Level, 2013.................................................... 99 Table 9.4: Worker Characteristics and Wages, SOEs and the Private Sector ............................................... 102 Table 9.5: Electricity and Energy Budget Shares by Quintile and Heating Group, 2013 ....................... 102 Table A1.1. Sectors where Tax Evasion is Prominent..................................................................................................... 110 Table A1.2: Denmark: Mapping of Compliance in Business Segments............................................................... 110 FIGURES Figure 1.1: General Government Fiscal Operations, 2009–14...................................................................................... 4 Figure 1.2: Public Debt, 2009–14.................................................................................................................................................. 4 Figure 1.3: Decomposition of Change in Average Revenues from 2006–2008 to 2012–2014................. 5 Figure 1.4: Decomposition of Change in Expenditures from 2006–2008 to 2012–2014............................ 5 Figure 1.5: General Government Expenditure by Function, 2014.............................................................................. 6 Figure 1.6: General Government Debt-to-GDP Ratio, Alternative Scenarios....................................................... 7 Figure 1.7: Additional Fiscal Reforms Can Yield a More Sustained Reduction in the Debt Ratio............ 8 Figure 1.8: The Debt Path is Particularly Sensitive to Growth or Exchange Rate Weakness...................... 8 Figure 2.1: Serbia Tax-to-GDP Ratio, 2009–14....................................................................................................................13 Figure 2.2: Average Cost, Tax Administration per Employee......................................................................................16 Figure 2.3: Taxpayers per Tax Administration.....................................................................................................................17 Figure 2.4: Serbia: Top Ten Constraints for Businesses .................................................................................................17 Figure 2.5: How Firms Perceive Tax Administration..........................................................................................................18 Figure 3.1: The Public Wage Bill, Regional Comparison, 2013.................................................................................. 24 Figure 3.2: Public Wage Bill Spending in Serbia ................................................................................................................ 24 Figure 3.3: Average Wage, Public and Private, 2002–14............................................................................................... 24 Figure 3.4: Serbia: Primary Education Employees vs. Pupils ...................................................................................... 26 Figure 3.5: Pay Subsystems in the new Wage Law........................................................................................................... 29 Figure 3.6: What is Needed to Estimate the Fiscal Impact of new Wage Law................................................ 29 Figure 4.1: Pension Benefits in Serbia are Among the Highest in Europe Relative to GDP Per Capita........................................................................................... 32 Figure 4.2: Old-age Pensioners below Retirement Age.................................................................................................. 33 Figure 4.3: Newly Retired Old-Age Pensioners below Retirement Age, 2013.................................................... 33 Figure 4.4: Pension Beneficiaries by Type, 2013................................................................................................................ 33 Figure 4.5: Average Projected Old-Age Benefits Relative to the Current Average Wage, 2013–73.............................................................................................................. 35 Figure 4.6: Pension Spending, 2013–73................................................................................................................................. 36 Figure 4.7: Pension Fund Balance, 2013–73........................................................................................................................ 36 Figure 4.8: Reduction in Benefits per Year of Early Retirement................................................................................ 36 Figure 4.9: Impact of 2014 Reforms on Pension Spending......................................................................................... 38 Figure 4.10: Benefit Impact of Delinking General Point Value from Post-retirement Indexation................................................................................................................................... 39 Figure 4.11: Pension Spending Impact of Delinking.......................................................................................................... 40 Figure 4.12: Percentage of Elderly Collecting Public Pensions Today and Estimated Percentage Eligible for Benefits in 2050............................................................................... 40 Figure 5.1: State Support to the Economy, 2000–14...................................................................................................... 43 Figure 5.2: Composition of State Support to the Economy, 2000–14.................................................................. 43 Figure 5.3: Guaranteed Debt, 2007–14 ................................................................................................................................. 46 Figure 5.4: Debt service for Guaranteed Debt (Interest and Principal) Real Prices ..................................... 46 Figure 5.5: Budget Support to Agriculture by Type of Program .............................................................................. 49 Figure 5.6: Number of Active Farmers, 2006–13 ............................................................................................................ 50 Figure 5.7: Milk Subsidies and Dairy Production, 2004–13 ........................................................................................ 50 Figure 6.1: PISA Performance and Public Spending on Education......................................................................... 58 Figure 6.2: Reading Gap, Serbia and Comparator Countries (PISA 2009)......................................................... 59 Figure 6.3: Early Childhood Education in Serbia, 2014.................................................................................................. 60 Figure 6.4: Public Spending on Education..............................................................................................................................61 Figure 6.5: Students, Classes, and Teachers. Primary and Secondary Education, 2000–13.................... 62 Figure 6.6: Full-Time and Part-Time Teachers. Primary and Secondary, 2008–12........................................ 62 Figure 6.7: Primary and Secondary Student-Teacher Ratios, Serbia and the OECD, 2000–12............... 63 Figure 6.8: Teacher Characteristics by Urban-Rural Location and Quintile....................................................... 64 Figure 6.9: Population of Serbia by Age Group, 1990–2050 ..................................................................................... 65 Figure 6.10: Number of Primary and Secondary Schools, 2000–13......................................................................... 65 Figure 6.11: Per Capita Financing of Education in ECA Countries ............................................................................ 67 Figure 7.1: Serbian Population Trends, 1990–2013 ....................................................................................................... 70 Figure 7.2: Disease Burdens, Serbia, 1990–2010 Disability-Adjusted Life Years .......................................... 70 Figure 7.3: Child Immunization and Antenatal Care by Welfare Quintile ......................................................... 70 Figure 7.4: Nutrition Outcomes .................................................................................................................................................. 71 Figure 7.5: Outpatient Contacts per Capita per Year..................................................................................................... 71 Figure 7.6: Age-standardized Prevalence of Chronic Conditions, Serbia and Comparators.................... 71 Figure 7.7: Preventive Examinations ...................................................................................................................................... 71 Figure 7.8: Preventive Screening Rates................................................................................................................................... 72 Figure 7.9: Total Public and Private Health Spending, 1995–2012, Serbia and Comparators................ 72 Figure 7.10: Total Public and Private Health Spending, 2005–13, Serbia and Comparators..................... 72 Figure 7.11: Private Out-of-pocket Health Payments, 1995–2012 ........................................................................... 73 Figure 7.12: Public Health Spending, 1995–2012 .............................................................................................................. 73 Figure 7.13: Insurance Pool Composition..................................................................................................................................74 Figure 7.14: Insurance Revenue Composition........................................................................................................................74 Figure 7.15: Capital Outlays............................................................................................................................................................. 75 Figure 7.16: Salaries ............................................................................................................................................................................ 75 Figure 7.17: Spending on Hospitals ............................................................................................................................................ 75 Figure 7.18: Spending on Hospitals .............................................................................................................................................76 Figure 7.19: Spending on Curative Services ............................................................................................................................76 Figure 7.20: Spending on Prevention ..........................................................................................................................................76 Figure 7.21: Pharmaceutical Spending...................................................................................................................................... 77 Figure 7.22: Pharmaceutical Spending...................................................................................................................................... 77 Figure 7.23: Healthy Life Expectancy and Public Health Spending.......................................................................... 77 Figure 7.24: Bed Density, 2005–11 ............................................................................................................................................. 78 Figure 7.25: Hospital Admissions, 2005–11............................................................................................................................ 78 Figure 7.26: Average Acute Care Length of Stay, 2005–11........................................................................................... 78 Figure 7.27: Bed Occupancy Rate for Acute Care, 2005–11.......................................................................................... 79 Figure 7.28: Unmet Health Need for Financial Reasons................................................................................................. 81 Figure 7.29: Relative Increase in Poverty Due to Out-of-Pocket Payments.......................................................... 81 Figure 7.30: Catastrophic Payments, 2003–10 ................................................................................................................... 81 Figure 7.31: Catastrophic Payments by Quintile, 2008–10 .......................................................................................... 81 Figure 8.1: Total Social Protection Spending in Serbia, 2005–13 ........................................................................... 83 Figure 8.2: Social Protection Spending .................................................................................................................................. 84 Figure 8.3: Social Assistance Spending , 2013 (war benefit simulated)............................................................... 86 Figure 8.4: Serbia’s Social Assistance Spending in Serbia, by Program .............................................................. 86 Figure 8.5: Means-tested and Non-means-tested Social Assistance, 2006–13 ............................................. 87 Figure 8.6: SA Coverage by Country, Poorest and Richest Quintiles ..................................................................... 89 Figure 8.7: Distribution of Benefits, Poorest and Richest Quintile ......................................................................... 89 Figure 8.8: Generosity of Benefits, Poorest and Richest Quintiles ......................................................................... 89 Figure 8.9: Program Coverage and Coverage Distribution by Quintile ................................................................ 90 Figure 8.10: Benefits by Program and Quintile .................................................................................................................... 91 Figure 8.11: Cost-benefit Ratio of Social Assistance ........................................................................................................ 91 Figure 8.12: Coverage by Program and Quintile ..................................................................................................................92 Figure 9.1: Average Old-age Pensions by Benefit Level and Gender.................................................................. 100 Figure 9.2: Average Old-age Pensions by Age and Gender ..................................................................................... 100 Figure A1.1: Sectors Prominent in Shadow Economies Internationally ............................................................... 111 Figure A1.2: Shadow Economy by Sector............................................................................................................................... 111 Figure A1.3: Rollout of the Chinese “Golden Tax System”............................................................................................. 115 BOX Box 1.1: A Snapshot of Serbia’s Pre-and Post-crisis Fiscal Performance........................................................... 5 Box 3.1: Need for Better Personnel Data......................................................................................................................... 28 Box 5.1: Legal Framework Governing the SOEs............................................................................................................ 45 Box 5.2: The Main Budget Support Programs for Agriculture ............................................................................. 48 Box 5.3: IPARD 2014–2020...................................................................................................................................................... 52 Box 6.1: School Network and Per Capita Financing in Moldova ........................................................................ 66 Box 8.1: Serbia’s Social Assistance Programs ............................................................................................................... 85 Box 8.2: Main FSA Provisions Introduced by the New Law on Social Welfare............................................ 88 ACKNOWLEDGEMENTS This report was prepared by a World Bank team led by Abebe Adugna, lead economist, and Lazar Šestović, senior country economist. The chapters were written by the following: Lazar Šestović, Ashley Taylor, and Abebe Adugna (introduction and country context); Rajul Awasthi and Oleksii Balabushko (tax administration); Zachary Mills and Srdjan Svirčev (wage bill and public administration); Duško Vasiljević, Bojan Shimbov, and Bekzod Shamsiev (subsidies and state support to the economy); Anita Schwarz (pensions); Katia Marina Herrera Sosa and Igor Kheyfets with support from Nina Arnhold (education); Patrick Hoang-Vu Eozenou and Timothy Johnston, with support from Biljana Kozlovic (health); Aylin Isik- Dikmelik and Frieda Vandeninden, with support from Marijana Jašarević (social assistance); and Ashley Taylor (distributional impact of fiscal consolidation). The World Bank team is deeply grateful to the Serbian Government for its close collaboration during preparation of the report. In particular, thanks are due to senior officials in the Ministries of Finance, Public Administration, Education, Health, and Labor and Social Policy, and the Office of State Aid. Special thanks also go to Ivailo Izvorski, Practice Manager, and Satu Kahkonen, Global Practice Director, who provided continuous support, guidance, and technical advice. Aristomene Varoudakis (Advisor, DECOS), Pavle Petrović (President, Serbia Fiscal Council), Plamen Kaloyanchev (Serbia Desk Economist at the European Commission) served as peer reviewers, and the team is grateful for their rich comments and feedback, along with those received from the IMF country team. Finally, the team wishes to thank Ellen Goldstein, Country Director for Southeast Europe, and Tony Verheijen, Country Manager for Serbia, for their valuable advice and guidance; Hermina Vuković - Tasić for her support to the team during country visits; and Mismake Galatis and Zakia Nekaien-Nowrouz for support in formatting and document processing. EXECUTIVE SUMMARY EXECUTIVE SUMMARY 1. Since the global economic and financial crisis of investment, and continue toward income convergence with 2008, Serbia has struggled with a weak economy and Western Europe. While many factors determine the quality a deteriorating fiscal position. Until 2008, fiscal deficits of human capital, the level and efficiency of current public were moderate and public debt declined significantly. Since spending on edu­ cation, training and skills development is the start of the global economic and financial crisis in 2008, critical. In light of the 2015–17 fiscal consolidation program however, Serbia has struggled with the interlinked problems already in place, Serbia’s principal avenue to enhancing of minimal growth and unfavorable fiscal dynamics. As investments in human capital in the short to medium term economic activity has stagnated, revenues have fallen and would be through efficiency gains. expenditures, particularly mandatory spending on pensions and wages, have remained high. At the same time, structural 5. The objective of this report is therefore two-fold: (i) fiscal issues, such as continued state support to state-owned propose policy options and recommendations (beyond enterprises (SOEs) and tax administration inefficiencies, those built into the current program) that would help have been a drag on growth. As a result of these pressures, solidify the ongoing fiscal consolidation program and general government fiscal deficits averaged 5.6 percent of help achieve public debt sustainability over the medium GDP a year between 2009 and 2014. Reflecting the high term; and (ii) given near-term fiscal constraints, identify fiscal deficits and poor economic growth, Serbia’s public oppo-rtunities for enhancing the efficiency, quality, and debt has more than doubled, from 34 percent of GDP in equity of current public spending on health, education, 2008 to 71 percent at yearend-2014. and social protection over the medium term. 2. Unchecked, Serbia’s growing public debt is unsustain­ 6. At more than a third of its GDP in 2014, Serbia’s tax able. If the fiscal challenges are not addressed and the revenue is already high, and given recent increases in noninterest fiscal deficit is not reduced—in other words, if tax rates, the scope for further tax rate increases to from 2015 onward the primary deficit is unchanged at 2.4 support fiscal consolidation will be limited. Among percent of GDP—by 2020 public debt will reach 100 percent recent tax policy changes were the 2012 increases in of GDP. Growing public debt not only absorbs signifi­ cant the VAT rate from 18 to 20 percent for the general rate resources, it also poses high rollover risk. Fiscal and debt and from 8 to 10 percent for basic goods and communal vulnerabilities make it critical that the government pursue services; and a rise in the corporate income tax rate from fiscal consolidation to achieve debt sustainability and 10 to 15 percent. However, with tax-to-GDP at about 34 assure medium-term macroeconomic stability. percent in 2013–14, the revenue impact of these policy changes has been modest, in part because of economic 3. In an effort to overcome its fiscal challenges, the conditions but also due to inefficient and ineffective tax government has since November 2014 put in place and administration, including high compliance costs and poor made progress on an ambitious fiscal consolidation and management of tax arrears. While improvements in tax structural reform program to halt the rise in public debt administration will be neither rapid nor likely to generate and send it downward by 2017. The program is supported considerably more revenue, especially in the short term, by a 3-year Precautionary Stand-by Arrangement, improving how the country collects its revenues could approved by the IMF Board on February 23, 2015. Over the over the medium term reduce the tax compliance cost, medium term, the consolidation program should reduce improve the business climate, and facilitate economic public spending from 46.8 percent of GDP in 2014 to 40.7 growth and revenue collection. percent by 2017, mostly by cutting recurrent spending in particular on public sector wages and pensions costs and 7. In Serbia tax administration imposes a high cost of reducing fiscal support to public enterprises (restructuring compliance which adversely impacts the investment large public enterprises). climate, contributes to a high level of informality, and disproportionately impacts smaller businesses. 4. In the short to medium term, the priority for Serbia Tax administration currently makes it harder to operate a is to pursue the fiscal consolidation program with vigor, business. For example, Serbia ranks low in Doing Business seeking where possible additional fiscal measures, for on paying taxes: the number of payments (67) and example, in tax administration, the wage bill and public the time to comply (279 hours) are far worse than the administration, and subsidies. Even as it consolidates its averages for Europe and Central Asia (ECA) and the OECD fiscal position, however, Serbia will need to significantly countries. The clarity of taxpayer obligations is often improve the quality of its human capital and skills to become compromised by the amount of discretion tax authorities more competitive in the region, attract foreign direct have, along with such other problems as the absence of I EXECUTIVE SUMMARY formal interpretations of tax-related legislation and the transactions, Serbia needs tax strategies to combat diversity of opinions between tax offices. Small businesses the shadow economy. International experience shows are particularly affected by the high costs of compliance. that, to be successful, efforts directed at the informal For example, 2013 BEEPS data indicate that small and economy should include measures both to prevent medium firms are far more negatively impacted by both tax evasion more effectively (compliance, audit); and tax administration and tax rates than large firms, so that to curb cash transactions and incentivize cashless transactions (banking, use of third-party information, incentives for SMEs remain informal. exchange of information between financial intelligence units and tax authorities). To yield meaningful results, 8. The tax authorities use risk management systems such efforts need to be sustained over many years, but only to a limited extent. Although a compliance if sustained, benefits in terms of additional revenues risk management methodology is in place, it has not (estimated at a quarter of a percentage point of GDP) often been applied. While there are plans to segment are not negligible. taxpayers by size and risks, many activities rely on factors other than risk. For example, audit plans emphasize 12. Steps can be taken to improve Serbia’s tax medium and large taxpayers, but 72 percent of audits administration, make it more pro-growth, and in 2013 were of micro and small companies. Frequent create opportunities for higher revenue collection ad hoc decisions interfere with planned audit activities over the medium term. Table 1 contains a full set of and prevent a focus on tax collection efforts. While the recommendations, but among key steps are: • Lower compliance costs by improving taxpayer number of audits is growing, both hit rates and yields services and reducing uncertainty in the interpretation are declining. of tax statutes. • Reorganize and restructure the tax administration to 9. Tax arrears continue to be large and remain engage the right staff skills mix. problematic. The authority to write off uncollectible • Refocus audits on large taxpayers and reduce the debt is weak, resulting in large tax arrears for which there number of audits that do not produce results. are no prospects of recovery. Arrears include amounts • Improve the management of tax arrears through both that are past the statutory collections period and for stronger collection efforts and clarifying authority to corporations that have been liquidated or are bankrupt or write off uncollectible debt. are to be privatized, from which the tax authorities are not • Re-evaluate the tax administration IT strategy and allowed to pursue recovery by law. A 2012 tax amnesty update the IT system. attempted to resolve the large backlog of arrears, but • Combat the informal economy by improving both taxpayer services and enforcement against data from January 1, 2015, already suggest that arrears tax evasion, and by providing incentives and are increasing, having reached RSD 711 billion, two-thirds infrastructure for cashless transactions. of which are classified as having no prospect of recovery (with the remainder accounting for RSD 236 billion or 6 percent of GDP). Expectations of future tax amnesties The Wage Bill and Public Administration may also be undermining efforts both to collect arrears and to enforce current tax obligations. 13. Serbia’s general government wage bill has grown significantly over the past decade, imposing a high 10. Serbia underinvests in tax administration. It spends burden on the budget. The wage bill accounted for 10.1 less per employee than EU countries, including Romania percent of GDP in 2013, significantly above the regional and Hungary. While some of the differences may be average of 8.4 percent. Not only are reported average due to lower pay reflecting on labor market conditions, wages higher in the public than in the private sector but the a considerable portion relate to underinvestment in differential seems to have widened. A comparison based analytical capacity, technology, and other essential on a recent Labor Force Survey found evidence of public sector wage premiums, particularly for lower-skill jobs, even tools of modern tax administration. For example, there after the recent 10 percent across-the-board wage cuts is a clear need for more auditors and a more forceful (see Annex 2). The lack of a centralized establishment and large taxpayer office rather than the existing network of pay control system contributes to the high public wage bill, tax inspectors throughout the country. along with significant areas of overstaffing. In November 2014 the government made cuts in both wages and 11. Finally, given the relatively large informal employment. These short-term measures, while welcome, economy (estimated at 30 percent of GDP) and wide- do not fully address the serious structural issues of wages spread underreporting of sales turnover and cash and staffing in the public sector. II EXECUTIVE SUMMARY 14. Significant pockets of overstaffing exist in the centralized controls; standardize indexation adjustments public sector, with potential inefficiencies in a large through the single base pay; and reduce and consolidate the number of agencies. For example, although there are number of allowances and benefits at 10–12. This reform is fewer students in recent years, there are more teachers scheduled to start with adoption of a new Law on Salaries (see the discussion of education sector issues below). in Public Administration in 2015. While the law is intended The health sector nonmedical cadre is overstaffed to remove many of the pay inequities and bring greater and the remedial measures introduced have so far had transparency to the public pay structure, some elements of little impact. There is also evidence of overstaffing the reform are not yet defined, such as the new structure in the police and security forces, though data access of job classification and the basis for pay increments in restrictions make this hard to estimate accurately. the new wage law (though there is a proposal to make pay Finally, many public agencies and public enterprises increments performance-based). are budget-dependent but not subject to public sector salary rules or establishment controls, so there is a need 18. Efforts are also underway to right-size the public to link their freedom to set wages and staff numbers administration, but they are at an early stage. Ambitious with a corresponding level of accountability. targets have been set for the right-sizing program, such as reduction of the public sector workforce (excluding state- 15. Lack of a centralized establishment and pay control owned enterprises) by 75,000 over the next three years system has contributed to the high public sector wage and, as of June 2015, to have a 6.5 percent reduction in the bill. Structural weaknesses in wage control systems number of employees from the end-2013 level. All budget have resulted in more than 2,200 job titles, 71 entities have been asked to develop a plan for cutting the elements of remuneration, 5 different base salaries, number of employees. The second phase of the reforms 900 different job coefficients, 19 laws, and a plethora will focus on restructuring and right-sizing of the public of by-laws that regulate salaries in 11,000 budget sector based on a comprehensive functional review of the institutions. Although the 2005 Law on Pay for Civil central administration, the Ministry of Finance and possibly Servants and Employees instituted a centralized single the ministries of education, health, labor, and agriculture. pay regime for all civil service employees, it applies only Functional reviews are expected to identify targeted savings to about 5 percent of total public employment. Other to be incorporated into the 2016 and 2017 budgets while sectors and agencies are regulated through separate minimizing disruptions to service delivery. legislation. Institutions and organizations use different coefficients and base salaries for similar positions, and 19. Important steps for limiting the growth of the allowances and benefits proliferate without centralized wage bill, supporting fiscal consolidation, and making oversight, making it virtually impossible to compare public administration more effective are the following: the remuneration of similar public jobs. • Continue with recent measures, such as the hiring freeze and attrition, to limit staffing growth in public 16. While Serbia has in principle a well-developed administration. system for controlling staffing levels at the central • Define currently undefined elements of the new pay level, in practice there has not been sufficient structure, such as the extent to which allowances oversight and control. Every central government will be consolidated; the new job structure and budget organization, at the time of its creation, is classification; the basis for pay increases; and whether required to have an act of systematization setting employees who are above the new pay coefficient out the number of positions permitted. However, the will take a pay reduction or will be grandfathered into budgeting process does not require a limit on the the new system. number of staff within each Government body, leaving • Put in place a centralized establishment and payroll each ministry free to instruct the payroll department to control system. add staff, whether or not the position is included in the • Consider reducing staff in health, police, and (to a personnel plan. Public agencies and public enterprises lesser extent) education and integrate right-sizing also have by law considerable autonomy in hiring and within regular budget processes. setting pay, which is not balanced by accountability • Undertake a comprehensive functional review of public for performance. Regulatory fragmentation has thus administration to simplify administrative procedures contributed to the growth of the wage bill. and eliminate duplicate tasks and functions. 17. The government has initiated public wage system reform but significant design and implementation challenges remain. The pay reform aims to consolidate all 16 different base salaries into a single base salary for the entire public sector; create six subsystems; introduce more III EXECUTIVE SUMMARY Public Pensions 3. With the rise in the number of people who became of working age after 1990 who may not have ever 20. Serbia is currently the fourth highest spender on participated in the formal labor market, Serbia will pensions as a share of GDP in Europe, behind Ukraine, probably start to see an increase in the number of France, and Italy. In 2012–14 general government pension elderly who are ineligible for any type of pension by spending reached 13 percent of GDP, up 2 percentage 2025 or 2030. Serbia will need to consider options for points relative to the 2006–08 average. Spending is driven alleviating poverty among them, for example: provide a by a generous benefit structure relative to current wages, flat universal pension to all above a certain age; provide and by a high share of young retirees. a targeted noncontributory benefit to the elderly poor; or unify provisions for old-age poverty with the social 21. To curb the spending, the government undertook assistance system. three pension system reforms in 2014. First, amendments to the pension law in July 2014, which became effective in 4. Finally, the government may want to consider options January 2015, raised the retirement age for women to 65, for restructuring the farmers pension system, for equalizing it with that of men (with a gradual transition example, whether to set up separate systems, integrate between 2015 and 2032); introduced actuarial reductions all farmers into the national pension system, or of 0.34 percent of the benefit per month of early retirement integrate only those willing and able to pay, recognizing for both men and women; and tightened extended service that some will remain outside the formal labor system. requirements. Second, the Pension and Disability Insurance Law was amended again in December 2014 to preclude 23. Key steps toward a medium- to long-term pension any increases in pensions before the system reaches a reform strategy are to: pension expenditure level of 11 percent of GDP. Third, • Discuss minimum pensioner needs and how to provide the Law of Temporary Reduction of Pension Payments, at least survival level benefits for the elderly who have effective in November 2014, temporarily reduced pension no income. benefits above RSD 25,000 per month by 22 percent • Move away from equalizing pensions for different and above RSD 40,000 by a further 3 percent. While the cohorts of workers and toward linking contributions to pension reduction was billed as a 10 percent reduction in benefits, not just within cohorts, but across cohorts as benefits, the reduction in spending is approximately 5.8 well, if possible. percent of pension expenditures (cuts were levied only on • Introduce some provision for those who are not part of the portion of benefits above the average pension). The the formal labor market. 2014 reforms are estimated to have a reasonable impact • Consider options to restructure the farmers’ pension on the short-run finances of the pension system, yielding system. savings of 0.63 percentage points of GDP in 2015. The 2014 reforms have thus addressed much of the short- term reform agenda in the pension system to the extent Subsidies and State Support to the Economy politically possible; the near-term focus should now be on sustained implementation of those reforms. 24. State support to the economy stood at 5.2 percent of Serbia’s GDP in 2014, about twice government spending 22. Over the medium to long run, four related pension on public investments and close to government spending issues need to be addressed: on public health. State support includes direct subsidies, 1. It is critical that the government engages in a discussion soft loans, and activated guarantees, which went up from of minimum pension needs and a prolonged information 0 percent of GDP in 2008 to almost 1 percent in 2014. campaign to educate the public that Serbia can no Beyond these, the government is often called upon to longer afford an average pension benefit that is 70 cover unpaid social contributions, utilities bills, and taxes percent of average wage. on behalf of state-owned enterprises (SOEs), although information on the amounts spent is not available and 2. With the indexation of the value of the general point hence not included in the analysis. to inflation, as currently legislated, which equalizes pensions for different cohorts of workers, pension 25. Subsidies to SOEs, agriculture, and the private sector in benefits are set to drop to 47 percent of average wage Serbia are inefficient. Subsidies to SOEs do not encourage in 2025. The government would be wise to delink the efficiency in recipients and generate significant direct and general point indexation from indexation of pensions indirect pressure on the state budget. In recent years, the post-retirement and gradually move indexation of state has issued guarantees to support the liquidity of the general point to growth in average wages, while some SOEs in dire financial conditions, significantly adding retaining indexation of pensions post-retirement to to Serbia’s public debt. State support to public enterprises inflation so that the pension system does not implode. is often fragmented, and lacking in transparency about IV EXECUTIVE SUMMARY how it is allocated. Similarly, the current system of arrears to Srbijagas. A separate financial restructuring state support to agriculture, based mainly on area and plan is expected that will be based on improved collection animal payments, should be rethought: it is not the most and increased transit and network fees. On EPS, the appropriate way to make Serbian farms more productive government has committed to comprehensive reform, and competitive during the process of EU accession. State including streamlining of the organizational structure and support to private investment and export promotion is also management, staff right-sizing, and financial restructuring fragmented, nontransparent, and lacking mechanisms anchored in improved collections, increased efficiency, cost for evaluation. savings, and tariff increases. 26. Many state-owned and public enterprises in Serbia 29. In 2014 agriculture subsidies amounted to about 1 are loss-making and financially nonviable without state percent of GDP and covered a wide variety of programs: support. The combined losses of SOEs exceeded 1 billion general services and support, output payments, rural euros in 2013, the latest year for which final accounts are development support, market support, input subsidies, available. Direct budget subsidies—principally to SOEs and area and animal payments. The significant variation and agriculture—averaged 3.5 percent of GDP over the in types and levels of support has created disincentives last three years. The biggest SOE recipients of direct for long-term planning and investment in farms and agro- budget subsidies are Railways of Serbia, Roads of Serbia, processing. Until 2011, most direct payments to producers and JP Resavica, a coal mining company; together they consisted of input subsidies for diesel fuel and fertilizer, accounted for about 0.7 percent of GDP annually. Until with the balance provided as price subsidies for cereals 2012 companies in the Privatization Agency (PA) portfolio and oilseeds. Today, area and animal payments account received sizable direct budget support (0.3 percent of GDP for 60 percent of all direct payments, input subsidies for annually) but this has since been significantly reduced and 20 percent, and producer subsidies for 15 percent. The is expected to fall further as privatization is completed. milk subsidy program is the most inefficient, and if phased While direct subsidies have been slightly reduced over the out could bring savings of almost 0.1 percent of GDP per last two years, other forms of support to SOEs (guarantees year. In addition, capping of subsidies to prevent very large and soft loans) have gone up significantly. farms from benefiting from subsidies could bring savings on a similar scale. 27. In recent years, guarantees have been issued to support the liquidity of SOEs, in effect replacing 30. Serbia has in recent years subsidized strategic direct budget subsidies. Most of the recent increases in investors and supported export and investment guaranteed debt went to Srbijagas for liquidity support promotion programs and development agencies. State as the company continues to be in financial difficulties subsidies to strategic investors were mainly to Fiat and Air due to low collection rates, high operating costs, and an Serbia; direct subsidies to the two averaged 0.25 percent unfavorable pricing policy. Other contributors to the rising of GDP annually for 2013–15. While it is too early to assess stock of debt guarantees have been Roads of Serbia, the full impact of these investments, Fiat has become by Serbia Railways, and EPS, but these have mostly been far Serbia’s largest exporter, and Air Serbia has completely guarantees for investment projects. In the last couple revamped its fleet, expanded its network, and in 2014, for of years, guarantees have also been issued to several the first time in many years, recorded a net profit. However, commercial SOEs, most notably Zelezara Smederevo and the current system of state support for investment and Galenika, in effect subsidizing commercial companies. export promotion is weak, fragmented, nontransparent, and difficult to evaluate. There is a need to consolidate 28. The growing stock of debt guarantees has pushed and reform the agencies, with a focus on increasing their up amortization of debt service on called guarantees— transparency and efficiency and to align them to EU state particularly for Srbijagas, Roads of Serbia, and Serbia aid policies. Railways. Amortization of called guarantees is likely to stay elevated for the next few years because financial and 31. Much can be done to reduce state support to operational restructuring of these SOEs is bound to take SOEs and enhance the efficiency and effectiveness time. However, if the government manages to restructure of subsidies to agriculture and the private sector (see some of those enterprises benefitting most from Table 1 for a full set of recommendations): guarantees, and require from those enterprises to service at • Support to SOEs: Accelerate resolution of the PA least some, if not all the debt, the additional savings could portfolio; and restructure public utilities to improve be between 0.3 and 0.4 percent of GDP annually (between their financial performance and reduce direct and 2016 and 2017). The corporate restructuring plan for indirect budget subsidies. Srbijagas adopted in December 2014 includes unbundling • Agriculture subsidies: Rebalance sector support the distribution section, divestment of noncore assets, and toward rural development and measures that support resolving the companies that have accumulated the most competitiveness and away from direct budget V EXECUTIVE SUMMARY support; gradually redesign and eventually reduce the mathematics. The country also has a much larger share milk subsidy and reallocate it to rural development; of students that perform below the basic proficiency encourage enlargement of farms by allowing farmers level. Learning strategies, individual factors, and school to access budget support for both owned and leased resources help explain Serbia’s lower outcomes than land; and cap subsidies to limit support for very large comparator countries. farms. • Private sector support: Reform the state 35. Despite a declining student population and fewer development and export promotion agencies, classes, the total number of primary and secondary introduce robust monitoring and evaluation (M&E) teachers has gone up over the last two decades. In 2012, systems, ensure transparency, and ensure links with there were 21 percent fewer students in primary schools broader economic strategy. and 13 percent fewer in secondary schools than in 2000. Meanwhile, the total number of primary teachers went up by 18 percent and secondary teachers by 25 percent. Opportunities for Improving the Efficiency and Equity Although the number of full-time teachers has declined of Public Spending in Social Sectors slightly since 2010, the number of part-time teachers has been growing, reaching 40 percent of the total teacher workforce by 2012, up from 27 percent in 2008. Education Controlling for the rising share of part-time teachers, the number of full-time equivalent primary teachers was still 32. While access to primary and secondary education 4.2 percent higher in 2012 than in 2000, with an increase is high in Serbia, the coverage of preschool education of 19 percent for secondary teachers. is low by international standards. Coverage of early childhood development (ECD) reaches only 52 percent 36. Schools have yet to adapt to the declining student of boys and 49 percent of girls – very low in comparison population. By 2030, compared to 2013 Serbia’s population to the EU 2020 ECD enrollment target of 95 percent. is expected to shrink by 11 percent—800,000 people. Access for Roma children is particularly low at 5 percent As the school-age population continues to decrease, so for boys and 7 percent for girls. Low ECD enrollments are the demand for education services. However, the school problematic because ECD programs impart generic skills network, designed to meet past demographic needs, has and the ability to “learn how to learn”; it is difficult and yet to adjust fully to the changing demographics. The costly to catch up if individuals have a disadvantageous number of primary schools has gradually begun decreasing start. There are geographical disparities in access to ECD to reflect the decline in student population. In 2010 programs because preschool education is primarily funded Parliament issued a bylaw requiring municipal councils to through municipal budgets, whose resources differ widely. prepare a “plan for the number and territorial distribution of primary schools” within their jurisdictions. While initial 33. Serbia’s public spending on education is work has begun within individual municipalities, there comparable to the OECD average but higher than is room for more rationalization of the school network, the average for countries of similar size from the ECA both primary and secondary. More schools need to be region. The government spends 5.2 percent of GDP (or consolidated, particularly in urban areas. EUR 1.5 billion) on education annually which is about 1 percent of GDP higher than the level for ECA countries 37. Schools in Serbia have become increasingly inefficient of similar size. The central government finances all levels and unequal in their relative spending. The traditional of education, but most central government spending, education funding mechanism, based on inputs rather than about 42 percent, goes to primary education, with about the number of students, offers few incentives to improve 25 percent going to tertiary and about 22 percent to efficiency. In contrast, per capita financing, a hallmark of secondary. As in other countries, more than 70 percent countries with high-performing education systems and of recurrent central government spending on education widely used in ECA, provides a way to improve transparency goes to salaries. Serbia has 155,000 employees in its and equity in resource allocation because it can effectively education sector, accounting for 28.6 percent of total target poor and disadvantaged groups by adding weights general government employment. Going forward for student characteristics to the funding formula. There is savings could be realized if Serbia moves its spending on an urgent need to reduce the spending imbalances among education towards that of peer countries. schools by introducing per capita financing in Serbia, building on the previous (unsuccessful) effort in this area. 34. However, despite the significant public spending, The effectiveness of resource allocation could be made the quality of education in Serbia is low. The latest more transparent and significantly enhanced by moving PISA results (OECD 2013) show that Serbia students lag from input-based to per capita financing, an area on which behind the OECD average by about 1 year of schooling in Serbia has already started work. VI EXECUTIVE SUMMARY 38. These are among steps that can be taken to improve 42. Total public and private health spending is high and spending efficiency and learning outcomes in education has gone up faster than the regional average in the past (see Table 1 for a full set of recommendations): decade. In 2013, total health expenditure represented • Increase access to ECD, particularly for Roma children, about 10.6 percent of GDP compared to 8.6 percent for using existing facilities and redeploying teachers to the EU countries and 7.1 percent for Western Balkan countries. extent feasible, and as the fiscal space opens, scaling up Total public health spending increased from 5.2 percent investments in ECD programs. of GDP in 2000 to 6.4 percent in 2013, higher than the • Consolidate the school network and reduce excess average for upper middle-income countries (3.9 percent) teachers in primary and secondary education. and slightly higher than the EU average (6.3 percent). Over • Reduce the unequal spending of schools by replacing half the public health budget was directed to hospitals in input-based budgeting with more equal per student 2013 with a quarter spent on pharmaceuticals. Despite financing; and fully develop and pilot the funding formula. high public spending, private out-of-pocket payments for • Regularly measure learning outcomes at the school level health (OOP) have also gone up markedly, from 2 percent and link schools input with learning scores to better inform of GDP in 2002 to 4 percent in 2013. policy decision-making. 43. Notwithstanding some progress in recent years, inefficiencies persist in public spending for hospital Health care, primary care, and pharmaceutical and medical devices, and the share of nonmedical hospital staff is 39. Serbia performs relatively well on health outcomes particularly high. Hospital bed capacity and admission compared to countries at similar income levels. Life rates are relatively high, and there is scope to improve expectancy at birth, at 75 years in 2013, remains good; it the efficiency of acute inpatient care, since both hospital has improved by four years since the mid-1990s because spending and average length of stay are higher than the of progress in treating cardiovascular diseases, neonatal regional and EU averages. With regard to primary care, disorders, and neoplasms. Infant mortality rates are lower despite relatively high spending on prevention services, than the regional average and are converging toward EU there are gaps in coverage of key preventive and primary levels. Coverage of maternal and child health services health care services, and outpatient contact rates are is good overall, although with gaps for the poor and the relatively high. This again suggests significant scope Roma. for efficiency improvement, which could be stimulated by introduction of provider payment reforms that link 40. As the population of Serbia has aged, the burden of allocated budgets to outputs and quality of care. The vast noncommunicable diseases has grown. Since 1990, the majority of transfers to primary care centers are based on Serbian population has decreased by an average of about line-item budgets, which provide little flexibility or incentive -0.2 percent annually. The percentage of the population for managers to rationalize staffing, provide better service, aged 65 and above has gone up from 10 to 14 percent or improve quality. Continued centralized procurement in 2012, and is projected to reach 25 percent by 2050. of hospital drugs, price negotiation for off–patent drugs, Due to its aging population, the disease burden in Serbia and improved drug price benchmarking could also help is now weighted toward noncommunicable diseases achieve savings beyond those already realized in recent (NCDs) and external causes, such as injuries. The share of years. As mentioned, roughly one quarter of public health NCDs in total disability adjusted life years went up from care expenditures in 2013 was on pharmaceuticals versus 81 percent in 1990 to 86 percent in 2010; the top three an EU average 12.3 percent. Reducing this ratio by one causes of premature death in 2010 were heart disease, third, to 18 percent would yield potential savings of up to stroke, and cancer. 0.4 percent of GDP, based on 2013 spending levels. Finally, while coverage of medical staff is within regional norms, 41. Use of hospital care went up between 2006 and the share of nonmedical staff (25 to 30 percent) is twice 2013. In a recent survey, 7.8 percent of respondents aged as high as in OECD countries and preliminary estimates 15 or more (compared to 6.5 percent in 2006) said they suggest that if Serbia were to reduce non-medical staff to had been treated in a hospital in the 12 months preceding levels comparable with OECD averages savings could be up the survey. This increase cannot be explained only by the to 0.2 percent of GDP. aging of the population but rather also by other factors, including unnecessary hospitals admissions, shortcomings 44. Among steps that can be taken to improve spending in primary care, excessive use of acute care beds for long- efficiency and the quality of health care are to (see term care, and inadequate use of day surgeries. Waitlists Table 1 for a full set of recommendations): for elective procedures are frequent and significantly • Reduce excess noncontractual and nonmedical staff, longer than in OECD countries; they contribute to the high and urgently address payment arrears and financing prevalence of bribery, particularly in the hospital sector. imbalances for hospitals. VII EXECUTIVE SUMMARY • Continue to implement reforms to save on including the largest one (in terms of spending) do not pharmaceutical and medical devices, and monitor focus on the poor (with low coverage and regressive prescription and dispensing practices. distribution of benefits) but rather focus on other • Reform provider payments for primary care and hospitals, objectives, such as population growth or provision of complemented by broader public administration benefit to war veterans. Simulations indicate that a shift reforms to improve quality and accountability for service of some of the resources from categorical programs provision. to the well targeted FSA can reduce the overall at risk • Reinforce the quality and coverage of primary and poverty rate by as much as 8 percentage points preventive care, as by strengthening screening and treatment for chronic diseases and promoting healthy 48. Despite relatively generous benefits, the poverty behaviors. impact of the categorical programs is negligible. Parental allowance is the largest in terms of coverage but reaches only about 4 percent of the population; Social Assistance wage compensation reaches only 2 percent and the parental allowance programs only 0.5 percent. The child 45. Serbia operates many social assistance (SA) allowance is the largest program in terms of coverage, programs with multiple social objectives. These include reaching almost 11 percent of the population and 25 poverty reduction; population growth (pronatality), and percent of the bottom quintile with coverage rates assistance to such vulnerable groups as veterans and decreasing as quintiles get wealthier. However, less than the disabled. Serbia has only one explicit anti-poverty half of the transfers, 46 percent, accrue to the poorest program, the means-tested financial social assistance quintile, and despite minimal generosity, its poverty program (FSA), previously called the Material Support impact is not insignificant due to its large coverage. for Low-Income Households (MOP) program. The Without the program poverty would be expected to other means-tested program is the pro-natalist child increase by 0.8 percentage point. allowance program. Other categorical and not explicitly means-tested programs are the caregiver’s allowance 49. FSA is a well targeted and cost-effective program, (noncontributory disability benefit); wage compensation with 74 percent of all benefits reaching the poorest during maternity leave (noncontributory); parental quintile, but its coverage is still low despite recent allowance (birth grant); benefit for foster care; school attempts to expand it. Only 11 percent of the poorest fee waiver for vulnerable children; and a plethora of quintile receive FSA1. The low FSA coverage may be due benefits for war veterans and families of fallen soldiers. to non-take-up issues or the additional conditions of a means/asset test in addition to the income test. In fact, 46. At about 2 percent of GDP spending on social the eligibility threshold is far below the income of the assistance is on a par with other ECA countries but bottom decile, which helps in targeting but also limits lower than the EU average (4.3 percent). In Serbia coverage. The cost-benefit ratio—the reduction in the 60 percent of SA spending goes to family and child poverty gap for each RSD spent on the program—is 0.85 allowance programs; and only 30 percent goes to poverty for FSA, the highest for any Serbian SA programs. This is reduction programs. The largest SA program is for wage a direct consequence of high targeting precision of the compensation during maternity leave, spending on FSA compared to other benefits. which rose to about 0.66 percent of GDP in 2013. Due to the link with employment, the program does not cover 50. However, the FSA design has implicit work unemployed mothers or those who are not in the formal disincentives. As in many other ECA countries, FSA is labor market. After the New Social Welfare Law was designed so that each additional dinar a beneficiary passed in 2011, spending on the last resort SA program, earns is a dinar lost in benefits, because the benefit is financial SA (FSA), went up to 0.34 percent of GDP but is calculated as the difference between a certain income still below the regional average of 0.5 percent. The two threshold and the net income of beneficiary families. means-tested programs—FSA and the child allowance— Below the threshold there is therefore no financial together account for just 30 percent of total spending incentive for a family to earn more income because it and 0.68 percent of GDP. will be automatically deducted from the benefit they receive—in effect, a 100 percent marginal effective 47. SA has little impact on poverty due to the prevalence tax rate. In addition, workers at the Centers for Social of small but expensive categorical programs resulting Work (CSW) have discretion in assessing income that in low coverage and targeting accuracy. Simulations can deter current benefit recipients from exiting the indicate that without any SA programs the poverty system. While improvements to SA design are necessary, rate would be only 1.9 percentage point higher than they may not be sufficient to provide incentives for work it actually is. This is not surprising as some programs, unless other barriers are addressed, such as lack of skills, VIII EXECUTIVE SUMMARY unavailability of support services, and the high taxes measures are designed and targeted matters on low-paid labor: at 36.7 percent the tax wedge on considerably. The negative impact on poverty of labor at lower wage levels in Serbia is one of the highest freezes and cuts in public sector wages may be limited anywhere, mainly due to the minimum social security by the fact that public sector employees in general tend contributions that employees and employers must pay. to be relatively well paid and far above the poverty line and by the exclusion of lower salaries from the cuts. 51. Effective steps to improve SA efficiency and equity Similarly, the impact of cuts in nominal pensions is and prioritize the poor would be to: eased because they are progressive, although freezing • Scale back the wage compensation program and use of pension indexation will have an impact across the the freed-up resources to expand FSA, the most effec- board, particularly for households that rely on one tive SA program in Serbia. pension as a source of income. Public sector right- • Means-test the birth grant to reinforce the safety net sizing and layoffs due to SOE restructuring are likely to and use the resulting savings (0.1 percent of GDP) to hit households harder, particularly where workers are expand either the FSA, child allowances, or child care lower-skilled. Mitigation measures include severance coverage. payments and support in finding new employment, • Redesign the FSA to introduce in-work benefits and but whether those laid off can find new employment remove disincentives for work. will depend on their education, skills, age, and location. • Complement the redesign of FSA with more determined Qualitative analysis has found that households have enforcement of the activation of FSA beneficiaries, link- limited strategies for coping with reduced pensions, ing them with adequate and accessible employment electricity tariff increases, or job losses. Given the support programs, and ensure better coordination broad-ranging reforms underway, detailed analysis between the National Employment Service and CSWs. and monitoring of the distributional implications of the (See Table 1 for a full set of recommendations.) ongoing fiscal consolidation program will be important. 54. Well-targeted support will be crucial given the Distributional Impact of Fiscal Consolidation declining overall fiscal envelope; to the extent possible, Measures it should be channeled through current programs to limit fragmentation and improve effectiveness. The 52. The distributional implications of the government’s reform priorities proposed for social protection—better core fiscal consolidation measures need to be looked targeting of SA to the poor, freeing up resources for more at both from a welfare perspective and to assess the effective programs, and redesigning programs to remove political sustainability of reforms. The distributional disincentives for work—are especially important when impact of reforms on public sector wages and right-sizing, considering how best to limit possible adverse effects pensions, state support to SOEs, and electricity prices of the government’s near-term core fiscal consolidation depends on the initial poverty and vulnerability profile measures. Other reforms areas outlined in this report may of households, the design and incidence of the reforms, also have serious distributional implications in the medium and the mitigating or compensatory measures that are term that also merit further investigation to inform their put in place. Certain facts from Serbia’s poverty and labor design—particularly how to implement measures to market profile are particularly important: (1) Relatively low address longer-term pension challenges and deliver health risk of poverty for retired individuals (13.0 percent based and educational services more effectively. on the 2014 SILC) compared to the national average (25.6 percent). (2) Public sector workers are on average Summary of Policy Recommendations better-paid than private sector workers, with public sector employment more prevalent among top income deciles. The recommendations of this report cover measures (3) Electricity is a primary energy source for households with both short-term and medium- to long-term and an important component of household budgets, horizons for adoption and implementation, depending especially for the single elderly. on their prioritization and technical and political feasibility. Table 1 summarize the recommendations 53. Because reforms leading to fewer job and higher across the different policy areas covered in this report, electricity prices are particularly likely to have split by time frame. negative welfare implications, and with the fiscal envelope reduced, how mitigation or compensation 1 Due to significant differences between the list of programs in the HBS and the Survey on Income and Living Conditions - SILC (and changes in the poverty measure- ment methodology) it is not feasible to do a comparison of FSA’s coverage over time. IX EXECUTIVE SUMMARY Table 1: Summary of Policy Recommendations Policy Recommendations Policy Area Short-term Medium- to long-term Tax Lower compliance costs by improving service to tax- Reorganize and restructure the tax administration— Administration payers and reducing uncertainty in the interpretation downsize, restructure, and ensure that staff have the right of tax statutes. skills mix. Manage tax arrears better, through both stronger Undertake a comprehensive reform of the tax admin- collection efforts and clarification of the authority istration risk-management system. Focus audits on to write off uncollectible debt. Limit the use of tax large taxpayers and reduce the number of audits that do amnesties for dealing with large arrears. not produce results. Hire more auditors and strengthen the Large Taxpayers Office. Enhance data exchange and Reevaluate the tax administration IT strategy and analysis capabilities using third-party sources (e.g., banks, update the IT: Assess current IT hardware and soft- property registry, customs, police, etc.) to make risk ware capabilities, and update as needed. management more effective. Combat the informal economy by improving services to reduce barriers to formalization, improve enforcement against tax evasion, and providing incentives to reduce cash transactions. Wage Bill Continue recent measures, such as the hiring freeze Implement a centralized establishment and payroll control and attrition, to limit staffing growth. While these system: To overcome the deficiencies of current self-reported measures do not address structural weaknesses, they personnel database, the government needs a comprehensive are critical to limiting staffing growth and delivering centralized payroll system to provide the fiscal oversight fiscal savings in the short to medium term. and reporting necessary to monitor employment growth, distribution of staff, and employment costs. Complete a comprehensive functional review of the central administration—the Ministry of Finance, Consider reducing staff in health, police, and (to a lesser and sector ministries, such as education, health, social extent) education and integrate right-sizing into the protection, and agriculture, to simplify administrative regular budget process: i.e., manage establishment control procedures, eliminate redundant tasks, and eliminate within credible budget ceilings. or restructure departments with duplicate functions, without compromising service delivery standards. Complete definition of the elements of the new pay structure, such as the extent of consolidation of allowances; new job structure and classifications; the basis for pay increase; whether employees now above their new pay coefficient will have their pay reduced or be grandfathered into the new system. A well-managed and shorter transition to the new system could also help contain costs. Pensions Sustain implementation of 2014 pension reforms Initiate work on a medium - to long-term reform strategy, which introduced parametric reforms, including rules including: a) a discussion of minimum pensioner needs for early retirement. and how to provide at least survival level benefits for the elderly who have no income; b) Move away from equalizing pensions for different cohorts of workers and towards linking contributions to benefits, not only within a cohort, but across cohorts as well, if possible; c) Introduce provision for those who are not part of the formal labor market, and d) Look at ways to restructure the farmers’ pension system. X EXECUTIVE SUMMARY Table 1: Summary of Policy Recommendations Policy Recommendations Policy Area Short-term Medium- to long-term Subsidies Reduce state support to SOEs by accelerating resolu- Make state support to the private sector more effective: tion of the PA portfolio. Reform the state development and export promotion agencies, introduce robust M&E systems, ensure Proceed with reorganizing large public utilities transparency, and ensure links with broader economic to improve their financial performance and reduce strategy. both the level of subsidies and debt service from the budget. Make agricultural subsidies more efficient and effective: a) Rebalance sector support, with more resources allocated to rural development and less to direct budget support (phase out the milk subsidy); b) Introduce a more targeted and efficient system of area and animal payments, to encourage farm expansion through, and c) Cap subsidies to limit support to very large farms that have less need of budget support. Education Reduce the number of teachers in primary and Increase ECD coverage, particularly for Roma children secondary education by applying a strategy to by using existing facilities and redeploying teachers to the right-size the teaching workforce, and undertake a extent feasible, and as fiscal space opens up, scaling up program of teacher rationalization, by redeploying investments in ECD programs to meet targets. current teachers. Improve the equity of teacher quality and distribution by reviewing current teacher deployment policies and realigning them to ensure that students in vulnerable and underserved areas have access to high-quality professional teachers. Reduce spending inequality between schools by replacing input-based budgeting with more equal per-student financing; fully develop and pilot the funding formula; and scale up per-student financing to achieve a transparent, efficient, and equitable system. Support student learning by regularly measuring learn- ing outcomes at the school level; and linking school inputs (resources) with outputs (learning scores) to better inform policy decision. XI EXECUTIVE SUMMARY Table 1: Summary of Policy Recommendations Policy Recommendations Policy Area Short-term Medium- to long-term Health Reduce excess non-contracted and nonmedical staff, Implement provider payments reforms for both primary and urgently address hospital payment arrears and care and hospitals, complemented by broader public financing imbalances. Identify the numbers and costs administration reforms to improve quality and accountability of noncontracted staff, and identify scope for savings for service provision. Shift to performance-based financing by reducing unnecessary nonmedical staff. A transpar- for primary and hospital care (adjust primary care capitation ent and consultative process will be necessary for this. financing and for hospitals base payments on diagnostic related groups) for hospitals; right-size hospital networks Continue to implement reforms to save on and rationalize service provision based on an updated pharmaceutical and medical devices, and more actively hospital master plan; and make managers more accountable monitor prescription and dispensing practices. For for health facilities by giving them more autonomy. outpatient prescription drugs, consider reforms to reimbursement policies (e.g., introduce flat dispensing Implement reforms that will lay the groundwork for fees or a regressive margin for medicines), and better addressing the challenges of an aging population: rationalize monitor prescription and dispensing practices to hospital service networks to convert excess hospital beds to control volumes. For higher-cost patented drugs, adopt long-term or social care; increase the use of ambulatory care innovative negotiation strategies (such as price-volume and day surgeries; reinforce adherence to clinical guidelines agreements) to bring down costs. and protocols; and better monitor the quality of care and health outcomes at all levels of the health system. Strengthen the quality and coverage of primary and preventive care, including through strengthening screening and treatment of chronic diseases and promoting healthy behaviors, for a healthier population and reduced costs over the long term. Social Assistance Complement the redesign of FSA with stronger Consider scaling back the wage compensation program implementation and enforcement of the activation and use the freed-up resources to expand FSA, Serbia’s of FSA beneficiaries, linking them with adequate and most effective SA program. accessible employment support programs. Ensure better coordination between the National Employment Consider means-testing parental allowances (the birth Service and the CSWs grant). Redesign the program and channel the resulting savings (0.1 percent of GDP) to expand FSA, child allow- ances, or child care coverage. Another option could be to consolidate the program with child allowances. Redesign the FSA to address built-in work disincentives. Introduce in-work benefits. While this will not bring any short-term savings (it may at first increase the cost slightly), it would be worthwhile in the medium to long term as it would incentivize work, increase self-reliance, and ultimately encourage full exit from the system. XII EXECUTIVE SUMMARY 55. The recommendations in this report identify administration, are focused on delivering this baseline and additional potential fiscal savings which could limiting risks of slippages which could push up the debt support an improved trajectory path for government profile. Additional savings are also identified, particularly debt-to-GDP. The near-term priority for fiscal consolidation for the period beyond 2017, which can help to sustain the is timely implementation of the government’s reform downward trajectory of government debt (Table 2). If program for 2015 to 2017, as supported by the IMF program. realized, these measures could yield potential additional Under this baseline scenario, the World Bank projection is fiscal savings per year of up to 1.1 to 1.6 percent of GDP that government debt-to-GDP, after peaking at 79 percent over 2017-2019. If these savings are used to reduce the in 2016, will move onto a downward trajectory, declining deficit then they could support a further improvement in to 71 percent by 2020. Many of the recommendations the debt path relative to the baseline, moving debt-to-GDP in this report, particularly on the public wage bill and down to 66 percent by 2020. Table 2: Estimated Fiscal Impact of Additional Identified Reforms Relative to Baseline (Percent of GDP) Chapter Reform 2016 2017 2018 2019 2020 Revenue and Tax 1. Improved work of the tax administration 0.25 0.25 0.25 0.25 0.25 Administration to tackle the informal economy Subsidies and State 1. Reduced calling of guarantees by -0.35 -0.25 -0.25 -0.25 -0.20 Support to the commercial SOEs Economy 2. Phasing out milk subsidy and the cap to -0.20 -0.20 -0.20 -0.20 -0.20 farm size is introduced, implementation from 2016 Education 1. Additional education cost savings over -0.08 -0.17 -0.25 -0.33 -0.42 medium to long term Health 1. Movement to OECD average staffing -0.04 -0.08 -0.12 -0.16 -0.20 norms of non-medical to medical staff 2. Gradual reduction in average share of -0.09 -0.18 -0.27 -0.36 -0.45 spending on pharmaceuticals Summary relative to Additional revenue 0.25 0.25 0.25 0.25 0.25 baseline Expenditures savings -0.76 -0.88 -1.09 -1.30 -1.46 Total impact on fiscal balance -1.01 -1.13 -1.34 -1.55 -1.71 Source: World Bank calculations. Note: Improved tax administration assumed to increase revenue to GDP by 0.25 percentage points of GDP per annum from 2016; Reduction in the calling of guar- antees by commercial SOEs assumed to reduce amortizations of called guarantees by half relative to baseline from 2016; Phasing out milk subsidy and the cap to farm size assumed to reduce spending by 0.2 percentage points in each year from implementation in 2016; Education savings based on assumption of additional reforms implemented from 2016 to 2021 to reduce gradually annual spending by 0.5 percentage points of GDP by the end of this period, i.e. to halve the 1 percent- age point gap in public education spending between Serbia and the average of regional peers in Central And Eastern Europe; Serbia’s share of non-medical staff of 25-30 percent is twice as high as in OECD countries and moving to OECD average staffing norms could yield annual savings of up to 0.2 percentage points of GDP per year with gradual implementation assumed over 2016 to 2020; potential savings on pharmaceuticals are assumed from a movement over 2016-2021 to a target of 18 percent of total health spending on pharmaceuticals from the 2013 level of 25 percent, as applied to a constant public health spending to GDP (with additional analysis needed to incorporate costs of new therapies and improving coverage). 56. The government’s fiscal consolidation program has reduction in the fiscal deficit and the public debt thereafter, already realized significant fiscal savings in the first half Serbia risks severe economic and social consequences. of 2015. According to the preliminary results for the first The measures outlined in the Government's reform six months public revenues were 1.2 percent of annual GDP program, as well as the additional savings outlined in this higher than last year, driven by higher non-tax revenues, report, would help to put the public debt on a downward while expenditures were 0.6 percent of GDP lower reflecting trajectory. If this is not achieved then there is a risk of lower wage bill and pension spending. Consequently, the heightened macro-fiscal instability, reducing investment general government fiscal deficit was only a quarter of the and confidence, and potentially a public debt crisis. In deficit, in nominal terms, seen in the first half of 2014. such a negative scenario, measures that would be needed to bring the public finances in order and to restore 57. Going forward, it is crucial to maintain the macroeconomic stability would be even more painful. The progress on fiscal adjustment. Without a full and timely likely resulting contraction of the economy would lead to implementation of reforms to ensure a sustainable even higher unemployment and to an increase in poverty. XIII I. Introduction and Country Context 1 I. INTRODUCTION AND COUNTRY CONTEXT CHAPTER 1. THE NEED FOR FISCAL CONSOLIDATION for 2001–08 was 1.9 percent of GDP) and successful A. Country Context restructuring of old Yugoslav debt, along with strong nominal GDP growth, led to a plunge in public debt from 1.1. Since the start of its transition in 2001, the 105 percent of GDP in 2001 to 29 percent in 2008. During Serbian economy has gone through episodes of strong this period, Serbia prepaid some of its major creditors, and weak growth and cyclical fiscal dynamics that including the IBRD. The government also built up its fiscal overlay significant structural fiscal challenges. The buffers: at the onset of the crisis state deposits reached early years of transition were marked by post-conflict €1.5 billion (4.3 percent of GDP). reconstruction, rapid implementation of structural reforms, and inflows of FDI—all of which led to strong 1.4. Public finances went through significant reforms. economic growth and a favorable outlook for public On the revenue side, the tax system was completely finances. Until 2008, fiscal deficits stayed moderate reformed early in the 2000s by reducing the number of and public debt fell significantly. Since the start of the taxes imposed on businesses and individuals from over global economic and financial crisis in 2008, however, 100 to just 6 and introducing the VAT in 2005. The Ministry Serbia has struggled with the interlinked problems of Finance (MoF), including the Serbia Tax Administration of weak growth and an unfavorable fiscal outlook. As and Customs, was modernized through the definition of economic activity has stagnated, revenues have fallen roles and functions typical of these institutions in the and expenditures, particularly on mandatory spending EU. The Public Procurement Office was established in on pensions and wages, are still high. At the same time, 2002, the Treasury in 2003, the State Audit Institution structural fiscal issues, for example, continued state in 2007, and then the Public Debt Administration. On the support to state-owned enterprises (SOEs) and tax expenditure side, there were efforts at reform but, given administration inefficiencies, have been dragging down their political sensitivity and the absence of significant growth. As a result, general government fiscal deficits fiscal pressures for reform, these were often incomplete averaged 5.6 percent of GDP a year between 2009 and or significantly delayed; as a result, public expenditures 2014, and public debt rose from 34 percent of GDP to 71 remained high throughout the period. On average, percent in 2014; in 2013 and 2014 debt service of about Serbia’s general government spending was about 45 a third of total revenues have become a significant percent of GDP annually, mainly due to mandatory problem for the budget. Increasingly, how Serbia can spending, in particular on pensions and the public wage ensure that its public finances will be sustainable in the bill. The government had attempted to introduce pension medium term has become a critical policy question. reforms in 2002 and 2003. Despite some important changes to the core civil service administration, the wage bill went up from 8.0 to 10.5 percent of GDP; civil service Serbia before the Crisis: 2001-2008 changes addressed only a fraction of the wage bill. In addition, subsidies provided to SOEs (3.2 percent of GDP) 1.2. In the early phase of transition (2001-2008) were high throughout this period as further restructuring Serbia, like its regional peers, had a very strong growth of “non-private” enterprises was delayed. episode, with the annual growth rate averaging 5.9 percent. The Serbian economy recovered significantly 1.5. The boom period, however, generated significant from the shocks that had occurred during the 1990s macroeconomic imbalances. As in many other ECA on the back of the rapid implementation of structural countries, the economic growth in Serbia was driven reforms, increased trade integration with Europe and almost entirely by consumption, which led to significant the rest of the world, and post-conflict reconstruction external imbalances. The current account deficit (CAD) of infrastructure. GDP in 2008 was 49 percent higher averaged 9.8 percent of GDP, which was financed mainly in real terms than in 2001. For ECA region as a whole, through new borrowing from abroad and to a lesser this period was also characterized by high average levels extent through FDI. As a result, over 2001–08 total of growth, at 5.5 percent, and the same drivers that external debt increased by €10 billion. supported Serbia’s growth performance were also seen in other countries of the Western Balkans. By way of comparison, Bosnia & Herzegovina experienced average growth over 2001-2008 of 5.4 percent, Albania 5.7 percent and Kosovo 6.9 percent. 1.3. During this period, Serbia managed to significantly reduce public debt and build a cushion against shocks. A relatively favorable fiscal position, reflected in higher public revenues and low deficits (the average deficit 3 I. INTRODUCTION AND COUNTRY CONTEXT Serbia after the Crisis: 2009-2014 1.7. As the economy slowed, Serbia’s general government fiscal balance deteriorated. Revenues fell 1.6. The global financial crisis caused a significant in 2008–11 and dipping again in 2013, but recovered in economic slowdown globally, regionally, and in Serbia 2014, in part due to increases in the VAT rate. Compared (Figures 1.1 and 1.2). Almost immediately access to with the pre-crisis period of 2006–2008 revenues were cheap financing ceased, and the unsustainability of down 3.0 percentage points of GDP in 2012–2014, mainly the consumption-led growth model was laid bare. due to declining personal income tax and VAT reflecting The Serbian economy was pushed into recession: the weak domestic demand; international trade taxes were economy contracted by 3.5 percent in 2009. Recession hit also down notably because of the external environment again in 2012 with a contraction of 1.5 percent, and once (see Box 1.1). Expenditures, on the other hand, have grown again in 2014, with GDP falling by 1.8 percent, this time steadily since the crisis, especially pension and interest mainly because of major floods. Overall, for 2009–14 expenditures, and wages and salaries are unchanged as a real GDP growth has been on average negative at –0.2 share of GDP. The result has been a steadily deteriorating percent, down 6.1 percentage points from the 2001–08 general government fiscal deficit, from about 2.6 percent average. Not surprisingly, the pace of reforms also slowed of GDP in 2008 to the peak of about 7.2 GDP in 2012, considerably. The regional trends were again similar, although it subsided to 5.6 percent in 2013. The 2013 although somewhat less pronounced: average growth decline in the deficit was primarily due to cuts in capital in developing ECA after 2008 was just under half its spending and subsidies and new rules for indexing previous level. salaries and pensions in the public sector, which lowered the spending on wages and pensions. In 2014 the fiscal deficit in 2014 was back up to 6.7 percent of GDP, partly because of amortization of called guarantees. The severe floods that hit Serbia in May 2014 further undermined the fiscal position, contributing an estimated 1 percentage point (pp) of GDP to the fiscal deficit compared to the pre-flood scenario. Figure 1.1: General Government Fiscal Operations, 2009–14 Figure 1.2: Public Debt, 2009–14 (Percent of GDP) (Percent of GDP) Total Total expenditures expenditures Total Total revenues revenues 5050 8080 4545 6060 4040 4040 3535 2020 3030 00 2009 2009 2010 2010 2011 2011 2012 2012 2013 2013 2014 2014 2009 2009 2010 2010 2011 2011 2012 2012 2013 2013 2014 2014 Source: Ministry of Finance, IMF, World Bank. Source: Ministry of Finance. 4 I. INTRODUCTION AND COUNTRY CONTEXT Box 1.1: A Snapshot of Serbia’s Pre-and Post-crisis Fiscal Performance (Percent of GDP) Av. 2006-2008 Av. 2012-2014 Change Revenue 42.1 39.1 -3.0 Taxes 36.7 34.3 -2.4 Personal income tax 5.2 4.1 -1.1 Social security contributions 11.4 10.9 -0.5 Corporate income tax 1.2 1.7 0.5 Value-added taxes 11.1 10.2 -0.9 Excises 4.1 5.3 1.1 Taxes on international trade 2.3 0.9 -1.5 Other taxes 1.4 1.3 -0.1 Non-tax revenue 5.0 4.6 -0.4 Capital revenue 0.3 0.1 -0.3 Grants 0.1 0.1 0.1 Expenditure (including amortization of called guarantees) 44.1 45.6 1.5 Current expenditure, of which: 39.4 42.1 2.7 Wages and salaries 10.2 10.2 0.0 Goods and services 7.8 7.7 -0.1 Interest 1.0 2.4 1.5 Subsidies 2.7 3.8 1.1 Transfers, of which: 17.6 17.9 0.3 Pensions 11.4 13.1 1.7 Other transfers 6.2 4.9 -1.4 Other current expenditures 0.0 0.0 0.0 Capital expenditure 4.2 2.7 -1.5 Net lending 0.6 0.4 -0.2 Amortization of activated guarantees 0.0 0.4 0.4 Primary balance (incl. amort. activated guarantees) -1.0 -4.1 -3.0 Fiscal balance (incl. amort. activated guarantees) -2.0 -6.5 -4.5 Memo: Fiscal cash balance -2.0 -6.1 -4.1 Source: IMF, World Bank staff calculations. Figure 1.3: Decomposition of Change in Average Figure 1.4: Decomposition of Change in Expenditures from Revenues from 2006-2008 to 2012-2014 2006-2008 to 2012-2014 (Percent of GDP) (Percent of GDP) 44 49 43 48 42 47 41 46 40 45 39 44 38 43 r. 08 ax ax es es l e s 14 ns rs es s t ies e ing 14 08 na ua es ue e nu ur sfe 20 tax cis i vic sio 20 et et 20 lar id tio 20 er dg nd dit en ve bs 2- Ex ran m om 12- er Int n rso 06- sa na 6- t le ed ev en re ate Pe co 01 Su ds 20 00 rt er nd inc rr dd xp tax Ne 0 e2 l in tiv an int he e2 he a g2 le ing -a ate n- nu ac na es Ot s Ot lue on a nu din od No nd pit ve ag or t. ve Va es Go or pe rp . re en W Ca Pe . re x Am Co .s sp Ta Av Av Av . Av Source: IMF, World Bank staff calculations. 5 I. INTRODUCTION AND COUNTRY CONTEXT 1.8. Reflecting the deteriorating fiscal balances, Serbia’s public debt, including guarantees, has more Figure 1.5: General Government Expenditure by Function, than doubled since the global crisis, from 32.4 percent 2014 of GDP in 2008 to over 70 percent at end 2014. (Percent of Total Spending) Guarantees for liquidity loans, issued principally for SOEs, grew rapidly, from 2.8 percent of GDP in 2008 to 8.3 percent at end 2013, but dropped somewhat in 2014 1% to 7.7 percent of GDP. Domestic public debt grew from 3% 2% 3% about 10 percent of GDP in 2008 to about 27 percent in 2014, and external public debt grew from about 17 percent of GDP to 41.7 percent. The stock of public debt 6% is expected to have reached around 71 percent of GDP by end-2014. 9% 38% 1.9. The 2014 supplemental budget laid out the first steps in the program of reduction of the wage bill and spending on pensions. These steps included: (a) No 12% indexation of wages as of October (the legal obligation was a 1 percent raise in April and October), and (b) a nominal 10 percent wage reduction as of November 13% 13% 2014. In parallel, Parliament approved the Law on Temporary Reduction of Pensions, also effective in November 2014. It reduced pensions above RSD 25,000 by 22 percent and those above RSD 40,000 by 25 percent. Social protection Public order and safety The primary structural components of the program are restructuring large public enterprises and improving the General services Defence investment climate. The former reinstates long-delayed Economic A airs Housing and communal services reforms in such vital areas as energy, railways, and road enterprises. Success of the fiscal consolidation program Health Sport, culture, religion hinges crucially on reducing the fiscal drain from SOEs. Education Enviroment Source: Government of the Republic of Serbia. Government Spending by Function Table 1.1: General Government Expenditure by Function, 1.10. Serbia spends almost 60 percent of its Pre- and Post-crisis consolidated general government budget on social (Percent of GDP) sectors: social protection (pensions and social Average 2006–08 2014 Difference assistance), health, and education. This spending is Total expenditures 44.07 46.67 2.60 estimated at 27.8 percent of GDP in 2014, with pensions General services 4.48 6.12 1.64 accounting for about half (Figures 1.5 and Table 1.1). Defense 2.39 1.34 -1.05 Spending on general services and economic affairs Public order and safety 2.39 2.71 0.32 accounts for 26 percent of the budget; shares of all Economic affairs 6.17 6.05 -0.12 other functions in total spending are much smaller. Environment 0.30 0.27 -0.03 Housing and communal services 1.72 1.31 -0.42 1.11. Compared to pre-crisis levels, spending on Health 5.84 5.73 -0.11 defense and housing have declined most, and Sport, culture, religion 0.96 1.09 0.12 spending on social protection, general services, and Education 3.75 4.25 0.50 education increased most (Table 1.1). Spending on Social protection 16.07 17.80 1.73 defense went down by about 1 percent of GDP and on housing by about 0.4 percent. Meanwhile, spending on Source: Government of the Republic of Serbia. social protection went up by 1.7 percentage points of Note: Data for subnational governments is not available, therefore these numbers are estimates and there are some differences compared GDP, mostly because of higher spending on pensions. to sectoral reports. Spending on general services went up by 1.6 percent of GDP and on education by 0.5 percent. Spending on other functions held steady. 6 I. INTRODUCTION AND COUNTRY CONTEXT B. Fiscal Sustainability under Alternative Public Debt with Fiscal Consolidation Program Scenarios 1.14. To halt the rise in public debt and set it on a downward trajectory by 2017, the government in Public Debt Path with No Reform November 2014 adopted an ambitious program of fiscal consolidation and structural reform. The 1.12. Given the weaker growth outlook, Serbia’s growing program is supported by a 3-year Precautionary Stand-by public debt is unsustainable without fiscal consolidation. Arrangement approved by the IMF Board in February 2015. If Serbia’s growth were to return to the levels seen prior to Over the medium term, the consolidation program aims to the global financial crisis of 2008-2009, then this would reduce public spending from 46.6 percent in 2014 to 40.7 support a stabilization of debt reduction within a constant percent by 2017, mostly by cutting recurrent spending. The primary surplus. However, with global growth much more fiscal consolidation program will focus on reducing public subdued, the baseline projection is for Serbia’s growth to wage bills and pension costs and reducing fiscal support average 2.9 percent through 2020—half the pre-crisis to public enterprises, mainly by restructuring large public level. Given a baseline growth outlook with no reforms, i.e. enterprises and improving the investment climate. a situation in which the primary deficit is unchanged from 2015 onwards at 2.4 percent of GDP (versus a baseline 1.15. A baseline debt sustainability analysis under the assumption of a move to a primary surplus by 2017), consolidation scenario shows the public debt-to-GDP public debt would reach 100 percent of GDP by 2020. ratio reaching 78.9 percent in 2016 before beginning to decline. This scenario assumes that real GDP growth will 1.13. The need to pursue fiscal consolidation within a have picked up to about 2 percent by 2017 and that the much weaker growth environment requires that the fiscal consolidation strategy operates as planned, with the authorities deliver on challenging spending reductions primary deficit declining from 3.7 percent of GDP in 2014 because the already high revenues-to-GDP ratio means to 0.8 percent by 2016 and thereafter moving into a small that its contribution will be minimal. Fiscal consolidation primary surplus. Over the near term gross government also requires addressing not only the fiscal deficit but also financing needs will remain significant, reaching 19 other government liabilities, particularly from guarantees. percent of GDP by 20172. This is a considerable risk given A significant part of the increase in public debt between likely tightening in financing conditions in coming years. 2008 and 2014 came from guarantees issued on behalf of SOEs, public utilities, and local governments. Growing 1.16. The projected public debt path, however, is highly public debt not only absorbs a significant amount of sensitive to slippages in the fiscal consolidation plan, resources in debt service (35 percent of total revenues) unexpectedly poor growth, or a negative real exchange that could be used for productive purposes, it also has a rate shock (see Figures 1.7 and 1.8). For example, if only high roll-over risk. The fiscal and debt vulnerabilities make half the projected fiscal consolidation (in terms of annual it critical that the government pursue fiscal consolidation reduction in the primary deficit) is achieved, in 2020 the to achieve debt sustainability and assure macroeconomic debt-to-GDP ratio would be 75 percent of GDP versus 71 stability over the medium term (see Table 1.2). percent in the base case. Low GDP growth that is only half a standard deviation higher than the baseline would push Serbia’s debt ratio to about 84 percent by 2017 Figure 1.6: General Government Debt-to-GDP Ratio, Alternative Scenarios (and rising if growth is weakening). Similarly, a one-off (Percent) real depreciation of 30 percent or a one-off realization Constant primary balance No policy change of 10 percent of GDP in contingent liabilities would push Reform from 2015 but growth of (constant primary balance the public debt ratio up to almost 100 percent of GDP, 5.9 percent from 2016 from 2015) since about 75 percent of the debt is in foreign currency. 120 Even more moderate real depreciations would thus have 101 sizeable impacts on the ratio, and a combination of 100 smaller slippages across core macro indicators and on 80 fiscal consolidation could mean that the debt ratio would 80 keep rising throughout the projection period. It is also 60 71 important to note that these sensitivities do not take into account spillovers of, for example, a rising debt burden, or 40 the effects of program slippages on investor confidence and hence interest costs and the currency. 20 2010 2012 2014 2016 2018 2020 Source: World Bank staff estimates. 2 See IMF SBA program document. 7 I. INTRODUCTION AND COUNTRY CONTEXT Table 1.2: General Government Fiscal Operations (Percent of GDP) Actual Projected 2014 2015 2016 2017 Revenue 40.0 38.7 37.7 36.9 Taxes 35.3 34.0 33.2 32.5 Personal income tax 3.8 3.6 3.4 3.4 Social security contributions 11.4 10.6 10.2 10.0 Corporate income tax 1.9 1.9 1.9 1.9 Value-added taxes 10.6 10.1 9.8 9.6 Excises 5.5 5.7 5.8 5.6 Taxes on international trade 0.8 0.7 0.7 0.7 Other taxes 1.5 1.4 1.4 1.4 Non-tax revenue 4.5 4.5 4.3 4.2 Capital revenue 0.0 0.0 0.0 0.0 Grants 0.2 0.2 0.2 0.2 Expenditure 46.6 44.6 42.4 40.7 Current expenditure 42.0 40.6 38.5 37.1 Wages and salaries 10.0 9.1 8.2 7.4 Goods and services 8.0 7.6 7.4 7.4 Interest 3.0 3.5 3.9 4.0 Subsidies 3.0 2.6 2.3 2.4 Transfers 18.0 17.8 16.7 16.0 Pensions 13.1 12.4 11.8 11.3 Other transfers 4.9 5.4 4.8 4.7 Capital expenditure 2.5 3.1 3.1 3.0 Net lending 1.4 0.1 0.1 0.1 Amortization of activated guarantees 0.8 0.8 0.7 0.5 Primary balance (incl. amortization of called guarantees) -3.7 -2.4 -0.8 0.3 Fiscal Balance (including amortization of called guarantees) -6.7 -5.9 -4.7 -3.8 Source: Ministry of Finance, IMF. Note: Projections are from IMF 2015, 2014 Article IV consultation and Request for Stand-by Arrangement. The Government’s Fiscal Strategy has slightly different figures for both revenues and expenditures since there was a change in the methodology used for reporting on gross wages and collected social contributions. Figure 1.7: Additional Fiscal Reforms Can Yield a More Figure 1.8: The Debt Path is Particularly Sensitive to Growth Sustained Reduction in the Debt Ratio or Exchange Rate Weakness (General government debt-to-GDP, percent) (General government debt-to-GDP, percent) No policy change 120 120 One time 30 (constant primary percent real 101 balance from 2015) 100 depreciation in 100 100 Baseline 2016 75 88 80 80 Negative growth Limited reform shock implementation 66 71 71 60 (1/2 of adjustment 60 Reform to primary balance) 40 Baseline plus 40 implementation of 20 additional reforms 20 2010 2012 2014 2016 2018 2020 2010 2012 2014 2016 2018 2020 Source: World Bank staff projections. Source: World Bank staff projections. 8 I. INTRODUCTION AND COUNTRY CONTEXT 1.17. The risks and consequences of not following through path even quicker. In addition, reforms covered in the with the implementation of the fiscal consolidation rest of this report can help to ensure sustainability of program are significant. Political, governance, and social fiscal savings as well as bring efficiency improvements factors could lead to a slower than needed implementation across the public sector. Indeed, as noted in the of reforms covered by this report. If these reforms, in executive summary, the report identifies a number of addition to those agreed under the IMF program, are not reform areas which could yield savings, particularly for implemented Serbia risks of facing serious macroeconomic the period beyond 2017, which could support a further problems, including a deeper contraction of economy, and improvement in the debt path relative to the baseline, most likely a public debt crisis. This in turn would lead to moving debt-to-GDP down to 66 percent by 2020 (Figure even higher unemployment and to an increase in poverty. 1.6). In such negative scenario, measures that would be needed to bring the public finances in order and to restore the macroeconomic stability would be even more painful. Early Successes with the Fiscal Adjustment in 2015 1.18. Consequently, Serbia’s government cannot be complacent about reforms and should look for all 1.19. Benefits of the fiscal adjustments were options that could help to achieve both near- and already seen in the first half of 2015, and continued longer-term fiscal adjustment as quickly as possible. implementation of reform measures will be needed A recently signed 3 year Stand-By agreement with the for sustained consolidation progress. Implementation IMF provides a strong foundation for fiscal adjustment of measures agreed under the IMF program led to a over the next three years, but reforms recommended in marked reduction of expenditures which, combined this report could help to bring the debt on a declining with higher revenues, resulted in a general government Table 1.3: General Government Fiscal Operations, January-June 2014 and 2015 (RSD milion and percent of GDP) as % of annual Contribution to growth, Jan-June 2015 Jan-June 2014 Difference GDP percentage points TOTAL REVENUES 805,199 756,169 49,030 1.2 6.5% Current revenue 802,217 754,084 48,132 1.2 6.4% Tax revenue 693,579 684,373 9,206 0.2 1.2% Personal income tax 68,112 67,320 792 0.0 0.1% Corporate income tax 38,900 45,312 -6,412 -0.2 -0.8% Value added tax 196,296 190,511 5,785 0.1 0.8% Excises 103,507 98,029 5,478 0.1 0.7% Customs 15,802 14,648 1,153 0.0 0.2% Other tax revenues 29,443 25,050 4,393 0.1 0.6% Social contributions 241,520 243,503 -1,983 0.0 -0.3% Non-tax revenues 108,638 69,711 38,926 1.0 5.1% Grants 2,982 2,085 897 0.0 0.1% PUBLIC EXPENDITURES 840,543 864,022 -23,480 -0.6 -2.7% Current expenditures 789,830 809,704 -19,873 -0.5 -2.3% Wage bill 203,135 228,024 -24,888 -0.6 -2.9% Purchase of goods and services 109,704 109,197 507 0.0 0.1% Interest payment 73,249 64,154 9,094 0.2 1.1% Subsidies 42,530 43,086 -555 0.0 -0.1% Social grants and transfers 340,567 343,066 -2,499 -0.1 -0.3% o/w Pensions 243,771 251,967 -8,196 -0.2 -0.9% o/w Social assistance 72,385 67,354 5,032 0.1 0.6% Other current expenditures 20,645 22,177 -1,532 0.0 -0.2% Capital expenditures 34,324 39,240 -4,917 -0.1 -0.6% Activated guarantees 15,039 12,473 2,566 0.1 0.3% Net lending 1,350 2,606 -1,256 0.0 -0.1% BALANCE -35,344 -107,853 72,510 1.8 n.a. Source: Ministry of Finance, World Bank staff calculations. 9 I. INTRODUCTION AND COUNTRY CONTEXT deficit which, in nominal terms, was only a quarter of the about 60 percent of Serbia’s total public expenditure deficit from the same period 2014. Revenues were 6.5 by function. In chapter 9, section IV examines the percent higher y/y in the first half 2015 compared to the distributional implications of the fiscal consolidation same period. This was mainly as a result of higher non- program and its welfare implications for the less well- tax revenues, reflecting additional taxation of wages in off. The report ends with a summary of conclusions and the public sector (classified as non-tax revenues) and recommendations. one-off measures such as sale of 4G license, transfer of profits from SOEs etc. In addition, VAT (on imports) and excises increased significantly. However, personal and corporate income tax performance was weak. On the expenditure side most of the savings come as a result of the cuts to wages and pensions. This was partially offset by an increase in interest payments (up 14 percent), with the primary balance moving into. In addition, it is important to stress that public investment spending went down significantly (by 12 percent). The increase in the stock of public debt has been stopped as net financing needs were reduced. The full impact of the fiscal adjustment on public debt could have been even higher if there was no a significant strengthening of dollar in early 2015 (one third of Serbia’s public debt is denominated in USD). C. How the Report is Organized 1.20. The objectives of this public finance review are two-fold: (1) Analyze Serbia’s fiscal challenges and propose policy options and recommendations to help solidify the ongoing fiscal consolidation program and achieve public debt sustainability over the medium term; and (2) recognizing that Serbia has little fiscal room to pursue new investments, identify opportunities for enhancing the efficiency, quality, and equity of current public spending on health, education, and social protection over the medium term. The report outlines additional measures that could support fiscal consolidation and identifies options for efficiency gains in public services, particularly health, education and social assistance. Such measures can also help to free up funds as resources are declining to finance temporary spending needs that may arise to limit the social impact of, for example, public sector restructuring and rightsizing. 1.21. The rest of the report is organized as follows: There are three overarching sections. In chapters 2–5 section II explores options and opportunities for fiscal consolidation in the areas of taxes, the wage bill, pensions, and subsidies—areas that could anchor long- term fiscal sustainability. Recognizing that Serbia’s fiscal constraints will not allow for significant new investments in the short term, section III examines, in chapters 6–8, options for increasing the efficiency, quality, and equity of current public spending on education, health, and social assistance (SA)—sectors that account for 10 II. Opportunities and Options for Fiscal Consolidation 11 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION CHAPTER 2. REVENUE AND TAX ADMINISTRATION 2.1. Scope for fiscal consolidation in Serbia lies primarily the short term, improving the way the country collects on the spending side, although revenue collection its revenues could reduce the cost of tax compliance, remains an important component of fiscal adjustment. improve the business climate, facilitate economic growth Serbia already collects a high share of GDP as taxes, and and revenue collection and enhance the effectiveness of given recent increases in tax rates, the scope for adjusting current tax policies over the medium term. tax policy is limited. At the same time, various indicators, such as the Doing Business, Business Environment and 2.3. This chapter focuses on changes to tax Enterprise Performance Surveys (BEEPS), and the Serbia administration that, while keeping revenue collection Taxpayers’ Survey3, show that the tax administration sustainable, can help reduce the burden on businesses currently performs poorly; indeed, it is often cited as a and support economic growth over the medium term. major business climate constraint in Serbia. The chapter begins with a brief discussion of the recent revenue performance, followed by an analysis of the 2.2. The principal tax administration challenges are efficiency and effectiveness of tax administration today these: The high cost of compliance is a burden on and where improvements are needed. The next section taxpayers, particularly small businesses. The clarity discusses strategies to combat the shadow economy, of taxpayer obligations is often compromised by the with insights from countries (see Annex 1). The chapter exercise of discretion by the tax authorities. Formal concludes with options for improving the efficiency audit plans emphasize audits of medium and large and effectiveness of tax administration, reducing taxpayers, but it is mostly micro and small companies the compliance cost, and promoting growth over the that are audited. More importantly, while the number medium term. The chapter shares the assessment and of audits is growing, both hit rates and yields are most of the recommendations on the tax administration declining. Large tax arrears are carried on the books with the recent IMF TA report, which goes into more without real prospects of recovery authority to write off details on organizational and implementation issues. uncollectible debt is not clear. Finally, the presence of a relatively large informal economy (an estimated 30 percent of GDP) is a problem: taxpayer services need to A. Revenue Performance be strengthened to provide incentives for formalization; and widespread underreporting of sales turnover and 2.4. Serbia’s revenues amount to more than a third of cash transactions suggest that it will be important GDP. The tax-to-GDP ratio was 34.2 percent in 2012, to improve enforcement against tax evasion. While 33.4 percent in 2013, and 35.3 percent in 2014 (Figure improvements in tax administration take time and are 2.1). This is fairly high. The average tax-to-GDP ratio not likely to generate considerable revenue increases in for the European Union (EU) was 40 percent in 2014. Figure 2.1: Serbia Tax-to-GDP Ratio, 2009-2014 45 40 35 30 25 20 15 10 5 0 Serbia Serbia Serbia Serbia Serbia Latvia Lithuania Bulgaria Romania Poland Slovenia Hungary Chile Turkey Mexico Korea 2010 2011 2012 2013 2014 2012 2012 2012 2014 2012 2012 2012 2014 2012 2012 2012 Source: European Commission Services - 2011; Data: Taxation Trends in the EU (2013) – 2014; Estimates: AMECO database – Autumn 2013 forecast 3 This survey is carried out on behalf of GIZ Public Finance Management Project in Serbia. 4 Khwaja, Munawer, and Indira Iyer. 2013. Revenue Potential, Tax Space, and Tax Gap. World Bank 13 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION Table 2.1: Serbia Tax Revenues 2008-2014 (Percent of GDP) 2008 2009 2010 2011 2012 2013 2014 Tax revenues 36.4 34.7 34.5 33.2 34.2 33.4 35.3 Of which: Personal income tax 5.0 4.6 4.5 4.4 4.6 4.0 3.8 Social security contributions 11.4 11.1 10.6 10.2 10.6 10.8 11.4 Corporate income tax 1.4 1.4 1.1 1.1 1.5 1.6 1.9 VAT 11.0 11.0 10.4 10.0 10.3 9.8 10.6 Excises 4.0 4.0 5.0 5.0 5.1 5.3 5.5 International trade taxes 2.4 2.4 1.4 1.1 1.0 0.8 0.8 Other tax revenues 1.3 1.3 1.5 1.3 1.2 1.1 1.5 Source: Ministry of Finance (MoF) consolidated general government, Bank staff estimates. Comparison with similar Eastern European countries finds measures implemented in recent years—VAT and CIT that Serbia’s ratio is higher than those of Latvia, Lithuania, rates went up in 2012—the fiscal impact of these policy Bulgaria, Romania, Poland, and Slovenia. Only Hungary’s is changes has been very modest, in part because of current higher. According to some estimates4, Serbia is punching economic conditions. Increases in VAT rates from 18 to 20 above its weight in terms of tax effort, i.e., its tax collection percent for the general rate and from 8 to 10 percent for effort is high relative to its income level (Table 2.1). basic goods and communal services in 2011 did not lead to the expected increase in VAT collections (see Table 1.1). 2.5. Unlike in the EU, in Serbia indirect taxes generate Similarly, the increase in the CIT rate from 10 to 15 percent the bulk of revenues, and so there could be some scope became effective on January 2013, but in 2013–14 the tax- for increasing the tax take from direct taxes. In the EU, to-GDP ratio held steady at about 34 percent of GDP. The taxes are split evenly, about a third each, between direct modest tax revenue performance—coupled with problems taxes, indirect taxes, and social security contributions. of arrears management, and high compliance costs8 —has In Serbia, the ratio is 15.3 percent for direct taxes, 52.2 brought tax policy and tax administration to the fore. percent for indirect taxes, and 32.5 percent for social security contributions. As in many countries in the region, 2.7. The increase in tax collections as a share of GDP in there is clearly a bias in favor of indirect taxes, mainly VAT, 2014 is mainly attributable to intensified enforcement and labor taxes, because they are easier to collect. This has efforts by the tax authorities supported by the tax interesting implications: (1) There is potential to increase police. International experience shows that such efforts revenue offtake from the corporate income tax (CIT) are unsustainable. A more strategic approach that targets through rate increases—but only after tax administration heightening taxpayer compliance can over time deliver a is improved. An estimate of CIT productivity puts it at more sustainable increase in tax revenue (see below for 10 percent; the ECA region average of 16 percent5. An a discussion of risk management). Since the tax burden IMF paper6 points out that there are still several tax on the economy is already high, reducing the informal expenditures on account of CIT, which together added up economy by encouraging voluntary compliance supported to revenue foregone of as much as 67.7 percent of total by enforcement would be a major step forward in increasing CIT collected in 2011. (2) The high dependence on social collection. The challenge is to create a tax regime that will security contributions leads to a high tax wedge, which is support private investment and growth over the medium a disincentive to formal employment7 and thus reinforces term, which in turn would help make the recent tax policy informality. changes more effective. 2.6. The revenue impact of recent tax policy changes has been modest due to weak economic conditions and a B. Current Weaknesses in Tax less-than-optimal tax administration. Despite tax policy Administration 5 Tax at a Glance, Europe and Central Asia, World Bank, 2013. 6 IMF Selected Issues Paper, Article IV Consultation, 2013. 2.8. How a tax system is administered affects both its 7 The IMF estimates that in 2011, the overall tax wedge in manufacturing, defined yield and its efficiency. A modern tax administration has as a difference between Total Labor Cost and the net wage, amounted to 41 percent of TLC or 70 percent of the net wage (IMF, 2013 Article IV). three major tasks: (i) facilitating compliance; (ii) enforcing 8 Serbia went from 162nd to 165th in Doing Business rankings between 2014 and compliance and reducing tax evasion, and (iii) improving 2015. 14 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION governance by keeping tax officials honest and tax efforts. A recent example is the decision to cancel audits in administration equipped with the tools to carry out the order to focus on inspections of cash registers, the revenue first two tasks. yields of which are likely to be negligible. 2.9. The clarity of taxpayer obligations is often compromised by too much discretion allowed to tax authorities. The main tax collection agencies are the Table 2.2: VAT Audit Performance, 2011–13 Serbia Tax Administration (STA), the Social Insurance Funds, the Serbia Customs Administration, and the Tobacco Administration. Recent tax administration reforms 2011 2012 2013 have expanded e-filing and integrated collection of social Value of VAT refund claims insurance contributions, but formal interpretations are (RSD billions ) 95.9 114.5 132.0 lacking, opinions might differ across tax offices, the binding Number of VAT refund rulings that are available are not recognized by auditors claims 40,121 43,500 44,958 (adding to taxpayer uncertainty) and individualized service Number of claims audited 1,962 2,175 2,469 is only intermittently available from tax offices. Claims audited percent 4.89 5.00 5.49 2.10. Tax authorities use the risk management system Percent of audits that only to a limited extent. The modern approach to risk result in adjustments 16.8 13.4 13.7 management is based on taxpayer segmentation to Additional tax from audits allow for identification of compliance behavior and risks (RSD billions) 0.7 1.4 1.1 by segment and to mitigate these risks. The responses of the tax administration are then focused on addressing the Source: Serbian Tax Administration. causes of noncompliant behavior and could take different modes, such as building taxpayer awareness, improving services to taxpayers, audit and enforcement. Compliance plans were drafted for 2011–14 using compliance risk Table 2.3: Planned vs Ordered Audits management methodology but were not put into action. While the plans segment taxpayers by size and discuss risks in registration, reporting, filing, and payment, many 2013 2014 activities of the tax authorities rely on factors other than Audit Type Planned Orders Planned Orders Issued Issued (as of Sept. 5) risk. There is a disconnect in how audits are planned and carried out that undermines the use of risk criteria. Audit Comprehensive – plans emphasize audits of medium and large taxpayers, sectors 3,760 1,093 4,032 436 but in 2013, 58 percent of audits were of micro companies Comprehensive – (annual sales of up to RSD 8 million) and 24 percent of small emerging risks 2,027 0 2,108 0 companies (annual sales of RSD 8–100 million), with only VAT refund 840 1,146 840 459 16 percent being audits of medium and large companies; the number of audits in 2013 was almost 26,000 thousand. Other audits (complaints) 750 242 750 104 Audits do not show high yields even for the most focused audits carried by the Large Taxpayer Office (LTO): only Total 7,377 2,481 7,730 999 59 percent generated additional revenues. Table 2.2 Percent of summarizes the data on VAT audits and audit yields. While plan completed 34 13 the number of audits is growing, both hit rates and yields are declining. Ideally, the trend should be the opposite. Source: STA and IMF staff estimations. 2.11. Institutionally the risk management function needs to be reinforced. While there is both a risk management unit and a Compliance Council, risk management has not 2.12. A re-evaluation of the efficiency and effectiveness been embedded into tax administration practices. The risk of the current risk model is warranted. There is a need management unit is under-resourced. The Compliance to focus audits on large taxpayers and also to reduce Council was disbanded early in 2013, and although it was the number that produce no results. Tax administration re-established later that year, it has held few meetings. should continuously monitor both audit hit rates and Frequent ad hoc decisions—as reflected in the wide yields and adjust the risk selection criteria as needed. The discrepancy between audits planned and audits ordered way audits are currently conducted does not allow for a by headquarters (Table 2.3)—undermine tax collection tight focus on risky taxpayers. VAT refund audits seem to 15 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION result in negligible additional revenues and a low strike 2.17. Serbia’s tax administration is under-resourced. rate, suggest the need to refine the VAT audit selection A simple comparison of cost per employee, calculated criteria. An enhancement of data exchange and analysis by dividing the administrative budget by the number of capabilities with third-party sources (such as banks, employees, shows that Serbia spends less per employee property registry, customs, police, etc.) may be necessary than EU countries, including Romania and Hungary to make risk management more effective. (Figure 2.2). While some of the difference may be attributed to job market conditions, a considerable 2.13. Many of the improvements needed in the tax portion is likely to be under-investment in analytical administration hinge on availability of a state-of- capacity, IT, and other essential tools of modern tax the-art information technology system, for example, administration. The organization structure needs to making the risk management system more effective and change: There is a clear need for more auditors and a improving both taxpayer services and communications stronger LTO rather than the current extended network with taxpayers. A re-evaluation of the IT strategy and of tax inspectors throughout the country. a thorough re-assessment of the current IT hardware and software capabilities of the tax administration are recommended, as are upgrades as needed to the current IT system and a new IT strategy. Table 2.4: Tax Arrears, 2012-14 2.14. Tax arrears are an issue despite the recent amnesty 2012 2013 2014 initiative. The Serbian authorities attempted to resolve a large backlog of tax arrears by introducing an amnesty in Total gross arrears as of 2012. The amnesty allowed qualified taxpayers to freeze December 31 of the respective their tax debt as of November 2012 for two years. Provided fiscal year (in billion RSD) 1,025 626 711 current liabilities were met during that time, all interests attributed to and included in the debt would be written Total uncollectable arrears as of off, with the remaining principal payable in monthly December 31 of respective fiscal instalments over two years. Interest and principal were year (in billion RSD) 574 420 475 not considered tax arrears unless a taxpayer had failed to comply with the terms. Tax amnesty programs, by providing Arrears as a share in tax benefits to delinquent taxpayers often to the disadvantage collections 79% 46% 49% of those who pay their taxes on time, often create a moral hazard problem rather than addressing the underlying Source: Serbian Tax Administration. issues of enforcement and arrears management. Serbia is likely proving the point. Figure 2.2: Average Cost, Tax Administration per Employee 2.15. Authority to write off uncollectible tax debt is (Euros) unclear in Serbia, resulting in large tax arrears being carried on the books without prospects of recovery 2010 2011 2012 (Table 2.4). Many are amounts that are past the 70,000 statutory collections period; others belong to corporate entities that have been liquidated, are bankrupt, or are 60,000 being privatized (in which case the law does not allow the tax authorities to pursue recovery). While there 50,000 was a considerable drop in tax arrears between 2012 and 2013, it is mainly attributed to the amnesty and is 40,000 likely to be reversed: data on arrears as of January 1, 2015 suggests that they are already increasing (now at 30,000 RSD 711 bn). Expectations of future tax amnesties may also be undermining efforts to both collect arrears and 20,000 enforce current tax obligations. 10,000 2.16. Many of the issues discussed are rooted in inefficient 0 tax administration. To improve tax compliance, Serbia ia nia d ary ds en ark lan would need a taxpayer-service-oriented administration rb lan ed ma nm ng Se Ire Sw er Hu Ro De eth that encourages compliance and manages risks. For that eN to happen, tax administration needs to be more efficient. Th Source: IOTA. 16 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION 2.20. Tax administration is also cited as a serious Figure 2.3: Taxpayers per Tax Administration investment constraint. Serbia ranks very poorly on the (Employee) World Bank Group’s Doing Business (2015): 165th out of 189 economies. Its scores on the sub-indicator Time to 2010 2011 2012 Comply (279 hours), and Number of Payments (67)9 are 1000.0 far worse than the ECA average and significantly poorer 900.0 than the OECD average. Both indicators are dependent 800.0 on the quality of tax administration. Improving tax administration should also have a positive impact on 700.0 Serbia’s Doing Business ranking. 600.0 500.0 400.0 Figure 2.4: Serbia: Top Ten Constraints for Businesses 300.0 (Percent Cited) 200.0 100.0 35 0.0 30 ia ia d ary ds en ark lan rb n lan ed ma nm ng Se Ire 25 Sw er Hu Ro De eth eN Source: IOTA. Th 20 15 2.18. Under resourcing of the tax administration 10 comes at a price: creating incentives for corruption. Serbia’s tax administration lags behind most of its 5 peers in terms of efficiency. It relies on a large number 0 of staff, who are underpaid. Figure 2.3 shows that the ity s ion r ce or ion ts s er to ate ion number of taxpayers per tax employee is lower than in ur rd ab an bil ec pt rat Co lat iso xr dl fin sta ls rru ist gu Ta dd ate ma all comparator countries. This combined with the low to l in Co dm re an uc or ss ca xa de ce inf ed liti eft pay and considerable discretion creates opportunities tra Ta Ac ly Po of th ate d es e, an for corruption. Clearly, such a situation negatively im tic qu ms ac Cr de sto Pr Ina impacts the ability of the tax administration to Cu serve taxpayers as well as applying sophisticated risk Source: BEEPS 2013. management. 2.21. The 2013 BEEPS (Business Environment and C. Tax Administration as a Business Enterprise Surveys) shows there has been some Constraint improvement in Serbia since the 2008 survey in terms of perceptions of firms about the tax administration and tax 2.19. Serbia’s tax administration has a significant rates. However, on both counts, Serbia is still worse than adverse impact on the investment climate and the the ECA average. In particular, on tax rates, as many as formal economy. Indicators from Doing Business, 25.5 percent of firms said it is a major constraint to doing Business Enterprise Surveys, and the Serbia Taxpayers’ business, and in respect of tax administration, 17 percent Survey, show that the tax administration currently found it objectionable. makes it hard rather than easy to carry on business. In fact, tax rates and tax administration are seen as among the top obstacles to doing business (Figures 2.4 and 2.5). 9 From July 2014, almost all tax returns were supposed to have been filed electroni- This can create powerful negative incentives to operate cally. Depending on the extent of successful compliance with this initiative, this may impact the Payments sub-indicator in the Doing Business rating. According to in the formal economy and could be contributing to the Doing Business methodology, if the majority of returns are filed electronically, the high level of informality in Serbia. High compliance the number of payments is taken as one (even if they are made several times in a year), in which case the 2016 DB report, which will reflect the 2014 situation, could burdens are usually associated with a higher incidence show an improvement in Serbia’s performance. of informality (Schneider and Buehn 2009). 17 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION Figure 2.5: How Firms Perceive Tax Administration Table 2.5: Tax Evasion by Mode and Questioning Technique (pooled sample) Serbia (Percent) ECA Benchmark Crosswise model Percent of firms Tax evasion: Underreporting of sales identifying tax -at least 10% of total sales 23.1 28.1 administrattion as a major constraint Tax evasion: Paying wages in cash - at least 10% of wages 25.0 25.8 - at least 30% of wages 4.3 18.8 Percent of firms Source: STS. identifying tax rates as a major constraint Table 2.6: Cash payments Made and Received, by Firm Size (Percent) 0.0 5.0 10.0 15.0 20.0 25.0 30.0 Micro Firms Small Firms Medium Firms All Firms Source: BEEPS 2013. Cash payments made 31.7 24.0 22.5 29.0 for own purchases (12.5) (10.3) (6.3) (11.4) 2.22. The compliance burden in Serbia is (% of total payments made) disproportionally heavy for smaller businesses. When disaggregated by firm size, the BEEPS data show that Cash payments 51.1 37.6 42.0 47.2 small and medium firms are far more negatively impacted received from (29.8) (20.4) (17.7) (26.5) customers by both tax administration and tax rates than large (% of total payments received) firms, which gives SMEs incentives to remain informal. The Serbian Taxpayer Survey10 (STS) of May 2014 also Source: STS. points to the fact that micro firms face significantly Notes: Averages only for firms reporting positive numbers (i.e., > 0%); figures in parenthesis also include firms that do not use / receive cash in transactions higher tax compliance costs relative to medium firms: (i.e., 0%-100%). the percentage of staff time spent on tax matters is 10 percentage points higher than in medium firms, and 2.24. The findings highlighted in Table 2.7 reveal micro firms spend almost 10 times as much in terms of that tax administration has a significant interest their sales on external tax advisors (whether or not the in improving taxpayer services. While the audit and tax advisors also handle accounting tasks). enforcement discussed above constitute a “stick” to prevent evasion, service to taxpayers is a “carrot” to 2.23. Under-reporting of sales turnover and cash reward compliant taxpayers. transactions fuel the cycle of informality. Tables 2.5 and 2.6, reproduced from the STS, are revealing. A significant proportion of surveyed firms admit to underreporting Table 2.7: Factors that Complicate Paying Taxes, by Firm Size, sales and paying wages in cash. And a large number of (Percent Citing) transactions seem to be in cash. Micro Firms Small Firms Medium Firms All Firms How STA deals with taxpayers 21.7 17.8 15.5 19.4 Time consumed in making multiple payments 14.1 20.0 16.6 15.6 Complexity of tax laws 25.9 22.6 26.2 24.0 10 STS is carried out on behalf of GIZ Public Finance Management Project in Serbia and covers a representative sample of micro firms (1-4 employees), small firms (5-19 employees) and medium firms (20–99 employees) and asks a broad set of Source: STS. questions related to taxation. Notes: Table displays the three most frequently chosen options. 18 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION 2.25. The results of the STS, Doing Business, and 2.29. To be successful, efforts to minimize the informal Enterprise Survey reports all underscore an urgent economy should use both “carrots” and “sticks” and need for review of tax administration efficiency and be sustained for a considerable period. A review of effectiveness. Clearly, there are opportunities to improve international experience shows that while it is important tax administration, in terms of strengthening audit to have clear “stick” strategies based on greater capacities, streamlining taxpayer services, and inculcating enforcement, ‘carrots’ to improve incentives to comply a client orientation in tax officials. A more responsive are also important. Review of the Serbian experience administration would provide positive incentives to shows that, beyond compliance enforcement efforts comply with the tax regime and become formal, although directed at the informal economy, reducing the high that alone may not be enough to tackle the broad issue of burden of tax compliance will be important to the tax the shadow economy and tax noncompliance. reform agenda. To yield meaningful results, these efforts will need to be sustained over many years. 2.26. Specific tax strategies are needed to combat the shadow economy. While positive measures such as 2.30. International experience shows that high improving taxpayer services and facilitating registration, expectations of a major revenue impact of reducing filing, and payment of taxes helps remove barriers to the shadow economy have not been realized. Most formalization, also needed to deal with this issue are firms in the shadow economy are small and micro; even measures related to better enforcement and prevention when they become formal and begin to comply with tax of tax evasion specifically in the shadow economy, and regulations, revenue gains may not be very large, at least disincentives for conducting business in cash. Some in the short term. As formalized firms grow, however, strategies to address this issue are outlined next. the amount of revenue they contribute over time can be substantial. Formal firms have more opportunity for growth than informal firms, due to such factors as greater D. Tax Strategies to Combat Serbia’s access to formal sources of finance. Nevertheless, Ministry of Finance estimates that additional annual revenues Shadow Economy could be around 0.25 percent of GDP. 2.27. Serbia’s shadow economy was estimated at 30 2.31. A useful way for Serbia to tackle its large informal percent of GDP in 2010, according to the U.S. Agency sector is a two-pronged strategy: (a) Measures to more for International Development (USAID) and the effectively prevent tax evasion, and (b) steps to curb Foundation for the Advancement of Economics (FREN). cash transactions and incentivize cashless transactions. Among fiscal and administrative stimuli11 to the Many countries have grappled with how to limit the shadow economy are the relatively high fiscal burden on informal economy and raise more taxes from it. A labor; complicated, costly, and opaque tax procedures; detailed discussion of strategies and the diversity of a poorly organized, understaffed, and under-equipped country experiences is presented in Annex 1. tax administration; and high corruption and poor quality of public services. 2.28. The high administrative burden of doing Measures to More Effectively Prevent business, when operating formally; the low quality of Tax Evasion the regulatory environment; and high corruption all have a bearing on the extent of the shadow economy. 2.32. One consequence of having a large shadow For example, on the Paying Taxes indicator in the Doing economy is the incentive to under-report sales and Business 2015 report—a composite index measuring economic activity. As technology has changed how the time spent to prepare returns and pay taxes; number cash sales are recorded, it has also thoroughly changed of tax payments; and tax liabilities as a percent of the techniques used for sales suppression, also known as profits—Serbia ranks at a 165th out of 189 economies. skimming. Skimming has always existed in one form or In terms of regulatory quality (cf. the World Governance another, among other reasons to evade taxes. Manual Indicators), Serbia scored -0.7 in 2013 on a scale of -2.5 skimming options were fairly simple for a business owner: (weak) to 2.5 (strong). The decision to operate informally (a) Failing to ring cash sales into the cash register with can also be affected by widespread corruption (Serbia the business owner keeping the cash, or (b) tampering ranked 86 in 2011 by Transparency International) and with the electronic cash register, to, e.g., divert sales to low tax morale. a second cash register that was kept off the books. This is most common in small and medium sized businesses, which usually have fewer internal controls and are often 11 The Shadow Economy in Serbia: New Findings and Recommendations for closely-held. There is a high incidence of cash sales in Reform, USAID, March 2013 19 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION Serbia, providing possibilities for skimming. In some and stimulating use of cashless operations could cases, the businesses involved in skimming may keep reduce the size of the informal economy and push up two sets of books and records, one for the tax authorities tax collections. Countries in Europe, America, and Asia and the other for the owner, who may want to show the gave demonstrated the efficiency of introducing non- real sales to a potential buyer. cash payments—electronic, banking channels, or card payments—to help combat the shadow economy. 2.33. As technology has allowed automation of sales records, it has also enabled automated skimming. The 2.36. Three steps can help reduce cash transactions: first generation suppression technology was Phantom- (a) tax policies and administrative efforts to boost ware, a hidden pre-installed option embedded within cashless payments, such as building the financial the operating system of a modern electronic cash infrastructure and policies to facilitate cashless register (ECR). The second generation is called Zappers, bank payments; (b) collection and use of third party programming options added to ECRs or point of sale information for tax purposes; and (c) information (POS) networks. They are carried on memory sticks or exchanges between financial intelligence units and tax removable CDs or can be accessed through an Internet authorities regarding cash transactions. link. Remote skimming of cash transactions is now possible without the knowledge or participation of the cashier who physically rings up the sale. This attribute E. Conclusions and Recommendations of Zappers allows skimming fraud to migrate beyond traditional mom-and-pop stores. Zappers allow owners 2.37. Serbia has few tax policy options. Its tax policy to place employees at the cash register, check their changes in recent years—VAT and CIT rates went up performance, but then remotely skim sales to cheat the in 2012—had only modest impact on total revenues. tax authorities. While it can in principle further stimulate the formal economy by reducing the high labor tax rates, the 2.34. Tax authorities have a wide range of responses revenue impact could be painful and would need to be in tackling electronic sales suppression. Those can carefully assessed beforehand by, e.g., investigating the be categorized as a compliance-oriented approach, an possibility of offsetting the resulting revenue shortfalls audit approach, and a fiscal till approach. Whatever from labor taxes by higher rates for less distortive the dominant line of response chosen, the measures direct taxes. However, the modest revenue gains from need to be part of a strategic approach that covers: recent tax policy changes suggest that the tax regime is (a) Identification of risks via special audits targeted complicated by the shadow economy and weaknesses in to specific sectors. Sample audits could help identify the tax administration. This can be seen in the negligible which retail and service sectors are most at risk. Many yield of recent increases in tax rates, particularly the countries focus on restaurants but high risks have also large increase in the CIT rate from 10 to 15 per cent. been identified in small supermarket chains, retail pharmacies, hairdressers, and other service providers.12 2.38. Improvements in tax administration are (b) An understanding of the nature of the POS business essential for sustainable revenue collection and a market, POS suppliers, both domestic and international, better investment climate over the medium term. and their relative shares of the market.13(c) Clear and Both the quality of enforcement on the one hand, and consistent legislation, in line with the strategic intent taxpayer services on the other need rethinking to change to combat electronic sales suppression, including the culture of tax administration to a client-oriented legislation criminalizing the supply, possession, or use of system. There is an on-going effort by the authorities electronic sales suppression software. to complete the Tax Administration Transformation Program, 2015-19, which is a structural benchmark under the IMF SBA. The program aims to address Steps to Curb Cash Transactions and most of the areas of concern that the Review raises: Incentivize Cashless Transactions (i) strengthen the tax administration’s governance, (ii) streamline organizational structures of headquarters 2.35. The use of cash makes it possible to conceal and field offices, including by reallocating employees real incomes and makes it almost impossible for to facilitate compliance efforts, (iii) phase in a modern tax enforcement and state statistics agencies to compliance risk management approach, (iv) strengthen trace such transactions. Tracking cash transactions arrears management, including write off procedures, (v) modernize information technology systems and business processes, and (vii) improve coordination and 12 Electronic Sales Suppression; OECD 2013, p.23 information exchange with other government agencies. 13 Ibid. p.24 20 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION 2.39. The key recommendations for modernization of tax administration are as follows: • Undertake comprehensive reform of the STA risk- management system. The efficiency and effectiveness of the current risk model needs to be re-assessed. Not only does the number of audits need to be reduced, but audits that are conducted need to concentrate on high-yield risky cases. Better data exchange and enhancing relationships with banks and other third-party sources may be necessary to make risk management more effective. The tax administration needs to be downsized and restructured and the staff skills mix optimized. • Better manage tax arrears. While there was a considerable drop in tax arrears in 2013, this is mainly attributable to the amnesty and is likely to be reversed: the latest data already suggests that arrears are increasing. Expectations of future amnesties may also be undermining efforts to both collect arrears and to enforce current tax obligations. • Update both the IT system and the IT strategy: Many of the tax administration improvements needed hinge on Serbia having a state-of-the-art IT system. It is recommended that the current system be assessed and upgraded, if needed, to support new approaches to maximizing revenue and minimizing avoidance. • Lower compliance costs by being more responsive to taxpayers and reducing the uncertainty in interpretation of tax statutes and precedents. Responses to taxpayer questions should be consistent, and being helped will improve taxpayer morale. • Combat the informal economy through reducing barriers to formalization, improving methods to combat tax evasion, and providing incentives to reduce cash transactions. 21 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION CHAPTER 3. WAGE BILL AND STAFFING IN PUBLIC ADMINISTRATION A. Introduction B. The Need for Wage Reform and Right- sizing 3.1. The unaffordable public wage bill is a pressing problem. The general government wage bill grew The Fiscal Burden of Public Sector Wages significantly in the early 2000s, from 9.1 percent of GDP in 2002 to 10.7 percent in 2008, and there is little oversight 3.4. To deliver sustainable fiscal consolidation, it is or controls on pay or staffing levels. From 2009 to 2014 necessary to restrain mandatory spending, which, for the wage bill was flat at 10 to 10.5 percent of GDP, but Serbia, centers on pensions, which in 2013 accounted with revenues drying up and other spending rising, it has for almost 30 percent of total general government become an unsustainable fiscal burden. In response to spending, and wages, accounting for 23 percent. the need for fiscal consolidation, in 2014 the government The government’s fiscal consolidation program for took extraordinary measures to contain growth of the 2015–17 targeted reductions in mandatory spending wage bill through both wage and employment cuts. on pensions and wages account for about two-thirds These near-term measures, however, do not address the of projected savings. Reductions in public sector wages serious structural issues in the design and management announced in 2014 and a nominal freeze for 2015–17 of the public wage system, such as a highly fragmented are projected to save about 1.2 percent of GDP over the regulatory environment governing public sector pay, lack three years. Another 1.2 percentage points (pp) of GDP of accountability, and the absence of a centralized payroll in savings is targeted from right-sizing the public sector database. Addressing these weaknesses will be important to bring the wage bill to just over half of the targeted not only from the perspective of sustainable control over total savings of 4.7 pp of GDP through 2017.15 The the fiscal cost of the wage bill but also to improve the Government’s new wage bill law, which will restructure efficiency and quality of public service, as discussed, for the public pay system, is expected to be fiscally-neutral example, in the chapters on health and education. in the short-term. 3.2. The government has recognized these structural 3.5. In comparison to neighboring countries, Serbia’s challenges and has a plan to address them that public wage bill is relatively high. In 2013, its wage incorporates both wage system reform and right-sizing bill-to-GDP ratio was 10.1 percent; the regional of the public sector. Public administration reform was a average was 8.4 percent (see Figure 3.1). International significant part of the Prime Minister’s Inaugural Speech comparisons, however, could have shortcomings, such in 2014, the main government agenda.14 It stated as its as differences in how the public wage bill is defined and ultimate goal “replacement of such an inefficient, non- how different accounting systems classify payments to transparent and unfair [public wage] system of numerous contract workers under goods and services rather than coefficients and pay scales by a unique system.” It also as spending on wages. Beyond simple ratios, fiscal committed the government to right-sizing the public affordability is a more important yardstick with which sector to make it more efficient. This initiative is being to evaluate whether the wage bill is affordable. Figure led by the Deputy Prime Minister and the Minister of 3.2 illustrates that in real terms the wage bill grew Public Administration and Local Self-Government with significantly faster than GDP in the early 2000s. As support from the Minister of Finance. the fiscal deficit has increased and government debt- to-GDP has risen markedly, fiscal consolidation has 3.3. The following sections analyze the Serbian wage become more urgent. As discussed below, there is also a bill from a regional context and discuss the challenges need to address the underlying structural pay and right- arising from both pay and establishment policies. The sizing issues to ensure that near-term consolidation is chapter then discusses reforms underway both with sustainable and improve public administration. regard to pay and right-sizing, outlining design elements that are not yet specified. The final section provides a brief conclusion and recommendations for strengthening the ongoing reforms. 14 The Government’s Public Administration Reform (PAR) Strategy was adopted in January 2014. Its objective is to strengthen public administration in accordance with the EU principles of good governance and to improve the quality of services delivered to citizens and businesses. It will focus on decentralization, depolitization, professionalization, rationalization and modernization. 15 Ministry of Finance and IMF staff estimates in Table 6 of IMF (2015), Staff Report for the 2014 Article IV Consultation and Request for Stand-By Arrangement. 23 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION Figure 3.1: The Public Wage Bill, Regional Comparison, 2013 (Percent of GDP) 14 12 10 8 6 4 2 0 Serbia Armenia Kazakhstan Georgia Albania Azerbaijan Tajikistan Slovak Republic Czech Republic FYR Macedonia Romania Turkey Kosovo Latvia Moldova Bulgaria Russian Federation Hungary Lithuania Poland Kyrgyz Republic Belarus Estonia Ukraine Croatia Bosnia & Herzegovina Montenegro Slovenia Source: World Bank, MoF. Figure 3.2: Public Wage Bill Spending in Serbia Figure 3.3: Average Wage, Public and Private, 2002–2014 (Real Growth Index, 2001=100) (Serbian Dinars) GDP Total Expenditure Wage Expenditure Private sector Public sector 220 60,000 200 50,000 180 40,000 160 30,000 140 20,000 120 10,000 100 0 2014 2012 2012 2013 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: World Bank, MoF. Source: Statistical Office. 24 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION Table 3.1: The Importance of the Wage Bill as a Source of Fiscal Consolidation Savings (Percent of GDP unless Otherwise Indicated) Share of Total Spending Av. 2006–2008 Av. 2012–2014 Change 2012–14, Percent Revenue 42.1 39.1 -3.0 Taxes 36.7 34.3 -2.4 Non-tax revenue 5.0 4.6 -0.4 Expenditure (including amortization of activated guarantees) 44.1 45.6 1.5 100 Current expenditure, of which: 39.4 42.1 2.7 92 Wages and salaries 10.2 10.2 0.0 22 Goods and services 7.8 7.7 -0.1 17 Interest 1.0 2.4 1.5 5 Subsidies 2.7 3.8 1.1 8 Transfers, of which: 17.6 17.9 0.3 39 Pensions 11.4 13.1 1.7 29 Other transfers 6.2 4.9 -1.4 11 Other current expenditures 0.0 0.0 0.0 0 Capital expenditure 4.2 2.7 -1.5 6 Net lending 0.6 0.4 -0.2 1 Amortization of activated guarantees 0.0 0.4 0.4 1 Fiscal balance (incl. amortization of called guarantees) -2.0 -6.5 -4.5 Source: IMF, World Bank staff calculations. Wage Levels Staffing Levels 3.6. Average wages are higher in the public than in 3.7. Only recently was the Government able to determine the private sector and the differential seems to have the true size of the public workforce. In September 2013 been widening (Figure 3.3). This may in part reflect as fiscal pressures grew, the MoF required each public the influence and leverage trade unions have in wage entity to submit detailed employee pay characteristics for negotiations in Serbia; in the past they have been able each individual every month to get public funds released. to negotiate higher wages. However, a comparison of This allowed the MoF to produce its first comprehensive average wages between the private and public sectors Register of Public Employees since 2003. It showed should be taken with caution; it does not control for that the public sector was about 20 percent larger than differences in job characteristics, such as education and estimated (Table 3.2). years of experience. A more appropriate comparison would take the differences into account. However, a recent Labor Force Survey for Serbia, where these differences are accounted for,16 also suggests public sector wage premia in some parts of the public sector, particularly for lower- skill jobs, even after accounting for the recent 10 percent cuts in wages (see Annex 2). The survey shows that the chances that public employees will have a higher (above the median) income are three times greater than that in the private sector. 16 Comparison of salaries was done at the ISCO (International Standard Classification of Occupations) levels between: employees in registered private sector; employees in public sector (including state and local governments) and public administration (public sector with exclusion of employees in public enterprises) 25 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION Table 3.2: Categories of Public Employment, 2013 Category Permanent staff Term staff Temporary staff Total Civil servants 29,102 2,861 4,090 36,053 Education 117,508 32,164 11,770 161,442 Health 124,416 8,675 4,500 137,591 Ministry of Interior 46,327 0 687 47,014 Ministry of Defense 22,469 9,727 857 33,053 Pension Insurance Fund 3,383 295 19 3,697 National Employment Service 1,831 211 0 2,042 Judiciary 15,109 1,590 2,982 19,681 Public agencies 1,754 117 268 2,139 Public enterprises 55,553 1,086 4,402 61,041 Local government 130,413 11,724 20,823 162,960 Other 97,135 4,550 12,602 114,287 TOTAL Headcount 645,000 73,000 63,000 781,000 Source: Government Employee Register. 3.8. There is evidence of significant pockets of Balkans, indicates overstaffing (see the Education chapter overstaffing in the public sector. Currently, the in this report). Similarly, the health sector has an overage public sector comprises a large number of agencies, of nonmedical staff, and while measures have been organizations, and government bodies and in practice a initiated to reduce the administrator-to-professional ratio, number of bodies in the same policy area have overlapping as yet they have had little impact. There is also evidence responsibilities and tasks. As a result, there appear to be of overstaffing among the police and security forces, significant inefficiencies—and high administrative costs. though data access restrictions make it hard to estimate an accurate number. Finally, many public agencies and 3.9. In education, for example, although in recent public sector enterprises depend on the budget but are years there have been fewer pupils, there are now more not subject to public sector salary rules or establishment teachers (Figure 3.4). This finding, coupled with the fact control. Their freedom in wage-setting and staffing needs that Serbia has the lowest teacher-to-pupil ration in the to be accompanied by corresponding accountability. Figure 3.4: Serbia: Primary Education Employees vs. Pupils (2008/9=100) Employees (Left Axis) Pupils (Right Axis) 108 102 100 106 98 104 96 102 94 92 100 90 98 88 96 86 2008/09 2009/10 2010/11 2011/12 2012/13 Source: Government Employee Register. 26 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION C. Lack of Control and Oversight statutory requirements for reporting on the number of personnel employed or pay policies by any public entity. 3.10. Serbia lacks control over both pay and While notionally the MoF manages the aggregate wage establishment policies. Structural weaknesses in wage bill ceiling per entity, this ceiling is not set top-down control systems have resulted in more than 2,200 job based on available resources but is regularly adjusted titles, 71 different elements of remuneration, 5 different upward in response to employee lobbying. base salaries, 900 different job coefficients, 19 laws, and a plethora of by-laws that regulate salary levels in 3.14. These structural weaknesses have obstructed 11,000 budget institutions. Although the 2005 Law on past MoF attempts to reduce the wage bill as Pay for Civil Servants and Employees (CSL) instituted different parts of the public sector continued ad hoc a centralized single pay-regime for all civil service hiring and pay increases. They have also resulted in employees, in fact it applies only to about 5 percent considerable pay inequity: similar public jobs are paid of total public employment. Pay policies and personnel different wages with apparently little justification management for other sectors and agencies were either based on performance or labor market competitiveness. legislated separately or delegated to public entities and enacted through a series of regulations, such as 3.15. In principle, Serbia has a well-developed system annual by-laws that set out different base salaries for controlling central staffing levels, but in practice and coefficients for different sectors. For example, there has not been sufficient oversight. Every central education, culture, all insurance funds, and health government budget organization, when it is created, employees are regulated by the Law on Salaries in State is required to have an act of systematization setting Organs and Public Services and supporting decrees, out the number of positions and the title, grade, and and there is separate legislation for local governments, responsibilities for each position. Each year, as part of judges, public agencies, and public enterprises. the annual budget process, each central government budget organization fills out a personnel plan that 3.11. There is a lack of transparency about the wages states the number of positions it would like to have of certain government employees. Several institutions, funded (existing and new) along with the title, grade, such as the Ministries of Defense and Interior, do not and estimated salary for each. This process generally disclose the regulations governing their pay system. proceeds from the bottom up. For example, school Institutions and organizations also use different directors send their proposed staffing plans to the coefficients and base salaries for similar positions. regional office of the Ministry of Education, which Allowances and benefits have proliferated without any passes them on to the Ministry’s central office, which centralized oversight. For these reasons, it is challenging sends them to the MoF. In principle, the MoF evaluates and time-consuming to compare the remuneration of each plan to see if it is justified given budget constraints similar public jobs. and government priorities. Before the hiring freeze, this oversight role apparently was not executed. In normal 3.12. As noted above, public agencies and public years (when there are no hiring restrictions) reportedly enterprises have considerable autonomy in hiring and powerful ministries and unions were influential in setting pay that is not balanced by accountability for dictating changes in authorized staffing levels. performance. The boards of these agencies may make personnel and pay decisions without requiring clearance 3.16. The budgeting process does not set a limit on the from the MoF or another central oversight agency. These number of staff within each government body. Serbia’s agencies have taken advantage of their autonomy budget law requires that a consolidated personnel plan to create new job titles, bonuses, and allowances as be enacted within 30 days and that its salary estimates extra compensation for their staff. Anecdotal evidence correspond to the amount allocated in the budget suggests that this autonomy has been greatly abused (Article 156), but does not dictate the number of staff through patronage-based hiring of staff and salaries on the government payroll. Individual ministries give the often considerably higher than similar jobs regulated by Treasury’s payroll department information on each staff the CSL. person (name, account number, and amount due, etc.) and the payroll department makes the corresponding 3.13. This fragmentation has contributed to the transfer from the ministry wage bill account to the growth of the wage bill because groups of public individual staff member. Each ministry can instruct the employees are able to lobby for changes to their payroll department to add staff to the payroll, whether particular laws and decrees to increase base pay, or not the position is in the personnel plan. change coefficients, or receive additional allowances. These piecemeal changes over time have caused a steady expansion of the total wage bill. There are no 27 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION D. Government Reforms Underway noted. The government has therefore embarked on a much more comprehensive reform of public pay structure 3.17. Responding to the severe fiscal pressures, the and staffing policies. government has taken significant measures to reduce spending on wages in recent years: a hiring freeze was imposed (for each 5 employees who leave, only 1 may Pay Reforms be replaced); indexation to inflation was scaled down; a solidarity tax was levied on all public employees earning 3.18. The Serbian authorities have chosen to reform the more than 60,000 dinars; a ceiling on maximum public public pay structure by centralizing several subsystems salaries was legislated; and the number of contract and introducing more centralized controls. The intent employees a ministry or agency could hire was limited is to achieve a balance between more radical reforms to 10 percent of total staff.17 An additional across-the- and the current situation of high fragmentation and low board 10 percent pay cut was imposed in November 2014 accountability. It will also remove many pay inequities to for all general government employees (thus replacing a uphold the principle of equal pay for equal work and bring solidarity tax), and in December the Budget System Law greater transparency to the public pay structure by having was modified to suspend indexation of public wages in one base salary and consolidating allowances into base years when the share of general government salaries pay. The Ministry of Public Administration is in charge of (excluding severance) is expected to exceed 7 percent of this reform, which is scheduled to start with adoption of GDP. These immediate measures, while delivering useful the New Law on Salaries in Public Administration in the fiscal savings, do not address the structural weaknesses second half of 2015 (the New Wage Law). Box 3.1: Need for Better Personnel Data The authorities have embarked on significant reforms in the pay structure without a robust centralized public employee pay and employment dataset. Serbia’s current payroll system in Serbia is decentralized and fragmented. Although there are multiple payroll systems, there is no centralized payroll reporting infrastructure which makes it very difficult to estimate the fiscal impact of the reforms without credible headcount and remuneration levels. To address this, in September 2013 the Ministry of Finance required all public institutions to report on the number, characteristics, and elements of pay for all their employees. While this database, the Public Employee Register, should in principle provide robust data, it has several shortcomings: • Full compliance has not been achieved despite the threat (so far unrealized) of sanctions. • It contains data entry errors and incorrect figures. • It has a high transaction cost, since the public institutions must fill out all data for every employee. The authorities are aware of these shortcomings but have as yet put in place no measures to address them. In the short term, it is recommended that the government do so by minimizing the possibilities for errors in data entry, simplifying the interface, and improving storage capacity to minimize the administrative burden.a In the medium term, the government should establish a centralized human resource management information system that can generate accurate payroll data on demand. This lack of data severely constrains the evidence base to design and implement the reforms and it is urgent that for the Government to address this situation. a Finalization and validation of the Public Employee Register is a structural benchmark under the IMF program with a target date of June 2015. 3.19. To improve transparency, the authorities have to be differentiated only by the coefficients for different decided to consolidate all 16 different base salaries job titles. It will also allow the authorities to have better into a single base salary for the entire public sector controls to monitor wage bill growth, since indexation (there is resistance, however, from the police and military). adjustments will be standardized through the single This reform reflects good practice and will allow base pay base pay. The authorities also stated that the number of allowances and benefits would be reduced to no more than 12. Some of the allowances will be eliminated and 17 In 2009, the government implemented similar policies: 10 percent cut for wages above 40,000 dinars, 15 percent cut for wages above 100,000 dinars, and a others consolidated into the base coefficients. maximum ceiling for public wages (6 times the national average). 28 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION 3.20. There would be six different pay systems under low compliance and mostly assigns the highest scores the new law, each with its own pay and grading system to all employees. Establishing effective performance (see Figure 3.5). This will add current employees to those appraisal systems, however, is a long-term process that governed by the civil service law and create a new pay requires legislative changes and investments in capacity scheme for public services, among them education, building, communications, and information systems. health, social protection, culture, tourism, and sport. Defining measurable and objective means to evaluate Local government, police, and defense, and members of performance for public employees has in many countries parliament, the judiciary, and state agencies will have their and sectors proven challenging (Hasnain, Manning, and own pay scheme. While public pay systems range from fully Pierskalla 2012). Research suggests that performance- centralized (Germany) to fully decentralized (Sweden), most related pay has only worked well in the public sector countries fall in the middle and limit the number of pay for health, education, and revenue administration and options for employees. Countries tend to centralize their not worked in other cases. Other evidence suggests pay systems to achieve greater fiscal control and improve that performance-related pay is more likely to have equity (equal pay for equal work). On this last objective, impact where planning, policy development, budgeting, the government is creating a generic jobs catalogue to monitoring and evaluation, and reporting are anchored ensure that all public employees in generic positions (clerks, to a performance framework—which is not the case in drivers, accountants, etc.) receive the same compensation. Serbia. The new pay structure will be derived from the current comprehensive job evaluation and pay grading exercise, 3.22. It will only be possible to estimate the fiscal which is supported by the Bank. Through this exercise, a impact of the new wage law after the new job new job catalogue will be developed to standardize and classifications are defined and allowances and reduce the number of job titles in the public sector. benefits are rationalized (see Figure 3.6). The job evaluation exercise will equalize positions according to responsibilities and competencies, and pay coefficients Figure 3.5: Pay Subsystems in the New Wage Law will only be assigned afterward. The government has indicated that the transition to the new pay structures will be fiscally-neutral in the short-term and that it will likely take several years and be contingent upon fiscal space. It is not clear, however, whether employees who Public are above their new pay coefficient will take a pay Services* reduction or be grandfathered into the new system. Civil Local Service Government Figure 3.6: What is Needed to Estimate the Fiscal Impact of New Wage Law MPs, Judges, State Police Agencies** Defence * Includes education, health, social protection, culture, tourism, sport. ** All elected officials will have a defined coefficient in the new law. Single Base Job Classification Financial Reference to Assign New Implications Wage Pay Grades and of New Wage 3.21. The authorities have yet to decide the basis Ranks Law for pay increments in the New Wage Law, though Number Rationalize of Pay Elements they have expressed a preference for increments Subsystems of Pay to be performance-based. This would require significant reforms to strengthen the government’s performance appraisal system, which currently has 29 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION Right-sizing of Public Administration change management strategies to overcome resistance, and leverage EU accession to mobilize support for reform. 3.23. The first phase of the right-sizing reform is Important steps to limit growth of the wage bill, support underway. As part of its fiscal consolidation agenda fiscal consolidation, and make public administration more for 2015–17, as supported by the IMF SBA program, effective are the following: the government has set out a series of fiscal structural reforms, including measures to address the public wage bill. • Define the remaining elements of the new pay Ambitious targets have been set for the right-sizing program, structure so that it results in a lower wage bill and fiscal including a reduction by the public workforce (excluding consolidation. The New Wage Law is a welcome reform SOEs) by 75,000 over the next three budget years. Besides and should significantly improve the transparency, continuing to apply the 5:1 attrition rule, the government equity, and manageability of public wages. But its will implement targeted separations. The first target, set for fiscal impact depends on how the new job classification June 2015, is to have 6.5 percent fewer employees than it structure is defined and whether the allowances and had at the end of 2013. All budget entities have been asked benefits are rationalized. The government must be to draft a plan for reducing the number of employees. vigilant in appropriately classifying jobs and rationalizing allowances so that the new pay structures support fiscal 3.24. The second phase of the reforms will focus on consolidation, transparency and equity. A well-managed restructuring and right-sizing the public sector. This will and shorter transition period to the new system could begin with a comprehensive functional review of the central help contain costs. administration and the MoF. There will also be functional • Implement a centralized establishment and payroll control system: More control of spending on wages, reviews of specific ministries, such as education, health, however, will not be possible until payroll data are social protection, and agriculture. Functional reviews improved. The self-reported personnel database is not a have been used in many countries to identify savings in sustainable solution and is replete with errors. A centralized a more strategic and targeted manner than across-the- system is critical to providing the fiscal oversight and board cuts.18 They are intended to simplify administrative reporting necessary to monitor employment growth, procedures, eliminate redundant tasks, and eliminate distribution of staff, and employment costs. or restructure departments with duplicate functions • Continue with recent measures—such as the hiring without compromising service delivery. They also include freeze and attrition—to limit staffing growth. While changing the organizational structure, job definitions, these measures do not address the structural weaknesses, and staffing levels to ensure that the organizational and they are critical to limit staffing growth and deliver fiscal functional structure determines public staffing needs. savings in the short to medium term. The functional reviews will not necessarily be limited to • Explore opportunities for reducing staff in health, staff but will also consider other expenditure items and police, and (to a lesser extent) education and integrate how services are delivered. right-sizing into the normal budget processes. Right- sizing reforms are more sustainable when they are 3.25. The functional review will be supported by the integrated into the budgeting process, when control is Bank and is expected to begin in mid-2015 and last two managed within credible budget ceilings and staff are years, though most of the analysis will be completed aligned to government priorities, performance targets, within the first eight months. The analysis is expected to and population dynamics. It appears that this is not identify savings that will be incorporated into the 2016 and currently the case in Serbia. 2017 budgets. The reviews will also attempt to minimize • Undertake a comprehensive functional review of disruptions to service delivery and improve business the central administration, the MoF, and specific processes wherever possible. sector ministries to simplify administrative procedures, eliminate redundant tasks, and eliminate or restructure departments that have duplicate functions without E. Conclusions and Recommendations compromising service delivery standards. Functional reviews will not necessarily be limited to staffing but will 3.26. The government’s reforms to address the public also consider other expenditure items and how services wage bill are a high priority for the required fiscal are delivered. consolidation and to improve public sector performance, but it will certainly not be easy to achieve them. The 18 Guiding questions for functional reviews include: whether there is a legitimate and necessary role for government in the delivery of this service; whether the comprehensive government reform agenda is challenging service could be delivered in whole or in part to the private or voluntary sector; but necessary. For the reforms to succeed, the government whether the organizational arrangements for service delivery can be rationalized; whether there are opportunities for cost-recovery, contracting in/out, and/or must retain political support, consistently communicate service network consolidation; and whether the resultant package of programs and its intentions, mobilize the needed expertise, employ activities is affordable within the budget and medium-term expenditure limits. 30 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION CHAPTER 4. PENSION REFORM: MEDIUM TO LONGER TERM ISSUES 4.1. Serbia is currently the fourth highest spender on A. Current State of the Pension System pension systems as a share of GDP in all of Europe, exceeded only by Ukraine, France, and Italy. The high 4.5. Pension spending is high in Serbia for two spending is driven by a generous benefit structure reasons: benefits are relatively generous; and there relative to the current average wage when compared is a high proportion of young retirees. Many of the to other European countries, and by a high proportion reforms adopted in 2014 are meant to at least partially of young retirees. Much of the pressure for both the redress this situation. As discussed in detail below, generous benefits and the early retirement come from pension benefits are being reduced temporarily for societal expectations. Indeed, in 2012–14 general higher-earning pensioners, and penalties are being government pension spending reached 13 percent put in place for early retirement to discourage young of GDP, up 2.1 percentage points of GDP relative to people from retiring. However, there is political pressure the average in 2005–07 (accounting for almost the to reverse some of these reforms. If the government whole 2.5 pp rise in spending, including activation of wants to benefit from fiscal savings19 and bring Serbia amortized guarantees). Given this increase, and the closer to international and European standards of fact that pensions account for about one-third of pension provision, it will be important to maintain current general government spending, pension restraint these reforms. is central to the Government’s fiscal consolidation program in 2015–17. 4.6. Compared with pension spending in other European countries and relative to its own income 4.2. Pension spending is largely being driven by levels, Serbian pension spending per beneficiary is relatively generous benefits, relative to average wage, unusually high. Figure 4.1 shows pension spending and large numbers of early retirees. Pension benefits in per beneficiary relative to GDP per capita in Serbia and in other European countries. Within Europe, only Serbia are high relative to GDP per capita and relative Cyprus and Montenegro exceed Serbia’s benefits of 66 to wage when compared to other European countries. percent of GDP per capita. It is also notable that Serbia The original pension laws also allow multiple pathways is grouped with six others as high-spending transition to retirement, allowing many people younger than countries. Five of the seven- country group originated what would be considered normal retirement ages in the former Yugoslavia, suggesting that its pension to retire. New pension legislation passed in 2014 is systems were already more generous than in the rest aimed at reducing some of this early retirement. The of Europe. This is not meant to imply that there are not Organic Budget System Law was also amended in 2014 pensioners in Serbia who are poor or that the pensions to eliminate pension increases until pension spending in Serbia in Euro terms are equivalent to those in other reaches 11percent of GDP. European countries. But relative to its own GDP per capita, Serbia pays relatively large benefits, and this 4.3. However, if the current pension law is implemented is a major factor in Serbia’s high pension spending as legislated, benefits, relative to the average wage, relative to GDP. are expected to drop even within the next 10 years, with surpluses in the pension system beginning as 4.7. There are also a large number of beneficiaries early as 2023. In the medium to long run, the situation in Serbia, many of whom are retiring well below the is completely reversed from the current generous internationally accepted age of 65 and are thus likely benefits and high spending. It is unclear, given the to receive benefits for a long time. Typically in the social expectations that have led to reversals of last 15 years of life, work capacity starts to decline. For previous reforms, whether the pension system as this reason, governments institute pension programs legislated will be maintained. The government would to provide income for those years when people are be wise to take palliative measures now rather than risk assumed to be unable to provide for themselves. implosion where the current system has to be replaced Unfortunately, the typical retirement age has been by something else in an emergency situation. By more or less frozen or even declined since pension keeping pension benefits and retirement ages at levels systems were first instituted while life expectancy has more typical of other European countries, pensions can increased. As a result, in many European countries be both adequate and more sustainable. people are living much more than 15 years after retirement and retiring while they are able to work. 4.4. The following sections first set out the current Lower retirement ages have come to be seen as a state of the pension system and its structure before the bonus for those in physically demanding occupations 2014 reforms. The details of these reforms and their likely impact are then assessed along with an analysis 19 Fiscal savings from penalties for early retirement are estimated at 0.1 percent of of impending issues before a brief conclusion. GDP per year by the Ministry of Finance. 31 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION or in occupations that society particularly valued, and 4.9. Reforms already in place are reducing the number society began to expect that after 30, 35, 40, or 45 years of new disability beneficiaries while increasing the of work, people “deserved” a pension. In 2013 (Figure number of old-age beneficiaries. Internationally, 4.2), over 20 percent of male old-age pensioners in Serbia about 10 percent of beneficiaries are expected to be were below the retirement age of 65 for men and over 10 disabled, with a large percentage of the rest being old- percent of women were below their retirement age of 60. age pensioners. The percentage of widows and widowers Fewer farmers retire early than other categories because largely depends on women’s labor force participation, one of the requirements for retiring before 65 for men which varies substantially from country to country. and 60 for women in at least 40 years of contributions Serbia’s number of disability pensioners is a bit on the for men and 35 for women. Most farmers retire with the high side at just under 20 percent (Figure 4.4). Up to 2003, minimum 15 years of contributions. If the threshold for disability criteria were much looser they are now, and retirees were raised to 65 for women, as it is in most other the number of young disabled has fallen substantially. European countries, as many as 41 percent of women Legal requirements prevent the pension fund from old-age retirees in Serbia would be considered “young” applying new criteria retroactively, although disability retirees rather than the current 9 percent. certification can be revoked in cases of fraud. Over time, the distribution of beneficiaries is expected to approach 4.8. Furthermore, the prevalence of young retirement that of other countries. However, the authorities need continues today. Of those newly retired with old-age to be aware that as the 2014 law begins to tighten the pensions in 2013, roughly half the men were younger than conditions for old-age pensions, the disability rates may 65 and almost 30 percent of the women were younger than begin to rise again: there is a possibility of increased 60 (Figure 4.3). Given the legislative changes that became fraud as people look for ways to continue to retire early effective in January 2015 (described below), there was an without reduced benefits. even greater rush for individuals to retire before the new rules took effect, resulting in even more new young retirees in 2014 who will be paid benefits for a long time. Figure 4.1: Pension Benefits in Serbia are Among the Highest in Europe Relative to GDP Per Capita (Percent) 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Luxembourg Slovenia France Malta Spain Greece Italy Cyprus Norway Ireland Iceland Germany Finland Sweden Denmark Portugal Austria United Kingdom Netherlands Georgia Bulgaria Albania Belarus Estonia Latvia Czech Republic Lithuania Russia Slovakia Romania Croatia Hungary Moldova Poland Amenia Kazakhstan Macedonia Ukraine FBIH Serbia Republika Srpska Montenegro Kosovo Azerbaijan Tajikistan Turkey Kyrgyzstan High Income High Income Lower Spending High Spending Young Countries Generous Spender Moderate Spender Transition Countries Transition Countries Source: Inverting Pyramid, World Bank, 2014. 32 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION Figure 4.2: Old-age Pensioners below Retirement Age Figure 4.4: Pension Beneficiaries by Type, 2013 (Percent) (Percent) 3.6% Male Female 50% 18.1% 40% 30% 59.4% 20% 18.9% 10% 0% Employees Military Self-Employed Farmers Source: PIO Fund 2013. Old-age Widow Disability Orphan Source: PIO Fund 2013. Figure 4.3: Newly Retired Old-Age Pensioners Below Retirement Age, 2013 (Percent) 4.10. The Serbian population, like that of all other European countries, is aging; in 2050, 25 percent are Male Female expected to be over the age of 65 in 2050, compared with 14 percent today. The old-age dependency rate 120% (the percentage of the population over 65 divided by the working-age population, assumed to be ages 15 to 64), is 100% expected to rise from 21 to 41 percent. This means that 80% with today’s population structure, there are as many as 5 people of working age to support each elderly person 60% while by 2050 there will be as few as 2.5 people of working age per elderly person. But even under today’s 40% more favorable demographic structure, the number 20% of actual contributors to the pension system is only 25 percent higher than the number of beneficiaries. When 0% the working-age population falls, reducing the number Employees Self-Employed Farmers Army of contributors, and elderly requiring benefits rise, the pension system will face even greater difficulties. Serbia is Source: PIO Fund 2013. expected to see a decline in the working-age population of 21 percent between 2010 and 2050 while the share of the elderly continues to rise. B. Design of the Pension System before the 2014 Changes 4.11. To understand how the Serbian pension system found itself in this position, it is important to understand how it was designed and how the design has evolved. The Serbian pension system was designed in 2002-03, but has been amended several times since then, 33 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION and some of the elements of the old Yugoslav system in most pension systems individuals will see their were retained, including the initial level of benefits and pension benefits fall relative to current average wages the flexible retirement age, which permitted a significant over the retirement period. Adjusting pension benefit amount of early retirement. As of recently, the Organic levels to increases in nominal wages has been found to Budget Law stipulates that pension spending can be up be too expensive, particularly as societies are aging. As to 11 percent of GDP. a result, public pension systems typically adjust pensions after retirement by inflation, to protect the pensioner’s standard of living, with the view that individuals who Level of Benefits want a more generous retirement can provide that themselves with additional saving. 4.12. The Serbian pension system as redesigned in 2002-03, is based on a point system. Individuals 4.15. However, indexing the value of the general point receive one point for each calendar year that they pay to inflation differs from the way other countries index contributions on the average wage prevalent in that the general point or revalue past wages. In the past, year. A person who pays contributions on twice the as in some other European countries like Germany for average wage receives 2 points per calendar year and instance, pensions after retirement were indexed to a person who pays contributions on half the average growth in nominal wages. As a result, if one teacher wage receives half a point. Similarly, if a person only retired in 1990, another in 2000, and another in 2010, all pays contributions on a salary equal to the average after 30 years of earning the average wage, in 2015 all wage for 6 months in a given calendar year, the person three would be receiving the same pension. The notion will earn half a point, as specified in Article 63 of the that people who had worked for the same amount of 2003 Pension and Disability Insurance Law. time in the same job at whatever the prevailing wages were at the time should receive the same pension 4.13. Upon retirement, the points a person has was, and still is, perceived as fair. While this notion of accumulated are converted to a dinar amount, using fairness retains the intracohort fairness, whereby people the value of the general point for the conversion. who paid twice as many contributions within the same A general point value was defined in the 2003 law cohort will receive twice as high a pension, it introduces based on average pensions received by individuals just an intergenerational inequity, with people who retired retiring in 2002 divided by the personal points they had from an earlier cohort and thus paid contributions on accumulated. What this meant was that the benefit the basis of lower wages, receiving the same pension as generosity imbedded in the former pension system was those who retire from a later cohort and who have paid carried into the new pension system. As Figure 4.1 showed, contributions on much higher wages. In most countries, Serbian pension benefits are still generous relative to fairness is defined as how linked the pension is to the other countries. According to the law, the value of the contributions an individual makes. In this example, general point was to be indexed same way pensions were the 1990 retiree earned lower wages and paid lower indexed. The initial law called for pensions to be indexed contributions than the next two and in most countries to 50 percent of nominal wage growth and 50 percent would receive a lower pension. Linking indexation of of inflation. In 2005, the law was changed to gradually the general point to the indexation of benefits post- move to 100 percent inflation indexation by 2009. But retirement, as is done in Serbia, insures that the three before that law was fully implemented, a sizable increase teachers get the same pension. This insures intracohort was granted in 2008. In the aftermath of the financial equity, but not intercohort equity. crisis, for 2009 and much of 2010 pensions were frozen. A 2 percent increase was granted in December 2010, 4.16. If the pension law continues to be implemented followed by an inflation adjustment in April 2011. In both as legislated, and the value of the general point October 2011 and April 2012, increases were based on continues to be indexed to inflation, a consequence of inflation plus half the growth of real GDP. From October linking indexation of the general point to indexation of 2012, increases were based on inflation only, with the pensions post-retirement will lead to a steep fall in the caveat that should the growth rate of real GDP exceed expected benefit relative to the average wage—and 4 percent, the difference between the growth and 4 a subsequent decline in expected pension spending percent would be added to pensions. relative to GDP. 20 Internationally, countries which use the point system typically index the value of the general 4.14. Serbia is now adhering to international best point to nominal wage growth while continuing to practice in indexing pensions to inflation, as a way index retirement benefits to inflation. Countries that to protect pensioners from cost of living increases. use a defined benefit formula typically also revalue the Assuming that workers continue to benefit from earnings on which the benefits are based by nominal productivity growth and consequently real wage growth, wage growth. And countries that use notional accounts 34 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION often use a notional interest rate equal to average employed, and employees, and are now being unified wage growth, which performs a similar function. In that for the military as well. Should the pension spending way, they avoid the steep drops expected in Serbian is maintained at 11 percent of GDP, average benefits benefits in the future and maintain a close link between would fall to approximately 42 percent of average wage contributions paid and benefits received. These are and remain roughly steady thereafter. some options that Serbia can consider incorporating in future changes of the legislation governing the pension 4.18. The reduction in relative benefits naturally insurance. translates into a reduction in pension spending relative to GDP. Pension expenditures, which are very high today 4.17. Indeed, should the law continue to be at over 13 percent of GDP in 2013, are expected to drop implemented as legislated, this link is projected to to 11.5 percent as early as 2025 (Figure 4.6) without the lead to benefits dropping from roughly 80 percent of 2014 reforms, but will still be above current EU levels of the net average wage in 2013 to 50 percent by 2025 9.5 percent of GDP. The Serbian Organic Budget System and to continue falling sharply thereafter (Figure 4.5). Law states that pension spending will fall until it reaches In 2013 old-age benefits from the Employee Pension 11% of GDP, but does not specify what will happen Fund stood at almost 80 percent of the net average once the spending levels begin to fall below that level. wage; in other European countries, benefits are roughly Clarifying this in the law (or through bylaws) should 50 percent of average wage. Serbian old-age benefits be among priorities for future legislative changes. As are expected to drop to just 47 percent of the net Serbian spending as a share of GDP continues to drop, average wage in 2025, making pensioners much worse it will reach the current EU levels by 2030 and will fall as off than workers in 2025. Benefits will continue to drop, low as 2.4 percent of GDP by 2075. Similarly, the current reaching as low as 7 percent of the net average wage deficit in the Employee Pension Fund, which requires 4.2 by 2075. Why would employers and employees want percent of GDP in financing from the general budget, to contribute 24 percent of their wage for 40–45 years will revert to an increasingly large surplus beginning in to get only 7 percent back in benefits for 15–20 years? 2023 (Figure 4.7). The reduction relative to the net average wage occurs entirely because real benefit levels are kept constant while real wages continue to grow. The issues are similar for all of Serbia’s pension systems because the benefit formulas have been unified for farmers, the self- Figure 4.5: Average Projected Old-Age Benefits Relative to the Current Average Wage, 2013–2073 (Percent) 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 2043 2045 2047 2049 2051 2053 2055 2057 2059 2061 2063 2065 2067 2069 2071 2073 2075 2013 2015 2017 2019 2021 Source: World Bank staff projections using World Bank PROST model (Pension Reform Options Simulation Toolkit) for the Employee Pension Fund, calibrated using 2013 data from the Pension Fund as a starting point. 20 Since the Organic Budget System Law stipulates that pension spending can be up to 11 percent of GDP, nothing in the Budget Law explicitly prevents it from falling below that level. 35 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION and years of service were phased in from the previous Figure 4.6: Pension Spending, 2013 – 73 requirement of age 53 with only 35 years of service (Percent of GDP) for women. As a result of these multiple pathways, individuals who retired relatively young were not considered early retirees but treated as fully privileged 16.0% retirees. In most countries, if individuals retire at age 60 rather than 65, they will receive benefits for about 5 years 14.0% longer. If people retiring at 65 are expected to receive 12.0% benefits for 15 years on average, allowing retirement 5 years earlier will result in a benefits package that is 10.0% about a third greater than for the person who retires at 8.0% 65. To even things out, most countries actuarially reduce the benefit for the early retiree to compensate for the 6.0% longer duration of receipt of benefits. Until the 2014 law, 4.0% Serbia did not do that. It treated each of the pathways to retirement as eligible for the full pension, even though 2.0% some were far more generous than others. Figure 4.8 2013 2018 2023 2028 2033 2038 2043 2048 2053 2058 2063 2068 2073 shows the penalties as of 2015, but still shows Serbian penalties as being on the low end. Source: World Bank staff projections. Figure 4.8: Reduction in Benefits per Year of Early Retirement (Percent) Figure 4.7: Pension Fund Balance, 2013 – 73 (Percent of GDP) 8 7 20.0% 6 15.0% 5 4 10.0% 3 5.0% 2 0.0% 1 0 5.0% Luxembourg Norway Hungary Czech Republic Germany Serbia Austria Greece Switzerland Finland Korea Canada Italy Japan Portugal Slovak Republic Sweden US Iceland Spain 10.0% 2013 2018 2023 2028 2033 2038 2043 2048 2053 2058 2063 2068 2073 Source: World Bank staff projections. Source: World Bank Early Retirement 4.20. Extended service privileges compound the impact of flexible retirement, resulting in large 4.19. Another feature inherited from the old pension numbers of early retirees. While flexible retirement encouraged early retirement, the Serbian system also system which has been carried over to today is a inherited the system of extended service privileges, in flexible approach toward retirement . The law before which individuals in quite a large number of occupations the latest changes allowed three pathways to retirement: were given extended service credit. For example, for (1) men who had reached the age of 65 and women who every 12 months they worked and paid contributions, had reached 60, with 15 years of service; (2) men and they were given credit for as much as 18 months of women who had reached 58 with 40 years of service for service, with different amounts of extended service men and 38 for women; and (3) anyone with 45 years of awarded to different occupations. For example, an service, regardless of age. For the second pathway ages individual who starts work at age 18 and works in an 36 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION occupation that gives 18 months credit for every 12 changes impact those yet to be retired. A second law, months actually worked can by age 48 accumulate the the Law of Temporary Reduction of Pension Payment 45 years of service credit allowing retirement at any age which became effective in November 2014 temporarily and the pension would recognize 45 years of service. reduced benefits above RSD 25,000 per month by 22 Employers of those in the privileged occupations are now percent of the amount above RSD 25,000 and reduced charged additional contributions commensurate with benefits above RSD 40,000 by a further 3 percent of the amount of extended service credit. The additional the amount above RSD 40,000. The Pension Insurance charge compensates for pensions being based on 45 Law was also modified in December 2014 to suspend years of service instead of 30, but does not compensate indexation of pensions in years when pension spending for the fact that the pension is received 17 years early (for is expected to be above 11 percent of GDP (similar to a male employee), which more than doubles the cost to the suspension of indexation of public sector wages the country of the retirement package. While some who discussed in Chapter 3). receive extended credit may have lower life expectancies, such as miners, there is no reason to expect that others 4.23. Projections suggest that the reforms have a who receive these benefits have lower life expectancies significant impact on the short-run finances of the than the rest of the population. Even workers like miners pension system. Given that benefits for those retiring are likely to leave behind widows and family members early are now reduced, it is impossible to know how who will receive a survivor’s pension for a long time. many people will actually retire early. The projections in Figure 4.5 are based on the assumption that 50 percent 4.21. The combination of these two factors, flexible of people would continue to retire early. The reduction retirement without penalties and extended service of 0.34 percent per month is a bit smaller than the privileges, explains the very high rate of young old- actuarially fair reduction of 0.5 percent, so the system age retirement. Typically countries have a choice of continues to provide a small subsidy for early retirement. paying adequate benefits to relatively older individuals The reduction of 4 percent per year of early retirement or paying much lower benefits to a much larger group is a significant improvement on the previous 0, but of people. Serbia’s attempt to pay relatively generous remains on the relatively low side internationally (Figure pensions to a wide range of people has led to the current 4.8). This subsidy to early retirement should encourage situation. The government can still choose to pay low some people to continue retiring early, but the reduction benefits to many people, but paying more adequate may force others to postpone retirement and continue benefits to those who are unable to work is a more working. The assumption underlying the projections was efficient use of limited resources. that 50 percent of those currently retiring before 65 would continue to retire and 30 percent would continue working and contributing, with the remainder dropping out or joining the informal sector without claiming a pension. C. Reforms Enacted in 2014 and Their Impact 4.24. The other variable affecting the impact of the 2014 reforms is the duration of the 2014 temporary 4.22. The Government of Serbia undertook three sets reduction in pensions. The projections assume the of important pension reforms in 2014 to deal with reduction will last for 3 years, 2015–17. The reduction both the generous benefits and early retirement that was modeled as a reduction in spending from the are the primary causes of overspending: it amended Pension Fund, even though the money may accrue to a the pension law effective in January 2015; and it reduced different account as tax revenue. Should this reduction pensions through the tax code effective in November be extended or lifted early, the projected impact would 2014. The pension law, amended in July 2014, raised of course be different. The small spending increase in the retirement age for women gradually between 2015 2018 comes from the assumed removal of the temporary and 2032 to 65, equal to that for men. And for the first reduction. The important outcome is that while there time, actuarial reductions of 0.34 percent of the benefit are short- to medium run improvements in pension per month of early retirement were enacted for those system finances, the long-run problems stemming from retiring before the age of 65. When the law is fully indexation of the general point remain. It should be phased in, early retirement will only be allowed at age noted that while the pension reduction was billed as a 60, but for now it is allowed at earlier ages but with a 10 percent reduction in benefits, because it is levied only maximum reduction of 20 percent even if the number of on the portion of benefits above the average pension, years exceeds 5. However, extended service retirees will the reduction in pension spending is about 5.8 percent. be allowed to continue retiring early, and some will not face the actuarial reduction, although there was some tightening of the extended service requirements. These 37 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION 4.25. Given the sizable improvement in pension emergencies in the pension system were dealt with, to the outcomes from enacting these painful reforms, it is extent politically possible, in 2014. However, as has already important that the Government stay the course and been shown, little effort has been put into addressing such allow them to bring the pension spending levels down medium-term issues as (1) societal expectations for the to more manageable levels. Figure 4.9 shows that the pension system; (2) de-linking of general point indexation reforms will succeed in bringing the pension spending from indexation of pensions post-retirement; (3) the rise of down to the maximum 11 percent level by 2020. informal labor markets; and (4) the farmers’ pension system. Figure 4.9: Impact of 2014 Reforms on Pension Spending (Percent of GDP) Societal Expectations vs. Pensioner Needs 4.28. Serbian society expects the pension system to pay average benefits of 70 percent of average wage, which Pre-2014 2014 Reforms is not affordable in Serbia or anywhere else in Europe. While the immediate cause of the high fiscal spending 16.0% on pensions is the 2008 increase in pensions which raised 14.0% the level to 70% of average wage, the question is why 12.0% there were demands to raise pensions to such a high level 10.0% compared to benefit levels in other countries that led to the Government’s decision to raise benefits in 2008. 8.0% The average benefit, as calculated in Serbia, combines 6.0% pensions paid for old age with those for disability and 4.0% those for survivors across all the systems. Since survivor 2.0% benefits are 70 percent of old-age benefits and one-third of the beneficiaries are survivors, keeping the average 0 benefit at 70 percent of average wage means that the old- 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 age benefit has to be substantially higher, 80 percent or more. Elsewhere in Europe, benefits for the newly retired Source: World Bank staff calculations. average about 63 percent of the average wage. With inflation indexation of benefits post-retirement, as is typical, average old-age benefits are about 50 percent of D. Issues Going Forward the average wage. And with the aging of the population all over Europe, it is not clear that even this benefit level will be affordable for long. 4.26. The main short-run issues relate to sustaining existing reforms, despite protests and potential 4.29. Whenever benefits fall substantially below improvements in the economy and the fiscal position. expectations in Serbia, political pressure starts to build Serbia’s generous pension benefits need to be pared to reverse the reforms. Under the 2005 law, indexation down. The initial efforts to date need to be continued. The fell from the previous 50 percent of average wage growth increase in the retirement age and the penalties imposed and 50 percent of inflation to 37.5 percent of average on early retirement also need to be continued as Serbia wage growth and 62.5 percent of inflation in 2006 and moves toward international best practices. These are even to 25 percent of average wage growth and 75 percent more urgent given the large cohorts of early retirees retired of inflation in 2007. In 2007 wage growth in Serbia was in 2014. It is unfortunate that the timing of the introduction substantial, close to 20 percent in real terms, which led to of these policies coincides with the downsizing of the the perception that pensions had fallen behind wages and public sector and the restructuring of public enterprises, were falling far behind the 70 percent societal standard. but shifting the problem from one part of the government As a result, after elections in 2008, there was a substantial budget to another does not solve it. If the government increase in pensions in October, just as the financial crisis faces absolute obstacles in downsizing and restructuring, it hit. Subsequently, while pensions were frozen for two years, could opt to provide one-off severance payments to these wages actually fell, again boosting the ratio of pension workers or retrain them rather than pushing them into the benefits to average wages. Even the more drastic measures pension system without penalties. taken in 2014 were not sufficient to reverse the 2008 increase or bring benefits down to international levels. 4.27. The government will need to begin soon to address the inter-related medium and longer-term issues 4.30. The only way to avoid pension spikes of this type remaining in the pension system. Most of the short-term and to alleviate political pressure is to undertake a 38 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION prolonged campaign to educate the public that the 70 4.33. It would be far better for the government to percent standard is no longer achievable in Serbia, and have a plan on how to reform the system before this that other European countries are not even trying to breakdown begins to occur. Lessons from pension achieve that level. The fiscal difficulties that Serbia has reforms throughout Europe and around the world are that faced in recent years has led to reactive pension policy, gradual changes are easier for individuals to understand with efforts to reduce short-run spending in response to and incorporate than sudden shifts. Starting to incorporate the latest crisis. People understand, more or less, that changes now would smooth the path to whatever the final when the country is facing a crisis, there has to be belt- benefit structure is. tightening all around. But when the fiscal situation improves, the expectation is that benefits will again rise to 4.34. Gradually moving indexation of the general 70 percent of the average wage and some political parties point to growth in average wages while retaining the publicly advocate for it. Little effort has been put into indexation of pensions post-retirement to inflation explaining that this target is no longer achievable. It is not might be one way to move to a more sustainable clear that it ever was, but with today’s lower contribution pension system. Figure 4.10 shows the impact on rates, the aging of the population, and slower growth, it benefits relative to average wage, if between 2016 will not be achievable in the foreseeable future. Explaining and 2025 the value of the general point were gradually this and showing that other countries do not see this as a moved from inflation to average wage indexation, reasonable target will help alleviate the political pressure as is typical in other countries. Whether the ultimate that has led to spikes and later reversions. benefit levels are adequate can be adjusted based on the outcome of the discussion suggested above, but 4.31. Societal expectations vary widely by country and moving in this direction avoids the abrupt reduction in can be changed over time. Countries across Europe benefits as a share of average wage. Figure 4.11 shows have widely differing expectations of their pension that delinking still allows pension spending as a share of systems. In Russia, the norm of pension benefits that GDP to fall to more typical levels. are 40 percent of the average wage is widely accepted. Comparisons with the past or comparisons across Europe on euro-equivalent benefit levels are not entirely Figure 4.10: Benefit Impact of Delinking General Point Value useful, given that the cost of living so varies widely in from Post-retirement Indexation (Percent of Average Wage) European countries. Health care systems also vary widely across countries, with individuals responsible for varying amounts of their own health care needs. It is important to open discussion of the minimum Base Delink benefits an elderly person in Serbia requires to live. The 90.0% government could then propose a benefits package that 80.0% is both affordable and adequate, making this the new 70.0% societal expectation. Furthermore, it needs to be clear 60.0% that benefits will probably be somewhat linked to an individual’s contributions and earnings but need not be 50.0% linked to wages in society at large. 40.0% 30.0% 20.0% Delinking Indexation of General Points and 10.0% Pension Indexation after Retirement 0.0% 2013 2018 2023 2028 2033 2038 2043 2048 2053 2058 2063 2068 2073 4.32. The juxtaposition of society’s current expectations with medium-run benefit projections suggests an Source: World Bank staff calculations. impending explosion. The steep drop in expected benefit levels shown in previous sections does not comport well with society’s benefits expectations. Countries faced with such a clash typically end up with ad hoc increases, particularly around elections, that break the logic of the pension system. Once people begin to feel uncertainty about what they will receive in benefits compared to what they contribute, or about whether they will even receive benefits, they tend to withdraw from the system, accelerating its breakdown. 39 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION benefit—old age, disability, or survivors. An even larger Figure 4.11: Pension Spending Impact of Delinking number benefited as a result of living with a spouse who (Percent of GDP) received pension income. The rise of the informal labor market suggests that in the near future as people begin to reach retirement ages, and an increasing percentage 2014 Reforms Base De-link may find themselves unable to work but ineligible for a pension. This phenomenon exists in almost all 16.0% middle- income countries. While improved incentives 14.0% and collection efforts can result in some additional 12.0% formalization, substantial increases in formalization 10.0% generally occur slowly along with economic growth. The current structure of the pension system as legislated, 8.0% where 20-year-olds entering the labor market will see 6.0% benefits falling drastically by the time they retire, does 4.0% not offer much incentive to join the pension system. 2.0% 4.36. Data provided by the Pension Fund of Serbia 0 show that as few as 55 percent of the population in 2013 2018 2023 2028 2033 2038 2043 2048 2053 2058 2063 2068 2073 the 35-39 age group, the prime working age group, are actually making contributions. Internationally, Source: World Bank staff calculations. this same percentage of the population is roughly the group that is eligible for full pensions when they retire. Today, 77 percent of the elderly are collecting benefits, Impact of the Rise in Informality in Labor suggesting a future gap which may need to be covered Markets through social assistance. Figure 4.12 shows the data for Serbia together with data for other transition countries. 4.35. A third issue that needs to be considered in restructuring the pension system is the lower level of 4.37. Since a significant portion of those who became of participation in the pension system than in the past working age after 1990 may not have ever participated and the consequent future rise in the number of elderly in formal labor markets, Serbia probably has until 2025 with no pension rights. In 2013, about 85 percent of the or 2030 before it starts to see a rising number of elderly population over 65 received some type of public pension who are ineligible for any type of pension. However, Figure 4.12: Percentage of Elderly Collecting Public Pensions Today and Estimated Percentage Eligible for Benefits in 2050 Based on Percentage of 35-39 Year Olds Making Contributions Today (Percent) 2010 2050 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Serbia Armenia Romania Russia Hungary Bulgaria Belarus Latvia Croatia Lithuania Czech Republic Estonia Poland Slovak Republic Georgia Republika Srpska Bosnia Federation Azerbaijan Kyrgyz Republic Turkey Kazakhstan Tajikistan Kosovo Albania LSTC HSTC YC Source: World Bank, Inverting Pyramid, 2014. 40 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION if the government should redesign or restructure the 4.39. Quasi-contributory schemes, where individuals whole pension system, it would be worth keeping make only limited contributions but receive a more in mind that in future some fiscal resources may be substantial benefit, are typically the worst option. needed to support those who are not eligible for a public Quasi-contributory schemes combine a huge element of pension, and thinking about how to design both systems social assistance with a limited element of contributory to minimize disincentives to joining the formal system. social insurance. Typically these schemes end up the worst of both worlds: they do not protect all poor 4.38. Countries typically pursue one or more of the elderly, since some people are too poor to make even following strategies to help alleviate poverty among the limited contributions. Individuals usually contribute the uncovered elderly: (1) provide a flat universal as little as they can and for as short a time as they pension to all individuals above a certain age; (2) can to access the highly subsidized minimum benefit. provide a targeted noncontributory benefit to the Individuals always perceive their contributions as being elderly poor; and (3) unify provisions for old-age pov­ more valuable than they typically are. When they have erty with the social assistance system. made even limited contributions, they feel they have a right to demand what they consider a decent pension, • Since the universal pension would go to all which leads to political pressure for higher and higher individuals above a certain age, it is typically the minimum benefits. If individuals have not been asked most costly of the three options but it offers the to make contributions, governments have more political fewest disincentives to joining the formal system. space to provide benefits that are affordable. Keeping benefits low and possibly making them available only at ages above the normal retirement age can help contain costs. Reform of the Farmers’ Pension Scheme • A noncontributory benefit targeted to the elderly poor can involve as little targeting as whether an 4.40. Farmers’ pension schemes are problematic individual receives a state pension from the pension throughout the world because of the difficulty of fund. This type of benefit is less costly overall, but can assessing farm income, when some of the output is be more complicated and thus costly to administer. consumed by farmer and family, and the difficulty Furthermore, if individuals know they will receive of assigning income and contributions to family benefits without having made any contributions, the members who might provide some farm labor. While cost of contributing becomes not only the cost of the some of the difficulties with farmers’ pensions are contribution itself but the loss of noncontributory similar to those for the self-employed, less farm income benefits, which combine to make formalization less is typically monetized, fluctuating weather conditions attractive. Again, keeping benefits low and available make income more volatile, and regional dispersion at higher ages helps curb some of these disincentives. makes collection, enforcement, and even delivery of • Unifying old age anti-poverty programs with the benefits more difficult. existing social assistance system has a number of advantages. Where the elderly live in households 4.41. Setting up separate farmers’ systems allows with nonelderly, providing benefits to households that the pension fund to assess flat contributions based are generally poor is more efficient than trying to on the area of the land, rather than the difficulty determine whether the elderly person within a larger of measuring income. Some countries have set up household is poor. There are dangers, however, that the separate farmers’ pension systems, among them elderly will be displaced from larger households in order to Austria, Finland, France, Germany, Greece, Italy, qualify for the benefit, which might increase total state Luxembourg, Poland, and Spain. However, all these support to the larger family unit but might result in systems require substantial state subsidies. Benefits greater isolation for the elderly. If the social assistance can also be designed to recognize that farmers typically program is meant to provide for the poor elderly, its have a lower cost of living because they have less need design may also need to be reviewed. Typically, elderly to purchase housing and food than urban dwellers. individuals accumulate assets over their lifetime to help Because farmers are often a vocal political group, their protect them when they become unable to work. Some benefits far outstrip the contributions the pension social assistance programs disqualify a household that fund can collect from them. These should therefore be owns even a few assets, even if they do not generate considered quasi-contributory schemes. Furthermore, an income. For instance, an elderly household may own as a country urbanizes, fewer and fewer labor market land that could be valuable, but the elderly individual entrants become farmers, reducing the number of or couple may not be able to provide enough labor to contributors to a system that still has to support generate income from it. a sizable number of retirees. This leads to further financing needs from the state budget. 41 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION 4.42. Integrating farmers into the national pension 4.46. Today’s political discussions are often focused system has the advantage of accommodating workers on achieving quantitative targets such as 70 percent who earn some income from agriculture and some from of average wage and not focused enough on what other sectors as well as workers who spend part of their pensioners today really need. As subsequent generations career in agriculture, but then move to more urban experience income growth, they will expect it to be areas, or vice versa. Some countries, like Serbia, have reflected in the pensions they themselves receive and a relatively integrated system, with the only difference will not be content with pensions that previous cohorts between farmers and non-farmers being the amount of with lower incomes might have settled for. Informal the minimum pension. As long as the system is subsidized, labor markets are likely to remain a part of the economy farmers are less likely to contribute. They also tend to push until Serbia’s income levels are substantially higher. The for higher minimum pensions, making the argument that government might want to think about how to provide they contribute just like everyone else and should not be at least survival-level benefits for those elderly who subject to lower pensions, even if they have fewer living have no income. The government might also consider expenses. restructuring the farmers’ pension system, particularly if a targeted or noncontributory option is available for 4.43. A third solution is to integrate those farmers who informal sector workers. are willing and able to pay into the national pension system but to recognize that some will remain outside 4.47. While there are legitimate concerns that the formal labor system. Many of those who by choice reopening the pension dialogue at this moment of or need remain outside the system will need some form of public sector restructuring might result in revisiting support. Since the choices are identical to those for other early retirement options, waiting to open the dialogue informal labor market workers, farmers should be treated on the longer term issues also has costs. The longer the similarly. transition period when moving to a new benefit formula, the smaller inequities there will be across cohorts. Sharper inequities are likely to be less politically sustainable and E. Conclusions and Recommendations risk allowing an implosion of the pension system. This consideration needs to be weighed against the risks of 4.44. Serbian pension policy needs to keep its current loosening the early retirement restrictions before they focus on controlling spending on pensions and reducing have become fully effective. the number of early retirees while beginning to move to a proactive discussion of how to provide old-age support in the medium and longer term and avoid the potential declines imbedded in the current legislation. Because pension spending is so high in Serbia, the government has rightfully focused on short-term measures to help alleviate fiscal pressures. However, projections of the system as currently legislated show decline in benefits over the medium to long term. Since abrupt shifts in policy are never beneficial for a program meant to provide long-term security over a person’s lifetime, the Government is urged to open a dialogue on reforming the system to allow time for gradual eventual reform. 4.45. The overall pension strategy needs to be reviewed to determine what the social needs really are and how best to fulfill them. Elements of the reform strategy should cover: • Discussion of minimum pensioner needs, • A move away from equalizing pensions for different cohorts of workers, which reduces the return for contributions for future cohorts, and toward linking contributions to benefits, not only within cohorts, but across cohorts as well, • Provision for those who are not part of the formal labor market, • Possible restructuring of the farmers’ pension system. 42 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION CHAPTER 5. SUBSIDIES AND STATE SUPPORT TO THE ECONOMY 5.1. Serbia’s current system of public support to SOEs, an increase in activated guarantees from none in 2008 agriculture, and the private sector is inefficient. to almost 1 percent of GDP in 2014. Beyond these, the Subsidies to SOEs do not encourage the recipient to be government is often called on to cover for unpaid social efficient themselves and generate significant direct and contributions, utilities bills, and taxes on behalf of SOEs, indirect pressures on the state budget. In recent years, but information on how much is amounts spent is not the state has issued guarantees to support the liquidity of available and is therefore not part of the analysis.21 some SOEs in dire financial conditions, significantly adding to Serbia’s public debt. State support to public enterprises 5.3. This chapter analyzes the different types of state is also significant but often fragmented and the allocations support for SOEs, agriculture, and private companies lack transparency. Similarly, the current system of state and explores options for reducing or rationalizing the support to agriculture, primarily based on area and animal subsidies to support fiscal consolidation. The chapter payments, is not the most appropriate way to make the begins with the analysis of support for SOEs, followed by Serbian farms more productive and competitive during the a review of the support to agriculture and to the private process of EU accession and should be rethought. And state sector. It concludes with options for further reducing the support to private investment and export promotion is subsidies or making them more efficient. fragmented, nontransparent, and lacks proper evaluation mechanisms. Figure 5.1: State Support to the Economy, 2000-14 (Percent of GDP) 5.2. In 2014 Serbia spent about 5.2 percent of GDP on subsidies and other forms of state support to the 6.00 economy (Table 5.1 and Figures 5.1 and 5.2). Subsidies and state support analyzed in this chapter cover the 5.00 general government level and include direct subsidies, soft loans, and called guarantees, which combined reached 4.00 5.2 percent of GDP in 2014—the highest level since 2000. 3.00 This is about twice the amount the consolidated general government spending on public investments and is close 2.00 to what the government spends on public health. State support to the economy increased most over the last 1.00 three years in part as a result of activated guarantees. 0.00 As resolution of SOEs was delayed, the government has 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 continued to extend guarantees to SOEs, especially public utilities, often for liquidity purposes. A growing number of Source: MOF. those guarantees have in turn been activated, resulting in Table 5.1: General Government Support to Economy, 2014 Figure 5.2: Composition of State Support to the Economy, (in RSD billion and as % GDP) 2000-14 (Percent of GDP) Amortization Subsidies, in cash Soft-loans of issued guarantees* RSD, bn as %GDP 6.0 202.0 5.2 Subsidies, in cash 117.0 3.0 o/w central government 87.6 2.3 4.0 for agriculture 37.1 1.0 for railways 13.3 0.3 for SOEs 18.7 0.5 2.0 for tourism 0.4 0.0 other (culture, national TV etc.) 18.3 0.5 o/w subnational governments 29.4 0.8 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Soft-loans 55.4 1.4 Amortization of issued guarantees / 1 29.6 0.8 Source: MOF. *Amortization only, interest payments related to guarantees are recorded as part of interest payments. Source: Ministry of Finance, IMF Notes: 1. amortization only, interest payments related to guarantees are 21 The government does not maintain an integrated, company-specific inventory of added to the total spending on interest payments information on the forms of state support each enterprise receives. 43 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION A. State Support to SOEs 5.4. State-owned enterprises still loom large in Serbia’s 5.5. Many state-owned and public enterprises in Serbia economy. There are about 1,200 SOEs and they employ are loss-making and without state support financially about 250,000 people (15 percent of formal employment nonviable. The combined losses of SOEs exceeded in Serbia). These enterprises include several major public 1 billion euros in 2013, the latest year for which final utilities, which are among the largest companies in Serbia, accounts are available (Table 5.2). Losses are spread and numerous companies of various sizes in various across all types of SOEs but are concentrated in former sectors operating under different legal frameworks (see conglomerates which are officially ring-fenced from Box 5.1). Heterogeneous in nature, they can be segmented bankruptcy and exempted from paying taxes and social into two groups, state and socially owned enterprises, contributions. These companies account for nearly half of and municipally owned enterprises (Table 5.2). The first all losses. To stay afloat, SOEs receive not only significant group includes public utilities, commercial companies, direct budget subsidies and soft loans but also indirect and companies in the Privatization Agency portfolio. support in various forms, including unpaid taxes and The second group consists mainly of local utilities (water contributions, state guarantees for loans, and arrears supply, district heating, cleaning, etc.) of different types to other state entities and public utilities. These forms and sizes; these are not covered in this report because of support have significant consequences, direct and their operational and financial (in) efficiency has been indirect, for the state’s fiscal accounts. Moreover, given discussed in a recent municipal public finance review how fragmented state support to public enterprises is, how (World Bank 2013). funds are allocated is far from transparent. Finally, the government does not maintain an integrated, company- specific inventory of information on the different forms of state support each enterprise receives. Table 5.2: The Nonfinancial SOE Sector, 2013 unless Otherwise Indicated No. of Operating Net profit/loss Assets No. of companies revenues (EUR Million) (EUR Million) employees (EUR Million) TOTAL (est.) 1,215 8,854 -1,055 34,190 251,848 1. State and socially owned enterprises (est.) 566 7,301 -1,007 30,613 181,496 Public utilities 24 3,560 -323 20,031 77,078 a. Large 6 3,353 -325 18,480 70,462 EPS .. 1,943 166 9,558 31,569 Railroads .. 233 -73 2,428 19,896 Post (core company) .. 201 25 305 15,133 Srbijagas .. 610 -449 1,443 3,011 Srbijagas core company .. 583 -439 1,414 1,181 EMS .. 168 14 751 1,348 Roads .. 225 -9 4,024 1,335 b. Other (estimated) 18 207 2 1,551 6,616 Commercial companies (est.) ~30 ~1,200 ~10 ~2,300 ~18,500 a. Selected large companies 5 1,092 9 2,156 16,404 Telekom (core company) .. 765 135 1,639 9,073 Smederevo steel smelter .. 189 -132 218 5,036 Jat tehnika .. 25 0 20 953 Prvi Partizan .. 54 5 67 889 Airport Belgrade .. 59 0 211 453 Other (excluding banks) ~25 .. .. .. ~2,000 Privatization Agency portfolio 514 2,449 -693 7,551 90,303 a. Companies previously in restructuring 140 1,284 -488 5,876 55,330 b. Other 374 1,165 -205 1,675 34,973 2. Municipal enterprises (est.) 649 .. .. .. 70,352 Municipal utilities (data for 2012) 352 1,281 -46 3,110 55,583 Other (data for 2010) 297 .. .. .. 14,769 Source: Agency for Business Registries, Privatization Agency. 44 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION Box 5.1: Legal Framework Governing the SOEs Different types of SOEs operate under different legal frameworks in Serbia. Public enterprises (PEs) are governed by the Law on Public Enterprises (PE Law), which regulates PEs established by the Republic of Serbia, municipalities, and autonomous provinces and also regulates activities of general interest for any company in Serbia, public or private. All but a handful of national SOEs – including some of the largest, such as EPS, EMS, Post, Serbia Gas, Forestry Management, and Roads – and all 300-plus municipal utilities fall under the PE law. A second group of enterprises are those corporatized into mostly joint stock companies (JSCs) or in fewer cases as limited liability companies (LLCs), including Telekom, Galenika, Jat Aircraft Maintenance, Belgrade Airport, and Railroads. These companies operate under the Company Law that came into effect in February 2012. In addition to these two laws, the Founding Acts and each company's articles of association (except for LLCs) also govern the rights, duties, and liabilities of the "founder" (in the case of PEs) or the "shareholder" (in the case of JSCs and LLCs) toward the enterprise, and vice versa. The activities of both groups are also regulated by sector-specific laws, although those laws focus more on sector policy-making and regulation rather than governance. A third group are those belonging to the PA portfolio, whose governance is still defined by old company laws from the 1990s and the first half of 2000, which for other companies were replaced by the new company law of February 2012. The state’s ownership rights are exercised mainly by line ministries—an arrangement that has often resulted in fragmented ownership and a lack of accountability for decision making and performance. Per the PE Law, the Republic of Serbia is the founder of PEs and the ownership rights are exercised by the Government of Serbia, which directly appoints PE boards and management, approves the annual business plans and development programs, and also approves a range of decisions related to, e.g., establishment of subsidiary companies, investments, prices, and profit distribution. For all practical purposes, however, given the direct reporting line between them and SOEs line ministries act as de facto owners. Line ministries manage the preparation, review, and approval of SOE business plans; nominate candidates for SOE boards and management; supervise SOE day-to-day operations; and monitor the performance of the enterprises in their portfolios. These arrangements result in a number of problems, among them: (1) the potential for conflicts between the policy-making and ownership roles of line ministries, since ministry SOEs can pursue policies that create disadvantages for private companies operating in the sector; (1) a lack of consistent approaches and good practices, which is often a result of different skill levels within government bodies (e.g., for drafting proper business plans); (3) increased scope for interference in day-to-day commercial decision-making, thereby undermining SOE boards; and (4) a lack of adequate monitoring and oversight of the SOE sector as a whole. To address some of these issues, the government in April 2015 adopted a decree to regulate the roles and responsibilities of the Ministries of Finance and Economy and line ministries for SOE monitoring, governance, financial reporting and transparency. It is moving to enhance the financial monitoring of SOEs by the MoF fiscal risk management unit. Direct Budget Subsidies established, and then the company was unbundled into separate passenger, freight, infrastructure, and holding 5.6. The high direct budget subsidies to SOEs are largely company. The corporate restructuring plan centers on asset due to the inefficiency of unreformed public utilities. disposal, network re-optimization, and staff rationalization. Over the last five years, direct budget subsidies to SOEs It is expected that as a result of the restructuring, starting averaged 0.9 percent of GDP, yet despite this significant in 2018 the freight section will receive no further subsidies. support, most SOEs do not perform well in terms of either financial results (obvious from the combined SOEs losses 5.8. Roads of Serbia also receives substantial direct of more than €1 billion in 2013) of operational efficiency. budget subsidies, which over the last three years aver­ aged 0.2 percent of GDP annually, although until 2012, 5.7. By far the biggest SOE recipient of direct budget it did not receive any. However, in 2012 the financing subsidies is Railways of Serbia. For the last five years, model for the roads changed. With some revenues from direct budget subsidies to Railways has averaged 0.4 tolls and excises redirected from the company budget to percent of GDP annually, though gradually declining (from that of the central government, the company began to 0.47 percent of GDP in 2011 to 0.34 in 2014 and 0.30 in rely on direct budget subsidies from the state.23 2015). Railways of Serbia is characterized by overstaffing, declining passenger and freight traffic, and lack of 5.9. JP Resavica, a coal mining company, is the third investment in network upgrade, among other problems; largest recipient of subsidies. Resavica’s direct budget because its revenues are less than half its operating subsidies have been going up: from 0.05 percent of GDP in expenditures, it depends fully on government support to stay afloat.22 In the Fiscal Strategy for 2015–17, as part of 22 For a detailed analysis see a Railway Policy Note, prepared by the World Bank the IMF SBA the government has committed to a major team in 2014. restructuring of the company. The first steps were taken in 23 Since the company is part of the consolidated general government budget, the early 2015: the Railway Reform Steering Committee was effect of the change is budget-neutral. 45 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION 2012 to 0.11 in 2014. The company is probably not viable Debt Guarantees and Debt Service without direct budget support or a privatization that would reorganize the company to attract new investment. The 5.11. Since in the past few years debt guarantees have government plans to resolve this company using a strategic become one of the main ways several large SOEs are partnership model, but it is not clear whether any investors supported, as a result the stock of debt guarantees has are interested in the company. gone up sharply and so has the amount of debt service for called guarantees. The stock of state guarantees 5.10. Until 2012 companies in the Privatization Agency have gone from about 3 percent of GDP in 2007 to just portfolio received considerable direct budget support, under 8 percent in 2014 (Figure 5.3). In the same period but have received far less since then. Until 2012 these the amount of debt service from called guarantees went companies had received on average about 0.3 percent of from zero percent in 2007 to about 1.2 percent of GDP in GDP annually in subsidies. By 2014 this was down to less 2014 and the situation is expected to worsen (Figure 5.4). than 0.05 percent. As the privatization process is completed, this form of state support is expected to disappear, although 5.12. Until 2010 debt guarantees were used primarily to there is a risk that privatization delays or reversals could lead support public utilities investing in major infrastructure to continued or even increasing subsidies to these companies. projects. However, in recent years, guarantees have been Figure 5.3: Guaranteed Debt, 2007–14 (Percent of GDP) 10.0 8.0 Liquidity - Other Liquidity - Srbijagas 6.0 Projects - Other 4.0 Projects - Fiat Projects - EPS 2.0 Projects - Railroads Projects - Roads 0.0 2007 2008 2009 2010 2011 2012 2013 2014 Source: MoF. Figure 5.4: Debt service for Guaranteed Debt (Interest and Principal) (Percent of GDP) 1.4 1.2 Agroziv 1.0 Smederevo Steel Mill 0.8 Galenika 0.6 Air Serbia 0.4 Railroads 0.2 Roads of Serbia 0.0 Srbijagas 2007 2008 2009 2010 2011 2012 2013 2014 2015 p 2016p 2017p Source: MoF. 46 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION issued to support SOE liquidity—in effect, replacing issued to commercial SOEs are activated budget would need direct budget subsidies (Figure 5.3). In the last few years, to pay about EUR 400 million annually to cover for those. guarantees have been issued not only to public utilities but However, if the government manage to restructure some also to several commercial SOEs, most notably Zelezara of those enterprises benefitting most from guarantees, Smederevo and Galenika, in effect subsidizing commercial and require from those enterprises to service at least some companies. if not all the debt savings could be between 0.3 and 0.4 percent of GDP annually (between 2016 and 2017)24 . 5.13. Most of the recent increases in guarantees has been for liquidity support to Srbijagas (Figure 5.3), which has been in constant financial difficulty. Low collection rates (typically less than 70 percent), driven Indirect Support through Foregone Taxes, primarily by inability to enforce payment from companies Contributions, and Utility Bills being restructured, such as Petrohemija, Azotara, and MSK, have been a problem but so have been the arrears of 5.17. Indirect support to SOEs is nontransparent, some district heating companies, the addition of noncore distortive, and inefficient. Some SOEs, especially those companies to its balance sheet through debt-equity swaps, in the PA portfolio, receive a range of indirect support and unfavorable pricing policy. Also contributing to the in the form of unpaid taxes, contributions, and utility surge in debt guarantees have been roads, railways, EPS, bills. Altogether, indirect support for SOEs is estimated and other companies, but these guarantees have mostly at more than €200 million, 0.6 percent of GDP, annually. been for investment projects. Companies being restructured have accumulated more than €2.5 billion, 7.5 percent of GDP, of liabilities to the 5.14. The growing stock of debt guarantees has pushed state as a creditor. Of this, according to the PA data, at up amortization of debt service on called guarantees, least €400 million (1.2 percent of GDP) is towards public particularly for Srbijagas, but also for Roads of Serbia utilities. These companies also owe more than €2 billion and Serbia Railways. Amortization of called guarantees of debt to private creditors, which so far has not been can be expected to stay elevated for the next several years called in because the Privatization Law has so far provided (Figure 5.4). Now, however, the government has taken protection against creditors. This protection was extended major steps to reduce the issuance of new guarantees; the for another year for largest 17 enterprises in mid-2015. 2015 Budget Law mandates no new state guarantees for Beyond the fiscal implications, the indirect support tips the liquidity support and quantitative limits on new guarantees playing field against the private sector. for projects; this is a performance criterion for the IMF program. 5.18. Some large public utilities benefit from the indirect support, but others are adversely affected by it. The 5.15. Reforming major public utilities is critical to Railways of Serbia continue to accumulate arrears to EPS, reduce debt guarantees and amortization, and thus estimated in 2014 at € 10 million; and the accumulation ease the budgetary and debt pressure exerted by public in the first three months of 2015 was at the same pace utilities. The corporate restructuring plan for Srbijagas as in 2014. The Railways of Serbia and RTB Bor, a copper adopted in December 2014 unbundles distribution. smelter in the PA portfolio, are two of the largest debtors The government also plans to divest non-core assets to EPS, undermining its financial position. And as already and resolve the companies that have accumulated the mentioned many of the financial difficulties of Srbijagas largest arrears to Srbijagas (Petrohemija, Azotara, MSK, are caused by arrears accumulated by companies from the Zelezara Smederevo). A separate financial restructuring PA portfolio. plan is expected to be developed, which will be based on improved collection and higher transit and network 5.19. Although these indirect subsidies do not fees. With regard to EPS, a deterioration of its financial constitute a direct budget expenditure, they still have position could present a major risk to the state budget. The significant fiscal implications. Unpaid utility bills create government has committed to its comprehensive reform, problems for public utilities25, in particular in Srbijagas and which will streamline the organizational structure and EPS, which then results in their needing further guarantees management, right-size staff, and financial restructure the or their guarantees are called and the government must company based on improved collections, higher efficiency, amortize them. Moreover, the protection from creditors cost savings, and tariff increases. The World Bank and the enjoyed by companies being under restructuring is seen EBRD are supporting the EPS reforms. 24 Under the assumption that GoS continues to service the debt of Railways, Roads of Serbia and for companies where such arrangement is part of the privatization 5.16. If GoS manages to shift the debt service obligation agreement. In addition, it is assumed that only a portion of the guaranteed debt from its books to enterprises which benefited from is assumed by SOEs. 25 Some of these problems will be eventually resolve by revisions of the Law on guarantees, savings could be significant. If all guarantees Payment Deadlines, which is supported by the IMF program. 47 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION by the business community as a major distortion of the 5.22. As noted, the support covers a wide variety of playing field and a significant deterrent to more private programs (see Box 5.2). Among factors that have made investment—finalization of privatization is regularly state support for agriculture less effective are year-to- identified as a high priority by the Foreign Investors year volatility in program spending, and the allocation of Council and other business groups. resources across programs, commodities, farm types, and regions, which in some cases have been out of balance or have not provided the right incentives. B. State Support to Agriculture Box 5.2: The Main Budget Support Programs for Agriculture 5.20. Budget support to agriculture has been volatile in recent years and the policy objective is not clear. Agricultural subsidies support a range of programs in Serbia, • Market support includes export refunds, intervention buying, from general services and support through output payments, and the costs of holding public reserves. In most years these rural development support, market support, and input measures accounted for less than 5 percent of total spending; subsidies to area and animal payments. Until 2011, most they were phased out in 2011. direct payments to producers consisted of input subsidies • Input subsidies mainly cover diesel fuel and mineral fertilizer, for diesel fuel and fertilizer, with the rest provided as price although breeding animals were added in 2011. Until 2008 subsidies for cereals and oilseeds. Today, area and animal interest on short-term loans was also subsidized. payments account for 60 percent of all direct payments, • Price subsidies, or output payments have mostly been used to input subsidies for 20 percent, and producer subsidies for support milk production. Wheat, sunflower and soybean prices 15 percent. The significant variation in types and levels of were subsidized in 2004–2006 and tobacco prices until 2010. support has created disincentives for long-term planning • Area and animal payments were first made in 2004–2008 and and investment in farms and agro-processing. Furthermore, then re-introduced in 2012. Recently they have supported crop as the following review will demonstrate, the current system production (except vegetables and fodder crops) and dairy of support based mainly on area and animal payments cattle. is not the most appropriate way to make Serbian farms • Rural development measures emphasize support for investment more productive and competitive during the process of EU by rural households in the renovation and construction of accession. It should be rethought over the medium term. buildings, purchase of equipment and machinery, and renovation and planting of perennial crops. Priority is given to people in mountain areas and farmers under 40. Programs to diversify rural Current Types of Support incomes and support farm enlargement and land consolidation were tried, but abandoned. Support for environmental protection 5.21. Budget support for agriculture has averaged about is minimal; it is limited to the preservation of genetic resources 4 percent of total spending (about 1 percent of GDP) and the development of organic farming. since 2008. While this is lower than in Croatia and FYR of Macedonia, it seems reasonable for a middle-income economy where the share of agriculture in total GDP is about 15 percent (Table 5.3). 5.23. State support to agriculture in recent years has been volatile (Figure 5.5). Until 2011, most direct payments to producers were in the form of subsidies for Table 5.3: Public Spending for the Agri-Food Sector in Rural diesel fuel and fertilizer and the rest subsidized prices for Areas (€/Ha utilized agriculture area – UAA) cereals and oilseeds. Payments for input subsidies were scaled down in 2012, after area and animal payments Annual Expenditure Country were reintroduced. The area and animal payments now (Less Export Subsidies) account for 60 percent of all direct payments, input EU 27 475.9 subsidies for 20 percent, and producer subsidies for Croatia 378.8 15 percent. The budget allocation for general services FYROM 147.7 and support is only 1–2 percent of expenditures, which severely limits the capacity to provide essential public Republic of Serbia 68.6 services, such as extension, research, animal breeding, Montenegro 67.3 plant and animal health, soil fertility control, and border Bosnia and Herzegovina 48.4 control. Albania 24.1 Source: Agricultural Policy and European Integration in Southeastern Europe, FAO; Budapest, 2014. 48 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION Figure 5.5: Budget Support to Agriculture by Type of Program (Million dinars, constant 2010 prices) Input Subsides 30,000.0 Area/Animal Payments 20,000.0 Rural Development Other Support Measures 10,000.0 Output Payments Market Support 0.0 General Services and Support 2006 2007 2008 2009 2010 2011 2012 2013 Source: Ministry of Agriculture and Environmental Protection. 5.24. The volatility has contributed to the lack of grants from government ministries. Some 64 municipalities clarity on agricultural policy. The significant variation in requested funds of RSD 1.5 billion for rural development types and levels of support has created disincentives for in 2013. Total public expenditure on rural development for long-term planning and investment in farms and agro- 2013 (all sources combined) thus amounted to RSD 3.6 processing. The volatility is partly the result of year-to-year billion. This is still low relative to total public spending on changes in budget support, particularly in 2009 when the agriculture, and for rural development needs. allocation was cut by 30 percent – as shown in Figure 5.526 Continual changes to the forms of government support 5.26. Access to Ministry of Agriculture support programs and changes to the level of spending on different programs is also problematic. The eligibility criteria for registration are further sources of instability. Even within programs, with the Farm Payment Agency (FPA) have been changed eligibility criteria and level of support can change more several times, and the institutional base for registration than once in a single season. While the frequent changes and payments still lacks capacity to cater to the hundreds in government may have heightened the volatility, at the of thousands of small farmers. Eligibility was limited in core been the lack of clarity about policy. 2009 by restricting access to rural households with fully paid contributions to the Farmers Pension Fund. Since 5.25. The increasing emphasis on direct payments many rural people don’t use other pension insurance to farmers has caused a steep drop in support for schemes, this excluded many potentially suitable rural development, from 6.8 billion dinars in 2006 beneficiaries. Further, new restrictions reduce support (44 percent of spending) to 1.9 billion dinars in 2013 levels for older farmers (over 65 years old). (7 percent). Producer subsidies (including area, output, and animal payments and input subsidies) are now the priority rather than promoting investment by farmers and Beneficiaries of Budget Support agro-processors and support for farm restructuring. Some additional support for rural development comes from the 5.27. Trends in the number of beneficiaries have tracked Vojvodina regional government and local municipalities. the amount of budget support, rising until 2008, then Of the Vojvodina government’s 2015 agricultural budget falling after the budget cuts in 2009, and recovering of RSD 7.15 billion for 2015, RSD 680 million is allocated slightly since 2011 (Figure 5.6). Only active farmers for investment and rural development – up from RSD 203 registered with the FPA can access support. Central Serbia million in 2013. In 2013 and 2014 some 1,700 Vojvodina has the highest number of beneficiaries, consistent with farms were provided with grants, low-interest loans, and the high number of farmers in Sumadija, while Western loan guarantees to support investment in greenhouses, hail Serbia, Vojvodina and Southern and Eastern Serbia have nets, irrigation, animal production, and household agro- a similar, much lower, number of farmer beneficiaries. processing. Another program provides annual payments of RSD 8,000–11,000/ha to farmers over 65 as an incentive to lease their land to younger famers. Local municipalities also finance a range of rural development activities, funded by 26 Excludes additional budget support for Vojvodina from the regional government. 49 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION 5.28. Vojvodina farmers receive the largest allocation crop production, fuel subsidies, and crop and animal of budget support, despite the lower number of active insurance shows that 60 percent went to Vojvodina, farmers, due to the larger average size of farms in 24 percent to Sumadija and Western Serbia, and 9 this region. Analysis of FPA payments for 2013 for percent to Southern and Eastern Serbia (Table 5.4). In 2013 these payments accounted for two-thirds of total budget support for agriculture. Note also the high Figure 5.6: Number of Active Farmers, 2006–13 average payments per active farm in Vojvodina and the low average payments in Southern and Eastern Serbia. Serbia Vojvodina There were no equivalent data available for livestock Central Serbia Sumadija and Western Serbia payments, but the regional allocation is likely to be similar to that for crops (see below). Southern and Eastern Serbia 5.29. Among commodities, cereal and industrial crops 400,000 and dairy production are the major beneficiaries of budget support. The benefits of input subsidies, the 300,000 main crop support vehicle, typically accrue to major 200,000 crops, such as maize and wheat, and industrial crops, such as oilseeds and sugar beet. As the main producer of 100,000 these crops, Vojvodina receives the highest proportion 0 of direct payments for crop production. 2006 2009 2008 2005 2007 2010 2012 2013 2011 Source: Farm Payment Agency. Table 5.4: Budget Support for Crops, Fuel, and Insurance by Region, 2013 Expenditure Percent of Total Number of Active Average Payment per (RSD ‘000) Farmers Active Farmer (RSD) Vojvodina 10,220,218.4 59.4% 81,847 124,870 Central Serbia 638,288.3 37.1% 235,353 27,122 Sumadija and Western Serbia 4,069,764.7 23.7% 151,569 26,851 Southern and Eastern Serbia 1,463,739.1 8.5% 83,874 17,452 Other areas 587,997.1 3.4% na na Total 17,191,503.7 100.0% 317,200 54,198 Sources: Ministry of Finance, Farm Payment Agency data, Bank Staff Calculations. Figure 5.7: Milk Subsidies and Dairy Production, 2004–13 Dairy Cow Numbers Production/Cow Nominal Milk Subsidy (m dinar) Milk Production (million litres) 800,000 4,500 Cow Numbers/Production per cow Production/Subsidies 700,000 4,000 600,000 3,500 3,000 500,000 2,500 400,000 2,000 300,000 1,500 200,000 1,000 100,000 500 0 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Sources: Ministry of Agriculture; Republic of Serbia Statistical Office. 50 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION 5.30. In all cases, farm structure conditions the impact support no matter what a farmer’s output. This is especially of budget support on production and performance. true for mixed-income farmers. Since farm earnings Vojvodina has been in a better position to seek support are unlikely to be a major source of household income for crop production because it has a much greater for these holdings, they are likely to view government proportion of larger farms (> 20 ha) that can benefit support as an income supplement rather than a resource from demand for Serbia’s cereal and oilseed crops. The to raise investment and productivity. Area and animal minimal response to milk subsidies reflects constraints payments thus preserve a farm structure dominated by related to farm structure. Dairy production is inhibited by smaller farms, when the policy should be to change this the limited capacity or incentives for dairy farmers with structure by increasing farm size. A more targeted area fewer than 10 cows, who account for 87 percent of dairy and animal payments system would encourage farms to farms and 60 percent of dairy cows, to raise more cows in expand through land purchase or rental, thus addressing order to reach the production threshold required for milk constraints imposed by the current farm structure. Rural subsidies.27 Although it has a relatively small proportion households unwilling to increase the size of their farms of total dairy cows, Vojvodina is in the best position to could be given a supplemental area-based payment if benefit from milk subsidies because it has the highest they leased their land to farmers younger than 45. proportion of larger herds (20 cows or more). 5.35. Introduce a subsidy cap: At the larger end of the farm spectrum, policy makers need to limit the level of Reforming State Support to Agriculture support provided to very large farms that have less need of public support. In the EU and other western countries, 5.31. There is a considerable scope to improve the this is achieved through payment caps that set an upper effectiveness of budget support for agriculture. This limit on the total budget support a single farm can receive. should begin by extending the policy focus to the medium- The analysis of farm structure suggests that payments sized farmers who dominate Serbian agriculture, in order should be capped for farms of 100 ha or more or those to broaden and deepen the basis for sector growth. A with a standardized output of more than €100,000. This clearer focus would also help to stabilize the often erratic would affect about 0.5 percent of all agricultural holdings nature of agricultural policy, which is due in part to a lack larger than 2 ha (approximately 1,850 farms), of which of clarity on sector priorities. most (about 1,600) are in Vojvodina. These farms account for about 24 percent of land use, 10 percent of livestock, 5.32. Rebalance state support to favor rural and 17 percent of sector output. The savings in subsidy development: A re-balancing of sector support is also payments could then be used either to reduce budget required, with more resources should be allocated to spending or be allocated to other programs. In December support investments and rural development and less to 2014, the Law on Agriculture was amended to eliminate direct budget support. This rebalancing would strengthen subsidies for land over 20 ha and land leased from the the government’s capacity to respond to the needs of Government of Serbia. medium-sized farmers for investment support and farm size expansion. The milk subsidy, which accounts to about 0.1 percent of GDP, should be phased out. EU Support for Rural Development and Alignment with the Common Agricultural Policy 5.33. Facilitate increased farm size. The differing patterns of response to subsidies, by region and by commodity, 5.36. The Instrument for Pre-Accession Assistance show that direct subsidies have little impact on production in Rural Development 2014–20 (IPARD) is an EU where farm structure is not conducive to investment. program of support to pre-accession countries to The milk subsidy makes this especially apparent. Several prepare their agriculture sectors for EU membership; critical changes are required to the budget support it can substantially boost the resources Serbia can framework in the short term. To begin with, government use for agriculture support (Box 5.3). Of the €175 should recognize how important land leasing is for million provided by the EU, most (€138.25 million) will increasing farm size by allowing farmers to access budget be allocated for investment in commercial farming and support for land leased from the state. Leases or rental agro-processing to improve competitiveness. This will agreements could be registered with the FPA to minimize be supplemented by smaller programs to support rural fraud, but leased land should not be classified as ineligible development and sustainable land management. for budget support, as it currently is. 5.34. Target area and animal payments more 27 Dairy farmers need at least 5 milking cows to be eligible for milk subsidies effectively. Area and animal headage payments reduce (3,000 liters of milk per quarter sold to a commercial processor), a herd of at least the incentive to raise production because they provide 8–10 cows is required. 51 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION Box 5.3: IPARD 2014–2020 Serbia is now finalizing an agreement with the EU on IPARD 2014–20, an EU program of support to prepare the agriculture sector for EU membership. Of the various support measures offered to pre-accession countries by the EU under the Instrument for Pre-Accession Assistance in Rural Development (IPARD), the program will have the following objectives: • Support the competitiveness of the agri-food sector and alignment with EU veterinary, phytosanitary, food safety and environmental standards, as well as restructuring and modernizing the sector. • Contribute to the development of sustainable land management practices by supporting organic farming and other agro-environmental practices. • Contribute to sustainable rural development by supporting diversification of economic activities and strengthening the LEADER approach (Liaison Entre Actions de Development de l'Économie Rural, meaning Links between the rural economy and development actions) • Support efficient program implementation, monitoring, evaluation, and publicity under the technical assistance measure. The EU will provide an estimated €175 million to support this program and the Serbian government will provide another €50 million. The table below shows how the EU finance will be allocated among the major program activities. Table B5.3.1: How EU Agricultural Support will be Used EU Allocation Country Percent of Total (€ Thousands) Investment in physical assets of agricultural holdings 76,040 43.5% Investment in physical assets for processing and marketing agriculture and fishery products 62,210 35.5% Measures to support organic farming and agro-environment practices 8,750 5.0% Local development strategies (LEADER approach) 5,250 3.0% Farm diversification and business development 17,500 10.0% Technical assistance 5,250 3.0% TOTAL 175,000 100.0% Source: Ministry of Agriculture and Environmental Protection, February 2015. Note: The program is expected to begin in 2016. 5.37. To reap the full benefit of EU support, the program and output subsidies, area and animal payments are an should be linked to the broader focus on medium- impediment to farm restructuring. size farms and the reforms of budget support already recommended. Without these changes to current policy, 5.39. However, Serbia is not obliged to align its the investment will benefit a narrow base of commodities agricultural support policies with the CAP before and farmers on which the sector will depend for growth. The EU accession. And even after, member countries have current regional and commodity disparities in performance considerable discretion as to the composition of their will also remain, and low-performing components of CAP support measures and the balance between CAP agriculture will increasingly weigh on sector and economy- and national budget support (as long as there is no wide growth. Used boldly, along with sector reform, the double counting). The support measures used before IPARD program offers a powerful way to facilitate some of accession should prepare Serbian agriculture to compete the controversial policy changes these reforms would entail. in an EU-wide market. Priority should thus be accorded to policies that promote investment, facilitate changes 5.38. How soon should Serbia align with the EU Common in farm structure, and build the institutional structure Agricultural Policy? Serbia began aligning its agricultural required by the EU for delivering CAP support programs. support policies with the CAP in 2011 by introducing area The current emphasis on area and animal payments, and animal payments and reducing input subsidies. Area commodity (milk), and input (fuel) subsidies preserves the and animal payments are now the largest component of current farm structure and reduces the budgetary funds agricultural support, followed by input subsidies for fuel available for investment. By limiting the budget allocation and producer subsidies for milk sold to dairy processors. for rural development, it also inhibits development of the Although easier to budget for and administer than input institutions needed to deliver rural development programs, 52 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION thus restricting access to an increasingly important source for export and investment promotion programs and of pre-and post-accession support for agriculture. development agencies. State subsidies to strategic investors mainly include subsidies to Fiat, the automobile 5.40. In the medium term area and animal payments company, and Air Serbia: in 2013–15 direct subsidies to need to be rethought. These payments are not the most the two averaged about 0.25 percent of GDP annually. appropriate way to make Serbian farms more productive While it is too early to estimate their full impact, some and competitive during the process of EU accession. preliminary indications seem positive: Fiat has become Indeed, the impact of area payments on farm productivity by far the largest exporter in Serbia, and Air Serbia has is highly questionable. The EU adopted area payments completely revamped its fleet, significantly expanding its as a way to continue to extend considerable budgetary network, and after years of losses recorded a modest net support to farmers with minimal impact on productivity. profit in 2014. Because details of the contracts signed with In fact Serbia needs maximum impact on productivity both investors are not fully known, the full economic and for minimum expenditure. Furthermore, neither Serbia fiscal impact of these transactions is difficult to estimate. nor the EU has objectives for area payments that could remotely be described as SMART,28 and it is hard to discuss how best to target payments without knowing what goal Support through Export and Investment they are supposed to achieve. Basic area payments are also inefficient as a means of improving the environment, Promotion Institutions since the payments tend to be applied equally in very different ecological conditions and thus are not related 5.43. State support for private investors is currently either to the value of the environmental goods produced administered by four different national agencies and a nor to the cost of producing them. Finally, as a means of network of regional development agencies, all of which supporting rural development, agricultural area payments report to the Ministry of Economy (MoE): miss the point that the majority of rural income already comes from nonagricultural sectors, which are likely to be • The Serbian Investment and Exports Promotion Agency the main sources of economic growth. While an urban- (SIEPA) is dedicated to helping foreign investors and rural income transfer could bring a small net benefit to buyers while raising Serbia's profile among international rural areas, it would also inhibit overall economic growth. business leaders. Created by the government in 2001 with a mission to support both foreign companies seeking to set up or expand business in Serbia and Serbian companies doing business abroad, it administers C. State Support to the Private Sector per-job-created subsidies for private investors. Between 5.41. The current system of state support for private 2007 and 2013, SIEPA spent in total about €260 million investment and export promotion is fragmented and for these incentives, 0.8 percent of 2014 GDP. nontransparent, and it lacks an effective evaluation • The aim of the Development Fund (DF) is to promote system. These agencies have overlapping mandates, economic development, improve competitiveness and there are no clear coordination mechanisms or and foster employment and balanced regional links to broader economic policy goals, e.g., value development. It runs several subsidized loan programs, chains with solid export potential. Although significant mostly targeting SMEs. Typically, these are for buying public resources are spent on the support programs, it equipment, although in some cases, they are for is not clear what their outcomes are and whether public operational capital. The programs are financed from resources are used efficiently. None of these agencies has their own revenues. In 2013 they amounted to about been through a thorough impact assessment to evaluate €100 million (0.3 percent of GDP) and in 2015 about results, although the few analyses that have been done €40mn (0.13 percent of GDP). The DF also administers indicate serious problems in their operations.29 loan programs financed from the budget; in 2014 about €65mn (0.2 percent of GDP) went to these activities, 5.42. State support to the private sector is mainly of and in 2015, about €28mn (0.1 percent of GDP) is two types: subsidies for strategic investors and support planned. The DF has also administered soft loans to SOEs from the PA portfolio, but these have plunged in recent years. Recent reports from the Anticorruption 28 Specific, Measurable, Achievable, Realistic, and Time-bound. 29 See, for example, the two reports of the Anti-Corruption Council on the Council highlights several weaknesses in DF operations, operations of the Development Fund and undue political influences many of them stemming from undue political influence http://www.antikorupcija-savet.gov.rs/izvestaji/cid1028-2585/izvestaj-analiza- politickog-uticaja-na-poslovanje-fonda-za-razvoj-republike-srbije and this report and a lack of transparency. on the problems related to a program of subsidizing railcar production http:// • The Export Credit and Insurance Agency (AOFI) was www.antikorupcija-savet.gov.rs/izvestaji/cid1028-2788/izvestaj-o-nenamenskom- trosenju-budzetskih-sredstava-na-programu-proizvodnje-i-remonta-sinskih-vozila- established by law to promote exports and build foreign za-potrebe-zeleznice-srbije-ad (both reports available in Serbian only). economic relations. It runs programs for short-term 53 II. OPPORTUNITIES AND OPTIONS FOR FISCAL CONSOLIDATION export financing, factoring, export credit insurance, and budget of both subsidies to them and debt service for guarantees, financed mostly through its own revenues. them. Over the past eight years the cumulative value of its • Enforce strict payment discipline between SOEs with programs is several hundred million Euros. zero tolerance for accumulation of arrears. To this end • The National Agency for Regional Development the government plans to expand the coverage of the (NARD) was founded in 2009 at the discretion of Law on Payments in Commercial Transactions to cover the Government of the Republic of Serbia as a public transactions between public entities (for example, agency tasked with professional and regulatory tasks of payments by Railways for electricity). This is a structural regional development. It runs subsidy programs, mostly benchmark for the IMF program. targeting small and micro companies. NARD is the • Eliminate all debt guarantees for liquidity support. Since primary resource for information and coordination of January 1, 2015 the government has not been issuing institutional, entrepreneurial, and individual initiatives any new guarantees for liquidity support and is limiting to develop all regions. project guarantees. 5.44. The government recently launched an initiative to Support to Agriculture consolidate and reform these agencies in order to make • Make support more predictable and improve the policy them more transparent and efficient and to align them framework in general. with EU state aid policies. New and redesigned services • Rebalance state support with more resources to support are expected to be directed mainly to investment and rural development and less for direct budget support. export promotion, with a view to providing greater value • Facilitate the move to larger farms, recognize the role of to investors and exporters. Experience from successful land leasing in increasing farm size, and allow farmers agencies shows that export promotion would include to access budget support for leased as well as owned building the image of the country (advertising but also land. advocacy); export support (exporter training, technical • Tighten the targeting of area and animal payments to assistance, capacity building, especially in regulatory encourage farm expansion through, e.g., land purchase compliance, information on trade finance, logistics, or rental or offer supplemental area-based payment if customs, packaging, pricing); marketing (trade fairs, household lease land to farmers under 45; exporter and importer missions, follow-up services • Cap subsidies and payments, setting a limit on the total by representatives abroad); and market research and budget support a single farm can receive, to limit the publications (general, sector, and firm-level information, amounts provided to very large farms that have less such as market surveys, on-line information on export need of public support. markets, publications encouraging firms to export, importer and exporter contact databases). Best Support to the Private Sector practice suggests that good investment promotion • Reform the state development and export promotion intermediaries are customer-oriented, anticipating well agencies to ensure transparency and linkage to in advance the information needs of potential investors. economic strategy generally, and periodically assess They are also prepared to provide easily navigable their effectiveness. data on the resources and costs of doing business in an economy so that can investors can quickly do cost- benefit analyses. The reforms in Serbia are expected to move export and investment promotion services toward these best practices. D. Conclusions and Recommendations 5.45. Much can be done to reduce state support to SOEs and increase the efficiency and effectiveness of subsidies to agriculture and the private sector. Support to SOEs • Accelerate resolution of the PA portfolio. Although this would have little direct impact on the budget, without it consolidating large public utilities will be very difficult. • Move quickly to reorganize large public utilities to improve their financial performance and relieve the 54 V. SUBSIDIES AND STATE SUPPORT TO THE ECONOMY III. Opportunities for Improving the Efficiency and Equity of Public Spending in Social Sectors 55 III. Opportunities for improving the efficiency and equity of public spending in social sectors CHAPTER 6. EDUCATION 6.1. Access to primary and secondary education is A. Quality of and Access to Education in high, but coverage of preschool education is low by international standards. For the Roma community Serbia access to all levels of education is significantly lower than for the Serbian population as a whole, particularly for early childhood development (ECD) programs. Quality of Education Low ECD enrollments are a serious concern because education benefits are cumulative: children who 6.4. Despite significant public spending, the quality participate in quality ECD programs later have higher of education in Serbia is still low. The government cognitive development and school outcomes. Because spends 5.2 percent of GDP (€1.5 billion) annually on ECD programs impart generic skills and ability to education. Although higher than for most peers from “learn how to learn,” it is more difficult and costly for the region, the amount is comparable to the average individuals to catch up if they have a disadvantageous for OECD countries (5.3 percent of GDP). However, what start. Among educational investments, ECD therefore matters significantly for learning is how resources are offers the highest returns. This is particularly true for spent, because higher spending does not necessarily the marginalized Roma community, because their labor translate into higher learning outcomes (Hanushek force participation is projected to rise over time. 1986). Serbia’s performance is consistent with its per student spending in education but there is room for 6.2. Public spending on education at about around 5.2 improvement. For instance, countries with similar per percent of GDP, higher than regional peers, but the student spending, like Croatia and Latvia, perform outcomes are far worse. As will be seen from this chapter, better in international student assessments like PISA Serbia can heighten the efficiency of its education (Program for International Student Assessment; see system by consolidating the school network, reducing Figure 6.1). 31 Poland has demonstrated that with the and realigning the number of teachers, and introducing same amount of resources for education and the right per capita financing. Serbia has an oversupply of policies, student learning can be significantly improved. teachers and the student population is declining. As a result, student teacher ratios are low: 12.7 for primary 6.5. PISA scores are in particular low. PISA is an education and 11.1 for secondary. Because there are international assessment that measures cognitive skills so many of them, teachers are the most expensive and how effectively students can apply their reading, budget item. However, the World Bank analysis for mathematical and scientific skills to solve real-world Serbia (2012) reveals that teacher quality, not quantity, problems.32 The latest PISA results (2012) show Serbia matters most to student learning. A possible solution students behind the OECD average by about 1 year of to the large number of teachers would be to redeploy schooling in mathematics. Serbia also has a much larger them, where possible, to expand preschool education share of students that do not achieve basic proficiency. coverage. The school network needs to be right-sized to This is problematic because countries with a large reflect the demographic decline. While work has begun proportion of students below proficiency averages are on this front in some municipalities, there is room to likely to lag when those students join the workforce promote school network rationalization from a supra- (OECD 2014). The EU 2020 target is to have no more than municipality point of view and to include secondary 15 percent of students below PISA level 2. In Serbia 40 schools. Resource allocation would be more effective if percent are considered functionally innumerate (below it were more transparent and would be enhanced by a lever 2) in math and about 30 percent of students who move from inputs- based to per capita financing. Serbia are functionally illiterate in reading. has already begun to do this. 6.3. The objectives of this chapter are four-fold: (1) Review the status and quality of education and access to it in Serbia. (2) Provide a brief overview of how resources are allocated in education. (3) Identify opportunities for efficiency gains by consolidating the school network 30 Preschool education was to some extent covered in the World Bank Serbia and the number of teachers and introducing per capita Municipal Public Expenditure Review. financing. (4) Provide complementary measures that, 31 PISA is a worldwide study of the performance of 15-year-old students in mathematics, science, reading, and, since 2012, problem-solving. According to the in addition to efficiency, can help improve the quality OECD, 40 PISA points is equivalent to what students learn in one year of school of service delivery. The analysis is directed to pre- (OECD 2012). 32 PISA seems to be a good predictor of economic growth—far better than university education, with brief attention to preprimary average schooling level—and there is international evidence that an increase education, which is mostly a responsibility of local of 50 points in PISA scores is associated with about 1 percentage point higher governments. 30 annual growth (Hanushek and Woessman 2007), an impact that shows in the medium term as cohorts enter the labor force and lasts for a long time. 57 III. Opportunities for improving the efficiency and equity of public spending in social sectors Figure 6.1: PISA Performance and Public Spending on Education Europe and Central Asia Latin America East Asia Western Europe & US /Canada 580 Hong Kong Korea 540 Japan Switzerland Poland Estonia Finland Netherlands Australia Ireland Czech Republic New Zealand Austria 500 France Belgium Denmark Latvia United Kingdom Math Score PISA 2012 Portugal Slovenia Norway Italy Iceland Lithuania Slovak Republic Sweden Spain United States Croatia Hungary Israel 460 Serbia Romania Cyprus Bulgaria Kazakhstan 420 Thailand Chile Malaysia Mexico Argentina 380 Indonesia Colombia Peru 340 0 2000 4000 6000 8000 10000 12000 14000 16000 Public expenditures per pupil (in PPP dollars), UNESCO 2012 or latest Source: UNESCO; OECD; World Bank staff estimates 6.6. Learning strategies, individual factors, and school 6.7. PISA is a sample-based test that does not resources help explain why Serbia is not doing as well measure quality or efficiency at the school level. as comparator countries (Figure 6.2). Student learning To measure school quality, national assessments are strategies, influenced by parents and teachers, are the needed, which Serbia currently does not do. Investment techniques pupils use when studying. Learning strategies in student assessments using standardized instruments explain 7 points of the difference in score between would improve the effectiveness and efficiency of the Serbia and the OECD and teacher practices another 2 education system and give policy makers information points. Other individual factors and school resources so that they can monitor student learning; linked to also contribute to the difference, but more of the information on school spending, which is currently Serbia-OECD difference remains unexplained because available, it would make it possible to gauge the it is difficult for PISA to capture all the factors that efficiency of the school and the system. influence classroom practices and learning. But there is international evidence that teacher effectiveness is very important for learning (World Bank 2014). 58 III. Opportunities for improving the efficiency and equity of public spending in social sectors Figure 6.2: Reading Gap, Serbia and Comparator Countries (PISA 2009) 70 60 50 Individual Factors 40 Socio-economic (individual) Preschool 30 Socio-economic (peers) 20 School Resources Teaching Practices 10 Learning Strategies Unexplained 0 Actual Gap -10 OECD EU Bulgaria Germany Croatia Hungary Slovenia Source: OECD 2009. 6.8. An Education Management Information System inequitable (Table 6.1). Preschool (ECE) in Serbia reaches (EMIS) linking access, quality, and finance data would only 52 percent of boys and 49 percent of girls—very low in improve education governance and better inform comparison to the EU 2020 target of 95 percent of children policy decision-making. Serbia does not have a system enrolled in preschool education (starting at age 4). Access that provides timely and disaggregated student and for Roma children is dismal, reaching only 5 percent of school-level data, as most top- performing countries do. An Roma boys and 7 percent of Roma girls34 (Figure 6.3B). Over EMIS system was supported by the World Bank Delivery 80 percent of wealthy children are enrolled in ECE but less of Improved Local Services (DILS) project but it is still at than 10 percent of children in the poorest quintile. Uneven early stages. While there is school-level information from access to ECE is attributed to a combination of municipal different sources (e.g., financing and education data), it has fiscal capacity and parental affordability. Households not yet been integrated into a single system. Production and cited access constraints, such as the costs of attendance dissemination of reliable education statistics is absolutely programs, as the second most frequent reason for children necessary for effective management of education and for not being enrolled in ECE programs (Figure 6.3A). The lack monitoring progress toward national and global targets. of access to ECE, and to child care more generally, is an Having data from all levels of education on such statistics important reason why few women participate in the labor as repetition, dropout, and completion rates, learning force in Serbia (World Bank 2015). outcomes, and expenditures per school is required to keep track of performance and to hold teachers and schools accountable33. Access to Education 33 Recent evidence from Mexico shows that using results from standardized tests 6.9. Access to primary and secondary education is as a diagnosis tool to design school improvement plans can be a cost-effective adequate and comparable with comparator countries, way of improving the quality of education services (De Hoyos, Garcia, and Patrinos, 2015). although uneven for Roma children. In contrast, access to 34 Refers to Roma children living in informal settlements. Source: UNICEF, Serbia early childhood education (ECE) is both low and extremely MICS5 2014 and Serbia Roma Settlements 2014. 59 III. Opportunities for improving the efficiency and equity of public spending in social sectors Table 6.1: Gross Enrollment Rates, Serbia and Comparator Countries Pre-primary Primary Lower Secondary Upper Secondary (2012) (2012) (2012) (2012) Serbia 58 101 99 86 Croatia 63 97 103 95 Poland 78 99 98 97 OECD* 83 102 n/a 99 Bulgaria 86 99 87 98 Hungary 87 100 101 102 Estonia 93 98 101 112 Slovakia 91 102 98 90 Slovenia 94 99 95 99 Source: UNESCO, UIS, 2014; OECD (Education at a Glance, 2011); and Government of Serbia, 2014. 6.10. The returns on ECD investments are among the and developing skills to meet labor market demands. highest in education. Enhanced access to high-quality Ideally, ECE investments could be derived by repurposing ECE for all children, with an emphasis on expanding some existing school infrastructure and using excess access for the Roma population, offers dual benefits of human resources in the education sector to expand ECE bridging the gap between Roma and non-Roma children coverage in fiscally neutral ways. Figure 6.3: Early Childhood Education in Serbia, 2014 A. Reasons for Nonattendance (in Percent) B. Percentage of Children aged 36-59 months in an organized ECE program Non-Roma Roma 70 90 81.6 80 60 70 50 60 52.6 40 50 41.6 30 40 31.6 30 20 20 10 8.6 7.6 10 5.9 5.7 3.2 5.8 0 0 am igh s d ed ity me ed t ice es en ble Poorest Second Middle Fourth Richest niz cil gr loy oh vic ho atm rv sa as o a se mp er to pr Di at rg df tre ys of oo s E re ne e se EC stl wd or el ca su /N en lev Co Po in en cro xp far nt ing w- tak re re er oo Lo pa rn Ov he ild st ea th B. Financing Education: Where Does the Ot Ch yi hl Bo ity uc cil tm as Money Go? No ef Th Source: Serbia Multiple Indicator Cluster Survey (MICS), 2014. 6.11. Serbia’s public spending on education are higher than the regional average. The government spends about 5.2 percent of GDP a year (€1.5 billion) on education35 (Figure 6.4) which means that Serbia spends almost 1 percent of GDP more on education than neighboring ECA countries (Figure 6.4). Total public 60 III. Opportunities for improving the efficiency and equity of public spending in social sectors expenditure per student36 has increased for all levels of percent of Serbia’s total budget, similar to what many education, primarily as a result of a declining student neighboring economies spend, which makes it the single population (UIS 2014). Education accounts for about 16 largest sector directly funded from the national budget. Figure 6.4: Public Spending on Education (Percent of GDP) 6 5 4 3 2 1 0 Romania Slovak Bulgaria Czech Croatia Central Hungary Serbia Europe & Republic Republic Europe and Central Asia the Baltics Source: World Bank Indicators. Data are average for 2006-2011 except for Serbia, where data are for 2014. 6.12. Primary education accounts for the largest share of total government spending. Although central Table 6.2: Public Expenditures on Education in the Republic of Serbia, 2010-2012 government finances all levels of education, most (Percent of the GDP) of its education spending, about 42 percent, goes to primary education,37 followed by tertiary, 25 percent, 2010 2011 2012 and secondary, 22 percent. Research and development receives 9 percent (Table 6.2). Preschool 1.0 1.0 1.1 Primary 2.1 2.1 2.1 6.13. As in other countries, more than 70 percent, of Secondary 1.0 0.9 1.0 recurrent central government spending on education Higher Education 0.8 0.7 0.8 goes to salaries. Only 5.7 percent goes to capital spending. Serbia has 155,000 employees in education, Education not classified by levels 0.4 0.3 0.4 28.6 percent of total general government employment.38 and ancillary services in education Of those in the education sector, 118,000 are permanently Total 5.2 5.1 5.3 employed. Salaries of teachers, like public employees, have gone up in the last decade. However, in an effort to Source: Government of Republic of Serbia improve the fiscal balance Serbia lowered teacher salaries in 2014 as part of the reduction of public sector salaries 6.14. Preprimary education spending is highly by 10 percent.39 Teacher salaries are relatively flat and not regressive, but primary education spending is pro- based on performance. A World Bank report (2012) found poor. There are geographical disparities in access to ECD that urban teachers are paid only 1 percent more than programs because preschool education is primarily funded rural teachers on average as a result of higher educational by municipal budgets, which widely differ in resources. qualifications. Because salaries are flat, greater financial Further, up to 20 percent of the cost of these ECE services resources for rural and less affluent areas often translate are recovered by user fees, so that the poorest households into more teachers rather than more qualified teachers. are unable to afford them. As a result, households from the top quintile that can afford preschool services are the primary beneficiary of government subsidies. This is highly regressive. In contrast, spending on primary education seems to benefit the poor because it is targeted 35 This includes the amount transferred to Vojvodina government, which is then to rural schools and schools that serve students from lower paid as teachers’ salaries. 36 Expressed in international dollars (current) and adjusted in terms of purchasing socioeconomic backgrounds, although it is not enough to power parity (PPP). offset the gap in performance between rural and urban 37 Overall, education is free and the government provide textbooks for students in the first cycle of primary education (Serbia 2014). students. Nonetheless, the system keeps producing 38 Data from August 2014. better educational outcomes for urban and more affluent 38 It appears from payroll data for August 2014 that the base salary of a primary populations (World Bank 2012). education teacher is about RSD 3,799 and of a secondary education teacher is RSD 4,100. 61 III. Opportunities for improving the efficiency and equity of public spending in social sectors C. Opportunities for Enhancing Efficiency Figure 6.6: Full-Time and Part-Time Teachers, Primary and Secondary, 2008–12 Reducing the Number of Teachers Primary 6.15. Serbia has an excess of primary and secondary Full Time Part Time teachers. Even with a declining student population and 60000 fewer classes, the total number of primary and secondary teachers has gone up over the last two decades. In 2012, there were 21 percent fewer students in primary schools 40000 than in 2000 and 13 percent fewer in secondary schools. Meanwhile, the number of primary teachers increased by 18 percent and of secondary teachers by 25 percent (Figure 6.5). Although the number of full-time teachers has declined 20000 slightly since 2010, the number of part-time teachers has been growing. By 2012, part-time teachers made up 40 0 percent of the total teacher workforce, up from 27 percent 2008 2009 2010 2011 2012 four years earlier (Figure 6.6). Source: Serbia Statistical Office data. Figure 6.5: Students, Classes, and Teachers, Primary and Secondary Education, 2000–13 Secondary Primary Full Time Part Time Students Teachers (FTE) Teachers Classes 40000 130 30000 120 110 20000 2000 = 100 100 90 10000 80 0 70 2008 2009 2010 2011 2012 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Serbia Statistical Office data. Secondary Students Teachers (FTE) Teachers Classes 130 120 110 2000 = 100 100 90 80 70 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Serbia Statistical Office data. Note: Number of full-time equivalent (FTE) teachers calculated as full- time + 0.56 * part-time; the 0.56 is estimated from payroll data. 62 III. Opportunities for improving the efficiency and equity of public spending in social sectors 6.16. Student-teacher ratios (STRs) in Serbia have 6.17. Recent reductions in student-teacher ratios and gone down so much in recent years that they are now average class sizes, however, are not likely to improve far below EU and OECD averages. At 12.7 students the quality of education. Evidence from the OECD per full-time equivalent (FTE) primary teacher Serbia is suggests that the relationship between average class below two-thirds of OECD member countries, average size and student learning outcomes is generally weak. 15.4 students per teacher. A ratio of 11.1 in secondary For example, an analysis of PISA 2009 results found schools is also far below the OECD average of 13.5 that “Class size in the language of instruction does not (Figure 6.7). If the high number of part-time teachers seem to have a direct impact on PISA performance in is taken into account, the student-teacher ratio looks reading” for 15-year-olds.40 In fact, the study cites the even lower: Serbian schools enroll 10.5 students for example of Finland, where both large and small classes every primary teacher and 9.1 for every secondary performed equally well in the reading assessment teacher. Paradoxically, average class sizes in Serbia are (Finland topped international PISA rankings in 2009). somewhat higher than OECD benchmarks, averaging 23 Meanwhile, students in France also perform well in PISA students in primary school and 25 in secondary school. and their class size is similar to that of Serbian students. The large class sizes are probably because the Ministry of Further, the OECD concludes that large class sizes have Education and Science (MoES) enforced minimum class not prevented many East Asian countries from having sizes norms by for primary and secondary education in above-average performance (OECD 2012). The World the 2009/2010 school year. The discrepancy between Bank (2012) also found no effect of average class sizes the low STR and the large average class size arises on grade 8 exam scores in Serbia. because 2.2 teachers are employed per class in primary schools and 2.8 in secondary. The ratios vary slightly by region. For instance, primary STRs are 14.6 in the Belgrade region and 11.6 in the central and South Serbia region. For secondary education, STRs of all regions tend to converge at 11. These ratios underscore the excessive number of teachers in Serbia compared to standard international practice. Figure 6.7: Primary and Secondary Student-Teacher Ratios, Serbia and the OECD, 2000-12 Serbia, Primary Serbia, Secondary OECD (2012), Secondary OECD (2012), Secondary 18 16.6 16 15.4 15.3 14 13.5 12 13.2 12.9 13.0 13.0 12.7 11.5 11.6 11.3 11.4 11.1 10 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: World Bank Indicators. Data are average for 2006-2011 except for Serbia, where data are for 2014. 40 OECD 2011. Education at a Glance. Indicator D2, box D2.1, p. 395. 63 III. Opportunities for improving the efficiency and equity of public spending in social sectors Table 6.3: Primary and Secondary Student-Teacher Ratios by Region, Serbia, 2009–12 Primary Education 2009 2010 2011 2012 Serbia North 13.0 13.5 13.5 11.6 Belgrade region 13.9 14.2 14.5 14.6 Vojvodina 12.4 13.0 12.8 12.5 Serbia South 12.8 12.5 12.5 12.0 Šumadija and West Serbia 13.3 12.9 12.9 12.4 South and Eastern Serbia 12.1 12.0 12.0 11.6 Secondary Education Serbia North 11.0 11.6 10.9 10.8 Belgrade region 10.8 11.2 11.0 10.7 Vojvodina 11.1 11.9 10.9 10.8 Serbia South 11.7 11.7 11.6 11.4 Šumadija and West Serbia 11.7 11.9 11.7 11.5 South and Eastern Serbia 11.8 11.3 11.4 11.3 Source: Serbia Statistical Office data. 6.18. While a large number of teachers are employed which is statistically significant. A 10 percent increase in the in Serbia, their qualifications are unequally distributed number of teachers who have a university degree correlated and reinforce inequalities in the education system. with increases in exam scores of up to 0.20 standard A World Bank analysis (2012) found that teacher quality deviations. This finding underscores the importance of as measured by academic qualifications and years of teachers to student learning outcomes in Serbia. Students experience do a great deal to explain differences in student enrolled in the country’s large, urban schools have access performance between urban and rural schools in Serbia. to better-quality teachers who are likely to impart better A regression analysis showed that a one-year increase in learning than those in rural schools (Figure 6.8). Thus, it is the average teacher experience corresponds to an increase in quality of teachers that matters for ensuring that students 8th grade exam results of up to 0.06 standard deviations, achieve the desired academic results, not the quantity. Figure 6.8: Teacher Characteristics by Urban-Rural Location and Quintile Percent of teachers with a university degree Teacher’s average years of experiance 2010 By muncipality welfare quintiles and urban-rural location By muncipality welfare quintiles and urban-rural location Urban Rural Urban Rural 80 78.8 19 75 18 73.9 71.7 17.1 17.1 70 68.5 17 16.6 16.5 66.9 percent 64.6 64.5 16.0 16.1 years 65 16 15.4 15.4 15.3 15.6 61.4 60 59.8 15 55 14 52.7 50 13 Q1-Low Q2 Q3 Q4 Q5-High Q1-Low Q2 Q3 Q4 Q5-High Source: World Bank, 2012. 64 III. Opportunities for improving the efficiency and equity of public spending in social sectors Consolidating the School Network distribution of primary schools within its jurisdiction. Schools within a municipality were to be merged with 6.19. The Serbian education system needs to adapt to other schools unless either of two conditions apply: (1) the declining student population. By 2030, the population enrollment is more than 400; or (2) the school has less of Serbia is expected to shrink by 11 percent, or 800,000 than 400 students but there is no other primary school people, compared with 2013. As the school-age population within 2 kilometers. Due to higher population densities, continues to decrease (Figure 6.9), so does demand for more urban schools were merged numbers than rural. education services. However, the school network, designed In rural areas, schools are often more than 2 km apart, to meet past demographic needs, is still unchanged. so smaller schools were retained due to equity concerns. School consolidation offers students from closing schools 6.20. Serbia is yet to complete right-sizing its school the opportunity to attend better and better-equipped network. The number of primary schools has is gradually schools. Although school consolidation has begun in dropped to reflect the decline in student population. In primary schools, the secondary school network has 2010 the Parliament issued a bylaw41 requiring municipal marginally expanded. Possible explanations include councils to prepare a plan for the number and territorial higher enrollments in 4-year TVET (Figure 6.10). Figure 6.9: Population of Serbia by Age Group, 1990–2050 65 and above 00-14 15-64 4M 2M 0M 1990 1995 2000 2006 2010 2013 2015 2020 2025 2030 2035 2040 2045 2050 Source: World DataBank: Health, Nutrition, and Population Statistics, 2014. Figure 6.10: Number of Primary and Secondary Schools, 2000–2013 Number of secondary schools (RHS) Number of primary schools (LHS) 3650 500 3600 400 3550 3500 300 3450 200 3400 100 3350 3300 0 2000/01 2006/05 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012 /13 2013/14 Source: Serbia Statistical Office 2015. 41 Bylaw N°80-2010, “On Criteria for Passing an Act on Preschool Institution Network and an Act on Primary School Network”. 65 III. Opportunities for improving the efficiency and equity of public spending in social sectors 6.21. More schools need to be consolidated, Introducing Per Capita Financing particularly in urban areas. Although since 2000, the student population is down 21 percent in primary schools 6.22. As the population of school-age children and 13 percent in secondary, in 2013, Serbia still had 95 diminished with little change in the number of percent of its primary schools, and there were actually schools, classes, teachers, and other school inputs, 5 percent more secondary schools. There is room to schools in Serbia have become increasingly inefficient continue the school consolidation process in the country, and unequal in their relative spending. The traditional for both primary and secondary schooling. During 2010, education funding mechanism based on inputs rather consolidation focused on the municipal level. The next than the number of students offers few incentives to step would be to close primary and secondary schools improve efficiency. In contrast, per capita financing that are less than 2 km apart if a supra-municipality view can effectively target poor and disadvantaged groups is used to look at the school network. The criteria would by adding weights for student characteristics to the then be to look at the infrastructure of schools that are funding formula. Per capita financing is a hallmark of less than 2 km apart and close those that are of lower countries with high-performing education systems and quality. To reduce the risk of dropouts, per capita financing is widely used in ECA countries (Figure 6.11). and transportation options should also be considered for schools that target students from disadvantaged families 6.23. Over the last few years Serbia has tried or ethnic minorities. This is particularly important because unsuccessfully to introduce per capita financing. historically students in some regions, like Central Serbia, The 2009 Framework Law on Education envisioned have had to travel long distances to get to school and gradual introduction of the new financing system, to transportation costs were not covered (UNICEF 2002). be completed by 2014/15. Introduction of per capita See Box 6.1 for Moldova experience. financing was supported by the WB Delivery of Improved Local Services (DILS) project. The project envisioned Box 6.1: School Network and Per Capita Financing in Moldova the design of the funding formula (national and local), its piloting in municipalities, and scale-up. The pilots were conceptualized as theoretical simulations of per The school network in Moldova had not been adjusting to capita financing allocations, since current law does not demographic shifts. While Moldova has 13 percent fewer schools allow transfer of resources per capita. This would allow than in 1991, as its d population declines it only needs to serve the MoES to calculate how much each municipality about half as many students now. As a result Moldova has a large would have received if the capitation formula were network of small schools—260 students on average compared to in place (World Bank 2012b). However, the national 437 in 1991—with the median school operating at 54 percent of and local financing formulas were not fully developed the capacity for which it was designed. Maintaining an oversized and were not piloted. In fact, by June of 2012 the 16 school network is inefficient and leads to misallocation of scarce municipalities that had enlisted for the pilots did not resources. receive the informal but necessary approval from the Ministry of Education and Technological Development The Government of Moldova has taken three measures to and withdrew. Although there were no pilots, thorough enhance efficiency, equity, and effectiveness in education: and substantial work was done on formulating the (1) It introduced per capita financing, as is common in OECD national formula. countries Moldova’s education financing is based on the number of students enrolled in a school rather than to school inputs. 6.24. There is an urgent need to reduce spending (2) School network consolidation was introduced. A feasibility imbalances between schools by introducing per capita assessment found that up to half of Moldova’s rural schools financing. Per student financing is a way to introduce may need to be reorganized to adjust to declining student a transparent system that could improve efficiency population. The assessment categorized schools as ones to close, and equity and generate savings for reallocation within ones to continue, and those that were uncertain. (3) Through the sector. The previous work done is a good base from better resource utilization a larger share of the budget was which to start if the government explores this type of made available for quality enhancement programs. As a result, efficiency mechanisms. between 2007–2015, the number of teachers was reduced by 15 percent and some were redeployed. Local authorities used some savings from school consolidation to raise teacher salaries and improve the quality of education. Source: Olefir 2013 66 III. Opportunities for improving the efficiency and equity of public spending in social sectors Figure 6.11: Per Capita Financing of Education in ECA Countries Piloting Not started Widely introduced No data Under discussion Russian Federation Estonia Latvia Lithuania Belarus Poland Czech Republic Ukraine Slovak Republic Kazakhstan Hungary Moldova Slovenia Croatia Romania Bosnia &Herz. Serbia Montenegro Kosovo Bulgaria Georgia Uzbekistan Kyrgyz Republic FYR Macedonia Albania Armenia Azerbaijan Turkmenistan Turkey Tajikistan Source: World Bank D. Conclusions and Recommendations 6.25. The budget envelope for education in Serbia listed reforms the government should put additional is slightly higher than that of many other European effort to overcome issues related to data collection and countries, but its outcomes are not as good. One goal dissemination. of educational financing should be to apply efficiency mechanisms that can create savings for either reinvesting 6.26. Increase ECD coverage, particularly for Roma in the system to support more efficient and effective children, using existing facilities and redeploying ways to improve learning or to support the overall fiscal teachers to the extent feasible; and as fiscal space adjustment. The following recommendations would opens, scale up investments in ECD programs. While improve and the efficiency of spending and the quality this recommendation may increase present costs on of education. In addition, in order to benefit quickly from ECD; it has one of the highest returns on investments. 67 III. Opportunities for improving the efficiency and equity of public spending in social sectors In addition, it helps levels the playing field and increase • Even out the inequalities in spending between schools opportunities for children of all backgrounds. by replacing input-based budgeting with more per • Reduce the number of primary and secondary teachers student financing; fully develop and pilot the funding by drafting a strategy to right-size the teaching formula; and rollout per student financing to a workforce and undertaking teacher rationalization, achieve transparent system for improving efficiency including redeployment. This recommendation is and equity. linked to the rightsizing of the school network and • Support student learning by regularly measuring has the potential to create savings that could be learning outcomes in each school; and linking schools either brought back to the budget or reallocated to resources (inputs) with learning scores (outputs) to investments in the sector. better inform policy decision-making and achieve • Improve the equity of teacher quality and distribution greater equity (through an EMIS system). While by reviewing current teacher deployment policies and implementation of assessments and an EMIS system realigning them to ensure that students in vulnerable require investments, these are relatively minor and underserved areas have access to highly compared to possible gains. professional teachers. 68 III. Opportunities for improving the efficiency and equity of public spending in social sectors CHAPTER 7. HEALTH A. Overview middle-income countries and the EU. This is followed by an analysis of health financing, public spending efficiency 7.1. While Serbia’s health outcomes compare well with and opportunities for further savings, and financial health those of countries at similar income levels, generous protection. It concludes with recommendations for short- social health insurance benefits combined with and medium-term reforms. inefficiencies in service delivery contribute to heavy spending on public health expenditure, service rationing, increased out-of-pocket payments, and hospital deficits. B. Health Outcomes The Health Insurance Fund (HIF) has been becoming more an active as a purchaser of health services, but financing 7.4. Health outcomes have improved in recent years, for both primary and hospital care is still primarily based and life expectancy and child health in Serbia compare on inputs, with few incentives for efficiency. The number well to those of countries at similar income levels. of medical staff and the number of hospitals per 100,000 Since the mid-1990s, for instance, Serbia has gained four persons are similar to comparable countries, but Serbian years of life expectancy at birth (to 75 in 2013). These health facilities employ too many nonmedical staff and gains were mostly accounted for by progress in treating have excess bed capacity. Social health insurance provides cardiovascular diseases (+1.7 years), neonatal disorders reasonably good financial protection for low income (+0.6 years) and neoplasms (+0.4 years). Infant mortality groups, but the poor are less likely to seek care for financial rates are lower than the regional average and converging reasons, and out-of-pocket health spending has been to EU levels. Improvements in infant and child mortality increasing across all income groups. were a major contributor to the improvements in life expectancy. 7.2. Despite recent progress, inefficiencies in public spending persist for hospital care, primary care, 7.5. As the population of Serbia is declining and aging, pharmaceutical and medical devices, and the share the burden of noncommunicable diseases is growing. of nonmedical staff is particularly high. In the hospital Since 1990, the Serbian population has been eroding sector, bed capacity and admission rates are relatively by an average of about -0.2 percent annually (Figure high, and it appears that acute inpatient care is inefficient, 7.1). By 2012 the percentage of the population aged 65 since both hospital spending and average length of stay and above had gone up from 10 to 14 percent, and is it are higher than regional and EU averages. As for primary projected to reach 25 percent by 2050. Due to its aging care, despite relatively high spending on prevention population, the disease burden in Serbia is now weighted services, there are gaps in coverage of key preventive toward noncommunicable diseases (NCDs) and such and primary health care services, and outpatient contact external causes as injuries. The share of NCDs in total rates are relatively high. Improvements in efficiency could disability-adjusted life years has gone up from 81 percent be stimulated by provider payment reforms that link in 1990 to 86 percent in 2010 (Figure 7. 2). The top three budgets allocated to outputs and quality of care. The vast causes of premature death in 2010 were heart disease majority of transfers to primary care centers are currently (19.9 percent), stroke (18.8 percent), and cancers (about based on line-item budgets, which give managers little 18 percent).42 flexibility or incentive to rationalize staffing and service provision, or to improve quality. Centralized procurement 7.6. The most important risk factors are diet, high of hospital drugs, price negotiation for off–patent drugs, blood pressure, smoking, household air pollution, and and improved drug price benchmarking could also help alcohol use. The prevalence of hypertension has been achieve savings beyond those already realized in recent rising since 2000. The incidence of daily smoking among years. Finally, while medical staff are within regional adults is 35.8 percent in 2013, compared to averages norms, the 25–30 percent share of nonmedical staff of 19 percent in the EU and 22 percent in the Western is twice as high as in OECD countries. The quality and Balkans.43 Risky behaviors and substance abuse are efficiency of health care could be vastly improved by a major concerns, especially among youth.44 shift to performance-based financing for both primary care and hospitals; further reforms to reduce costs 42 Almost 45 percent of total deaths are accounted for by cardiovascular diseases for pharmaceuticals and medical devices, including and neoplasms. Mortality from cardiovascular diseases is higher among men, while women suffer more from neoplasms. In 2013, 54 percent of the population ensuring that decisions to finance new drugs or expensive over 15 reported at least one NCD, with incidence increasing with age and rates procedures are based on international evidence; and higher among women (59 percent). reduction of nonmedical personnel. 43 However, tobacco excise tax rates are slowly increased. 44 According to a recent survey on substance use and gambling in Serbia, 13.3 percent of the respondents met the criteria for risky drinking and 6.2 percent 7.3. This chapter first review of the recent trends in for harmful or problematic drinking. Risky behavior in traffic is also common for drivers aged 18–34; more than 90 percent in that age group reported having health outcomes, coverage, and quality of health driven under the influence of alcohol and exceeding speed limits. Source: Institute services in Serbia as compared with other upper of Public Health of Serbia (2014) National Survey on Lifestyles of Citizens in Serbia. 69 III. Opportunities for improving the efficiency and equity of public spending in social sectors C. Coverage and Quality of Health Figure 7.1: Serbian Population Trends, 1990–2013 Services 7.7. Coverage of maternal and child health services Populaton, total Populaton ages 65 and above (% of total) is good overall but with gaps for the poor and Roma. Full child immunization is better for the poorest quintile 7.8 16 than the wealthiest, but lower for Roma (Figure 7.3). Percentage of the population aged 65+ 7.7 14 Although infant mortality rates are relatively low for 7.6 the population as a whole, at 13 deaths per 1,000 live 12 Total population (million) 7.5 births they are twice as high for Roma (Figure 7.4). 7.4 10 There is also a higher incidence of chronic malnutrition 7.3 8 (stunting) among Roma children, despite recent 7.2 improvements, which has serious implications for their 6 cognitive development and lifelong earning potential. 7.1 4 Low birthweight among children under 5 is also between 7 two to three times higher for the Roma. Government 6.9 2 programs such as the Roma health facilitators, who 6.8 0 have reached 140,000 Roma since the program began 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 in 2006, have helped improve their access to health Source: WDI. services, and the MOH has begun to finance these positions through the budget. However, the percentage of women aged 20–24 who have had at least one live birth before age 18 is 1 percent for Serbia and 38 percent Figure 7.2: Disease Burdens, Serbia, 1990 – 2010 for Roma settlements; this is likely to have implications (Percent of Disability-Adjusted Life Years) for both the education and the labor force participation of Roma women. Serbia’s total fertility rate is 1.6 births per women but 3.1 for the Roma (MICS 2014). NCD (right) Communicable (left) Injuries (left) Figure 7.3: Child Immunization and Antenatal Care by 12 88 Welfare Quintile 87 (Percent) 10 86 8 85 84 6 83 Children Fully Immunized 4+ ANC visits 82 4 100% 81 90% 2 80 79 80% 0 78 70% 1990 1995 2000 2005 2010 60% 50% Source: Institute for Health Metrics and Evaluation and Serbia Statistical Yearbooks. 40% 30% 20% 10% 0% Roma Poorest Second Middle Fourth Richest Source: MICS 2014. Note: Percent of children age 24-35 months who received all recom- mended vaccinations; percent of expectant mothers with 4 or more antenatal visits. 70 III. Opportunities for improving the efficiency and equity of public spending in social sectors have hypertension or are at risk, only a third of all adults Figure 7.4: Nutrition Outcomes have been diagnosed. Of these, in 2013 about 10 percent (Percent) of diagnosed cases were still untreated. Serbia Serbia Roma Settlements 20 Figure 7.6: Age-standardized Prevalence of Chronic 18 Conditions, Serbia and Comparators (0-64, per 100,000 citizens) 16 Serbia Western Balkans EU 14 120 12 10 100 8 80 6 60 4 2 40 0 20 Stunting Low birthweight Source: MICS 2014. 0 Note: Stunted is defined as less than two standard deviations of Malignant Diseases of Ischaemic cerebrovascular average height for age. neoplasms circulatory system heart disease diseases 7.8. Serbia has higher outpatient contacts per capita Source: WHO Health for All Database. than the EU, but there are gaps in the coverage and quality of primary care and preventive services. Though decreasing, outpatient contacts per year are higher Figure 7.7: Preventive Examinations (Percentage of population with a preventive examination in the past 5 than the EU average (Figure 7.5). Despite more frequent years) contacts with doctors, age-standardized health outcomes for the main NCDs are below EU averages (Figure 7.6). While preventive examinations have increased since 2006 2006 2013 (Figure 7.7), preventive screening for breast cancer, cervical 90 cancer, and colorectal cancer is still below the EU average (Figure 7.8). Diagnosis and treatment of hypertension is 85 improving but not yet up to par. While nearly half of adults 80 Figure 7.5: Outpatient Contacts per Capita per Year 75 70 Serbia Westerns Balkans EU 10.0 65 9.5 Blood Blood Blood 9.0 pressure sugar cholesterol 8.5 Source: National Health Survey 2006, 2013. 8.0 7.5 7.9. Hospital care increased between 2006 and 2013. The rate of hospitalization (hospital discharges) in 7.0 Serbia (179 per 1,000) is higher than the averages in the 6.5 OECD (156 per 1,000) and the Western Balkans (117 per 6.0 1,000). On average, in the 12 months period preceding 5.5 the survey, 7.8 percent of respondents aged 15 or older declared having been treated in hospital, compared to 5.0 2005 2006 2007 2008 2009 2010 2011 6.5 percent in 2006. This rate of hospitalization cannot be explained by the aging profile of the population Source: WHO Health for All Database. alone; other factors are unnecessary hospital admissions, 71 III. Opportunities for improving the efficiency and equity of public spending in social sectors 7.12. Total public and private health spending at 10.5 Figure 7.8: Preventive Screening Rates percent of GDP is high, and has been going up faster than the regional average for the past decade. In 2013, total Serbia EU health spending in Serbia represented about 10.6 percent of GDP, compared to 8.6 percent for EU countries, or 7.1 percent 70 for the Western Balkan countries (Figure 7.9). In absolute 60 terms (Figure 7.10), total average health spending per capita (US$990) is higher than the average in the Western Balkans 50 (US$790), but lower than the EU average (US$2,970). 40 30 Figure 7.9: Total Public and Private Health Spending, 1995- 2012, Serbia and Comparators 20 (Percentage of GDP) 10 UMIC West, Balkans EU-28 Serbia 0 Mammography Cervical cancer Colorectal cancer 11 Total health expendetures (%GDP) screening screening screening 10 Source: National Health Survey 2013 and Health at a Glance 2014. 9 shortcomings in primary care, excessive use of acute care 8 beds for long-term care, and inadequate use of day surgeries. 7 7.10. Waitlists for elective procedures are both common and significantly longer than in OECD countries. According 6 to HIF data, in 2013 nearly half (46.6 percent) of patients who underwent an intervention in Serbia had to go on a waitlist, 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 and only a third of waitlisted patients (36 percent) actually received treatment. Average waiting time in 2013 was 450 days for a hip replacement, compared to 101 days on Figure 7.10: Total Public and Private Health Spending, 2005- average in OECD countries, 707 days for a knee replacement 13, Serbia and Comparators, (123 days in the OECD), and 260 days for cataract surgery (2005 USD per capita) (75 days in the OECD). Clearly, there is significant rationing of care despite high expenditures and a generous benefit package. Waiting lists encourage bribery, which is particularly UMIC West, Balkans EU-28 Serbia Total health expendetures (2005 USD per capital) prevalent in hospitals. Shortcomings in quality of care, waiting lists, and unofficial payments all contribute to dissatisfaction 3000 with public health services. 2500 D. Health Financing and Expenditure: Trends 2000 and Composition 1500 7.11. Health care in Serbia is provided both through public 1000 and private sector. Government health spending is mainly 500 channeled through the HIF, which represented more than 90 percent of government health spending in 2013. The Law on 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Health Insurance governs both compulsory and voluntary health insurance. The HIF is in charge of managing and Source: World Development Indicators and WHO Global Health providing compulsory health insurance; voluntary insurance Expenditure Database. can be provided through private insurance. Other government health spending is mostly channeled through the budgets of 45 More than half of the adult population considers that corrupt practices occur subnational governments (7.5 percent in 2013). often or very often in public hospitals, with doctors and nurses among the top three categories of public official bribe recipients. 46 In 2013, slightly more than half of the respondents in Serbia declared being satisfied with public health services. 72 III. Opportunities for improving the efficiency and equity of public spending in social sectors 7.13. Serbia’s public health spending is significantly 7.14. Despite Serbia’s high public spending, private out- higher than that comparator countries, much of of-pocket payments (OOP) for health care have also it driven by spending increases in the 2000s. Total risen significantly in the past decade. OOP increased government health spending went up from 5.2 percent faster than government health spending between 2002 of GDP in 2000 to 6.4 percent in 2013. This is higher and 2012. While OOP represented 2 percent of GDP in than the average for upper-middle-income countries 2002, the share rose to 4 percent in 2013 (Figure 7.11). (3.9 percent) and slightly higher than the EU average Meanwhile, the government health spending-to-GDP (6.3 percent). In the Western Balkans, only the Bosnia ratio held steady at about 6.3 percent. The increase in the and Herzegovina government spends more on health. relative importance of OOP as a share of GDP contrasts In 2009–13, Serbia’s per capita government health with the average trend for the Western Balkans and to spending was three times higher than the average for the levels observed in upper-middle-income-countries: countries with similar GDPs (US$715 against US$298 typically higher government health spending and better per capita/year). insurance coverage reduces OOP spending on health (World Bank 2013). Figure 7.11: Private Out-of-pocket Health Payments, 1995 – 2012 (Percent of Total Health Expenditures) UMIC Western Balkans EU-28 Serbia 50 Out of pocket payment (%THE) 40 30 20 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: WDI and WHO Global Health Expenditure database. Figure 7.12: Public Health Spending, 1995 – 2012 (Percent of GDP) UMIC Western Balkans EU-28 Serbia 7 Public health expendeture (%GDP) 6 5 4 3 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: WDI and WHO Global Health Expenditure database. 73 III. Opportunities for improving the efficiency and equity of public spending in social sectors Public Health Revenues and Expenditures 2008–14 (Table 1). Despite continued cost pressures, expenditures in 2014 were only slightly higher than 7.15. HIF’s revenues and expenditures both fell in in 2013 in nominal terms, due in part to the across- real terms between 2008 and 2014. At 2010 constant the-board wage cuts for all civil servants (see chapter prices, HIF revenues decreased on average by -3.2 3) and to cost savings achieved on pharmaceutical percent a year, and expenditures by -2.7 percent over procurement (see below). Table 7.1: HIF Revenue and Expenditures, 2008–14 2008 2009 2010 2011 2012 2013 2014 Annual Change (%) Revenue (million RSD, nominal) 170,759 178,980 182,476 194,534 209,875 220,631 219,052 4.2% Expenditure (million RSD, nominal) 165,624 177,311 183,025 193,295 205,836 211,894 218,827 4.8% CPI (2010=1) 0.87 0.94 1.00 1.11 1.19 1.28 1.36 7.7% Revenues (million RSD, real) 195,959 189,973 182,476 175,039 175,945 171,748 161,064 -3.2% Expenditure (million RSD, real) 190,067 188,202 183,025 173,925 172,559 164,946 160,899 -2.7% Source: HIF budget and WDI. Figure 7.13: Insurance Pool Composition Figure 7.14: Insurance Revenue Composition 2% 0% 5% 4% 20% 41% 24% 8% 66% 1% 28% 1% Employees Other Employees Self-employed Persons receiving Self-employed Persons receiving Insured in accordance with fees in case of Insured in accordance with fees in case of Article 22 of the Law on unemployment Article 22 of the Law on unemployment Health Insurance Pensioners Health Insurance Pensioners Other Source: HIF. Source: HIF. 7.16. A minority of the working population finances the envelope. In 2013, about 6.9 million persons were majority of HIF revenue. Compulsory health insurance insured, 40 percent of whom were employees, 28 percent in Serbia follows a model of obligatory social insurance, pensioners, and 20 percent children, pregnant women, where current revenues are generated through employer or other vulnerable groups (Figure 7.13). The government and employee contributions. Payroll tax contributions covers the cost for vulnerable groups (retired people, represent about two-thirds of HIF revenues; transfers children, disabled, unemployed, etc.) per article 22 of the from the government constitute most of the remaining Law on Health Insurance. 74 III. Opportunities for improving the efficiency and equity of public spending in social sectors 7.17. The contribution rate for compulsory health insurance has gradually declined from 20.2 percent in Figure 7.16: Salaries 1994–96 to 16.2 percent in 1996–2001, 11.9 percent in (as % of Total Health Expenditures) 2001–04, and 12.3 percent in 2004, and in 2014 reached 10.3 percent. Reductions in contribution rates need to Western Balkans EU Serbia be accompanied by measures to better enforce revenue 65 collection. Employers facing financial difficulties do not always pay their compulsory contributions to the HIF, and 60 the economic crisis and the difficulties faced by SOEs have exacerbated the situation. Uncollected contributions have 55 been ramping up in recent years; in 2013 they represented up to 40 percent of HIF revenues. Uncollected revenues are 50 also driven by legal decisions on debt dormancy or write-offs for compulsory health insurance contributions, inefficient 45 debt collection from health contribution payers by the tax administration, and lower effective budget transfers.47 The 40 HIF was able to keep the budget balance mostly positive between 2008 and 2012 but by 2012 it had unpaid liabilities 35 2005 2006 2007 2008 2009 2010 2011 to health facilities equivalent to 6.6 percent of total HIF revenues. The HIF was able to resolve these liabilities, partly Source: HIF and WHO-Health for All database. through an agreement with the government in September 2012 to convert RSD 13 billion of liabilities into public debt. 7.19. Most of the government health budget is directed 7.18. Wages and salaries represent about 55 percent to hospitals (56 percent in 2013, 3.5 percent of GDP). of total health expenditure (6 percent of GDP); goods Although the share of total health spending allocated and services about 40 percent (4.2 percent of GDP); to hospitals has gone down since 2003, it is still slightly and capital spending less than 5 percent (0.4 percent of higher than the average in OECD countries (Figure 7.17). GDP). Most of the goods and services budget goes to drugs As a percentage of GDP, however (Figure 7.18), Serbia’s (25 percent of public health expenditure). Compared to EU spending on hospitals (3.5 percent of GDP) is only slightly countries, Serbia spends about 2 more percentage points of higher than in OECD countries (3.2 percent). Curative GDP on salaries (Figure 7.16); capital outlays, which used to and rehabilitative services account for about half of be lower than in other countries in the region and the EU, total health expenditure (4.5 percent of GDP), similar to are catching up with the EU level as a percentage of GDP the OECD average (Figure 7.19). Serbia is also spending (Figure 7.15). relatively more than the OECD average on prevention and public health services (Figure 7.20). Figure 7.15: Capital Outlays (as % of Total Health Expenditures) Figure 7.17: Spending on Hospitals Western Balkans EU Serbia (Percent of Total Health Spending) 10 OECD Serbia 9 55 8 7 50 6 5 45 4 3 40 2 1 35 0 2005 2006 2007 2008 2009 2010 2011 30 2012 2013 2004 2005 2006 2007 2008 2009 2010 2011 2003 47 Under Article 22 of the Law on Health Insurance, the monthly contribution base Source: HIF and WHO-Health for All database. rate is set at 15 percent of average monthly salary in Serbia, but the actual rate on which contributions are calculated is lower. 75 3.1 2.5 3.3 3.5 2.9 3.7 2.7 50 20 60 40 30 70 80 0 10 5 2 6 4 3 7 8 0 1 Serbia Israel 2003 New Zealand United States 2004 Canada Australia (Percent of GDP) United Kingdom 2005 Finland Japan Hungary 2006 Sweden Netherlands OECD Iceland 2007 Slovenia Greece 2008 (Percent of Total Health Spending) (Percent of Total Health Spending) Sweden Figure 7.18: Spending on Hospitals Spain Figure 7.20: Spending on Prevention United States 2009 Korea Germany Figure 7.19: Spending on Curative Services Serbia New Zealand 2010 Mexico Switzerland Slovak Republic 2011 Portugal Source: OECD Statistics and Serbia National Health Accounts (2014). Source: OECD Statistics and Serbia National Health Accounts (2014). Japan Austria 2012 Estonia Estonia 2013 Denmark Finland Switzerland Czech Republic Poland France Norway Luxembourg France Slovenia Korea Denmark Poland Portugal Germany Czech Republic Serbia Australia Netherlands Spain Turkey Luxembourg Hungary Austria Canada Greece Belgium Belgium Slovak Republic Iceland Norway Israel Mexico Italy Chile III. Opportunities for improving the efficiency and equity of public spending in social sectors 76 III. Opportunities for improving the efficiency and equity of public spending in social sectors 7.20. Spending on pharmaceuticals represented about also went up as a proportion to GDP from 2 percent in 25 percent of total public health spending in 2013. The 2005 to 3.3 percent in 2013 while in the region and the share of total pharmaceutical spending (public and private) EU it held steady at about 1.8 percent (Figure 7.22). Serbia in total health spending (Figure 7.21) is also significantly spends about twice as much as a share of public health higher in Serbia (31 percent) than the regional average (18.4 spending than the EU average (12.3 percent48 ). Most of percent for the Western Balkans) or the EU average (20.4 the spending on pharmaceuticals is driven by private percent). Moreover, the pharmaceuticals share increased expenditures. Such high private OOP payments on drugs between 2005 and 2011 when it was decreasing in both despite high government spending indicates gaps and the region and the EU. Total spending on pharmaceuticals inefficiencies in public sector provision. Figure 7.21: Pharmaceutical Spending Figure 7.22: Pharmaceutical Spending (Percent of Total Health Spending) (Percent of GDP) Western Balkans Serbia EU Western Balkans Serbia EU 33 3.5 29 3.0 27 2.5 25 2.0 23 1.5 21 1.0 19 17 0.5 15 0.0 2012 2013 2012 2013 2005 2006 2007 2008 2009 2010 2011 2005 2006 2007 2008 2009 2010 2011 Source: WHO Health for All Database and Serbia National Health Accounts 2014. E. Efficiency of Public Health Spending 7.21. While life expectancy at birth49 is comparable to data, annual public health spending in Serbia is about countries of similar income level, Serbia underperforms US$765 per capita (Figure 7.23), which on average should relative to what it spends on health. Based on 2012 correspond to two more years than Serbia’s current life Figure 7.23: Healthy Life Expectancy and Public Health Spending, 2012 75 Singapure Chile Cyprus Korea Rep. 70 Bosnia and Hercegovina Czech Republic Luxemburg China Columbia Qatar Israel Healthy life expectancy at birth (WHO) Mexico Tunisia Hungary 65 Serbia Azerbaijan 60 Indonesia Algeria Russian Federation Philipines Mongolia Kazahstan Syrian Arab Republic 55 India Bhutan Pakistan Turkmenistan 50 55 148 403 764 1100 2980 8100 Public health expenditure per capita ( 2005 USD, Log scale) Source: WDI; WHO 48 OECD 2014 Health at a glance: Europe 2014, and WHO-GHED. 49 Healthy life expectancy at birth (HALE) is a form of health expectancy that applies disability weights to health states to compute the equivalent number of years of life expected to be lived in full health. 77 III. Opportunities for improving the efficiency and equity of public spending in social sectors expectancy (65 years). Countries with level of healthy life expectancy (HALE) around 65 years old spend on average Figure 7.25: Hospital Admissions, 2005–11 US$410 per capita—46 percent less than Serbia, suggesting Inpatient care discharges (per 100) that there is scope for making public spending more efficient. Western Balkans Serbia EU 7.22. Despite some progress in recent years, inefficiencies 20 persist in public spending for hospital care, primary care, pharmaceutical and medical devices, and human 18 resources (particularly excess nonmedical staff). These will be examined in turn. 16 7.23. In the hospitals sector, bed capacity and 14 admission rates are relatively high, and there is scope to make acute inpatient care more efficient. The density 12 of hospitals is aligned with the regional average in the Western Balkans, but the number of beds per 100,000 is 10 much higher; in 2011 it was also high compared to the EU (Figure 7.24). Inpatient admissions have been increasing 8 and met the EU average in 2011 but are much higher than 2005 2006 2007 2008 2009 2010 2011 the regional average (Figure 7.25). Though average length of acute care stay has been decreasing it is higher than both the EU and the regional average (Figure 7.26). Finally, Source: WHO Health for All Database and Serbia National Health Ac- counts 2014. while bed density is high, the occupancy rate has dropped from 80–85 percent in 2005–2006 to 65 percent in 2011 (Figure 7.27). The best performing OECD countries have achieved good health outcomes with lower bed capacity and admission rates through reforms to reinforce primary and preventive care and rationalize provision of acute and long-term care services. Figure 7.24: Bed Density, 2005–11 Figure 7.26: Average Acute Care Length of Stay, 2005–11 Number of hospitals beds (per 100,000) Western Balkans Serbia EU Western Balkans Serbia EU 650 9.5 9.0 600 8.5 550 8.0 500 7.5 450 7.0 6.5 400 6.0 350 5.5 300 5.0 2005 2006 2007 2008 2009 2010 2011 2005 2006 2007 2008 2009 2010 2011 Source: WHO Health for All Database and Serbia National Health Ac- Source: WHO Health for All Database. counts 2014. 78 III. Opportunities for improving the efficiency and equity of public spending in social sectors on the policy agenda in Serbia for over a decade, with little Figure 7.27: Bed Occupancy Rate for Acute Care, 2005–11 or no progress. The government successfully introduced modest performance-based payments for primary care “chosen” doctors, in which their salary varied by 4 percent Western Balkans Serbia EU based on progress toward meeting service volume and 95 coverage indicators. While this was a major reform in terms of introducing performance pay for public servants, Serbia 90 still does not have a true capitation payment system for 85 primary care based on the principle of “the money follows 80 the patient.” The vast majority of transfers to primary care centers are based on line-item budgets, which gives 75 managers little flexibility or incentive to rationalize staffing 70 and service provision or improve quality. Similarly, while 65 the MOH and HIF have moved to introduce output-based payments for acute care at hospitals, based on DRGs, the 60 payment reforms have not been implemented, so hospitals 55 are still paid on line-item budgets. 50 7.27. Payment reforms need to be accompanied by 2005 2006 2007 2008 2009 2010 2011 reforms to enhance the autonomy and accountability Source: WHO Health for All Database. of health facilities, rationalize the hospital network and service provision, and professionalize managers. Recruitment of managers and staff has been subject to 7.24. There is considerable variation in primary care too much political influence, national and local; good performance and efficiency. A 200950 study on the managers who implement efficiency reforms (e.g., reduce efficiency of Dom Zdravlja (DZ) showed that even staff or utility costs) are penalized by having their budgets for primary care centers with similar levels of staff, cut. Managers currently have little authority to hire, equipment, and space, there is substantial heterogeneity reward, discipline, or even reallocate staff within their own in output produced after controlling for catchment area facilities, and little flexibility to reallocate funds among characteristics. Though outpatient contact rates are line items. Payment reforms need to be accompanied by relatively high, that is not always true for preventive and measures to increase their autonomy and accountability, primary health care services, despite the relatively high particularly for hospitals, and to train and recruit a cadre spending on prevention services). Efficiency in primary of professional managers. Global experience has shown, care could be stimulated by introducing provider payment however, that alone a shift to output-based payments is reforms to link budgets allocated to outputs and quality usually not adequate to rationalize staffing, hospital beds, of care. and improve service efficiency (e.g., increased use of day surgeries, or shifting excess bed capacity from acute to 7.25. Coverage of medical staff is within regional long-term care). Supply side measures led by the MOH in norms, but the share of nonmedical staff is not. coordination with HIF will be needed to support reforms. Physician density is higher than the regional average of 212 per 100,000 persons, but still lower than EU averages. 7.28. In the past two years, the government has saved Coverage for nurses (530 per 100,000), dentists (29 per over €32.6 million through centralized procurement of 100,000) and pharmacists (30 per 100,000) is similar hospital drugs, price negotiation for off–patent drugs, to other countries in the Western Balkans. Nonmedical and better benchmarking of drug prices. HIF had been staff, however, represent 25 to 30 percent of the health paying hospitals a lump-sum based on the reference price workforce—twice as high as can be seen in OECD of drugs consumed, but hospitals were purchasing directly countries. The share of nonmedical staff is particularly from wholesalers. Serbia has over 300 drug wholesalers, high in specialized hospitals (42 percent). compared to no more than 10 in more efficient markets, and these wholesalers were competing for business by 7.26. The provider payment system for both primary and offering hospitals “rebates” of up to 30 percent of the hospital care is input-based, with few if any incentives for drugs purchased. In 2013, the HIF piloted centralized quality or efficiency. Provider payment reforms have been procurement with framework contracts for hospital drugs, which eliminated rebates and resulted in cost savings 50 World Bank (2009) Serbia - Baseline Survey on Cost and Efficiency in Primary of over €25 million. Further savings were achieved by Health Care Centers before Provider Payment Reforms. Washington DC, World negotiating prices for off-patent medicines and improved Bank. drug price benchmarking. 79 III. Opportunities for improving the efficiency and equity of public spending in social sectors 7.29. HIF pharmaceutical expenditures are still high by 2013, with 336 health institutions owing suppliers RSD due to inadequate controls on volumes of outpatient 24,970 million. Reports in the local press have highlighted prescription drugs and increased use in hospitals of cases of some hospitals having their bank accounts high-cost, patented medicines. The pharmaceutical blocked due to arrears to supplier, which underscores market is dominated by branded generic products and the the urgency of the situation. Despite earlier efforts to reimbursement drug list is based on drug brand names. strengthen arrears monitoring systems, there is still no Since prices are the same for all drugs with the same adequate system for tracking debts and arrear payments international non-proprietary name (INN), manufacturers by indirect budget holders, such as health facilities. are competing on volume. On the other hand, the share of new, high-cost patented medicines on the drug list is growing. Due to the high prices and increasing volume of these products, total spending on drugs has shot up F. Financial Protection (Table 7.2). Moreover, the average annual number of prescription drugs per insured person in Serbia was 12 7.32. Despite the relatively high coverage of social to 14 in 2011–13 (HIF)—about twice the average in EU insurance, there are still financial barriers to accessing countries. This suggests serious inefficiencies driven by health care services, especially among the most over-prescription, especially of antibiotics. poor segments of the population. The proportion of household reporting unmet medical care need for 7.30. Social health insurance benefits are relatively financial reasons is nine times higher than the EU generous, and systems are not yet in place to assess average (Figure 7.28). According to the 2013 SILC survey, the cost-effectiveness of decisions to expand benefits or reimburse new expensive drugs or procedures. The more than 80 percent of respondents declared that they benefit package covers a wide range of services and owned a valid insurance card. However, more than 10 treatments, but there are few mechanisms to ensure percent of the poorest had forgone a visit to a doctor that any new services or medicines it covers are cost- or a dentist that they needed (SILC 2013). Moreover, effective or affordable within budget constraints. The the poorest households are also less likely to spend OOP use of health technology assessments (HTA) to assess amounts, which also suggests that forgone health care clinical effectiveness and affordability is common in for financial reasons is more likely among the poorest upper-income countries in the EU and could be adapted households. for Serbia. 7.33. As OOPs for health have risen over time, so too 7.31. Hospitals are accumulating payment arrears has the incidence of OOP causing poverty. Since 2008, to suppliers. The significant cost reductions on the incidence of impoverishing payments has been pharmaceuticals through central procurement has led more than 5 percent at a US$4 per capita/day poverty to savings at the center but contributed to financing reference (ECAPOV data based on HBS 2008 to 2010). problems for hospitals. Many were using their “rebates” from pharmaceutical purchases (up to 30 percent) to Without OOP, household consumption would have been finance local spending, including hiring non-contractual higher, and the poverty headcount would have been staff who were not subject to central monitoring of lower by 16 percent (Figure 7.29). Based on the 2010 staffing controls. According to HIF data, in 2011 the total HBS, as US$4/day the poverty rate went up from 6.9 to payables to suppliers of 338 health institutions was RSD 8 percent because of OOPs. 36,839 million. The arrears had decreased only slightly Table 7.2: Spending on the top 5 Patented Hospital Drugs, 2013 (RSD, thousands) 2011 2012 2013 Y/Y change Y/Y change INN BRAND Change 2011-13 (RSD, 000) (RSD, 000) (RSD, 000) 2011-12 2012-13 Trastuzumab HERCEPTIN 1,088,245 1,321,476 1,382,100 21.4% 4.6% 27.0% Rituximab MABTHERA 383,964 455,426 476,753 18.6% 4.7% 24.2% Capecitabine XELODA 109,539 160,057 183,150 46.1% 14.4% 67.2% Cetuximab ERBITUX 131,530 138,863 182,032 5.6% 31.1% 38.4% Infliximab REMICADE 105,631 100,432 168,423 -4.9% 67.7% 59.4% Source: HIF 80 III. Opportunities for improving the efficiency and equity of public spending in social sectors months, mostly due to medicines. Payments on drugs Figure 7.28: Unmet Health Need for Financial Reasons represent more than half of total personal payments. (Percent) This suggests a need to target policies to protect the poor and low-income elderly from health expenses, e.g., by 20 reducing or waiving copayments for low-cost medicines to treat common chronic diseases. 18 16 14 Figure 7.30: Catastrophic Payments, 2003–10 12 40% 25% 10% 10 5 8 Incidence of catastrophic payment (%population) 6 4 4 2 3 0 ia ia nia e ria ary 28 ny ia ark ec 2 rb tv an ma lga ma EU nm ng e La Se hu Gr Bu r Hu Ro De Ge Lit Source: National Health Survey 2013. 1 0 Figure 7.29: Relative Increase in Poverty Due to Out-of- 2004 2005 2006 2007 2008 2009 2010 2003 Pocket Payments Source: ECAPOV data based on HBS 2008 to 2010. % incrase in poverty headcount because of OPP 30 Figure 7.31: Catastrophic Payments by Quintile, 2008–10 25 (PL=$4/pc/day) 20 Incidence of catastrophic payments (OOP > 25% of total budget) 15 2008 2009 2010 10 3 5 2.5 0 2 2004 2005 2006 2007 2008 2009 2010 2003 1.5 Source: ECAPOV data based on HBS 2008 to 2010. 1 7.34. The incidence of catastrophic payments is higher 0.5 on average among poor and elderly households. Less 0 than 5 percent of households spend 10 percent or more Q1 Q2 Q3 Q4 Q5 of their budget on health, and less than 1 percent spend Source: ECAPOV data based on HBS 2003 to 2010 25 percent or more (Figure 7.30). In 2010 (Figure 7.31), the incidence of catastrophic payments was still three times as high among the poorest 20 percent (the difference was fivefold in 2008 after the crisis). Not surprisingly, elderly citizens were more exposed to catastrophic payments, and nearly 25 percent of single persons over 65 had had to deal with catastrophic payments in the previous 81 III. Opportunities for improving the efficiency and equity of public spending in social sectors G. Conclusions and Recommendations surgeries; strengthen adherence to clinical guidelines and protocols; and more carefully monitor the quality 7.35. Given the current constrained fiscal environment, of care and outcomes at all levels of the health system. in the short term government should focus on • Build up the quality and coverage of primary and implementing reforms that improve efficiency and preventive care, through, e.g., better screening and fiscal sustainability without compromising access treatment of chronic diseases and promoting healthy to health care services or their quality. Health behaviors, for a healthier population and reduced spending is already high as a percentage of GDP and costs over the long term. the government needs to close a large fiscal deficit. To design appropriate reforms in the health sector, the government needs better data management and improved oversight of use of funds within the network of health centers. HIF reports at aggregate level only, which prevents from more meaningful analysis. Priority measures that could contribute to improved efficiency gains over the short and long term are: Short to Medium Term • Reduce excess noncontracted and nonmedical staff, and urgently address payment arrears and financing imbalances for hospitals. Identify the numbers and costs of noncontracted staff, and identify scope for savings by reducing unnecessary nonmedical staff. Preliminary estimates suggest that if Serbia were to reduce non-medical staff to levels comparable with OECD averages savings could be up to 0.2 percent of GDP. Establish a transparent and consultative process for this. • Continue to work to achieve cost savings on pharmaceutical and medical devices, while building up monitoring of prescription and dispensing practices. For outpatient prescription drugs, consider further reforms to reimbursement policies (e.g., flat dispensing fees or a regressive margin for medicines) and improve monitoring of prescription and dispensing practices to control volume. For higher-cost patented drugs, introduce such negotiation strategies as price- volume agreements to bring down costs. Medium to Long term • Implement provider payment reforms for primary care and hospitals, complemented by broader public administration reforms to improve the quality and accountability for service provision. Shift to performance-based financing for primary and hospital care (adjusted capitation financing for primary care; case payments based on DRGs for hospitals); right-size hospital networks and rationalize service provision based on an updated hospital master plan; and increase the accountability and autonomy of health facilities and managers. • Lay the groundwork for addressing the challenges of an aging population: rationalize hospital networks to convert excess hospital beds to long-term or social care; increase use of ambulatory care and day 82 III. Opportunities for improving the efficiency and equity of public spending in social sectors CHAPTER 8. SOCIAL ASSISTANCE 8.1. Serbia operates a large set of social assistance A. Social Protection in Serbia programs with multiple social objectives of poverty reduction; population growth (pronatality), and/or 8.3. Social protection in Serbia comprises numerous assistance to other vulnerable groups such as veterans programs, from pensions and social assistance to and the disabled. It has only one explicit anti-poverty labor market policies. Over time total outlays on social program—the means-tested financial social assistance protection (SP) have risen, reaching about 16 percent program (FSA), previously called the Material Support of GDP in 2013 (Figure 8.1)—among the highest for for Low Income Households (MOP) program. The FSA ECA and only slightly lower than the EU average of 19 is well-targeted and is the most cost-effective program, percent. Like most other ECA countries, the majority with 74 percent of all benefits reaching the poorest of SP outlays go to pensions, which represented 13.3 quintile, but its coverage is still low despite recent percent of Serbia’s GDP in 2013 (Figure 8.2). Social efforts to expand it. Other categorical and non-means- assistance represents about 2 percent of GDP and 12.5 tested programs are the caregiver’s allowance, wage percent of total SP spending; labor market policies, compensation during maternity leave, the birth grant active and passive, amount for less than 1 percent of allowance, benefits for foster care, waiver of school fees GDP. for vulnerable children, and a plethora of benefits for war veterans and families of fallen soldiers. Although 8.4. Social protection accounts for over a third of the benefits are relatively generous, the impact of total budget spending in Serbia. Serbia is among only categorical programs on poverty is negligible. Among a few ECA countries that spend more than 30 percent measures that could be considered to make Serbia’s of total spending on social protection; the others are social assistance more efficient and more equitable Ukraine, Romania, Montenegro, Bulgaria, Croatia, would be scaling back the wage compensation program and Lithuania (ECA Social Protection Expenditure and and using the freed-up resources to expand FSA, further Evaluation Database). The problems of the pension means-testing some of the categorical programs, and system and recommendations for improving it can be redesigning the FSA to introduce in-work benefits and found in Chapter 4. This chapter is concerned with how remove disincentives for work. social assistance programs can be made more effective. 8.2. This chapter begins with a broad review of the social objectives and the amount of public spending in Serbia’s principal social assistance programs. This is followed by an assessment of the effectiveness of both the means-tested poverty alleviation and non-means- tested categorical programs. The chapter concludes with recommendations for improving the efficiency and equity of current public spending on social assistance. Figure 8.1: Total Social Protection Spending in Serbia, 2005–13 (Percent of GDP) 20.0 15.0 Social Insurance 10.0 Labor Market Social Assistance 5.0 0.0 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Europe and Central Asia Social Protection Expenditure and Evaluation Database, World Bank. Note: Spending on war veterans benefits was not available after 2011, and for subsequent years projections are based on past growth rates. 83 III. Opportunities for improving the efficiency and equity of public spending in social sectors Figure 8.2: Social Protection Spending, years noted (Percent of GDP) Tajikistan 2011 Kosovo 2013 Kazakhstan 2012 Azerbaijan 2011 Armenia 2012 Georgia 2013 Albania 2013 BIH 2009 Turkey 2013 FYR Macedonia 2011 Social Insurance Latvia 2012 Poland 2011 Labor Market Kyrgyz Republic 2011 Belarus 2012 Social Assistance Moldova 2010 Bulgaria 2013 Estonia 2011 Croatia 2012 Lithuania 2009 Montenegro 2013 Serbia 2013 Romania 2010 Ukraine 2011 0% 5% 10% 15% 20% Source: ECA Social Protection Database, World Bank. 8.5. Serbia’s numerous social assistance programs have a variety of social objectives. Broadly, their objectives can be divided into three groups: (1) poverty reduction, (2) population growth (pronatality), and (3) assistance to such vulnerable groups as veterans and the disabled. Serbia has only one explicit anti-poverty program—means-tested financial social assistance (FSA), previously called Material Support for Low Income Households (MOP). The other means-tested program is the pro-natalist child allowance program. Other programs are the caregiver’s allowance, wage compensation during maternity leave, the birth grant allowance, benefits for foster care, waiver of school fees for vulnerable children, and a plethora of benefits for war veterans and families of fallen soldiers. Other programs are categorical, and include the caregiver's allowance (non-contributory disability benefit); wage compensation during maternity leave (non-contributory); parental allowance (birth grant); benefit for foster care; school fee-waiver for vulnerable children; and a plethora of benefits for war veterans and for the families of fallen soldiers (See Box 8.1 for details of the main SA programs.) These programs are categorical and not explicitly means- tested, but may have positive distributional impacts due to the characteristics of their recipients. Municipalities also provide one-time assistance to vulnerable families. Finally, Serbia also operates social care services, such as day care programs and temporary shelter assistance for refugees as well as housing and heating allowances. 84 III. Opportunities for improving the efficiency and equity of public spending in social sectors Box 8.1: Serbia’s Social Assistance Programs Targeted (means-tested) Noncontributory Programs: Financial Social Assistance (FSA), Serbia’s last resort social assistance program previously known as MOP (Materijalno obezbedenje porodice or Material Family Support), provides income support for families or households that meet certain eligibility criteria related to incomes, asset ownership, and employment status of able-bodied members. The amount of the benefit is the difference between an administratively preset income threshold for a unit of assistance of specific size (from one to six members), using explicit equivalence scales, with a threshold level of RSD 7,843, and the actual income of the unit needing assistance (household or family). Eligibility thresholds and maximum benefit levels are updated twice a year to track growth in consumer prices. The program is financed by the central budget and designed by the Ministry of Labor, Employment and Social Policy (MELSP); municipal Centers for Social Work (CSWs) administer eligibility verification, certification, and payments; the CSWs are deconcentrated bodies of MELSP. Eligibility is verified each year and whenever circumstances change. The law also introduced the concept of activating those who are able to work; prescribing for the first time that beneficiaries able to work have the obligation as well as the right to participate in activities leading to their inclusion in society. The Child Allowance (CA) Program, financed by the MLSP, is intended to support the income of poor households with children. As in the FSA, eligibility is determined by asset tests. However, the benefit is fixed and does not vary with income. The income threshold of RSD 8,155 per family member is higher than for the FSA. Children are also required to attend school. Each child is entitled to the allowance until he or she reaches the age of 19 (26 if disabled). Households must reapply annually. Like to FSA, the child allowance is administered by the municipal CSW, where potential beneficiaries apply. Categorical Noncontributory Programs: The maternity leave allowance compensates mothers for lost earnings during maternity leave. The benefit is based on the mother’s net wage in the 12 months before the maternity leave and the length of employment. If a mother has been employed for more than 6 months, her compensation equals 100 percent of her net wage; if employed 3 to 6 months, 60 percent; and if employed less than 3 months, 30 percent. The maximum monthly compensation is capped at five times the average monthly wage in Serbia. This benefit is generous relative to similar types of compensation in EU countries, including the new member states from Central and Eastern Europe, where most benefits are financed from insurance contributions. The birth grant (parental allowance) was introduced in the 2002 amendment to the Law on Financial Support to Families with Children, and expanded in 2006 to allow benefits for first-born children. It is paid in one installment for the first child and in 24 monthly installments for the second, third, and fourth children. The amount of the benefit depends on birth order. To be eligible, the mother has to be entitled to health care. Disability benefits include both a personal disability benefit and a caregiver’s allowance (allowance for provision of care by another person). These benefits are extended to persons who have a disability from birth or childhood or adults who have no social insurance against the risk of disability. Potential beneficiaries may apply to the CSW, where eligibility is determined based on an applicant’s medical condition. The caregiver allowance takes the form of monthly payments to individuals who require care and assistance with filling basic needs due to nature and the degree of the injury or illness. War veteran benefits comprise various forms of income support to war veterans, survivors, civilian victims of war, and their families. Benefits include wage compensation for working veterans, cash compensation for disabled veterans, a caregiver’s allowance, and survivor’s benefits. Source: Adapted from “Activation and Smart Safety Nets in Serbia: Constraints in Beneficiary Profile, Benefit Design, and Institutional Capacity” (2013), World. Social Assistance and Labor Spending: 8.7. Sixty percent of the Serbia’s SA spending goes to Regional Comparison family and child allowance programs; only 30 percent is directed to poverty reduction (Figure 8.3). The outlays 8.6. Serbia’s spending—2.08 percent of GDP—on on family and child allowances52 represent 1.2 percent of social assistance is comparable to that of other ECA GDP, and go to parental allowances (birth grants), wage countries but lower than the EU average of 4.29 compensation, child allowances, and foster care. Of these percent (Figure 8.3).51 Several new EU member states programs only the child allowance is means- tested, and spend similar amounts—Poland, 2 percent; Latvia, 1.8 thus has the additional objective of poverty reduction. percent; and Lithuania, 2.4 percent—but others spend The other categorical benefits (war veteran and disability more: Hungary, 4.2 percent; Slovenia, 3.5 percent; and benefits) represent 25 percent of SA spending (about 0.5 Slovakia, 2.8 percent. percent GDP). 85 III. Opportunities for improving the efficiency and equity of public spending in social sectors Figure 8.3: Social Assistance Spending Percent of GDP, 2013 (war benefit simulated) 53 Other 6.0% 5.0% Social/non-contributory pension 4.0% Low income/last-resort program 3.0% 2.0% Family and child allowances 1.0% 0.0% Disability benefits Georgia 13 BIH 10 Croatia 12 Ukraine 12 Romania 10 Estonia 11 Kyrgyz Republic 12 Belarus 13 Lithuania 09 Serbia 13 Albania 13 Armenia 12 Moldova 13 Montenegro 13 Turkey 13 Kosovo 13 FYR Macedonia12 Kazakhstan 12 Azerbaijan 11 Bulgaria 13 Latvia 12 Poland 13 Tajikistan 11 Housing and utility War veteran related benefits Source: Europe and Central Asia Social Protection expenditure and evaluation Database, World Bank Note: Spending on war veterans benefits was not available after 2011; projections for subsequent years are based on past growth rates. 8.8. The largest SA program is wage compensation is twice the amount spent on FSA. Due to the link with during maternity leave whose spending has risen employment, the program does not cover unemployed over the years, reaching about 0.66 percent of GDP in mothers or those who are out of the formal labor market. 2013 (Figure 8.4). While eligibility is directly related to The benefit is proportional to previous wages, which employment status (formal workers and self-employed), decreases its ability to alleviate poverty but does allows the financing comes from the State Budget through the for smoothing consumption before and after pregnancy. MLESP, so this program is treated as non-contributory. Similar programs that in some other ECA countries Although the rapid spending increase for this program are usually contribution-based and part of the social was contained starting in 2011,54 it still accounts for insurance pillar, so they do not divert resources away more than one-third of total SA spending, and the cost from programs targeted to the poor. Figure 8.4: Serbia’s Social Assistance Spending in Serbia, by Program (Percent of GDP) Foster Care 0.80% Caregivers Allowance 0.70% 0.60% Financial Social Assistance (FSA) 0.50% Family and Child Allowances % of GDP 0.40% 0.30% Child Allowance 0.20% Veterans and Disability Benefits 0.10% Wage Compensation During 0.00% the Maternity Leave 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Europe and Central Asia Social Protection expenditure and evaluation Database, World Bank. Note: Spending on war veterans benefits are not available after 2011; projections for subsequent years are based on past growth rates. 51 2011 value, ESSPROS database, Eurostat 54 At the end of 2010, the formula for calculating the benefit was changed to 52 Family benefits programs are regulated by the law on financial support to ensure a tighter link between the employment and contribution record and the families with children (2005). actual wage of the beneficiary mother, on one hand, and her compensation 53 In Serbia, the main categories are (1) FSA; (2) family allowances: child during maternity leave, on the other, and to limit previously existing possibilities allowance, parental allowance, wage compensation during maternity leave and for inflating the reference wage. As a result, in 2011 the cost of the wage foster care; (3) disability: caregiver allowance; (4) war veteran-related benefits: compensation during maternity program was contained relative to 2010 despite and (5) other: preschool allowance. a notable increase in the number of claimants. 86 III. Opportunities for improving the efficiency and equity of public spending in social sectors 8.9. After the new Social Welfare Law in passed in able-to-work beneficiaries (see Box 8.1).55 Consequently, 2011, spending on SA went up to 0.34 percent of GDP spending on FSA almost doubled (from 0.16 percent of but it is still below the regional standard. The last resort GDP in 2010 to 0.34 percent in 2013), though it is still program was thoroughly revamped in 2011 in order below the regional average of 0.5 percent. In 2012 the to expand coverage and the adequacy of the benefit; number of beneficiaries also reached a historical record regulate the provision of social care services and link it of more than 221,000 direct and indirect beneficiaries, to cash assistance (case management); and introduce and in 2013 beneficiaries constituted about 3 percent of behavioral conditions and incentives for activating the population in 2013 (Table 8.1). Table 8.1: FSA Spending and Beneficiaries, 2005–13 FSA 2005 2006 2007 2008 2009 2010 2011 2012 2013 Spending (million RSD) 2,216 2,660 3,005 3,675 4,577 5,062 7,726 10,168 12,659 Beneficiaries 99,781 111,674 131,053 139,570 151,477 166,942 166,309 221,403 n.a. Source: ECA Social Protection Expenditure and Evaluation Database, World Bank. 8.10. Despite significant reforms in recent years to been very low, which explains the government programs expand coverage, means-tested transfers still account to influence fertility choices. However, the evidence on the for less spending than untargeted SA (Figure 8.5). The impact of pronatalist programs (mostly from wealthier two means-tested programs have clear poverty alleviation countries) on fertility and the labor force participation rate objectives, and in the case of the child allowance an of women is mixed. For instance, purely financial measures additional population growth objective; together they (birth bonuses, more generous allowances for higher-order account for just 30 percent of spending and 0.68 percent births) have little or no impact. of GDP. While this represents a significant increase, it is still relatively low compared to the share of non-means- 8.12. Rationalizing the untargeted programs would tested benefits, which may be limiting the impact of create fiscal space for poverty-targeted programs. social assistance on poverty. Balancing multiple social policy objectives is always difficult, but given the evidence, rationalizing spending on 8.11. It appears from the current composition of SA untargeted categorical programs may create fiscal space spending that there is room to make SA ore effective in to either combine them with other services to improve addressing the government’s social policy objectives. their impact, or expand poverty-targeted programs. The Serbia’s population has been declining for the last 20 next section provides evidence on how well SA programs years (GoS, 2014) and participation in the labor market has perform and analyzes coverage gaps and poverty impact. Figure 8.5: Means-tested and Non-means-tested Social Assistance, 2006–13 (Percent of GDP) 2.50% 2.00% Non-Means Tested Social 1.50% Assistance Means Tested 1.00% Social Assistance 0.50% 0.0% 2006 2007 2008 2009 2010 2011 2012 2013 Source: ECA Social Protection Expenditure and Evaluation Data- base, World Bank. 55 Recently, the government has announced a proposed revision of the 2011 law that would increase activation of FSA beneficiaries and improvement the provision of public services in local communities. 87 III. Opportunities for improving the efficiency and equity of public spending in social sectors B. How Effective are Social Box 8.2: Main FSA Provisions Introduced by the New Law on Social Welfare Assistance Programs 8.14. Serbia faces a serious coverage gap: only 35 The 2011 Law on Social Welfare significantly changed the FSA percent of the poorest quintile receives any social benefit levels and coverage, particularly for beneficiaries living in assistance. Poverty in Serbia is relatively high and the at- multi-member households and for households where members risk poverty rate was 24.5 percent in 2013, compared to are unable to work. In addition, FSA recipients are expected to a 16.6 percent average for the EU 2856. Coverage of the become more active in addressing their problems. In nominal bottom quintile, which roughly corresponds to the poor terms, the new benefit is set at a higher level, calculated on a new in Serbia, is among the lowest (after Spain) among EU28 equivalence scale aligned to the modified OECD scale (1 for the countries (Figure 8.6). Countries with similar or even less first adult, 0.5 for the second and each additional adult, and 0.3 SA spending have been able to achieve higher coverage: for the child). For households where no member is able to work, in Latvia coverage of the poor reaches 70 percent and the law provides for a 20 percent benefit increase. The maximum in Bulgaria it reaches 59 percent. Also, since most SA number of eligible members was raised from five to six, while programs are not means-tested, it is not surprising that the nine-month eligibility timeframe for households where the almost 15 percent of the richest quintile are covered by majority of members is able to work remained unchanged. The social assistance. Reforming these categorical programs land ownership threshold was increased from 0.5 to 1 hectare for should be a government priority; doing so could bring households where all members are unable to work. The definition savings or allow resources to be reallocated to programs of individuals unable to work also changed to include college and that do target the poor. university students, pregnant women and caretakers of disabled family members. These amendments are expected to increase 8.15. The impact of SA on poverty is limited by low the number of FSA recipients by 60 percent and spending on coverage and inaccurate targeting. In fact, simulations social assistance by 80 percent. There is a new emphasis on showed that a shift of the resources from categorical the activation of FSA recipients through education, training, programs to the well targeted FSA can reduce the employment and community based work. The new Law gives overall at risk poverty rate by as much as 8 percentage the possibility to the CSWs to sign agreements with beneficiaries points (i.e. the risk poverty rate would be 18.6 percent for their activation (individual activation plans) and with other compared to the current rate of 24.5 percent). This service providers, such as the National Employment Service. is not surprising as some programs, starting with the largest in terms of spending, do not focus on the poor Source: Matkovic, G., Poverty in Serbia during the transition – Trends, (low coverage and regressive distribution of benefits) policies, dilemmas. Paper presented at the World Bank International Con- ference on Poverty and Social Inclusion in the Western Balkans, Brussels, but have other objectives, such as population growth or December 14-15, 2010 providing benefit to war veterans. 8.16. In general social assistance could be much better targeted: only 23 percent of all transfers 8.13. Most public spending on labor market policies go to the poorest quintile (Figure 8.7). This is largely goes to passive measures. While spending on labor because for the largest programs (e.g., maternity wage market policies totaled less than 1 percent of GDP, there compensation), significant shares reach the wealthier is a large discrepancy in the amounts funds allocated to half of the population. Compared to other countries, in passive programs (financial assistance to unemployed) Serbia a very low share of benefits accrue to the poorest. and active labor market policies (ALMPs). Passive ones Similarly, the leakages of social transfers to the richest are favored despite changes in the law on employment quintile (about 28 percent of all benefits) is the highest and unemployment insurance that opened some fiscal in the region (Figure 8.7). The benefit incidence is in space to increase ALMP funding. There is an array of fact higher for the richest quintile than for the poorest, active measures, such as training (vocational and post- because the main social assistance program, maternity education); employment incentives (employment subsidies wage compensation, is earnings-related. for self-employment, rehabilitation programs, and work ability assessments); and direct job creation through public work. However, ALMPs represented only 0.1 percent of GDP in 2013, low compared to most European countries, while passive measures (mainly unemployment benefits) accounted for 0.57 percent, relatively high for ECA countries. 56 The at-risk poverty line is 60 percent of the median equivalent income, using the OECD equivalence scale. 88 III. Opportunities for improving the efficiency and equity of public spending in social sectors Figure 8.6: SA Coverage by Country, Poorest and Richest Quintiles (Percent of Population) Q1 Q5 100 90 80 70 60 50 40 30 20 10 Malta Luxemburg Hungary France Netherlands Romania Sweden Finland Iceland Slovakia United Kingdom Austria Norway Lithuania Germany Denmark Latvia Slovenia Estonia Belgium Poland Czech Republic Bulgaria Portugal Italy Greece Serbia Spain Source: ECA Social Protection Expenditure and Evaluation Database, World Bank. Figure 8.7: Distribution of Benefits, Poorest and Richest Quintile (Percent of Total Benefit) Q1 Q5 70.00 60.00 50.00 40.00 30.00 20.00 10.00 0 Netherlands United Kingdom Poland Czech Republic Lithuania Finland France Sweden Denmark Germany Malta Norway Hungary Slovakia Slovenia Portugal Iceland Luxemburg Romania Austria Belgium Estonia Greece Spain Italy Bulgaria Serbia Source: Europe and Central Asia Social Protection expenditure and evaluation Database, World Bank. Latvia Figure 8.8: Generosity of Benefits, Poorest and Richest Quintiles (Percent of Total Income) Q1 Q5 70.00 60.00 50.00 40.00 30.00 20.00 10.00 0 United Kingdom Lithuania Netherlands Hungary Germany Sweden Serbia Estonia Luxemburg Denmark Finland Slovenia France Belgium Austria Norway Spain Czech Republic Iceland Portugal Latvia Romania Malta Poland Slovakia Greece Bulgaria Italy Source: ECA Social Protection Expenditure and Evaluation Database, World Bank. 89 III. Opportunities for improving the efficiency and equity of public spending in social sectors 8.17. The generosity of social assistance is relatively 8.18. Overall SA performance masks significant differ­ high in Serbia, for both the bottom and the wealthiest ences in programs. Clearly, the performance of SA as a quintiles, compared to most EU28 countries (Figure whole depends on the design of each benefit: a relatively 8.8). In fact, SA transfers represent 37 percent of total small program that effectively targets the poor may be income for the bottom quintile, demonstrating not only counterbalanced by a non-targeted scheme with larger that the level of transfers is relatively high, but also coverage. To understand the interaction of SA programs that the poor have very few other income sources and in Serbia and to assess their relative performance, it is are relying on SA transfers to survive (Figure 8.8). For important to analyze program performance indicators. the richest quintile, SA transfers represent only 13.2 percent of income, but Serbia’s generosity to the richest is still higher than in any other country. The high level of benefits for the richest is because benefits in the maternity wage compensation program are higher for those whose previous earnings were high. C. Performance of Categorical (Non-Targeted) Benefits 8.19. Categorical benefits, which are responsible for just 0.5 percent. Worse, maternity wage compensation two-thirds of Serbia’s SA spending, cover only a small reaches only 0.4 percent of those in the bottom quintile share of the population and the poor (Figure 8.9). but a full 4 percent in the wealthiest quintile. Coverage Parental allowance is the largest categorical program in by quintile is fairly even for the parental allowance (a terms of coverage, but it reaches only about 4 percent of universal program) but increases for the higher quintiles the population; shares are even lower for maternity wage for wage compensation and disability benefits. compensation at 2 percent and parental allowances at Figure 8.9: Program Coverage and Coverage Distribution by Quintile (Percent of Population) War veteran benefit Allowance for care Q1 Q2 Wage compensation during maternity leave Q3 Financial social assistance Q4 Q5 Parental allowance Child allowance 0 2 4 6 8 10 12 Source: ECA Social Protection Expenditure and Evaluation Database, World Bank. 90 III. Opportunities for improving the efficiency and equity of public spending in social sectors 8.20. The distribution of transfers is regressive due of the average income for all beneficiaries (16 percent for to the high cost of wage compensation where only 2 war veteran benefits, 7 percent for parental allowances) percent of the transfers reach the poor (Figure 8.10). and about 21 percent of total income for the wealthiest More than half of the benefits of that program accrue quintile (29 percent for war veteran benefits, 4 percent for to the wealthiest 20 percent of the population, and 80 parental allowances) which are among the highest in any percent of total benefits go to the wealthiest 40 percent. ECA country. Nevertheless, simulations have found that the In effect the program excludes women who are not poverty rate would have increased by only 0.1 percent if Figure 8.10: Benefits by Program and Quintile (Percent of Benefit) Q1 Q2 Q3 Q4 Q5 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 Monetary Child Parental Allowance Wage compensation War veteran social assistance allowance allowance for care during maternity leave benefit Source: ECA Social Protection Expenditure and Evaluation Database, World Bank. in the formal labor market, who most likely come from there were no wage compensation program or war veteran the poorest quintiles. Similarly, the distribution of war benefits, and by 0.3 percent without the allowance for care. veteran benefits is quite regressive, with only 1 percent In other words, the cost-benefit ratio, which measures how of total transfers directed to the poorest and more than effectively a transfer reduces the poverty gap, is low for 80 percent directed to the two wealthiest quintiles. The categorical programs (Figure 8.11). The ratio represents the distribution of benefits is relatively even across quintiles poverty gap reduction for each dinar spent on the program. for parental allowances and allowances for care. The closest it is to 1, the better cost-benefit effectiveness is, as each spending reduces - by the same amount - the 8.21. Although they are relatively generous, the poverty gap (in this case below the first decile), and is not poverty impact of categorical programs is negligible. ‘lost’ to some non-poor households. Wage compensation transfers represent about 22 percent Figure 8.11: Cost-benefit Ratio of Social Assistance Monetary social assistance Child allowance Parental allowance Allowance for care Wage compensation during maternity leave War veteran benefit 0.00 0.10 0.20 0.30 0.40 0.50 0.60 0.70 0.80 0.90 1.00 Source: World Bank. 91 III. Opportunities for improving the efficiency and equity of public spending in social sectors D. Performance of Poverty-Targeted below the RSD 7,100 average for the bottom decile, which Programs helps with targeting but also limits coverage. 8.22. The child allowance reaches one-fourth of the 8.25. Even with accurate targeting and relatively high poorest quintile but is only modestly targeted. Child average benefits, low coverage limits the impact of the allowance is the largest program in terms of coverage, FSA on poverty. Without FSA, the poverty rate would reaching almost 11 percent of the total population increase by 0.7 percent to 26.4 percent. Following the and 25 percent of the bottom quintile; coverage rates 2011 reform, FSA benefits are relatively more generous, decrease by quintile. However, less than half of the constituting on average 32 percent of the total income for transfers (46 percent) accrue to the poorest quintile, and all beneficiaries, and 48 percent for those in the bottom 30 percent goes to the second poorest quintile. Despite quintile. low generosity, its impact on poverty is not insignificant, however, due to the breadth of its coverage. In the 8.26. On the other hand, the FSA is Serbia’s most cost- absence of the program poverty would be expected to effective SA program. The FSA cost-benefit ratio, which increase by 0.8 percentage points. represents how much the poverty gap is reduced by each RSD spent on the program, is 0.85, is the highest of all SA 8.23. The FSA is a well-targeted: 74 percent of its programs in Serbia. The closest this ratio for one SA program benefits reach the poorest quintile. Also, the inclusion is to 1, the more effective that program from a cost-benefit error of the FSA is quite small, with only 1.6 percent of all standpoint is. This is a direct consequence of the high benefits going to the richest quintile. Comparison of FSA targeting precision of the FSA compared to other benefits. with similar poverty-focused programs in other countries finds FSA well above average for targeting accuracy in 8.27. The impact of SA on poverty could be enhanced the ECA region57 and on a par with the targeting of major by expansion of its coverage. In addition to the fact that programs in developed countries. coverage of the poor are low, the actual SA program may be undercovering some at-risk population groups, for instance, 8.24. However, despite recent reforms its coverage the elderly, only 8 percent of whom receive a SA transfer, and is still low (Figure 8.12). The adoption of the Social in particular, only 7 percent receive the FSA. Even though the Welfare Law in 2011 has resulted in an expansion of recent reform raised the eligibility threshold, the asset test FSA, evidenced by a 30 percent increase in the number still prevents many elderly from being eligible. Coverage also of beneficiaries. However, the FSA still does not provide depends on outreach efforts to identify those eligible, which sufficient coverage: FSA benefits go to only 11 percent is not very strong in Serbia, and on the administrative burden of the poorest quintile.58 The low coverage of FSA may of attaining and maintaining eligibility, which is significant. be due to non-take-up issues or to additional conditions This burden on the applicant is likely to be particularly heavy of the means/asset-test (in addition to the income test). for minorities, such as Roma, resulting in limited coverage In fact, the eligibility threshold, RSD 5,300 is considerably despite their vulnerability. Figure 8.12: Coverage by Program and Quintile (Percent of Population) Q1 Q2 Q3 Q4 Q5 30.0 25.0 20.0 15.0 10.0 5.0 0.0 Child Monetary Parental Allowance War veteran Wage compensation allowance social assistance allowance for care benefit during maternity leave Source: ECA Social Protection Expenditure and Evaluation Database, World Bank. 57 The regional average is based on targeting accuracy (share of transfers received measurement used in this analysis is not the best option. by the poorest quintile) of last resort SA programs in other ECA countries, 58 Due to the significant differences between the list of programs included in the using harmonized consumption aggregate (ECA POV) and an absolute poverty HBS and SILC (and changes in the poverty measurement methodology) it is not line. Hence a direct comparison with the income-based and relative poverty feasible to do a comparison of FSA coverage over time. 92 III. Opportunities for improving the efficiency and equity of public spending in social sectors 8.28. There are implicit work disincentives in design of targeted programs by redesigning elements of current the FSA. Just as in many other ECA in the ECA region, FSA programs. The Government could therefore consider the is designed so that each additional dinar a beneficiary following reforms: earns is a dinar lost in benefits, since the benefit is • Scale back the wage compensation program59 and calculated as the difference between a certain income use the freed-up resources to expand FSA, Serbia’s threshold and the net income of beneficiary families. most effective SA program. Simulations60 indicate As a result, below the threshold there is no financial that if maternal wage compensation resources were incentive for a family to earn more income because it will used to provide average benefits to households that be automatically reduced from the benefit they receive— are below the income threshold but are currently not making this a 100 percent marginal effective tax rate. receiving FSA, the at risk-poverty rate would decline to The CSW worker’s discretion in making the income 16.8 percent (about 8 percentage points), spending on assessment can also deter current benefit recipients from FSA would more than double, and its coverage would exiting the system. The procedure for determining FSA expand from 3 to 11 percent of the population (with eligibility includes an assessment by the social worker, e.g., about 80% of the poorest quintile covered). to identify possible foregone opportunities for earnings • Means-test the parental allowance (birth grant). and to check for informal employment. Since there is no Redesign the program, at a minimum to stop providing structured evaluation process, the CSW worker has some benefits to the wealthier 50 percent of the population, discretion in assessing certain elements of family income and channel the resulting savings (0.1 percent of when applying income eligibility criteria. This could lead GDP) to expanding FSA, child allowances, or childcare to denial of FSA for a current recipient if a different coverage. Another option could be to consolidate this CSW worker comes up with a different estimate. Once program with child allowances. approved, therefore, some recipients may feel reluctant • Redesign the FSA to remove the built-in work to exit the system because of fears about future reentry. disincentives. Introduce in-work benefits. While this will not bring any fiscal savings in the short term (in fact 8.29. Improving SA design is necessary but not it may temporarily increase the cost slightly), it would sufficient. Redesigning the benefit design to provide more be worthwhile in the medium to long term because it financial incentives to work would be insufficient unless would incentivize work, increase self-reliance, and allow other barriers to work are addressed, among them lack some to eventually exit from the system completely. of skills, unavailability of support services, and high labor • Complement FSA redesign of FSA with more taxes on low-paid labor. Labor taxes in Serbia are average determination implementation and enforcement for higher-wage earners but very high for low-paid jobs. A of the activation of FSA beneficiaries, linking them comparison with OECD and neighboring countries shows with adequate and accessible employment support that the tax wedge on less well-paid workers in Serbia is programs, and facilitating coordination between the among the highest, 36.7 percent (World Bank 2012), due National Employment Service and the CSWs. to the minimum social security contributions employees • Finally, to protect the vulnerable from any energy tariff and employers are mandated to pay. increases, channel current or future subsidies through the current social assistance program to eliminate fragmentation and make such transfers more effective. E. Conclusions and Recommendations 8.30. There is scope for Serbia to continue to modernize its safety net and make it more efficient and effective. The current safety net is designed to address multiple social policy objectives, but a large portion of the spending goes to non-poverty-targeted programs. Only 35 percent of the poorest quintile receive any SA transfer—very low compared to EU 28 countries, even those with similar levels of spending. Similarly, only 23 percent of all transfers go to the poorest quintile, while 28 59 The government is working on amending the Law on Financial Support to percent accrues to the richest—the highest in the region. Family with Children. Details of the proposed amendments are expected to be As a result, SA has very little impact on poverty. available by June 2015. 60 Due to limitations of the SILC 2012 data, it is not possible to simulate the full eligibility criteria for FSA. The rudimentary simulations undertaken only consider 8.31. While balancing multiple social policy objectives the FSA income eligibility requirement (RSD 6,774 per equivalent adult in 2012) is challenging, SA spending could be made more and not the asset test. The simulations are intended to be illustrative; estimating the full impact would require simulation of FSA full eligibility requirements and effective by shifting resources from categorical to calculation of the actual benefit for each eligible household (compared to the average benefit used in the illustrative simulations). 93 VIII. SOCIAL ASSISTANCE IV. Distributional Impact of Fiscal Consolidation in Serbia 95 IV. DISTRIBUTIONAL IMPACT OF FISCAL CONSOLIDATION IN SERBIA CHAPTER 9. DISTRIBUTIONAL IMPACT OF FISCAL CONSOLIDATION MEASURES 9.1. What might be the distributional implications A. Serbia’s Poverty and Labor Market of the main elements of the government’s fiscal consolidation program? The objective of this chapter is Profile in Brief to make an initial assessment of this question focusing 9.4. Two facts about Serbia’s poverty and labor on core measures the government has announced in market profile are important to consider when areas of public spending–i.e., reforms to the public looking at the distributional impact of core near- administration wage bill, pensions, and state support to term fiscal consolidation measures. The first is the public enterprises (through resolution of the Privatization relatively low risk of poverty for those who are retired Agency portfolio and privatization generally) along with compared to the national average. The second is that the proposed electricity price increase of 12 percent. public sector workers on average are paid more than The latter, which is to be confirmed reflects a rise in private sector workers. both excise taxes and tariffs as part of the financial restructuring for Elektroprivreda Srbije (EPS); a prior 9.5. On average pensioners in Serbia are at a relatively action for the first review under the IMF SBA program.61 low risk of poverty, as measured by their incomes. Based on the 2014 SILC, individuals aged 65 and over 9.2. Evidence on the potential incidence and have an at-risk of poverty rate of 20.7 percent; the direct channels of distributional impact of the general poverty rate is 25.6 percent.62 The poverty main spending consolidation measures can inform gender gap is reversed here with males aged 65 and over analysis of options about any further consolidation having a lower poverty rate than females of the same age measures and the political sustainability of reforms. compared with higher poverty rates for males relative to The evidence presented below relies on a number of females in other age categories. As discussed in Chapter different datasets and sources to look at the potential 4, early retirement is relatively common high in Serbia near-term distributional impact of reforms that directly (i.e., those in receipt of pensions may not be elderly) and affect household incomes and expenditures. More there may be elderly who are not retired. Looking at the detailed approaches could also inform discussion of the split by labor market status, the retired, who account for policy-tradeoffs from fiscal consolidation measures, for 26 percent of the population aged 15 or more, have an example, looking across the range of fiscal instruments average poverty rate of 13.0 percent compared with 15.1 or incorporating general equilibrium or the dynamic percent for the employed, who account for 39 percent of impacts of having more efficient and a higher quality the population aged 15 or more.63 of public service provision. It is also worth emphasizing that given the general fiscal constraints on Serbia it will 9.6. As highlighted in Chapter 3, average wages are be important to ensure that any temporary mitigating higher in the public than in the private sector. Based measures do not themselves give rise to sustained new on LFS data for 2014, recent estimates from IPSOS spending obligations. indicate that this differential rises from 8 percent for the lowest decile of salaries up 38 percent in the 6th 9.3. The remainder of this section is structured as decile and 20 percent in the 9th. Of those occupations follows: First are presented some characteristics of that can be paired across private and public sectors, poverty and labor market profiles that relate to the the public has higher salaries in 85 percent of the groups most likely to be affected by fiscal consolidation 32 types of occupations for which comparison is measures, namely the public sector and SOE workers possible.64 Public sector workers on average have higher and pensioners. The chapter then presents evidence of education levels and years of experience but evidence the potential impacts of reforms on those areas. suggests that these do not drive the wage premium with, for example, evidence from the LFS suggesting 61 Government of Serbia Memorandum of Economic and Financial Policies, Attachment I, in IMF (2015), Republic of Serbia 2014 Article IV Consultation and that on average SOE workers earn more than private Request for Stand-By Arrangement. sector workers for any given level of education, with 62 The at-risk-of-poverty threshold (relative poverty line) represents 60 percent of the median national disposable income in dinars. In the 2015 SILC for a single the exception of tertiary.65 person household this was RSD 13,408 per month. 63 Poverty figures from 2014 SILC headline indicators. Structure of the population by activity status from the 2013 SILC. 9.7. Public sector employment is more prevalent in 64 Since the public sector wage cut of 10 percent, this is estimated to have fallen the top income deciles (see Table 9.2). It accounts for to 63 percent. about 33 percent of total employment in Serbia. For the 65 World Bank, “Addressing the poverty, gender, and social impacts of privatization in Serbia”, mimeo, prepared as background for the SOE DPL (World Bank, 2015, bottom 40 percent of the income distribution, about 15 Serbia - First Programmatic State Owned Enterprises Reform Development Policy percent of those who are employed work in the public Loan Program Project). sector; in the top 60 percent, about 40 percent work 97 IV. DISTRIBUTIONAL IMPACT OF FISCAL CONSOLIDATION IN SERBIA in the public sector. Of employed workers at risk of percent of the bottom 40 and 3 percent of the poor are poverty fewer than 10 percent work in the public sector. employed in the public sector, compared to 23 percent Taking into account the employment rate, then, about 5 in the top 60 percent. Table 9.1: At-risk-of-poverty Rate by Age and Labor Market Status Male Female Total Average 26.2 25.0 25.6 Age group: 18–24 30.2 27.7 29.0 25–54 26.6 25.2 25.9 55–64 27.2 21.1 24.1 65 and over 17.9 22.8 20.7 Labor Market Status: Employed persons 16.4 13.4 15.1 Employees 8.4 8.7 8.6 Self-employed 39.7 36.0 38.4 Not employed 38.9 32.2 35.1 Unemployed 51.0 42.5 47.1 Retired 13.6 12.7 13.0 Other inactive persons 27.9 33.5 31.7 Source: 2014 SILC, NBS. Table 9.2: Labor Force Statistics by Income Group, aged 18–65 All Bottom 40% Top 60% Poor (below 60% median income) Non-Poor Labor force participation (%) 71.9 71.4 72.1 72.1 71.8 Unemployment rate (%) 31.7 52.1 18.6 58.2 23.0 Employment rate (%) 49.0 34.2 58.7 30.2 55.3 Self-employment (% of employed) 24.7 49.3 15.4 62.1 18.0 Public sector (% of employed) 32.8 14.6 39.7 9.6 37.0 Source: World Bank Serbia SCD. Based on Statistical Office of Republic of Serbia’s SILC data. Note: Labor force statistics derived from household surveys can differ slightly from those derived from the more specialized Labor Force Surveys, but comparisons across income groups are expected to be reliable. B. Public Sector Wage Bill Reforms 9.9. However, right-sizing reforms leading to lay- offs are clearly likely to have more direct impact on 9.8. The negative impact on poverty of recent freezes household incomes. In 2015 the government plans to and cuts in public sector wages is expected to be limited reduce government employment by 5 percent (about by the facts that public employees tend to be relatively 27,000 employees) through attrition and targeted well paid and far from the poverty line and that the cuts separations by preparing wage bill envelopes for individual did not apply to lower salaries. The 2014 revised budget public institutions.66 Among the mitigation measures are removed public sector wage indexation as of October 2014 severance payments, to be determined based on current and imposed a nominal 10 percent reduction in wage as legislation. To the extent that attrition is used, public of November 2014, excluding employees with salaries employees may transition to pension status, limiting the below RSD 25,000). Poverty and social impact analyses impact on their incomes from the separation. The ability for the World Bank’s 2009 and 2011 Public Expenditure of those who lose their jobs to find new employment will Development Policy Loans also noted that the civil service depend on their education levels, skills, and age as well wage freezes these operations supported were expected to as geography. Further details of the profile of separated have little if any poverty impact because civil servants tend workers (as has been assessed for SOEs in the Privatization to be far from the poverty line. Portfolio) will be needed to assess the likely impact. 66 Government Memorandum of Economic and Financial Policies, IMF SBA program document, 2015. 98 IV. DISTRIBUTIONAL IMPACT OF FISCAL CONSOLIDATION IN SERBIA C. Pension Reforms 9.11. Based on data on the beneficiaries of old- age pensions, about 43 percent had 2013 pensions 9.10. The impact on poverty of the cuts in nominal below the lower threshold for cuts. From the average pensions is mitigated by their progressivity. The 2014 pension and the number of beneficiaries by age, it is Law on Temporary Reduction of Pensions as of November possible to construct the distribution of old-age pension 2014 reduced pensions above RSD 25,000 per month by beneficiaries, who accounted for about 60 percent of 22 percent and those above RSD 40,000 by 25 percent. those who received pensions in 2013 (Table 9.3). About These thresholds compare with a poverty line for single 37 percent had pensions subject to the 22 percent cut individuals of RSD 13,408, although individual pensions and 19 percent were subject to the 25 percent cut. may be supporting the incomes of multiple household About 20 percent of those who had pensions whose members. Using pension administrative data, it is possible monthly income was above RSD 25, per month would to examine the distributional implications of the cuts on see it fall to below that level after the cut. Within individual pensions. The implications of the parametric the aggregate picture (Figures 9.1 and 9.2), there reforms to pensions that the government also introduced in are substantial differences across pension types and 2014 (extending the statutory retirement age for women, gender. Army pensioners are significantly more likely, increasing the minimum retirement age, and introducing and self-employed pensioners significantly less, to be actuarial penalties for early retirement) are less clear-cut. subject to the higher cuts. Almost all female old-age They may prompt individuals to work longer rather than pensioners in 2013 had pensions below the RSD 25,000 retire but the impact on incomes will dependent on whether threshold. Younger pensioners are more likely to have a pension is the sole source of income upon retirement or higher pensions, but also more likely to be able to find whether alternative employment is also sought. alternative sources of income. Table 9.3: Old Age Pension Beneficiaries by Type and Pension Level, 2013 Self- Employees Army Employed Total No. (000) 350.7 0.0 17.2 367.9 Pension below RSD 25,000 % total beneficiaries 44.5% 0.1% 45.0% 43.4% No. (000) 293.3 4.6 18.6 316.5 Pension above RSD 25,000 but below RSD 40,000 % total beneficiaries 37.3% 20.6% 48.9% 37.3% No. (000) 143.2 17.7 2.3 163.2 Pension above RSD 40,000 % total beneficiaries 18.2% 79.3% 6.1% 19.3% Memo: No. (000) 168.8 0.1 15.2 184.0 Number with pre-cut pension above RSD 25,000 lower % total beneficiaries 21.4% 0.4% 39.8% 21.7% threshold but post-cut pension below that Number with pre-cut benefits above RSD 40,000 cut-off 14.8 1.2 0.3 16.3 No. (000) who would have higher benefit if pension were reduced to % total beneficiaries 1.9% 5.3% 0.9% 1.9% RSD 40,000 and taxed at a lower rate Source: Pension administration database 2013. World Bank staff calculations. 9.12. To address the concern over the impact of earlier 9.13. Qualitative analysis illustrated the limited coping pension freezes, a qualitative study was conducted strategies of the poor and low to middle segment of with focus group discussions and in-depth interviews. pensions. The main coping strategies reported were This was motivated by findings, using simulations based reduced consumption (the predominant mechanism) and on the 2009 Household Budget Survey, that prolonging additional employment or support from family members the freeze through 2010 may have added 0.6 percentage (with agricultural pensioners using their own resources points to the poverty incidence between 2009 and 2011, more). Given that consumption had been reduced over with more marked impacts in rural areas (note that this recent years, it was reported that there was limited estimate is based on the previous HBS approach rather space for further reductions. In terms of government SA than the SILC).67 The qualitative research and its findings are of relevance for the recent cuts and the freeze in 67 See World Bank Public Expenditure DPL in 2011. The qualitative research (IPSOS Strategic Marketing, Qualitative Assessment of the impact on pensioners of a indexation of pensions. freeze in pensions in Serbia 2010) was commissioned as background for the DPL. 99 IV. DISTRIBUTIONAL IMPACT OF FISCAL CONSOLIDATION IN SERBIA programs, the perception was that they did not work well, services to pensioners, the most vulnerable groups were with the most vulnerable pensioners having access to a judged to be those with the lowest incomes (minimal very limited number of assistance programs, allowances, income and agricultural pensioners), those pensioners or benefits (for example, rural pensioners are affected by with severe health problems, pensioners in rural areas the criterion that owning 0.5 ha of land could preclude and single households and two-member households access to SA). From the perspective of providers of living on a single pension. Figure 9.1: Average Old-age Pensions by Benefit Level and Gender (Percent) Men (post tax) Men Women (post tax) Women 100% 100% 90% 90% 80% 80% 70% 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% 10 20 30 40 50 10 20 30 40 50 Source: Pension administration database 2013. World Bank staff calculations Figure 9.2: Average Old-age Pensions by Age and Gender (RSD 000 per month) Men Women 60 50 40 30 20 10 0 50 60 70 80 90 100 Age Source: Pension administration database 2013. World Bank staff calculations. 100 IV. DISTRIBUTIONAL IMPACT OF FISCAL CONSOLIDATION IN SERBIA D. Reduced State Support to Public whole and only about 12 percent of PA workers report that they are able to save from their incomes (although this is Enterprises higher than for the private sector). Their earning potential is also lower than that of workers in other SOEs or the 9.14. As discussed in Chapter 5, the government’s private sector, although one in five has access to land that program of reform for state support to public could be used for agricultural purposes. Compensation enterprises incorporates both reductions in direct mechanisms under previous privatizations were mainly and indirect support and corporate and financial financial, from the Transition Fund, to limit the impact of restructuring of major SOEs. The associated layoffs are a temporary unemployment. Active labor market policies direct channel of impact on household welfare but can be were not found to have been very effective in helping mitigated by support to transition to new employment or people to find jobs but the National Employment Service through SA programs. The longer-term potential benefits did guarantee access to health insurance. Other support of more efficient and higher-quality service delivery, the measures, such as social assistance, were too small and impact on fiscal savings and job creation and growth of had too-tight eligibility thresholds to benefit a significant the private sector are much harder to quantify. proportion of the households that would be affected by privatization. Generally focus group discussions also found 9.15. Recent poverty and social impact analysis of the a fair amount of uncertainty or lack of information about restructuring of companies in the Privatization Agency the process of redundancy and workers’ rights. (PA) portfolio underscores the potentially significant direct welfare implications of job losses and the need 9.18. For workers made redundant by the resolution to build up mitigation mechanisms (World Bank, 2015b). of the PA portfolio, the authorities are committed to In the short run, the reforms will result in job losses. The provide redundancy packages. In addition, a targeted authorities estimate that for the 140 PA companies being expansion of NES services might help make them more restructured as of August 2014 up to 30,000 jobs (of a relevant to the needs of workers in the SOE portfolio, total of 55,000) could be lost. Progressive divestiture of the particularly younger ones. Other prospective programs of remaining companies in the PA portfolio (374 companies support are direct provision of employment opportunities with about 35,000 jobs) is not expected to result in massive in public works programs and reduction of disincentives to job losses, because those companies already operate on a employment creation. commercial basis without significant state support. Based on a multidisciplinary approach using quantitative and 9.19. Broadening the outlook to non-PA SOE workers qualitative data, given the profile of workers currently in who may face redundancy from restructuring, they the PA portfolio, the impact of job losses on households is too are likely to need support to manage the transition likely to be significant and there is a need for to build up the to new employment opportunities or retirement. As mitigation mechanisms used in the past. noted, the share of public sector workers among the poor is relatively low and the distribution of non-PA SOE wages is 9.16. Re-employment of workers in companies in the skewed to higher levels relative to the distribution of private PA portfolio is likely to be difficult. Workers dismissed as formal and also PA SOE workers (Table 9.4). Non-wage part of previous privatizations have had great difficulties benefits of about 27,000 RSD annually for non-PA SOE in finding new jobs, particularly workers with similar workers are about 15 percent higher than the levels for PA profiles to those in the PA portfolio: older, low-skilled, and SOE workers and private formal workers.68 The education living in areas that were greatly dependent on SOEs for profile of PA and non-PA SOE workers also differs; the latter employment . In a few areas, the share of employment in have more tertiary education, the rates of which in PA SOEs firms within the PA portfolio reaches 40 percent; levels of trail those of the private formal sector. 15 percent are not uncommon. And dismissed workers who do find employment are most likely to do so in the informal sector as occasional laborers doing seasonal work. The lower quality of such jobs can add to the nonmonetary pressures on individuals. The analysis also found that gender differences that were identified in terms of the impact of redundancy or overall vulnerability mostly relate to cultural norms and traditional expectations that men would be the bread winners. 9.17. The ability of laid-off workers to cope by accessing savings or alternative incomes may be limited. The wage 68 Interestingly, the benefits of public sector employment are such that almost 60 premia of PA workers is smaller than for the SOE sector as a percent of individuals, when asked if which sector they would like to move to if they had another job, stated the public sector. 101 IV. DISTRIBUTIONAL IMPACT OF FISCAL CONSOLIDATION IN SERBIA Table 9.4: Worker Characteristics and Wages, SOEs and the Private Sector (Percent) Privatization Agency SOE SOE non-Privatization Agency Private formal Private informal By educational attainment: Less than secondary 10.6 12.2 10.9 24.6 Lower secondary 35.6 19.1 29.2 35.4 Upper secondary 36.7 40.8 40.5 35.4 Tertiary 17.1 27.9 19.5 4.6 By wages (RSD/month): Under 25,000 36.2 23.8 52.5 76.4 25,000 to 45,000 37.2 57.2 39.1 20.6 Over 45,000 26.6 19.0 8.7 3.0 Source: World Bank, 2014, Addressing the poverty, gender and social impacts of privatization in Serbia, mimeo, based on LFS data. E. Electricity Tariff Adjustment household budget survey data.69 It is also an important budget item: in 2013 households spent almost 7 percent 9.20. Although not discussed in detail earlier in this of their budgets (close to 9 percent for households in the report, a proposed increase in electricity costs due to a bottom quintile) on electricity alone (Table 9.5). About rise in excise duties and tariffs as part of the financial 18 percent of the households (36 percent in the bottom restructuring of EPS could have sizable distributional quintile) spend more than 10 percent of their budgets implications. Electricity is a vital energy source for on electricity—a threshold that often seems to signal households in Serbia and important component of their affordability concerns. Not surprisingly, households that budgets. The analysis in this section draws on the findings rely on electricity as their main heating source have to from the 2013 HBS and is in the process of being updated. spend more share of the household budget on electricity (9.2 percent); households that used district heating or 9.21. Nationally electricity accounts for 72 percent of gas spent, on average, less than 6 percent of their budget total household energy expenditures based on 2013 on electricity. Table 9.5: Electricity and Energy Budget Shares by Quintile and Heating Group, 2013 (Percent) Main Heating District Electric Firewood Combined Gas Overall Source: Heating Heating Heating Quintile Share of electricity in the household budget 1 6.9 10.3 8.8 9.9 9.8 8.9 2 6.5 11.6 8.0 9.5 7.7 8.2 3 6.0 10.0 6.7 7.9 6.2 6.9 4 5.6 9.4 5.9 6.6 5.4 6.2 5 3.7 6.4 4.6 4.5 4.3 4.5 Overall 5.1 9.2 7.1 7.4 5.5 6.8 Total energy expenditures share in household budget 1 17.5 10.6 10.1 12.2 17.4 10.7 2 16.7 11.7 10.4 14.4 14.3 11.7 3 17.2 10.1 11.6 12.4 13.1 12.7 4 15.7 9.6 12.5 11.9 13.2 13.1 5 11.4 6.6 12.8 9.9 11.8 11.3 Overall 14.5 9.4 11.3 12.0 12.9 11.9 69 This section is based on World Bank (2012) “Electricity reforms and energy captures energy expenditures, not physical consumption of energy by source (i.e., affordability in Serbia”, mimeo, which uses the 2010 HBS. This analysis is in electricity consumption is calculated from expenditure data and administrative the process of being updated to examine poverty and social impact of the data on the household tariff structure). This implicitly assumes bills are paid in full. current proposed changes in electricity tariffs and this section will be updated (2) Data on metering (whether single or double tariff) or electricity arrears are not accordingly. There are some caveats on the use of HBS data: (1) The HBS only available in the survey. 102 IV. DISTRIBUTIONAL IMPACT OF FISCAL CONSOLIDATION IN SERBIA 9.22. The highest budget share of electricity spending is reported by single elderly households (9 percent) followed by households below the national poverty line (9.0 percent). The shares of total energy expenditures tend to be lower than or close to the average for most groups, except single elderly households, for whom energy accounted for a larger share of the household budget (15 percent). 9.23. The estimated electricity tariff price increases of 12 percent in 2015 including both excise tax and tariff increases, will need to be accompanied by adequate protection of the poor and vulnerable. Indeed the new Energy Law 2014 stated that the vulnerable population needs to be protected. The nature of the tariff adjustment (application by tariff categories and levels of consumption) and its timing, along with any temporary compensation measures, will be a key determinant of their impact on poverty and vulnerability. Good targeting is crucial when working within a tight, and declining, fiscal envelope, and particularly when the objective is to alleviate the impact of price increases at the bottom of the welfare distribution. In addition, as highlighted in Chapter 8, any future protection should be channeled through current SA programs to eliminate fragmentation and make the transfers more effective. Simulations based on HBS 2013 data suggested that a 12 percent increase in household electricity prices would increase poverty by 0.3 percentage points. 9.24. The 2010 paper also spelled out the findings of focus group discussions on energy affordability with members of vulnerable groups, defined as members of poor households (with incomes of less than RSD 8,000 per household member)70. The high cost of electricity and unpaid electricity bills represent a considerable problem for vulnerable households. The discussions also confirm the importance of firewood in making warmth affordable, although it is less of an option in urban areas where buildings are not fitted with chimneys. Focus groups also confirmed that winter is a very stressful, particularly for poor people, with energy bills often representing 80 percent of what they might get from the main SA program. Some mechanisms for coping with energy payments are bad for the energy sector (theft, non-payment) or for households (growing debt, cutting consumption, being cold). 70 Results are based on a total of 12 Focus Groups, equally divided between recipients of the MOP and poor non-MOP recipients. Focus groups were also equally divided between Belgrade, Novi Sad and Nis (4 each), and between rural and urban areas. 103 REFERENCES European Commission. 2013a. “Developing Personal and Household Services” European Commission. 2013b. Taxation trends in the European Union, 2013 edition, Luxembourg, 2013. Gertler, P. et al. 2010. “Labor Market Returns to Early Childhood Stimulation: A 20-year Follow up to an Experimental Intervention in Jamaica.” California, University of California Berkeley Government of the Republic of Serbia. 2014. “Employment and Social Reform Programme in the EU Enlargement Process. Belgrade: Government of Serbia Government of the Republic of Serbia. 2014. 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Serbia - Baseline Survey on Cost and Efficiency in Primary Health Care Centers before Provider Payment Reforms. Washington DC. 106 Annex 1: Strategies to Combat the Shadow Economy ANNEX 1: STRATEGIES TO COMBAT THE SHADOW ECONOMY: EXAMPLES FROM AROUND THE WORLD Serbia’s shadow economy was estimated at 30.1 technology has changed the way cash sales are recorded, percent of GDP in 2010, according to the U.S. Agency for it has also thoroughly changed the techniques used to International Development (USAID) and the Foundation suppress sales. for the Advancement of Economics (FREN). Among the causes of the shadow economy are the relatively “Skimming” has always existed in one form or another in high fiscal burden on labor; complicated and costly tax order to, inter alia, evade taxes. Manual skimming could be procedures; a complicated and opaque tax system; and a achieved quite simply acts, by, e.g., failing to ring up cash poorly organized, understaffed, and underequipped tax sales in the cash register with the owner keeping the cash; administration. Other relevant factors are the poor quality or tampering with an electronic cash register to divert sales of public services, which undermines taxpayer morale, and a to a second cash register was kept off the books. This is most culture of relatively high tolerance for the shadow economy. common in SMEs because they usually have fewer internal There may also be other institutional and economic factors controls and are often closely-held businesses. The STS Report that help to explain the breadth of the shadow economy. found a high incidence of sales made in cash in Serbia, which In some economies it has been observed that, owing to offers opportunities for skimming. In some cases, a business low productivity, many enterprises can only make a profit involved in skimming may keep separate sets of books and if they evade paying taxes. That may also be true in Serbia. records, one for the tax authorities and the other for the The economic crisis may have exacerbated this situation owners, who may want to show the real sales to a potential and forced even more productive businesses to shift some buyer of the business. For example, skimming by closing of their operations into the informal sector. the cash registers at a certain point in the evening resulted in large-scale fraud by an Australian restaurant: amended Other features of the economy that have a significant assessments issued to on the business owners amounted to bearing on the extent of the shadow economy are a high $A8.4 million in tax and penalties (USAID 2013). administrative burden on doing business; the low quality of the regulatory environment; and insecurity about the As technology automated sales records it also automated law. For example, according to the Doing Business 2015 skimming. The first-generation suppression technology, report, on the Paying Taxes indicator, Serbia ranks as low which appeared shortly after the turn of the millennium, as 165th out of 189 economies. As for regulatory quality, was Phantom-ware. Phantom-ware is a “hidden,” pre- on the World Governance Indicators, Serbia scored –0.7 in installed programming option embedded within the 2013: the range is normally –2.5 (weak) to 2.5 (strong). The operating system of a modern electronic cash register decision to operate informally is also affected by widespread (ECR). It can be used to create virtually a second till and corruption (on which Transparency International ranked may preserve a digital (off-line) record of the skimming (a Serbia 86 in 2011) and low tax morale. second set of digital books). Physical diversion of funds into a second drawer is no longer required, and the need for This note focuses on strategies a tax regime might adopt to manual recordkeeping of the skim is eliminated. 71 combat the shadow economy. These can broadly be grouped into two categories: (1) Measures to more effectively The second generation is called Zappers. Zappers, which prevent, and (2) steps to curb cash transactions and are more advanced technology than Phantom-ware, are incentivize cashless ones. Other ways to tackle the shadow special programming options added to ECRs or point of sale economy, such as the development of a modern financial (POS) networks. They can be are carried on memory sticks infrastructure with “plastic money” and e-payments, and or removable CDs or accessed through an Internet link. The strategies to change the compliance culture in a country, programs are created by external software manufacturers, are not discussed here. not till manufacturers (Ainsworth). 71 Ainsworth, p.1. Phantom-ware may exist on many systems for completely Preventing Tax Evasion More Effectively legitimate reasons, such as enabling the buyer of a second-hand ECR to clear the system before starting to use it. It is hidden because it would be undesirable to authorize random use by employees. Often it relies on manual reprogramming, One consequence of a large shadow economy is that is an in which case it is called self-help phantom-ware. Often assistance by suppliers is needed to bring up the hidden phantom-ware functions. The fact that incentive to underreport sales and economic activities. As reprogramming is not recorded makes it difficult to detect. 107 Annex 1: Strategies to Combat the Shadow Economy Because Zappers are not integrated into operating generally accepted by businesses. Voluntary compliance systems, their use is difficult to detect. Zappers liberate works best where tax requirements are integrated with owners from the need to personally operate the cash standard business record and accounting systems. register. Remote skimming of cash transactions is now When such systems are reliable, compliance costs for possible without the cashier who physically rings up the both businesses and tax administrations are likely to be sale knowing. This attribute of Zappers allows skimming minimized.72 fraud to migrate beyond the traditional mom and pop stores. Zappers allow owners to place employees at the The OECD Forum on Tax Administration in “Guidance cash register, check their performance (monitor employee and Specifications for Tax Compliance of Business theft), but then remotely skim sales to cheat the taxman and Accounting Software” provides recommendations (Ainsworth: p. 1). for both tax administrators and software developers that apply to all accounting and business software and Awareness of the significant risks of sales suppression therefore include cash registers and POS systems (OECD has led to a wide range of responses by tax authorities 2010, p. 5). that can be effective in tackling the challenges and risks of electronic sales suppression. Those can be categorized The Guidance Note sets out seven principles (OECD 2010, as compliance oriented, audit, and fiscal till approaches. p. 10) for computerized business and accounting systems. Of course in reality most government responses in fact Based on those principles an innovative approach to consist of a broad mix of measures often combine two or voluntary compliance in this domain could be certification even all three of these categories. Whatever the dominant of the quality of POS systems. Specific standards for POS line of response a country chooses, the measures taken systems should apply internationally. This could have far- need to be part of a strategic approach that includes: reaching benefits, substantially reducing the market for electronic sales suppression; providing tax administrators, • Risk assessment: risks can be identified by special software developers, and users with certainty about audits targeted to specific industries. Extending the the compliance quality of POS systems; and reducing sample audits could help identify which retail and service compliance costs for all (OECD 2013, p. 25). sectors are most at risk. In many countries the focus is on restaurants but high risks have also been identified for Raising awareness of the devastating effects of sales small supermarket chains, retail pharmacies, hairdressers, suppression, both for tax revenues and for keeping the and other service providers (OECD 2013, p. 23). playing field level for private businesses, can also be part • An understanding of the POS market and POS suppliers, of the voluntary compliance approach. both domestically and internationally owned, and their relative shares of the market (OECD 2013, p. 24). • Clear and consistent legislation that reflects the The Audit Approach strategic intent to combat electronic sales suppression, including laws criminalizing the supply, possession, or use The audit approach comprises a variety of methods, of electronic sales suppression software (OECD 2013). ranging from the individual audit of a retail taxpayer through specialized e-audits to criminal investigations of taxpayers and suppliers of sales suppression software. The Compliance-Oriented Approach The basis for successful audits or investigations, however, is intelligence-gathering. Intelligence can originate both The Forum on Tax Administration's report Monitoring from public sources, such as ECR or POS manuals purchased Taxpayer’s Compliance (OECD 2013, p. 24) states that from a bookstore, and from internal information gathered compliance by taxpayers can be viewed in terms of by tax officers during audits or investigations, such as a whether compliance is achieved voluntarily or is corrected supplier’s client database. Tax laws must provide a legal by tax administration verification and enforcement basis for information-gathering. actions. In individual audits, traditional best audit practices Enforcing compliance via frequent checks, substantive such as calculation of private consumption, the search audits, and prosecutions is an expensive way to ensure for negative cash holdings, gross profit analysis, volume adequate compliance, so most tax administrations control, and operating cash flow/ net sales ratios can attempt to maximize voluntary compliance, encouraging prove useful to determine whether a business is likely to taxpayers to cooperate and actively comply with the tax be engaging in electronic sales suppression. Auditors can laws. This reduces the cost of administering the tax system but only practicable only when system requirements are well understood, relatively easy to comply with, and 72 Tax Guidance Series-Record Keeping: www.oecd.org/dataoecd/29/25/31663144.pdf 108 Annex 1: Strategies to Combat the Shadow Economy be taught how to obtain information from ECRs and POS • preservation of a complete audit trail and in some cases systems to reveal suppressed transactions. event monitoring; • equipping the system with a monitoring apparatus of Many revenue authorities have trained specialized some type; and e-auditors in the use of computer-assisted audit tools and • other technical measures to guard against subsequent techniques (CAATTs) to import large datasets and carry alterations in a way that will ensure that data integrity is out a wide range of analysis, and the use of specialized maintained (OECD 2013). audit software such as IDEA, ACL, or SESAM (OECD 2013, p. 18). In early versions fiscal tills secured the sales data at the end of a day’s operations; today, data are generally secured at After hardware and software are seized in a criminal the time they are created. investigation, testing and analysis in a computer forensic laboratory to search systems and tools that have been The working method is as follows: At the end of every secured. While the prime focus for seizure of data will be working day, the entrepreneur generates a daily financial the POS system, there are other sources for digital business report. All sales reflected in that report are written to a information that may be relevant, such as computers with protected memory, where the counts are updated with the back office systems and external storage media that could sales totals of that day. In some countries, the counts were be related to the use of zappers and phantom-ware. As long expanded to include ticket counts, refund totals, and other as seizure and review of such sources is legal, the challenge items. is to access the information so that it can be copied (OECD 2013, p. 20). If the digital analysis is aimed at detecting Originally, the ROM was sealed and secured in the machine the existence of electronic sales suppression software, itself by fixing it to the chassis with resin or epoxy. When analysis will largely focus on program files and entries in cash registers became more and more sophisticated and the operating system. The analysis procedure varies and systems became more and more PC-based, the protected can often require a range of expertise. One approach used memory could be placed instead in the separate printer often good results is to obtain application software from (then called a fiscal printer). the secured materials and review them. This can be done by running the program on another physical computer or A receipt issued states specifically whether it is a genuine on a virtual machine. fiscal receipt, representing a recorded sale, or is produced for training, as a pro forma invoice or a copy ticket. Fiscal Finally, a full criminal investigation is a possibility, using receipts also have a stamp in the footer containing a logo traditional criminal investigative techniques and even that must meet specific requirements regarding font and undercover operations jointly with other law enforcement lay-out (OECD 2013). agencies to target POS manufacturers. When sufficient evidence has been obtained to indicate guilt beyond a More recently, a growing number of countries, including reasonable doubt, the evidence is referred to a prosecutor Sweden, Turkey, the Netherlands, Greece, and many other for tax and any other criminal charges that may arise. EU members, are seeking to improve taxpayer compliance The goal of criminal prosecution, in addition to punishing by mandating the use of certified cash register systems the offender, is to deter others from committing similar for all cash-related business or for all business in specified offenses and enhance compliance by communicating the economic activities (e.g., restaurants). The aim is to stop message that tax evasion will be prosecuted and publicized. abuse and protect honest business owners from unfair competition. This approach is characterized by the use of equipment that adds a digital signature to some or all of The Fiscal Till Approach the data items on a receipt using encryption technology. This may include a monitoring device for storing receipt A growing number of countries have chosen to make the and signature data and updating grand totals in secure use of fiscal tills mandatory: cash registers that are required memory. Technical solutions of this kind not only add to conform to a set of specified technical requirements digital signatures, they also keep track of the tax-relevant (OECD 2013, p. 37), such as: data on receipts (OECD 2013). • electronic preservation of detailed data on transactions in specified formats, encrypted in specified ways, and A Sectoral Approach stored on specified devices; • detailed records that are only available when the tax A further refinement is for a tax administration to auditor requires them; conduct its own analysis of informal sector tax risks in addition to general analysis of the contribution 109 Annex 1: Strategies to Combat the Shadow Economy of specific business segments to informal activities segments and the impact of compliance management generally. Tax-specific sector analysis is intended activities. to identify economic sectors that combine a high incidence of shadow economy activities with above- An A.T. Kearney study of the shadow economy in Europe average revenue potential. To be of practical relevance found that heavily regulated industries and those that for compliance management, analysis needs to go one require regular contracts with customers had the lowest step further than the general plan for counteracting the levels of informality (Figures A1.1 and A1.2). Across Europe, shadow economy and identify precise subsegments of the study found that informality is highest in construction, economic activities that require priority attention and manufacturing, and wholesale and retail trade. specific strategies to improve compliance. Advanced Major improvements in reducing tax evasion can be Table A1.1. Sectors where Tax Evasion is Prominent Australia Belgium Canada Sweden USA Construction Construction Construction Construction Car sales Transport Gambling Hospitality sector Restaurants Construction Restaurants Transport Agriculture Hairdressers Health care Hairdressing and beauty salons Car sales Real estate agents Taxi companies Medical professions Cleaning services Diamond industry Taxis Trade in used metals Restaurants Clothing and textiles Dentists Hairdressing E commerce Real estate agents Motor vehicle retailers E-commerce Labor providers Art and antique dealing Heating oil distributors Source: OECD. tax administrations therefore have created sectoral expected from more in-depth sectoral analysis and risk maps of compliance in specific business segments. development of business-specific compliance improvement A common feature in such risk maps is the prominence measures. of construction and transport (in particular taxi companies) as areas of widespread tax evasion. Curbing Cash Transactions73 It is therefore highly recommended that the Serbian tax administration draw up its own compliance risk map to The principal reason that shadow activities emerge all identify priority areas for risk management. over the world is cash or payment for goods and services with cash, since cash makes it easier to conceal real incomes and almost impossible to trace such monetary Table A1.2: Denmark: Mapping of Compliance in Business transactions, thereby ensuring that this type of activity is Segments concealed from tax and law enforcement as well as state statistics agencies; the consequences are concealment of Segment Noncompliant Businesses, real incomes and tax evasion. By tracking cash transactions Percent and stimulating the use of cashless operations, the size Manufacturing 8 of the informal economy would presumably shrink, and Construction 17 tax collection would rise. The experience of countries Wholesale and retail trade 14 in Europe, America, and Asia proves the efficiency of Transportation 16 encouraging non-cash payments–electronic banking Hotels and restaurants 23 channels or card payments—as a way to combat the Consultancy 12 shadow economy. Finance and insurance 4 There are three main strategies that have been adopted: Examples from a tax gap and compliance analysis for • Tax policies and administrative efforts to boost cashless Denmark shows the importance of properly prioritizing payments and focusing initiatives to reduce sector-specific informal activities. Continuous gap analysis also makes it possible 73 Hyung Chul Lee, Senior Public Sector Specialist; Congyan Tan, Economist; Mariela Sanchez, Consultant; and Dzmitry Yarashevich, Voice Secondee are major to monitoring shadow economy trends in various industry contributors to this section. 110 Annex 1: Strategies to Combat the Shadow Economy • Collection and use of third-party information for tax There is also much still to do to build up financial purposes infrastructure and policies to facilitate cashless payments • Exchange of information between financial intelligence in the banking sector, but that discussion is for another units (FIUs) and tax authorities about cash transactions. occasion. Figure A1.1: Sectors Prominent in Shadow Economies Internationally (Percent of GDP) Distribution Average 40 35 30 25 20 15 10 5 0 Construction Wholesale Hotels Manufacturing Transport Agriculture, Community, Health Real estate renting, Mining, electricity, and retail and restaurants storage, and hunting, forestry social and and social work and business financial trade, etc communication and fishing personal activites services, etc. service activities Note: Examples are based on data for six focus conutries: Germany, Spain, Italy, Poland, Romania and Turky. Source: Dr Friedrich Schneider, Johannes Kepler University of Linz, Austria; Organisation for Economic Co-operation and Development; Eurostat; A.T. Kearney analysis Figure A1.2: Shadow Economy by Sector (Euro billion) O cial GDP 2013 Shadow economy 1.678 1.194 993 663 519 374 475 329 177 65 134 115 230 201 157 34 73 33 4 5 20 37 23 Manufacturing Real estate Wholesale Transport Construction Health Community, Hotels Agriculture Private Sectors Other and retail and and social social and and restaurants house-hold without personal communication network personal with employed shadow services service activities person economy Shadow economy as % sector 15% 7% 20% 14% 31% 10% 9% 19% 15% 12% - - Note: Eurostat reports by industry only gross value added (GVA) GDP sector split derived from the reported GVA numbers. Other personal services include entertain- ment, message, prostitution, household, and others. Material costs account for roughly 30 percent of that segment, they include new and second-hand goods and materials and may partly be reported both in the offical and unofficial GDP. Source: Eurostat, Dr Friedrich Schneider, Johannes Kepler University of Linz, Austria; A.T. Kearney analysis 111 Annex 1: Strategies to Combat the Shadow Economy Tax Policies and Administrative Efforts to Boost consider undeclared work to be more problematic than Cashless Payments undeclared or underreported goods or services (Jensen & Wohlbier, 2012). Several EU countries provide tax incentives A number of countries have provisions in their tax laws to encourage individuals to declare payments for household and financial sector regulations that give businesses service, which are otherwise highly likely to remain in disincentives for cash transactions and encourage the underground economy. They offer tax deductions for the expense of household cleaning, cooking, and individuals and businesses to conduct their financial laundry; care for children, old people, or disabled people; dealings through banking channels. Individuals in particular and maintaining a house maintenance to encourage need incentives that encourage cashless transactions. Cash movement of undeclared work into formal economy and transactions between business and individual consumers create jobs. The scope of eligible services, the amount of are a risk area. If individuals pay for the goods and services the tax deduction, and other specific tax incentives vary they consume, businesses have an opportunity to not by country; however the intention is to get undeclared report or to underreport the sales. However, consumers services to be declared by subsidizing household service have no incentive to seek invoices or receipts, because expenses to reduce the cost difference between formal they do not normally claim a tax credit for VAT or report and informal services. Public interventions to narrow the it as an expense for their income tax. If businesses offer cost difference from direct subsidies to household service their customers a lower price if they pay in cash than providers or users to such revenue expenditures as tax competitors do, customers are very likely to accept the deductions and exemptions, or reduced VAT rates. The discount. Cases like this are very difficult for the authorities European Commission’s report “Developing Personal and to detect, since there is no cross-checking and no conflicts Household Services” (2013) gives a detailed overview of of interest between sellers and buyers. Incentive programs tax incentives in the EU Member States. must therefore be designed to encourage consumers to engage in cashless transactions. Here are some ideas from Hong Kong: Hong Kong is known for the promotion other countries that Serbia might use. of its public transport card, the Octopus card, which is a smartcard that stores value. Now Octopus is growing China: In 2007 China’s Ministry of Finance launched beyond the subways and ferry stations where it started the public official card program and by 2011 its use was to become an accepted form of payment at many retail enforced. Officials in China’s central government must establishments. use a bank card to pay for 16 types of expense, from travel and meals to printing and conference registration India: India’s Income Tax Act requires third parties, such fees. Initially adopted as an anti-corruption measure, as banks, companies, and property registries to regularly it has also facilitated use of cashless transactions by provide information on the financial transactions of public officials and encouraged business partners to taxpayers (Section 285BA). Since unaccounted money adopt enabling infrastructures. Since 1999 local tax is often used to finance property transactions, this is an administrations in China have also held invoice lotteries important source of information about possible cash with rewards for reporting tax-evasive activities. Recently, transactions that the tax department can investigate. Two however, Beijing and some other local governments no years ago another provision was added (Section 194IA) longer do so due to the increasing prevalence of invoice to provide for deduction of tax at source on all property usage and non-cash transactions. transactions above Rupees 5 million. The purpose of this is to ensure that any hidden cash investment into property is Colombia: Article 850.1 of Colombia’s Tax Code gives recorded and at least minimum tax is collected. individuals a 2 percent VAT refund on purchases made by debit and credit card or by electronic banking for Mexico: Since the Mexican Central Bank has a mandate to products and services paid at the general 16 percent rate promote use of the most efficient payment instruments, or 5 percent rate. Since January 1, 2014, Tax Code Article in a number of ways, such as advertising campaigns, it 771.5 had required that, for expenses to be deductible, encourages the use of credit transfers instead of checks or they must be made through deposits in bank accounts, cash. Transition rules apply to secure rights and obligations bank transfers, checks, and credit or debit cards. Al Cash acquired during the effective term of the law, such as payments will only be deductible if they are within certain the obligation to file tax returns. To allow the Mexican ranges; different ranges apply for gambling. Tax Administration Service (SAT) to receive information on cash deposits, financial institutions must report cash European Union: Apart from facilitating electronic deposits made to the accounts of taxpayers when the payments, some EU member states have adopted monthly amount accumulated in all the accounts a monetary incentives and deterrent measures to encourage taxpayer holds in a single financial institution in the formalization of the shadow economy. EU countries financial system exceeds Mex$15,000. All acquisitions of 112 Annex 1: Strategies to Combat the Shadow Economy cashiers’ checks must also be reported. In January 2009, to recommendations, there are two aspects: one, provisions combat fraud the Mexican Central Bank set a Mex$20,000 in laws and regulations, i.e. the legal framework, and, two, ceiling on bearer checks. The 2014 Tax Reform bill allows required procedures needed to be laid down to ensure Mexican tax officials to screen credit-card data. Article implementation. 91 of the Mexican Income Tax Law, states that SAT may A number of countries have in place disincentives for audit incomes if credit card expenditures do not match the businesses to use cash: individual’s declared income. Initiatives have also been launched to offer payment services via mobile phones. Colombia: A discount on retail sales tax was introduced to intensify the use of e-payment cards in Colombia. The Federal Law on the Prevention and Identification of Operations with Illicit Resources, 2012, Article 32, prohibits EU: In 2010, the EU introduced a new rule (Directive use cash or precious metals over specified amounts for 2010/45/EU) on e-invoicing, which liberalized e-invoicing certain transactions. Other activities now regulated by requirements and to encourage e-invoicing adopted the anti-money laundering (AML) rules are construction the principle of equal treatment of paper and electronic services, property development, and the sale or purchase of invoices in terms of integrity and authenticity of contents. goods on behalf of clients; such services worth about Mex$ One major development was that an e-invoice could $500,000 must be reported. Similarly, the sale of new or be issued through any electronic channel and did not used vehicles, boats or aircraft worth about Mex$400,000 need advanced electronic signature or electronic data must be reported and the use of cash for such sales is interchange (EDI), which had previously been required for capped at about Mex$200,000; if a transaction has a e-invoicing. On the other hand, Chile, Korea, and Mexico higher price, the difference is to be paid by bank transfer recently adopted mandatory e-invoicing but only allow or check. more structured electronic formats such as XML. Due to the EU’s recent liberalization, the share of e-invoicing among Peru: Pursuant to Law No. 28194, obligations that are 17 billion invoices received by business and governments fulfilled through cash payments exceeding Soles74 3,500 or in Europe is estimated to have gone up from 8 percent in US$1,000 must be made by bank accounts, wire transfers, 2008 to 24 percent in 2014 (Koch-Billentis 2014, p. 32). payment orders, credit cards, non-negotiable checks, or other means of payment provided by Peruvian financial India: In India, the Income Tax Act discourages the use entities. Obligations paid for in cash may not be deducted of cash for business transactions through Section 40A and by the debtor as an expense or be used as a credit for tax Rule 6DD. For instance, Section 40A (3) and (3A) provide purposes. that any expense over Rupees 20,000 in a single day will not be deductible as a business expense if payment is In their tax laws and financial sector regulations, a not made through bank instruments. Rule-6DD identifies number of countries provide disincentives for cash cases and circumstances in which a payment or aggregate transactions in business and encourage individuals and payments exceeding Rupees 20,000 may be made to a businesses to conduct their financial transactions through person in a day through an instrument other than by an banking channels. Authorities find it hard to detect informal account payee check drawn on a bank or a bank draft. transactions in cash rather than transactions traceable through bank transfers and credit or check card payments. Kazakhstan: The Resolution of the Government of the Informal firms—those not registered for tax—often pay or Republic of Kazakhstan (December 29, 2012 No. 1743) receive cash only for their business and also pay cash to their states that individuals who carry on certain types of employees. Formal firms that want to under-report income business are obliged to accept payment cards and therefore prefer cash transactions and pay cash to their own informal to install POS terminals. Based on work performed in 2013, employees. In either case, firms are evading income tax or according to the Plan for 2013–15, the People’s Bank VAT completely or partially, and informal employees are of Kazakhstan and Kazkommertsbank have introduced not subject to income and social security taxes. Having a service to accept payments through payment cards provisions in tax laws and financial sector regulations that by means of POS-terminals whose cost is affordable to give businesses disincentives for cash transactions and business entities (about 10,000 tenge, equal to about $55). encourage individuals and businesses to conduct their Another five banks are considering doing the same. financial transactions through banking channels ensures that the tax authorities can track business transactions to Mexico: The 2014 Tax Reform bill package75 will require lower the risk of tax evasion. In terms of application of the uniform creation of electronic invoices, and all invoices documenting transactions carried out by or between ‘Nuevo Sol’ is the Peruvian currency. 74 Mexican enterprise taxpayers must be electronic and made These reforms were effective January 1, 2014. The Tax on Cash Deposits Law 75 available through the Internet. Only certain small taxpayers was approved by Mexican Congress on October 31, 2013 and published in the Official Gazette on December 11, 2013. are allowed to continue producing paper invoices. 113 Annex 1: Strategies to Combat the Shadow Economy Furthermore, deduction of expenditures of a company electronically to the tax authority. Since 2007 it has been in Mexico must be backed by a digital tax receipt (CFDI) mandatory that designated businesses that provide goods according to article 29 of the Mexican Tax Code, and and services primarily to consumers, such as lawyers, payments that exceed Mex$2,000 should be made accountants, or doctors, should issue cash receipts at the through electronic funds transfer; personal check; credit, consumer’s request. Since 2010, designated businesses debit or service cards; or through an electronic pocketbook. have to issue cash receipts where the value exceeds KWN To acquire fuel for sea, air, and land vehicles payment 300,000 (about US$290) even if the consumer does not should be made using the methods specified even if the request it. Businesses that violate the duty of issuing cash amount is lower Mex$2,000. receipts are subject to a penalty of 50 percent of the transaction value. The value of cash receipt transactions Lastly, the state has subsidized purchase and installation increased 4.4 times after the receipts were introduced, of electronic payment terminals in retail shops, which has from KWN 18.6 trillion in 2005 to KWN 82.4 trillion in 2012. significantly increased their use. The list designated businesses for which issuance of cash receipts is mandatory has continued to expand, and in July South Korea: Since the late 1990s a number of measures 2013 the threshold for mandatory issuance went down have been adopted to encourage electronic payments, from KWN 300,000 to KWN 100,000. among them electronic payments in business-to-consumer (B2C) and business-to-business transactions. Individual businesses that use double-entry bookkeeping should Electronic Tax Invoices (ETI) for Curbing VAT transfer and receive funds through a business bank account Refund Fraud when they supply and purchase goods and services. It is believed that transactions between businesses South Korea has also introduced measures to encourage are more transparent than those between businesses record-traceable payments, such as credit cards, check and consumers. Invoices are critical role for verifying cards, and electronically traceable cash receipts in B2C transactions because they have a cross-checking function transactions. All these measures should give consumers between business sellers and buyers in invoice-based input incentives to prefer electronically traceable payments tax credit VAT system. However, there are still problems of over cash. With these measures, consumers began to ask input tax credit fraud based on fictitious invoices. business sellers to accept credit cards, and it is now believed that by curbing cash translation the measures contributed Korea introduced the electronic tax invoice (ETI) and to a considerable extent to broadening tax base. The basic the early warning system (EWS) to curb fictitious invoice idea is that the incentive structures motivate consumers to fraud. The ETI has been recognized as a valid invoice use traceable payment methods, which create a conflict since 1997. However, it only became mandatory in 2011 of the interests of buyers and sellers: In this new setting for all corporate businesses and in 2012 for individual business sellers really have to accept customers’ new businesses for which turnover exceeded KWN 1 billion payment demands. (about US$ 990,000). The EWS to tackle possible frauds was established early in 2012 based on the ETI. The basic The basic incentive is to allow credit card or check card usage idea is that the EWS issues warnings of possible fraud as a deduction from the individual’s income when they file even before a tax return is filed if it detects suspicious an income tax return. When it was introduced in 1999, 10 transactions from the real-time ETI information. The percent of credit or check card usage in value terms (not warnings prompt tax officials to check the site and visit exceeding KWN 3 million, about US$2,900) that exceeded taxpayers, and can also trigger tax investigations if 10 percent of total wage income was eligible for income needed. Even without investigation, it can warn taxpayers deduction. As a result, between 1998 and 20003 credit card to file a correct tax return. It is reported that in 2012 EWS usage soared at an annual growth rate of 57.6 percent in detected KWN 5.04 trillion in fictitious invoice transactions terms of number of transactions and 47.7 percent in terms and charged KWN 374 billion in tax. of total value (Bank of Korea 2013 Since 2004, with mature usage of credit cards the incentives have been curtailed. As of 2013, 15 percent of credit card usage exceeding 25 percent of total wage income is an eligible deduction. Mandatory Payments through a Business Bank Account In 2005, electronically-traceable cash receipts were introduced so that consumers can pay cash and ask Individual businesses that should maintain double-entry businesses to issue cash receipts if they do not want to a bookkeeping according to the South Korean Income use credit or check card. Sellers then issue cash receipts Tax Law and providers of professional services, such as through terminals that transfer the transaction information lawyers, accountants, and doctors should use a business 114 Annex 1: Strategies to Combat the Shadow Economy bank Account (BBA), when they supply or purchase goods Taiwan’s MoF initiated its e-invoice development and services for business purposes; when they pay or project in 2004 and in 2010 the promotion of e-invoice receive payments through financial institutions; and applications project was proposed to extend the scope when they pay personal expenses or rent. This mandatory of adoption. The MoF has established an e-invoice initiative took effect on January 1, 2007. Double-entry platform to provide such services as invoice certification, bookkeeping is mandatory for individual businesses whose tax services, data exchange, and statistical analysis. annual sales exceed a designated amount, depending on the industry sector they are in. For example, the threshold While the Chinese76 government has not yet rolled out for individual businesses in agriculture, forestry, fishery, electronic invoicing for combined business and tax mining, or wholesale or retail businesses is KRW 300 purposes, it has acknowledged the benefits of using million (about US$ 300,000). Any individual businesses information technologies for tax control. This led to the in that category that do not use BBAs are subject to a creation of the Golden Taxation Project (Figure A1.3) in penalty of 0.2 percent of the noncompliant payment 1994. This system is being rolled out gradually; where it amount. is in place, its use is mandatory for all VAT-able invoices. The Golden Tax System is an on-line invoice-checking Taiwan and China: Invoicing is critical for both Taiwan network based on paper invoices. It now links some and mainland China for tax compliance purposes, and 4,000 tax authorities at and above the county level. It modern systems are the foundation that supports a rising is viewed as a major success since it has significantly volume of cashless transactions. Although most invoicing decreased tax fraud. Currently the system is in its third is still paper-based, businesses increasingly use online rollout phase. systems. Figure A1.3: Rollout of the Chinese “Golden Tax System” Aiming to cover VAT taxation and on-line checking system Aiming to covering all categories of taxes 1st Stage 2nd Stage 3rd Stage Launched two separate running The online taxation network Estimated 5 years construction and systems which are covering all of the tax bureau at and 8billin RMB investment ”Anti-counterfeiting taxation above country level. system” and Cross-check auditing A overall taxation CTAIS (China system” The network contains 11 sub systems Taxation Administration Information which covering the whole process of System) will be established. 50cities was picked fore test VAT taxation. (refer to the next side) running. Including 7 sub-systems, 36 modules. All of the ordinary VAT taxpayers are Could deemed as handwork compulsive to be involved The 7 sub-system are: enagment, computerization. taxation, auditing, punishment, execution, relief, monitoring system. Covering all catageories of a taxes taxation and auditing To link and share inforamtion with commercial bureau, banks, customs and statistic deprtment. Taiwan now has a lottery mechanism to encourage Turkey: As part of an initiative to reduce the number consumers to get B2C invoices. The Government of Taiwan of cash transactions, Turkey established new payment introduced the Taiwan receipt lottery as early as 1951 as requirements and mechanisms. Payments of amounts an incentive to raise revenues. As of 2011 prizes ranged over TL 8,000 and any rental payments over TL 500 must from NT 200 to NT 10 million and total prizes amounted be made through the banking system or a postal office. to NT 7 billion (US$20 million). Self-employed doctors, dentists, and veterinarians must use POS devices in their offices. For receipts to be accepted, 76 China’s Law on Administration of Taxation of the People’s Republic of China they must be generated by these devices. To help eliminate (2001) regulates tax compliance in mainland China. The implantation ordinance the informal economy, enterprises employing more than of the law No. 362 Decree of State Council of the People’s Republic of China— 10 employees must pay their salaries, including bonuses, Regulation of Implementation of Tax Collection and Administration of the People’s Republic of China (2002) also rules tax compliance. through banks. 115 Annex 1: Strategies to Combat the Shadow Economy Several countries, among them France, Turkey, Greece, Italy, India: Provisions in the Prevention of Money Laundering Sweden, Norway, and the Netherlands, have also imposed Act (PMLA) 2002 and in the Financial Intelligence Unit caps on cash payments, require merchants to issue receipts operating rules form the core of the legal framework for each transaction, and have allowed merchants to refuse India has put in place to combat money laundering. The cash to compel the use of cards. These measures have directors of the FIU-INDIA and of enforcement have made fiscal controls easier and have allowed merchants to been given exclusive and concurrent powers to implement make major changes to gain efficiency. the provisions. The regulations require reporting of cash transactions to the tax authorities, which allows them to investigate cases to determine if the cash represents Collection of Third-part Information for Tax unaccounted income that can be made taxable. The PMLA Purposes and rules impose the following obligations: Countries across the world provide for third parties such as • Banking companies, financial institutions and financial institutions to share information regularly with intermediaries to verify identity of clients. tax authorities or other financial intelligence units (FIUs). Some have already been covered in previous sections. • All reporting entities must report to the director, FIU-IND There follows the experiences of several countries with the on all purchases and sales by any person of immovable collection and sharing of cash transactions data with the property valued at Rs 5 million or more that is registered competent authorities. by the reporting entity. Colombia: The law requires financial institutions to keep • All reporting entities must report to the director, FIU-IND records of account holders and financial transactions for on all cross-border wire transfers valued at more than five years. Secrecy laws have not been an impediment Rs500,000 or its equivalent in foreign currency when to bank cooperation with law enforcement officials, either the origin or the destination of the funds is India. since Colombian law makes an exemption to client confidentiality rules when a financial institution suspects • Every banking company, financial institution, and money laundering. General negligence laws and criminal intermediary, must report to FIU-IND information on all fraud provisions ensure that the financial sector complies cash transactions where forged or counterfeit currency with its responsibilities while protecting consumer rights. notes or bank notes have been used as genuine or where The Financial Superintendent supervises obligated entities. any forgery of a valuable security or a document has taken In June 2008, the Financial Superintendent issued a circular place to facilitate a transaction. effective that October77 that further tightened financial reporting requirements for the financial, insurance, and • Every reporting entity (a banking company, financial securities sectors, with strict deadlines for submitting institution, intermediary or a person carrying on a regular transaction reports: financial entities have to report designated business or profession) must maintain records monthly cash transactions over Col$10 million (US$5,000), and furnish information78 to FIU-IND relating to: wire transfers of US$500 equivalent, and transactions of - All cash transactions valued at more than Rs 1 million (10 smaller amounts that over a month add up to Col50 million lakhs) or the equivalent in foreign currency or US$50,000, and wire transfers of US$1,500 equivalent. - All series of cash transactions integrally connected to each other that have been valued at less than Rs 1 million Providers of mobile banking services in Colombia must (10 lakhs) or the equivalent in foreign currency where all share the following information with the tax authorities to transactions in the series took place within a month be eligible for the 2 percent VAT refund on purchases made - All transactions involving receipts by nonprofit by debit and credit card, as well as electronic banking for organizations valued at more than more than Rs1 million, products and services paid at the general 16 percent rate or the equivalent in foreign currency or 5 percent rate: the basis for calculating the two VAT - All cash transactions where forged or counterfeit currency points to be refunded, the total amount of VAT generated notes or bank notes have been used as genuine or where and paid in the transaction (at the general 16 or 5 percent any forgery of a valuable security or a document has taken rate), and the information of the parties to the transaction. place to facilitate the transactions - All suspicious transactions, whether or not made in cash - All cross-border wire transfers of the value of more than Rs 77 External Circular No. 022 2007, regarding the System for Preventing Assets 500,000 (five lakhs) or the equivalent in foreign currency Laundering and Terrorism Financing (“SARLAFT”). The 2009 regulation incorporates some new reporting standards that must be adhered to in reporting where either the origin or destination of the funds is India to the regulator. - All purchase and sale by any person of immovable property 78 In India, the Income Tax Act also requires third parties such as banks, valued at Rs 5 million (50 lakhs) or more that is registered companies and property registries to regularly provide information on the financial transactions of taxpayers (Section 285BA). by the reporting entity. 116 Annex 1: Strategies to Combat the Shadow Economy Mexico: As part of the National Anti-Money Laundering aspects of financial systems and criminal law. FIUs are (AML) / Countering the Financing of Terrorism (CFT) an important component of these strategies. An FIU Strategy, Mexico has restricted the use of cash in its is a central national agency responsible for receiving, financial sector.79 The AML/CFT General Provisions for analyzing, and transmitting disclosures on suspicious banking institutions were amended on June 16, 2010 to: transactions to the competent authorities. Combating • Limit the amounts of US$ in cash that banking institutions the crimes of money laundering and financing terrorism are allowed to accept from clients or occasional customers is essential to the integrity of financial systems but if such through deposits or other transactions, and efforts are to be successful, traditional law-enforcement • Obligate banking institutions to report transactions methods need to be supported by contributions from involving US$ in cash that exceed the limits set in the the financial system itself, in particular by financial regulations. institutions implementing know-your-customer principles and reporting suspicious transactions to an FIU. The On September 9, 2010, almost identical rules were imposed following examples illustrate how FIUs are set up, collect on currency exchanges and securities brokerages. New information, and share it with tax authorities. requirements have also been put in place for identifying clients performing transactions in smaller amounts Colombia: Colombia’s FIU (Unidad de Información y (starting at US$ 500), which should counter structuring of Análisis Financiero/ UIAF) is the central authority for transactions to avoid detection of suspicious transaction reporting unusual financial operations. The unit operates reports (a.k.a., smurfing). For wire transfers, the authorities within the Ministry of Treasury and Public Credit, along report that the threshold has been changed to US$1,000. with other AML regulators established by the law. The UIAF investigates unusual financial operations reported Financial institutions in Mexico also have to report cash by certain sectors of the economy that are obliged to deposits made to taxpayer accounts when the accumulated report directly because they are especially vulnerable to monthly total of cash deposits in all the accounts a taxpayer money-laundering related activities, and any person or holds in a single financial institution exceeds Mex$15,000. entity who reports voluntarily. All acquisitions of cashiers checks must also be reported. The main functions of the UIAF, as established by Law Peru: Law Nº 2830680 requires that any person, national or 526 of 1999, are to: alien, entering or leaving the country, must declare under • detect and prevent possible asset laundering and oath, cash or financial instruments he or she carries for terrorist financing in all economic activities; amounts greater than US$10,000 or its equivalent in local • collect, centralize, and analyze the information received or foreign currency.81 Moreover, Law Nº 28306 requires from financial institutions, other companies, and records of cash transactions (Article 9) and the recording individuals; and notification of cash transactions. That obligation • report specific cases to the Superintendence of Finance, applies to certain institutions and individuals specified in the Tax Administration, and the Prosecutor’s Office; article 8 of the law. • carry out AML studies and provide best practice guidelines for sectors and economic operations South Korea: To collect the information needed for characterized by a particular risk of money laundering taxation, Korea enacted the Act on the Submission and occurring; and Management of Taxation Data in 2000. It required that • propose new AML control mechanisms and amend central government agencies, local governments, financial those already operative. institutions, public or private organizations that receive subsidies from the government or public organizations, and Mexico: In 2004, the Mexican federal government state-owned companies regularly provide specified tax- created its FIU with the primary function, aligned related information to the National Tax Service. with international standards, of being the national governmental body responsible for receiving, analyzing, and disseminating financial information concerning Information Exchanges between FIUs and the transactions suspected of being related to money Tax Authorities laundering or terrorist financing (ML/TF). Recent efforts to draw up effective strategies for anti- Peru: Peru’s FIU is the ‘Unidad de Inteligencia Financiera money laundering and combating the financing of del Perú (UIF-Perú)’. The UIF-Peru is a unit of the Peruvian terrorism (AML/CFT) bring together distinct but related Regulator for Banks, Insurance Companies and Pension Funds (SBS) and is responsible for receiving, analyzing, 79 Refer to section 4 for more details. processing, and transmitting information in order to 80 For an English version, see Act Nº 28306. 81 6th complementary, transitory, and final provisions of Act Nº 28306 detect (ML/TF). The UIF-Peru also helps obligated 117 Annex 1: Strategies to Combat the Shadow Economy individuals or organizations (those covered by the AML or complete data sets of suspicious transaction report CTF laws) to contributes to establish specialized systems information, which the tax administration uses in its to detect ML/TF operations. automated data matching and data mining programs. Ireland: Ireland requires financial institutions and other Italy: The Italian FIU has direct access to the Anagrafe reporting entities to submit Suspicious Transaction dei Conti Account and Deposit Register maintained by the Reports to both the tax administration and the FIU, and tax administration, which has information on accounts broad gateways permit the agencies to share information. and financial transactions carried out by financial After the requirement that financial institutions submit intermediaries. Since 2009, information obtained by the suspicious transaction reports to the tax administration FIU from the Anagrafe dei Conti has been extremely useful. was introduced in 2003, the Irish Revenue carried In particular, the information has been used in analyzing out extensive discussions with the institutions. These suspicious transaction reports, improving international emphasized the obligation to submit suspicious cooperation by providing information to be shared transaction reports where there were suspicions of money with overseas FIUs, and enhancing the effectiveness of laundering and the predicate offense was a possible inspections and audits, especially those with respect to tax crime. The campaign was successful: suspicious non-cooperative financial intermediaries. Legislation has transaction reports submitted went up from about 3,000 also been passed that gives the Italian FIU direct access in 2003 to 5,000 in 2004 and 14,000 in 2008. About to the Anagrafe Tributaria (Tax Register) which will give 80 percent of the reports received relate to possible the FIU access to information on Italian taxpayers. The tax offenses. Since 2003, Irish Revenue has settled 578 Italian FIU has signed memoranda of understanding with civil tax assessments supported by information in the the Bank of Italy and the Insurance Supervisory Authority suspicious transaction reports, raising additional revenue setting out mutual obligations to share information and €60.1 million. Currently 25 tax crime prosecutions cooperate in combating money laundering and ensuring underway in Ireland were initiated based on information effective supervision. A memorandum of understanding in suspicious transaction reports. Specialists from the FIU is currently being negotiated between the FIU and and the tax administration meet regularly to discuss their the Securities Supervisory Authority. The Italian FIU analyses of suspicious transaction reports, coordinate works closely with the Guardia di Finanza; 97 percent investigations where there is evidence of both tax and of suspicious transaction reports are submitted to the non-tax offenses, and discuss broader operational issues Guardia di Finanza for investigation into suspected related to money laundering investigations. Each agency money laundering or tax evasion. The FIU may also also attends feedback meetings between the other delegate investigations and audits of non-cooperative agency and businesses required to submit reports. This financial intermediaries to the Guardia di Finanza. ensures that the agencies display a united front in their dealings with the public. Turkey: In 2009 and 2010 the Turkish FIU received suspicious transaction reports related to possible usury carried out using POS machines. Specialists within the FIU analyzed these reports and determined that, in addition to usury, the predicate offenses underlying the reports included possible tax crimes. The FIU shared its analysis with the Tax Inspection Board, which investigates tax crimes in Turkey. The board launched a number of investigations, during which officials identified additional unreported taxable income and evidence of tax offenses. The board shared the results of its investigations with the FIU, which resulted in the FIU submitting the case to the public prosecutor’s office for prosecution of money laundering offenses. Australia: In Australia, the tax administration has a right of access to all FIU information, including direct access to all suspicious transaction reports, via a secure online connection. This may be used for any purpose relating to administration of taxes and enforcement of the tax law. The FIU also provides the tax administration with 118 ANNEX 2: PUBLIC AND PRIVATE SECTOR SALARIES BY OCCUPATION ANNEX 2: PUBLIC AND PRIVATE SECTOR SALARIES BY OCCUPATION (PRIVATE SECTOR INDEX=100) Public sector 1 Administration 2 Before After Before After 10% reduction 10% reduction 10% reduction 10% reduction Information and communications technicians 78.9 % 71.0 % 78.9 % 71.0 % Information and communications technology professionals 82.7 % 74.4 % 82.0 % 73.8 % Administrative and commercial managers 90.6 % 81.5 % 91.9 % 82.7 % Experts, sciences 94.6 % 85.1 % 94.3 % 84.8 % Refuse and other elementary workers 98.8 % 88.9 % 100.2 % 90.2 % Cleaners and helpers 100.9 % 90.8 % 102.6 % 92.4 % Personal service workers 101.4 % 91.3 % 102.7 % 92.4 % Building and related trades workers, excluding electricians 101.5 % 91.3 % 102.4 % 92.1 % Production and specialized services managers 101.7 % 91.6 % 103.9 % 93.6 % General and keyboard clerks 102.2 % 92.0 % 102.4 % 92.2 % Food processing, wood working, garment and other crafts, and 103.5 % 93.2 % 103.1 % 92.8 % related trades workers Laborers in mining, construction, manufacturing, and transport 104.1 % 93.7 % 104.9 % 94.4 % Legal, social, cultural, and related associate professionals 104.2 % 93.8 % 105.1 % 94.6 % Health-associated professionals 104.6 % 94.2 % 110.2 % 99.2 % Legal, social, and cultural professionals 104.8 % 94.3 % 106.8 % 96.1 % Business and administration professionals 105.3 % 94.8 % 105.2 % 94.7 % Other clerical support workers 108.4 % 97.6 % 108.4 % 97.5 % Customer services clerks 109.4 % 98.5 % 110.9 % 99.8 % Business and administration associate professionals 110.2 % 99.1 % 110.6 % 99.6 % Teaching professionals 110.2 % 99.2 % 104.8 % 94.3 % Numerical and material recording clerks 111.9 % 100.7 % 111.4 % 100.3 % Drivers and mobile plant operators 113.4 % 102.0 % 114.4 % 102.9 % Sales workers 114.5 % 103.1 % 114.7 % 103.2 % Metal, machinery, and related trades workers 119.0 % 107.1 % 119.0 % 107.1 % Other / unspecified 121.0 % 108.9 % 119.1 % 107.2 % Chief executives, senior officials, and legislators 121.1 % 109.0 % 122.5 % 110.3 % Electrical and electronic trades workers 121.6 % 109.4 % 123.3 % 111.0 % Agricultural, forestry and fishery laborers 123.1 % 110.8 % 122.2 % 110.0 % Science and engineering associates professionals 125.9 % 113.3 % 124.7 % 112.3 % Health professionals 126.9 % 114.3 % 127.0 % 114.3 % Stationary plant and machine operators 132.7 % 119.4 % 132.1 % 118.9 % Protective services workers 157.1 % 141.4 % 157.3 % 141.6 % Source: Serbia Labor Force Survey 2014; analysis by IPSOS. 1 Includes state and local governments. 2 Includes central public administration but not state-owned enterprises. 119