RIGA - When beginning work on drawing up the 2011 budget, the Latvian government will have to decide whether to implement tough budget cuts recommended by the World Bank, reports news agency LETA. The World Bank’s public expenditure review includes several hundred recommendations on how Latvia can achieve the necessary budget consolidation for 2011.
In the several hundred page document, the World Bank points out that the planned savings are possible to achieve by carrying out pension reforms, implementing reforms within the state administration, as well as many other areas. For example, the World Bank points out that immediate savings can be achieved by recovering a portion of larger pensions that have been paid out, whilst at the same time leaving the smallest pension categories untouched. The World Bank also recommends increasing the retirement age in Latvia from 2015.
According to the World Bank, there is little, if any, room for further reductions in the budgets for health and education. The public expenditure review concludes that the health sector and the education sector have borne the brunt of fiscal adjustment in the 2009 and 2010 budgets.
The report points out that structural reform of health and education are on track and are showing measurable improvements, but they need to be continued with care and commensurate financing. The World Bank goes on to say that there is still much to be done in the health and education sectors to make them perform to the high standards of an EU member state.
The World Bank also points out that despite some consolidation in 2009, the public administration could be further streamlined at the national and municipal levels of government, although to ensure that it retains skilled and motivated civil servants, it warns against further reductions in public sector salaries at the national government level.
The report also states that short-term savings can be achieved through a reduction of the maximum salary levels to bring them closer to the current average salaries paid by ministries and agencies, thus saving 1.5 million lats (2.1 million euros) in 2011, and 2 million lats in 2012.
Further staff reductions to pre-2007 levels, particularly in agencies subordinated to ministries and local government bodies, are possible, according to the World Bank, and, if implemented carefully, would not risk the quality of public services. At the same time, the government could merge several ministries and government bodies with one another, thus reducing expenditures by approximately 3 to 3.5 million lats.
The report also goes on to say that significant savings can be found from phasing out direct subsidies to loss-making enterprises at both the central and municipal levels. The World Bank then points out that in order to improve the equity impact of the welfare system, the government could replace the earnings-related Parental Benefit with an augmented flat Childcare Benefit of 100 lats paid from the budget. Another idea is for Family State Benefits to be targeted to poorer households with children, to improve their impact and reduce waste.
Furthermore, in order to retain and attract good teachers, the government could maintain the level of salaries of general primary and secondary teachers and the parity of teacher remuneration with workers with similar qualifications in the public sector. The World Bank also recommends that the government could reduce budget-financed student places in higher education, financing these at a more adequate level, and prioritizing them for the poorest applicants.
The World Bank also mentions in its report several areas where the government can save in the health care sector, even though it also goes on to say that the most important opportunities for structural reforms created by the economic crisis have already been seized by the Ministry of Health.
Consolidation of the 2011 state budget, though, will not be possible if only spending is reduced; the tax burden will also have to be increased, believe bank economists. In order to reduce the deficit in the 2011 state budget to 6 percent of GDP, according to the Bank of Latvia’s estimates, budget consolidation must be equal to at least 400 million lats. The Finance Ministry’s projection, based on the latest economic trends, is 350-395 million lats.
SEB bank socioeconomic expert Edmunds Rudzitis said on Sept. 30 that there were no signals at the moment suggesting that the budget deficit could be reduced only at the expense of spending cuts, and without increasing the tax burden. He said he expects that the easiest way will be sought to solve the budget deficit problem, and taxes will be raised. Most probably, this could concern property taxes. “This is inevitable,” Rudzitis pointed out.
Nordea bank chief economist Andris Strazds also said that budget consolidation in the necessary amount would be impossible without tax increases. Strazds said the most likely tax changes might be lifting of the reduced value-added tax rates and introduction of progressive income tax that, according to various estimates, could bring in an extra 100 million lats each year. “Increasing direct taxes, though, would damage the competitiveness of Latvia’s exports and options for attracting new investment,” said Strazds.
It is important that next year’s budget consolidation does not take place at the expense of taxpayers, but rather by reducing expenditures, the president of the Bank of Latvia Ilmars Rimsevics believes. In an interview on Latvian Radio, he emphasized that it would be wrong to cut expenditures equally in each sphere, and mentioned culture as an area where cutting expenditures further should not take place.
The head of the central bank pointed to the necessity to carry out structural reforms. “The head of the government must look at what type of education is being financed in Latvia, and what we see as the end product,” said the Central Bank chief, who explained that it is necessary to evaluate how many schools there are in Latvia, how many teachers there are, and if children are being educated properly. At the same time, it is also necessary to evaluate the work of higher education establishments, their curricula, as well as how many scholarships are on offer.
“The same goes for the health sector and the state administration,” said Rimsevics, who emphasized that discussions must take place on structural reforms, and these discussions must be public, so that it is clear to people which functions the state could give up.
Even greater budget consolidation measures should be carried out than those previously discussed, in order to achieve a budget deficit of below six percent of GDP next year, indicated Finance Minister Einars Repse (New Era) in late September.
Repse said that the official agreement with the lenders foresees a budget consolidation of 395-440 million lats, though current tendencies (an improving export sector) allow the hope that the necessary consolidation could amount to 350-395 million lats. However, the actual situation will only become clear once the economic indicators for the third quarter are known.
The finance minister repeatedly stressed that it would be a good thing to reduce the deficit even further, to below six percent of GDP, saying that this could only be good for the country.
The minister stressed that the new government should not get carried away with tax increases, but should transfer the tax burden from labor onto consumption, meaning the abolishing of reduced VAT rates and an increase of the tax-free minimum on salaries. The minister also predicted that the new government would have to discuss the sustainability of the current pension system.
The minister noted that it was not only the Finance Ministry that developed the state budget, and reminded that each ministry should come forward with its own proposals for reducing spending.