Examples of Public Expenditure Cuts and Rationale for Savings – Case of

EstoniaJürgen Ligi

Minister

Structure of the Presentation

I. Principles of economic policies

II. Consolidation effort 2008+

III. Conclusions: policy implications, political economy lessons

I. Principles of economic policies

Hypothesis:

Natural emphasis on long-term supply side policies has minimized sizable governmental intervention in the demand side, including fiscal

Key Indicators

• Population:• Area:• GDP• GDP per capita:• GDP vs EU-27(PPS):• Average monthly wage• CPI•Total government expenditures

• 1.34 million• 45 226 km²• 14,5 bln EUR• 10821 EUR• 64%• 784 EUR• 3,0%• 42% of GDP

1. Culture of prudence – enables to switch on the autopilot

• Small and efficient government sector

• Early, rapid and extensive privatization, mostly to strategic investors

• Relatively low level of corruption (26th in Transparency International CPI in 2010)

• Stakeholder accountability (by state, by tax-payer, as a member of eurozone, NATO)

2. Robust and simple monetary and fiscal framework – stability as a merit and trust builder

• Currency board-backed fixed exchange rate 1992-2011; euro 2011+

• Sound fiscal management since transition - natural preference of conservative fiscal policy

• Mid-term budgetary objective “balanced or in surplus” well rooted informally for a long time. New MTO – structural surplus

Estonia` s budget fairly balanced over the last decade. Surplus restored in 2013

Very low debt enables to keep the tax burden relatively light to back economic

growthPublic debt 2001 and 2011 (% of GDP)

0

10

20

30

40

50

60

70

80

90

EU (27) EE SK

2001

2011

3. Simple and transparent tax system

• Income tax has one bracket and one rate for households and distributed corporate earnings alike

• Most of the goods and services are subject to a single VAT rate with only a very few items taxed at a lower rate

• Relatively low level of capital taxation

• Baseline: no punishment on success - business stimulates the economy, generating sufficient resources also for social safety nets

• Relatively low tax burden

4. Pension and health care systems reformed at an early stage - low risk compared to EU in

terms of sustainability

• Fundamental change of public expectations on the role of state and of state budget

• Reforms have put a ceiling on the future liabilities of the state

• II pension pillar introduced in 2002• State Health Insurance Fund established in 2001,

buying health services from service providers (general practitioners and hospitals)

• Estonia’s long term fiscal sustainability is the best in the EU. However, it is likely that future reforms are needed

5. Open and business-friendly trade, investment and labor policies

• Continually substantial flows of FDI (cumulatively ca 76% of GDP as of end-2010)

• Quick and easy business establishment and registration

• Strong and competitive telecommunications and banking sector, integrated with Scandinavian and European markets

• Flexible labour market – easy hiring and firing, low level of wage indexation, low degree of unionization

Labour market has served as a good substitute for the exchange rate channel, allowing the economy to cope well in recession

.

Source: Estonian Tax and Customs Board, Statistics Estonia

II. Consolidation Effort 2008+

Although rough times of consolidation are behind, the mentality of saving lasts - majority of measures are

long-term; operational expenditures freezed

Improvement of the budget position 2008-2010

0

2

4

6

8

10

12

14

16

18

2008 2009 2010 Cumulative 2008-2010

Scale of the improvement of budget position (% of GDP)

Principles of Fiscal Adjustments 2008+

• Count on the internal adjustment of the economy and buffers collected pre-crisis

• Euro - better confidence builder than fiscal loosening

• Co-financing of EU structural funds protected

Decisiveness of the government to consolidate did not lag behind fall of GDP

Consolidation at Glance

• Cumulative tightening in 2008-2010 amounted to ca 16% of GDP in nominal terms, compared to the baseline

• 2/3 of measures on the expenditures side• 1/3 of measures on the revenues side

• Ca 70 % long-term measures• Ca 30 % one-offs (incl. 1+ years)

Cuts covered most of the agents. Some examples:

• Cut of operational expenditures of the public sector (20% compared to pre-crisis level)

• Lower increase of pensions from 2009 onwards (5% increase in 2009 instead of ca 14%, no increase in 2010 and 2011)

• Major cuts of road maintenance, local gov. funding, defence budget• Reform of the compensation scheme for sick days and reduction of

health insurance costs by 8%• Suspending govt. co-payments to the II pillar pension funds for

2009 and 2010, gradual resumption of payments thereafter• Borrowing of local government curbed by a law (2009-2010) –

same measure for public foundations• Etc

• Changes in employment contract act and related acts: marked increase in market flexibility

Operating expenditures have fallen remarkably and are freezed below pre-

crisis level

6,60 8,30 9,87 8,94 8,50 8,25

4,66

5,48

6,274,88 5,05 4,78

10,1

22,3

17,1

-14,3-1,9

-4,0

-20

-15

-10

-5

0

5

10

15

20

25

0

2

4

6

8

10

12

14

16

18

2006 2007 2008 2009 2010* 2011**

staff costs management costs change in operating costs (%)

* available resources (budget, with funds transferred from the previous year)** state budget

The slowdown of the economy counterbalanced the effect of the

indirect tax rises on prices

• Rise of unemployment insurance tax

• Rise of alcohol, fuel and tobacco excise

• Rise of VAT from 18% to 20%

• Dividends from the state owned companies

• Sale of land

• Temporary stop of the step-by-step lowering of the income tax rate

The euro objective made it easier to consolidate, but was no way the cause

for action• New law on strict financial management and control for LG-s since

2011

• In order to counterbalance the suspension of the II pillar pension system the contributions would be higher 2014-2017

• Health expenditures - efficiency gains planned by fine-tuning the hospital network and putting emphasize on prevention

• Retirement age increased gradually

Estonia is now in a completely different fiscal position as most other developed nations

Summary of consolidation 2008+

• Pre-crisis fiscal management allowed for automatic stabilizers to play their cushioning role

• Deficit 2.8% of GDP in 2008 (3% surplus in 2007)• No need to borrow, as financial assets at 10% of GDP

• Credibility of state finances and fiscal position within the Maastricht limits ensured

• Deficit 1,7% of GDP in 2009• Lower spending, structural measures, revenue increases

(sales, dividends, tax) and temporary measures

Summary 2008+: real economy

• Flexible labour markets and transparent business environment facilitated rapid adjustment on company level

• Nominal average wage decline 7% by end-2009, 15% in the public administration

• Increased flexibility of labour legislation, active labour market policies

• Strong banking system• Capital and liquidity management in regional groups• High domestic buffers – Tier 1 capital 15%, required reserve

ratio 15%• Not a single cent of taxpayer money spent to prop up banks

III. Conclusions: policy implications and political economy lessons

Policy implications• Consolidation pays off even in a relatively short term, at least in

a small, open and flexible economy

• Buffers give a breathing space when it is most needed and the market conditions for lending are in the heights

• Timing is crucial - never put off fiscal consolidation until tomorrow

• Balanced approach in terms of sectors, and positioning of public administration as a frontrunner helps to legitimate the decisions

• Fundamentals need to be in place:• strong public and private balance sheets• general culture of flexible markets and readiness to

adjust

Political economy lessons for the eurozone

• Member States have to be ready for internal adjustments - need a change in mentality

• EU policy coordination frameworks are growth-enhancing and consolidation-fostering, if rigorously implemented:• Reformed SGP and new Excessive

Imbalances Procedure• financial market integration• structural reforms agenda (EU2020)

Thank you!