1
Dr Zofia Szpringer Research Bureau of the Chancellery of the Sejm Warsaw, March 2014
Recent developments in public finances in Poland In 2013, as compared with previous years, economic situation in Poland has deteriorated. The Polish economy weakened considerably in 2012 and the first half of 2013 as a result of weaker than expected economic growth in the EU, slow growth in key trading partners, confidence effects which weighed on private consumption and investment, and a decline in public investment. State budget revenues for 2013 could not be realized in the amount originally projected, while expenditures could not be significantly reduced. In order to face this situation, and avoid the risk of a recession, it was necessary to amend the state budget1 enabling higher deficit. Also, general government (GG) deficit predicted originally by the Polish authorities in the Convergence Programme (CP) for 2013 was finally revised from 3.5% of GDP to 4.8% of GDP. Although the implementation of the revised state budget was better than expected2, at the end of 2013 and later, many changes in existing laws were introduced. They were designed not only for increasing budget revenues and reducing budget expenditures to overcome the excessive deficit (Poland is from 2009 in excessive deficit procedure - EDP3), but also for reducing public debt, which approached the dangerous level set by national prudential procedures4. Of course, there were also
1 Such amendment was aimed at reducing budget revenues (on PLN 23.7 bn.) and budget expenditures (on PLN 7.7 bn). 2 See: http://www.mf.gov.pl/documents/764034/2835964/20140319_December_2013.pdf 3 On 7 July 2009, the Council decided, in accordance with Article 104(6) of the Treaty establishing the European Community, that an excessive deficit existed in Poland and issued a recommendation to correct this deficit by 2012 at the latest. Then, the Council revised its recommendations and shifted this deadline (firstly, by 2014 and then by 2015). Poland has not taken effective action in 2013 in response to the Council recommendation (it missed the general government deficit target for 2013 recommended by the Council and has also not adopted the required amount of consolidation measures). The headline target is likely to be met in 2014, due to a large extent to a one-off transfer of pension funds' assets, which does not guarantee a sustainable correction in the following years. 4 In 2010, the first prudential threshold of public debt as defined in Act on Public Finances (50% of GDP) has been exceeded. Further persistence of significant imbalances in public finances would risk breaching another prudential threshold (55% of GDP), which would imply powerful - and potentially pro-cyclical - tightening of fiscal policy. Therefore in 2010 began to implement a strong fiscal consolidation plan whereby General Government headline deficit declined in the period 2011-2012 by 4 percentage points compared with a deficit recorded in 2010, the average annual structural effort was revised up to 1.6% of GDP and exceeded recommended by the Ecofin Council, the fiscal effort (1 ¼% 2 changes of a different nature, aimed at stimulating economic growth (such as for example a deregulation of some professions, the Polish Investment Programme, National Road Construction Programme for 2011-2015, Programme "Flat for young", de minimis guarantee programme). Generally, changes of laws were aimed at strengthening the financial frameworks. So, in this information the most significant changes of those frameworks are presented, including also related action on the EDP, because such adjustments should promote economic growth in Poland in the coming years. As it seems, they should also facilitate future entry into the euro area, however, it cannot be ignored that there will be some factors, which may affect the public finances, such as local and parliamentary elections (in 2014 and 2015 respectively) as well as unstable international political situation (this aspect is not taken into account in the following information). In addition, it should be noted that European Commission is less optimistic, in projection of general government deficit for 2015, than Polish government, therefore it proposes to take additional measures in order to fully carry out the correction of the excessive deficit. *** Changes in Act on Public Finances and other acts5 were aimed at strengthening the fiscal framework, especially by: 1) introduction of permanent stabilizing expenditure rule (SER), 2) modifying regulations regarding the Multi-Annual State Financial Plan (MYFP), 3) improving intra-annual monitoring of budget execution6. The new stabilizing expenditure rule (formula of that rule and other details, see in the Annex) is setting the expenditure level and covers almost the whole general government sector, excluding only units which are not legally able to generate significant deficits7 and expenditures fully financed from the EU funds. Moreover, the
of GDP) in 2010-2012. See: http://ec.europa.eu/economy_finance/economic_governance/sgp/deficit/countries/poland_en.htm
5 See: for example information on legislative process on government bill on the amendment of certain acts in connection with the implementation of the Budget Act (the Sejm paper No 1788), on government bill on change the Act on Public Finances and some other laws (the Sejm paper No 1789), on government bill amending the law on state forests (the Sejm paper No 2041). 6 See: Fiscal governance in Poland – 2013 update, in: Fiscal frameworks in the European Union: Commission services country factsheets for the Autumn 2013 Peer Review. Occasional Papers 168 , December 2013. 7 This applies to Independent Public Health Care Institutions, state funds (other than Social Security Fund, Agricultural Social Insurance Fund, Labour Fund, Demographic Reserve Fund), Polish Academy of Sciences and its organizational units, budget institutions, state and local government cultural institutions, state film institutions, state or local legal entities - Social Insurance and legal 3 correction mechanism foreseen by the rule is based on the result of the whole General Government sector. In this sense, the rule appears to be consistent with ESA958. However, it should be added that introducing the SER, as countercyclical fiscal policy response, required removing the provision of the Act on Public Finances according to which the draft budget for a given year cannot include a deficit higher than the deficit set for this year in the Multi-Annual State Financial Plan. Introduction of permanent stabilizing expenditure rule The SER sets a general level of expenditure of the public sector. The expected level of expenditure of local governments (and some other entities) is deducted from the overall expenditure level. The expected level of expenditure by this sub-sector will be forecast taking into account all the rules that apply to the local government units. The remaining part of the amount - the limit - would be binding on the rest of the public finances sector. It means that if local government expenditure is forecast to increase faster than the dynamics implied by SER for the whole public sector, then the rest of the GG sector would have to compensate for this dynamic by adjusting its spending level accordingly. Furthermore, if the GG deficit turns out to be excessively high due to the local government sub-sector, the deviations from medium-term objective (MTO) are accumulated and when the sum exceeds 6%, the correction component is added to the SER formula9. Additionally, in order to reinforce budgetary discipline of local governments, two other elements were adopted. Firstly, the government introduced a uniform type of long-term financial forecast for all local governments. Secondly, the right to monitor the situation of local governments will be conferred on Regional Financial Chambers and in the case of threat to the delivery of public
persons referred to in art. 9 paragraph 14 of the Act on Public Finances, and local government budgetary entities, executive agencies. 8 However, the differences between the national rules and ESA-95 will remain. In particular, according the national definition of the public sector, thresholds (55% and 60% of GDP, until recently also 50%) shall be applied for the purposes of judging whether the sanctions for breaching public debt should be applied. At the end of 2012, public debt according to the national definition was nearly 3% of GDP lower than that based on ESA95 mainly because of the exclusion of the debt of the National Road Fund. 9 Originally the government planned to complement SER with a legally binding limit for the deficit of the local government sub-sector. However, it dropped this plan arguing in the 2013 update of the Convergence Programme that the current rules are sufficient to limit fiscal imbalances in this sub- sector. This is reflected in a continuing decrease in aggregate deficit of local governments over the recent years. From 2014 onwards local government units are subject to individual debt constraints reflecting their economic capacity to pay off liabilities. The new limit will depend on the ability of the unit to generate adequate surpluses in the current budget and income from the sale of property.
4 duties, they would require a preparation of a remedial programme by the local government in question. The Ministry of Finance will be responsible for monitoring and calculating the deviation from the rule. Such information will be probably presented in the report on the implementation of the budget act, which is presented to the Sejm and the Supreme Audit Office by 31 May of each year. Although, the Act on public finances does not foresee any particular independent monitoring of the compliance with the rule, it is worth to add that according to the Polish legal order, the Supreme Audit Office presents to the Sejm annual reports on the execution of the budget act and implementation of statutes and other legal regulations governing the budgetary process, which would include the SER. On the whole, the new stabilising expenditure rule seems to address well the Economic Policy Committee advice given to Poland. In particular, the SER seems to promote compliance with the reference values on deficit and debt set in accordance with the Treaty on the Functioning of the European Union (TFEU), and set a multiannual time horizon which is superior to a rule that only sets a target for one year from the point of view of avoiding pro-cyclicality10; However, it seems that the effectiveness of SER may be weakened by the absence of the independent ex-ante monitoring of compliance with the rule (e.g. independent estimates of input variables like the impact of discretionary revenue measures), and absence of automatic correction mechanism in the event of actual expenditure exceeding the level set by the rule11. Modified regulations regarding the Multi-Annual State Financial Plan (MYFP) The deadline for the preparation of an update to the Multi-Annual State Financial Plan by the Council of Ministers was changed as of 2013. It is now consistent with the European Semester and the amended Council Regulation (EC) No 1466/97/EC.
10 See: Fiscal governance in Poland – 2013 update, op. cit. pages 59-61. The advice for Poland was: “Polish authorities should keep up the momentum and further improve the fiscal framework design and functioning by introducing the following measures: - Enhance the enforceability and transparency of the fiscal rules by adjusting the definitions used in national accounting to ESA 95 standards and ensuring sufficiently broad coverage. - Strengthen medium-term planning by enhancing its connection with annual budget preparation, and by fostering the mechanisms of coordination between government tiers. - Complete the design of the new permanent expenditure rule to make it sufficiently comprehensive, transparent, binding and to support more countercyclical fiscal policy responses. - Improve intra-annual monitoring of budget execution”. 11 Op. cit. 5
The new deadline is 30 April, while the old one was two months after the publication of the state budget. The MYFP will consist of the Convergence Programme and the annex that sets goals together with their implementation measures. The Convergence Programme will contain, in particular, key objectives of social and economic policy, planned actions and their impact on the level of revenues and expenditures of general government sector, including long-term sustainability of public finance, the initial level of expenditure according to SER and the preliminary estimates of macroeconomic variables together with assumptions needed to calculate them. Change in the law meant that the MYFP cease to be only a state budget plan because, MYFP as a Convergence Program will cover almost all of the public finance sector, moreover, it will be bound under the European Semester with the implementation of the Strategy Europe 2020 and National Reform Programme12. It will be also better linked with the performance budget (which, however, is not obligatory for local government units)13, and it will need introduction of spending reviews. Probably, it would be more efficient to present performance budget in MYFP only in accordance with COFOG classification14. Improving intra-annual monitoring of budget execution. According to the 2013 update of the Convergence Programme, the Polish authorities were working on improving the scope and frequency of data collection in units of general government in order to meet the requirements of Council Directive 2011/85/UE of 8 November 2011. The effect of this work is that the following fiscal data will to be published on the website of the Ministry of Finance: concerning the central government subsector and social security funds sub-sector (monthly with a one-month delay), and concerning the local government sub-sector (quarterly with a one-quarter delay)15, in addition a reconciliation table showing the methodology of transition between data from public
12 http://ec.europa.eu/europe2020/pdf/nd/nrp2013_poland_en.pdf 13 because ministers should submit, by the deadline of 15 April each year, to the Minister of Finance information on the implementation of the MYFP in terms of budgeting (ie. targets, together with indicators of their implementation, in the system comprising the main functions of the state). The information on the execution of the task-oriented spending is then included in the government report on the execution of the budget act, which is submitted to the Sejm. 14 Classification of the Functions of Government. 15 http://www.mf.gov.pl/en/ministry-of-finance/fiscal-data-for-eu-budgetary-surveillance
6 accounting and the statistics of general government, in accordance with ESA 95, will also be available on the website. Also, the Central Statistical Office will publish data concerning: contingent liabilities with potentially significant impact on the budget, including those relating to nonperforming loans, liabilities of public enterprises, public-private partnership agreements considered off balance sheet, guarantees granted by the sector as a whole and all sub-sectors, as well as the shares of general government in the capital of private and public companies (if the amounts are economically significant). In 2013 entered into force changes in functioning the State Audit Office - SAI16, which reinforce independent control of public finances. They include, inter alia, change of management17, refining the formula of control and presentation of its results, improvement of communication with the public. The SAI submits to the Sejm follow-up analyse of how audit conclusions concerning the making or application of law have been used, and the SAI’s post-audit recommendations started to be used for amending existing law18. Reducing the excessive deficit In order to implement the recommendation of the Ecofin Council from 2013 on reduction of the excessive deficit19 Poland has taken a number of measures (including among the others the measures announced in the Convergence Programme. Update 2013 (CP 2013) and additional actions implemented on the occasion of the amendment of the Budget Act for 2013 and in the preparation of the Budget Act for 2014)20.
16 See regulations introduced by the Act of 22 January 2010 to the Act on the Supreme Audit Office of 23 December 1994. 17 On 27 August 2013, after being sworn in at the Sejm, Krzysztof Kwiatkowski has started his six-year term of office as President of the Supreme Audit Office. He is very active, independent and responsive to abnormalities and irregularities. 18 According to Article 11a of the Act on the Supreme Audit Office: “1. The President of the SAI may move to the Marshal of the Sejm to request the Prime Minister to provide a statement on audit conclusions concerning the making and application of law. 2. The Prime Minister shall submit the statement referred to in paragraph 1, together with substantiation, to the Marshal of the Sejm, within 60 days of the request. 3. If the statement referred to in paragraph 1 provides the need to amend generally applicable legal regulations, it shall define the timeframe for the initiation of legislative work for these amendments and the authority responsible for developing proposals for appropriate regulations”. 19 See: Council recommendation of 9 July 2013 on the National Reform Programme 2013 of Poland and delivering a Council opinion on the Convergence Programme of Poland, 2012-2016. Official Journal of EU of 30 July 2013 C 271. 20 See: Information on measures taken by Poland to implement the Recommendation of the Council on Article 126.7 of the TFEU of 21 June 2013. 7
They concerned, for example: pension system, budget revenues, disciplining and limiting public expenditures (see table 1, which shows financial dimension of those measures in 2013 and 2014, however during 2014 additional measures were taken, and they will be presented soon in the Convergence Programme update 201421). Measures undertaken to improve the pension system in Poland were the Government's response to the challenges for public finances resulting from the aging of the population, and they contained: a) reducing the number of people entitled to early retirement and the introduction of bridging pensions22, b) changes in the conditions of acquisition of pension rights by the officers and soldiers23 , c) increase in the retirement age24 , d) changes in the pension system25 (such as for example a transfer of a part of the pension rights of the insured, expressed by the State Treasury bonds, from the Open Pension Funds (OFE) to the Social Insurance Institution (ZUS), establishing a new amount of compulsory contribution transferred to the OFE equal to 2.92%). The effect of the changes in the pension system will be an abrupt reduction of public debt in 2014, resulting mainly from the one-off effect of the redemption of the State Treasury securities purchased by the Ministry of Finance. According to preliminary estimates, assuming that half of the insured goes to ZUS, the public debt-to-GDP ratio will decrease as a result of changes in pensions by about 7 percentage points, and the ratio of the general government debt by about 8 percentage points. Therefore, after the entry into force of the changes to the pension system, it is
21 According to amended Act on State Forests the state budget will receive funding in the amount of PLN 1.6 bn. in 2014-2015, and since 2016, it will receive annual appropriations in the amount of 2% of revenues from timber sales. 22 Entry into force of the Act on early retirement in 2009. 23 In force from 1 January 2013. They provide that the representatives of the uniformed services will acquire the right to a pension after the joint fulfilment of two conditions: age and length of service. The amendments set the minimum retirement age of "uniforms" to 55 years (previously 35 years), and the minimum length of service to 25 years – until now it was 15 years (Act amending the Act on pensions for retired professional soldiers and their families, the Act on pensions for retired officers of the police, the Internal Security Agency, the Intelligence Agency, the Military Counterintelligence Service, the Military Intelligence Service, the Central Anticorruption Bureau, the Border Guard, the Government Protection Bureau, the State Fire Service and the Prison Service and their families and certain other acts). 24 On 1 January 2013, the provisions came into force amending the number of regulations with respect to inter alia, a pension provision, whose main objective is to gradually raise the retirement age for women and men to achieve the same level of 67 years (Act of 11 May 2012 amending the Act on pensions from the Social Insurance Fund and certain other acts). 25 Based on the Review of the pension system published in June 2013, after a broad public debate. 8 planned to adequately (by 7 percentage points) reduce the public debt thresholds on which the Stabilizing Expenditure Rule correction mechanism is based26. Revenue measures were focused on increasing tax revenues, reducing fraud and abuses, and shadow economy and assuring adaptation to EU law. For example changes in VAT: a) extended use of the reverse charge mechanism27, b) introduced of joint and several liability in the customer's VAT for tax liabilities of the seller of steel products, fuels and rough gold, as well as for the sellers of these goods28, c) increased from 1 April 2013 the VAT rate from 8% to 23% on folk art goods and folk arts and crafts29. Changes in excise duty introduced the excise duty on natural gas for heating purposes (with the exception of households) and excise growth for cigarettes30. Measures on disciplining and limiting public expenditures concerned not only introducing the SER, but also maintaining the principle of a balanced current budget of the local government units and system of individual debt limits for them. Measures also embraced corrective actions (which provide, among the others, limiting new investments to investments that do not generate growth of the debt; non- disbursement of funds for the promotion of the unit; limiting tasks other than mandatory, funded from own resources), and limitation of expenditure on salaries of board members and allowances of local government councillors, which should help to protect the budget against actual increase in spending on the above goals, reduction (from 2010, continued in 2013-2014) of the wage fund in the state budget entities by adopting general rules for freezing it at the nominal level of the previous year31, consolidation of the liquidity management of the public finance, reduction of
26 According to ESA95 rules, the general government revenues will register a value equal to the amount of assumed pension liabilities, which is equal to the value of the assets acquired and redeemed. According to the ESA2010 rules, this transaction, as a rule, will be reflected in the financial accounts, without impact on the outcome of the sector. 27 Act of 26 July 2013 amending the Act on VAT and certain other acts. 28 Act of 26 July 2013 amending the Act on tax on goods and services and certain other acts, 29 Act of 7 December 2012 amending the Act on VAT and certain other acts. 30 Act of 7 December 2012 on the amendment of certain acts in connection with the implementation of the budget act. 31 with the exception inter alia, of the remuneration of judges delegated to the Ministry of Justice or other organizational unit subordinate to the Minister of Justice or supervised by him, whose salaries are funded from the resources at the disposal of the Minister of Justice, prosecutors and assessors of the prosecutor's office and without employees of state higher education schools (the next stage of remuneration growth results from the Ordinance of the Minister of Science and Higher Education of 5 October 2011 on the conditions of remuneration for work and granting other work-related benefits for employees in public schools). 9 expenditures on the implementation of the Common Agricultural Policy and other actions. It may be added, that according to the information of Polish Ministry of Finance on measures taken by Poland to implement the Recommendation of the Council of the EU on Article 126.7 of the TFEU of 21 June 2013 expenditure projected in the draft budget for 2014 were also considerably lower than it would be as a result of applying the SER (see: Ministry of Finance graph, which shows the scale of spending cuts presented in the draft budget for 2014, compared with the amount of potential spending, in the Annex). The scale of adjustment varied from PLN 9 to 36 bn., depending on the selected baseline scenario. In comparison to the projected path of fiscal adjustment presented in CP 2013, the impact of automatic stabilizers and the pro-cyclical income elasticity was much stronger. These factors and unfavourable income structure of GDP growth and a significant slowdown observed in the first half of this year reflected in lower than projected general government revenues. As a result it was forecasted that in 2013 the general government revenues will reach 36.6% of GDP, i.e. 1,3 percentage point of GDP less than projected in CP 2013. Tax revenues will be lower by 0.6 percentage point of GDP and EU funds, where the general government is the ultimate beneficiary, will decrease by 0.4 percentage points of GDP. The general government expenditures to GDP in 2013 were expected to be higher by 0.1 percentage point of GDP than in CP 2013, which was influenced on the one hand by a higher than expected increase in social spending by 0.3 percentage point of GDP, on the other, by a deeper-than-expected decline in investments by 0.2 percentage point of GDP (due to a lower absorption of EU funds). As a result, despite taken consolidation measures, it was anticipated that the general government deficit will increase compared to 2012 by 0.9 percentage point, with the decline in revenues by 1.8 percentage point and expenditures consolidation by 0.9 percentage point of GDP. As a result, the nominal deficit will reach in 2013 about 4.8% of GDP. As indicated above, the increase in the deficit compared to that assumed in the CP 2013 is almost entirely due to cyclical factors, in particular the decline in tax revenues due to the strong pro-cyclical deterioration in tax elasticities with respect to the tax base and decrease of this base share in GDP. It should be noted that the European Commission – even with a lower GDP growth forecast for the current year (i.e. 1.1% vs. 1.5% forecasted by the Polish Government) – forecasted revenues of the sector at 37.6% of GDP, i.e. one percentage point higher 10 than in the forecast for 2013 presented here. In view of the impact of fiscal consolidation on economic growth, it was considered that the implementation of deeper consolidation (i.e. nominal deficit reduction to the level of 3.6% of GDP) would jeopardize the growth recovery in 2013, with a significant risk of recession. This would probably lead to an even deeper slump in tax revenues and rise the general government deficit well above 5% of GDP. Ministry notices, that it should be borne in mind that in the terms of strongly changing tax elasticities and the tax base share in GDP, in order to asses the structural measures one should apply a bottom-up approach, which presents a settlement of the financial consequences of various systemic changes. Calculation of the structural efforts by using estimates of unobservable categories, i.e. the output gap, may in fact lead to not fully reliable results. The continuation of a fiscal policy, including taking additional measures to enhance the revenue side permanently and limit expenditure growth, will allow Poland to fulfill the Council recommendations in 2014. It is predicted that – taking into account the effects of changes in the pension system – in 2014, the general government will reach a 4.5% of GDP surplus, which will be largely the result of one-off effects of changes in the pension system. It is estimated that the general government revenues will reach 44.9% of GDP and expenditures will reach 40.4% of GDP. It is also assumed that the structure of fiscal consolidation will sustainably reduce the excessive deficit in Poland, and in 2015 the general government deficit will reach 3% of GDP. For 2015, the European Commission is less optimistic than the Polish authorities and expects a general government deficit of 3,3% of GDP, however the Council of the EU in its recommendation from December 2013 says that Poland should reach a deficit target of 2,8% GDP in 2015, excluding the impact of assets transfer to the pension reform. The 0.3 percentage points of GDP difference is mainly due to lower current revenues based on a lower projection for nominal GDP growth as well as higher government expenditure on intermediate consumption. According to the Commission the deficit targets are subject to implementation. Moreover, it has to be noted that the current deficit forecast is based on ESA-95. As of autumn 2014, a new set of rules will be in place (ESA-2010). Under the new set of rules, a transfer of assets would no longer count as general government revenue. Thus, the general government balance 11 is expected to show a deficit of 4,2 % of GDP in 2014 and 3,9 % of GDP in 201532. Since the Council is to decide on an abrogation based on the EDP figures assessed by Eurostat in spring 2015 under ESA2010, additional measures are required to compensate for those elements of the pension reform, which will not reduce the deficit any longer under ESA201033. We may also add that IMF after its visit to Poland34 in 2013 noticed that:
1. After a sharp slowdown, the Polish economy is starting to recover,
2. The monetary policy stance is appropriate,
3. Fiscal policy is balancing the need to support the economy with further fiscal consolidation,
4. Over the medium term, moderate further fiscal consolidation will be needed to put the public debt ratio firmly on a downward path,
5. While the planned changes to the pension system will improve the fiscal aggregates, further reform of the social security system is needed,
6. The authorities’ regulatory and supervisory efforts have helped further bolster the resilience of the financial system. Also generally positive, and with some good recommendations, was the assessment done by the OECD (see: OECD Economic Surveys Poland, March 2014) .
32 Under ESA-2010 the following effects of the planned pension reform would not result any longer in a deficit reduction: one-off asset transfer of 8.5 % of GDP in 2014, regular asset transfer in 2014 (0.3 % of GDP) and 2015 (cumulated effect of 0.6 % of GDP). Only the change in the number of contributors to the first pillar would remain under the new rules (0.2 % of GDP in 2014, cumulated effect of 0.4 % of GDP in 2015). While the switch to ESA2010 is estimated to have a positive impact on GDP figures, the size of the impact of higher GDP on fiscal figures is expected to be negligible. 33 See: Council Recommendation of with a view to bringing an end to the situation of an excessive government deficit in Poland, December 2013. 34 See: Poland—Concluding Statement of the 2013 Staff Visit, Warsaw, November 22, 2013. 12
ANNEX The stabilizing expenditure rule (SER)35 The SER, which will be binding in budgetary process for 2015, is an element of implementation of the Council Directive 2011/85/EU on requirements for budgetary frameworks of the Member States and the Council recommendation under the excessive deficit procedure of 21 June 2013. In addition to these legal requirements, it is expected that the rule will ensure sustainability of public finances in Poland and will correct their possible excessive imbalances. At the same time, SER should not cause excessive tightening of fiscal policy, especially under conditions of severe economic downturn. The main goal of the rule is to reduce and stabilize the general government deficit, and consequently – the public debt. For this purpose, the expenditure resulting from the rule will cover the general government expenditure with two exceptions. First, the calculation of the limit will exclude budget spending of EU funds and that part of the expenditure which is financed by means of a non-refundable grant from the EU and EFTA countries, and second, the costs of units which do not have the ability to generate high deficits will be also excluded. The rule will therefore cover about 90% of the expenditure of the general government. From the amount of spending determined this way we subtract the expected level of consolidated expenditures of local government units (LGUs) and their associations; units referred to in Article 139 of the Act on Public Finance and units of the National Health Fund (NFZ). The rest of the amount will be a limit distributed within the rest of the sector. The limit will be legally binding and aggregated. This means that the expenditure of some units covered by the limit (about 2/3 of government spending) will be able to grow faster at the expense of slower growth or decrease in expenditures of other entities subject to the limit. Decisions on directions of fiscal policy, and thus the distribution of the limit amount will be taken by the Government and the Parliament in compliance with applicable laws and programmes.
Formula of the stabilizing expenditure rule is defined as follows: * * EXPENn = EXPEN n-1 × En ( CPIn) × [GDP n + Cn] + En( ∆DM n) where:
EXPENn – the expenditure level specified in the draft budgetary act for year n; * EXPEN n-1 – the expenditure level specified in the draft budgetary act for year n-1 adjusted by the updated CPI forecasts;
Em(xn) – forecast in the draft budgetary act for year m variable x in year n;
CPIn – consumer price index in year n; * GDP n – medium-term real GDP dynamics for last 8 years starting from n;
Cn – size of the correction implied by the correction mechanism, expressed in percentage points;
∆DMn – forecast level of discretionary measures in taxes and social security contributions planned for year n;
35 See: the Sejm paper nr 1789 http://www.sejm.gov.pl/Sejm7.nsf/druk.xsp?documentId=0A202835B8528121C1257BF900515C8F and http://www.mf.gov.pl/documents/764034/1010438/Appendix+1+- +Stabilizing+expenditure+rule+EN.pdf
13 n – year for which the expenditure level is calculated.
The SER, will provide a permanent basis for calculating the expenditure limits. Measures taken in the amendment act lower the limit of spending in future years in a sustainable manner, because even if any of the categories of expenses increase in the coming years, within the overall permanently reduced ceiling, they will have to be offset by a decrease in other expenses. In line with the formula, the expenditure grows substantially in the medium-term real GDP growth rate multiplied by the projected CPI. In addition, the model includes an adjustment resulting from erroneous forecasts of inflation and projected discretionary measures on the revenue side. In case of imbalance in public finances, the growth in expenditure will be further revised. If public debt (calculated using the average annual exchange rate and reduced by free cash to fund next year's borrowing requirements) exceeds 55% of GDP or the deficit (including pension reform costs) exceeds 3% of GDP, the stronger correction is applied (2 percentage points subtracted from the medium real GDP growth). This adjustment takes place regardless of the economic forecast. Otherwise, if the debt exceeds 50% of GDP, a normal correction is applied (1.5 percentage points), unless strong economic slowdown is projected (next year's projected real GDP growth lower by over 2 percentage points than mid-term – the so-called "bad times"). Where none of the above conditions is met, the correction depends on the sum of the differences between the general government nominal balance and the medium-term budgetary objective – MTO (currently 1% of GDP). The purpose of this corrective mechanism is a temporary reduction (increase) in the amount of expenditure growth below (above) the real medium-term GDP growth, as long as there are excessive deviations from the target. This mechanism will ensure long-term sustainability of public finances. It is worth noting that the mechanism is automatic and precisely determines the type of correction. If the sum of the differences exceeds -6% (+6%) of GDP, a simple negative (positive) correction is applied. The exception is "bad times", when the negative correction is suspended and the "good times" (projected next year's real GDP increase by over 2 percentage points than the mid- term) when the positive correction is suspended symmetrically. The impact of the proposed rule on deficit and debt was analyzed using model simulation. The basis of the simulation were the European Commission forecasts for 2013-2014, for 2015 to 2040 – the projected path of potential real GDP growth was assumed from the guidelines on macroeconomic assumptions for the long-term financial forecasts of local government units developed by the Ministry of Finance. For the period 2041-2050 it is assumed that the potential real GDP growth in the amount will be similar as in 2040. Then, the path of potential GDP was connected with output gap and inflation modelled with autoregressive stochastic processes (estimated on historical data for Poland). At the same time, the revenue–to-GDP ratio and forecast errors of GDP and inflation were simulated, also stochastically. The obtained simulations show that, by application of the rule, the average nominal general government balance in 2014-2050 is (automatically) at a level close to MTO (-1% of GDP), and stabilization of expenditure at the level of operational objective ensures that the public debt to GDP ratio stabilize at a safe level (below 40% of GDP). Exceeding the limit will be possible in the event of war, state of emergency or natural disaster throughout the territory of the Republic of Poland. In these situations, the amount of expenditure will continue to be calculated according to the formula, to allow for specifying another amount of expenditure by multiplying the adjusted amount of the previous year (EXPENn-1), after ending the exit clause. Calculation, according to the model, of the sum of the differences between the general government nominal balance and the operating goal (MTO) will also continue. Recommendation arising from the directive to monitor compliance with the rules by the independent budgetary authorities does not require changes in the Polish legal system. 14
Under the Act on the Supreme Audit Office, the SAI shall examine "in particular the implementation of the state budget and the implementation of laws and other legal acts in the field of financing, economic, organizational and administrative activities" and controls the execution of the budget. Due to a much wider range, the new rule at the time of entry into force will replace the temporary expenditure rule, which limited the growth of certain budget expenditure to forecast CPI inflation rate increased by 1 percentage point. Temporary expenditure rule concerned only about 10-12% of the general government, i.e. the planned budget discretionary spending and so-called new legally mandated expenditure, which also included the existing legally mandated expenditure, when the act determining them was modified. Entry into force of SER will also change the sanctions applicable beyond prudential limits of public debt. Previous sanctions invoked after exceeding the threshold of 50% of GDP will be replaced by sanctions resulting from the correction mechanism of the SER. The stabilizing expenditure rule provides for a different type of sanction that primarily will affect a much wider range of public sector, thus ensuring more effective correction, which will also depend on the forecast of the economic situation for the next year. The rule would set the level of expenditure of the public finance sector (as defined by the Polish law) and the government funds managed by the BGK (a state-owned bank), e.g. including the National Road Fund – which, together, encompass almost the whole Polish GG sector – excluding the expenditure financed with non-returnable EU funds as well as expenditure of those units which are obliged by law to balance their budgets. The formula that determines the level of expenditure for the year t+1 consists of five steps: (1) the level of expenditure for the year t (corrected with updated values of inflation), is multiplied by (2) forecasted inflation in year t+1 and by (3) an eight-year average real GDP growth rate (for the period from t-6 to t+1). The level of expenditure is further reduced by (4) a correction component, in case of public debt above 50/55% thresholds or GG deficit above 3%, as well as in case of accumulated deviations of GG balance from the MTO (in nominal terms). Finally, the level of expenditure is changed by (5) the forecasted value of discretionary measures on the revenue side. The level of expenditure computed in this way is then adjusted for the expected level of expenditure of local governments, the entities referred to in Article 139(2) of the Act on Public Finances and the National Health Fund. The remaining part - the so-called limit - will be divided between the remaining entities of the GG sector and will be binding on them. Escape clauses allowing for the determination of arbitrary expenditure limits disregarding the SER formula are provided only in the event of martial law or a state of emergency, or a natural disaster throughout the territory of Poland.
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Table 2. Key macroeconomic and budgetary variables - Poland 2004-2014 plan Latest Committee projectionsa 2013 plan 2014 plan update of the update of the 2004 2005 2006 2007 2008 2009 2010 2011 2012 Polish Polish 2013 2014 2015 Conv ergence Conv ergence
Programme 2013 Programme 2013
Real GDP growth Poland 5.3 3.6 6.2 6.8 5.1 1.6 3.9 4.5 1.9 1.5 2.5 1.5b 2.5 3.8 rate - volume Percentage change EU (27 on previous year 2.6 2.2 3.4 3.2 0.4 -4.5 2.0 1.7 -0.4 0.1 0.1 b countries) Output gap (% of Poland -1.1 -1.1 -1.1 -0.7 -2.2 -2.7 potential GDP)
Total general Poland 37.2 39.4 40.2 40.3 39.5 37.2 37.5 38.4 38.3 37.8 37.2 government revenue (% of EU (27 GDP) 43.8 44.2 44.7 44.6 44.6 44.1 44.1 44.6 45.4 countries)
Total general Poland 42.6 43.4 43.9 42.2 43.2 44.6 45.4 43.4 42.2 41.3 40.5 government expenditure (% of EU (27 46.7 46.7 46.2 45.5 47.0 51.0 50.6 49.1 49.3 GDP) countries)
Poland -5.4 -4.1 -3.6 -1.9 -3.7 -7.5 -7.9 -5.0 -3.9 -3.5 -3.3 -4.8 -3.9c -2.8d General government deficit EU (27 -2.9 -2.5 -1.5 -0.9 -2.4 -6.9 -6.5 -4.4 -3.9 (% of GDP) countries)
Primary balance Poland -4,7 -5,2 -2,3 -1,1 -0,8 -0,9 (% of GDP)
Structural balance Poland -8,2 -8,3 -5,4 -3.8 -2.7 -2.2 (% of GDP)
Poland 45.7 47.1 47.7 45.0 47.1 50.9 54.9 56.2 55.6 55.8 55.7 51.0c 52.5 General government gross EU (27 62.2 62.7 61.5 58.9 62.2 74.5 80.0 82.4 85.2 debt (% of GDP) countries) a - according to the Council Recommendation relating with situation of en excessive government deficit in Poland. See: COM(2013)906 and COM(2013)907. b - Eurostat nwesrelease euroindicators 34/2014 - 5 March 2014. c - Surplus of 4,6% of GDP planned by Polish government and fall of gross debt to 51% in 2014 are mainly effects of the one-off transfer of pension funds assets of 8,5% of GDP. d - under the new set of rules (ESA - 2010) it is expected deficit of 4,2% of GDP in 2014 and 3,9% of GDP in 2015. Source: Eurostat and CP data.