Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized SOWING THE SEEDS OF Public Disclosure Authorized A SUSTAINABLE FUTURE NORTH MACEDONIA | PUBLIC FINANCE REVIEW Report No. 135704 – MK Republic of North Macedonia Public Finance Review Sowing the Seeds of a Sustainable Future March 2019 © 2018 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org Some rights reserved This work is a product of the staff of The World Bank. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Attribution—Please cite the work as follows: “World Bank. 2018. North Macedonia Public Finance Review: Sowing the Seeds of a Sustainable Future. Washington, D.C.: The World Bank.” All queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: [email protected]. SOWING THE SEEDS OF A SUSTAINABLE FUTURE Contents Acknowledgements xvi Acronyms xvii Overview 1 Chapter 1: The Need for Fiscal Reforms 10 1.1 Country Context and Fiscal Dynamics 10 1.2 Government Revenues 20 1.3 The Level and Composition of Public Spending 21 1.3.1 Spending by Economic Classification 22 1.3.2 Spending by Functional Classification 24 1.3.3 Budget Rigidity 26 1.4 Efficiency of Public Expenditure 27 1.4.1 Economic Efficiency 27 Chapter 2: The State of Public Financial Management 30 2.1 Sector Overview 30 2.2 Institutional Shortcomings Related to PFM: Selected Issues 32 2.2.1 Policy-based Fiscal Strategy Development and Budgeting (Formulation, Management and Monitoring) 32 2.2.2 Budget Executon and Control Process 39 2.2.3 Evaluation, Reporting and Monitoring of Government Liabilities 41 2.2.4 Public Sector Internal Financial Control and Audit 44 2.3 Reform Options 45 Chapter 3: Fiscal Decentralization and Service Delivery 46 3.1 Sector Context 46 3.2 Institutional Issues and the Vertical Structure of Government 48 3.3 Expenditure Assignments: Implications for Efficiency and Equity 50 3.4 Reinforcing the Local Revenue Base: Tax Assignments 54 3.5 The Intergovernmental Transfer System 56 3.6 Municipal Indebtedness and Borrowing Controls 62 3.7 Reform Options 64 Chapter 4: Tax Policy Options for Increasing Revenue 66 4.1 North Macedonia’s Tax System in International Context 66 4.1.1 Effective Tax Rates on Factor Incomes and Consumption 69 4.2 Personal Income Tax 71 4.3 Indirect Taxes: Vat and Excise Duties 75 4.3.1 VAT 76 4.3.2 Excise Duties 78 4.4 Corporate Income Tax 81 4.4.1 Technological Industrial Development Zones 82 Contents V REPUBLIC OF NORTH MACEDONIA | PUBLIC FINANCE REVIEW, MARCH 2019 4.5 Taxation of Immovable Property 84 4.6 Tax Compliance and Administration 86 4.7 Reform Options 86 Chapter 5: Ensuring the Sustainability of the Pension System 89 5.1 Introduction 89 5.2 Recent Developments and Features of North Macedonia’s Pension System 91 5.3 Sustainability of the Pension System 99 5.3.1 Baseline Scenario 99 5.3.2 Alternative Policy Simulations 102 5.4 Conclusions and Reform Options 106 5.4.1 Reform Options 106 Chapter 6: Improving Social Assistance to Meet the Needs of the Most Vulnerable 108 6.1 The Social Protection System 108 6.2 Social Assistance Spending 109 6.3 Performance of Social Assistance Programs 113 6.3.1 Coverage 113 6.3.2 Distribution of Benefits and Beneficiaries 115 6.3.3 Contribution to Consumption 116 6.3.4 Impact of Social Transfers on Poverty 117 6.4 Conclusions 119 6.5 Reform Options 120 Chapter 7: Making the Grade on Education 122 7.1 Sector Overview 122 7.2 North Macedonia’s Spending on Education in International Context 129 7.2.1 Public Spending Trends and Composition 129 7.3 Efficiency of Spending 133 7.3.1 Efficiency of Resource Use 134 7.4 Financing Mechanisms 137 7.5 Intra-national Assessment of North Macedonia's Education Spending and Outcomes 139 7.6 Reform Options 140 Chapter 8: Strengthening Public Spending to Improve Health Outcomes 143 8.1 Introduction 143 8.2 Health Outcomes and Services 144 8.2.1 Life Expectancy 144 8.2.2 Maternal and Child Health 145 8.2.3 Noncommunicable Diseases 145 8.2.4 Quality of Care 148 8.2.5 Financial Risk Protection 150 8.3 Total Health Spending: Trends and Relative Health System Efficiency 151 8.3.1 Trends 151 8.3.2 Relative Health System Efficiency 153 8.4 Public Health Spending 153 VI Contents SOWING THE SEEDS OF A SUSTAINABLE FUTURE 8.4.1 Overview 153 8.4.2 Allocative Efficiency 155 8.4.3 Cost-Control Reforms 157 8.5 Reform Options 161 Chapter 9: Rebalancing Government Support to Improve Agriculture 163 9.1 Introduction 163 9.1.1 Rationale and Objectives 163 9.1.2 Methodological Approach 164 9.2 Agricultural Structure, Challenges, and Strategic Priorities 164 9.2.1 Structural Characteristics 164 9.2.2 Policy Priorities and Institutions 168 9.3 Public Spending on Agriculture and Rural Development 169 9.3.1 Total Public Spending 169 9.3.2 Spending by Economic Category 170 9.3.3 Spending by Function 171 9.3.4 Spending by Category of Support 171 9.4 Analysis of the Efficiency, Effectiveness, and Equity of Spending 173 9.4.1 Efficiency of Spending 173 9.4.2 Spending Effectiveness 179 9.4.3 Spending Equity 183 9.5 Reform Options 185 References 187 Annex 1. The Government Program, 2017–20 193 Annex 2. The Fiscal Impact of Reform Options 195 Annex 3. Investment Tax Incentives in Selected Countries 198 Annex 4. Education Regressions 204 Annex 5. Funding Formulas for Education 206 Annex 6. Average Net Wages 208 Annex 7. Air Pollution in North Macedonia 209 Annex 8. Health Spending in North Macedonia and Comparators 210 Annex 9. Structure of Agricultural Output, North Macedonia 211 Annex 10. Guaranteed Minimum Income Comparisons 212 Contents VII REPUBLIC OF NORTH MACEDONIA | PUBLIC FINANCE REVIEW, MARCH 2019 List of Figures Chapter 1: The Need for Fiscal Reforms Figure 1.1. GDP per Capita Growth Rates, 2001–08 and 2008–16 Averages, 11 Figure 1.2. Income Convergence with the European Union in Different Growth Scenarios 11 Figure 1.3. Fiscal Policy Trends of the General Government, 2001–17 12 Figure 1.4. Central Government Budget Execution, 2006–17 12 Figure 1.5. North Macedonia’s PPG Debt, 2006–17 14 Figure 1.6. PPG Debt-to-GDP Ratio, North Macedonia and Comparator Countries, 2008 and 2017 14 Figure 1.7. North Macedonia’s PPG Debt, Contribution to Change as Percent of GDP, 2008–17 14 Figure 1.8. General Government Gross Financing Needs, North Macedonia and Comparators, 2017 14 Figure 1.9. Maturity Profile, North Macedonia’s General Government Debt, 2017–35 15 Figure 1.10. Average Time to Maturity, General Government Debt, 2012–17), Months 15 Figure 1.11. North Macedonia’s General Government Debt Composition, 2012–17 16 Figure 1.12. North Macedonia’s General Government Debt Composition by Currency, 2017 16 Figure 1.13. North Macedonia PPG Debt, 2015–21 17 Figure 1.14. North Macedonia Gross Financing Needs, 2015–21 17 Figure 1.15. Debt Sustainability Scenarios: North Macedonia’s PPG Debt, 2015–21 17 Figure 1.16. General Government Revenues, 2003 and 2017 20 Figure 1.17. Composition of Public Revenues in North Macedonia, 2009–17 20 Figure 1.18. General Government Spending, 2014–17 Average 21 Figure 1.19. Cumulative change in Expenditures, 2009–17 Average 21 Figure 1.20. General Government Expenditure by Economic Classification, 2017 21 Figure 1.21. Central Government Expenditure by Functional Classification, 2017 21 Figure 1.22. Budgeted and Realized Capital Expenditures, 2009–17 24 Figure 1.23. Structure of Completed Public Construction Works, 2006–17 24 Figure 1.24. Budget Rigidity, 2011–17 27 Figure 1.25. Public Sector Performance Index, 2006 28 Figure 1.26 Public Sector Performance Index, 2016 28 Figure 1.27. Public Sector Efficiency Index by Sector Spending, 2016 28 Figure 1.28. Public Spending by GDP per Capita 2016 29 Figure 1.29. Public Sector Performance Score by Sector Spending, DEA Analysis, 2016 29 Chapter 2: The State of Public Financial Management Figure 2.1. PEFA Comparison 31 Figure 2.2: North Macedonia: Structure of the Budget 32 Figure 2.3. Original and Revised Budgets and Actual Revenues, 2014–16 35 Figure 2.4. Original and Revised Budgets and Actual Expenditures, 2014–16 35 Figure 2.5. Original Budget and Actual Revenues, 2014–16 35 Figure 2.6. Original Budget and Actual Expenditures, 2014–16 35 Figure 2.7. Ranking on the Open Budget Index 36 Figure 2.8. Elements of Public Participation 36 Figure 2.9. Self-Reported Unpaid Expenditure Obligations, May 2017 41 VIII Contents SOWING THE SEEDS OF A SUSTAINABLE FUTURE Chapter 3: Fiscal Decentralization and Service Delivery Figure 3.1.