Spending Reviews in the Republic of Croatia

1. Spending Reviews in the Republic of Croatia Mladenka Karačić Ministry of Finance of the Republic of Croatia Bishkek, April 2017

2. Recommendations of the EU Economic and Financial Affairs Council • After adopting the Decision on the Existence of Excessive Budget Deficit in the Republic of Croatia in January 2014, the Economic and Financial Affairs Council recommended the fiscal adjustment dynamics for the Republic of Croatia with the aim of reducing the budget deficit to the level beneath 3% by the end of 2016. • Based on the Recommendations of the Council, the Croatian Government adopted the 2014 Specific Recommendations for the Republic of Croatia Implementation Plan in July 2014, which, inter alia, defines the key steps, results and deadlines within the framework of measures which Croatia must take in order to achieve fiscal consolidation. • One of the measures to achieve sustainable public finances is to implement spending reviews, with the aim of reducing overall government spending.

3. Preparing the implementation • The Ministry of Finance worked with the World Bank and the International Monetary Fund to organise two workshops • Best practices and the experience of other countries • Methodology, the necessary data and analytical tools • Recommendations based on their experience

4. Key documents of the spending review process • Decision to Implement the Spending Review for the Croatian State Budget (23 October 2014) • Decision on the Appointment of the President and Committee Members for Implementing the Spending Review for the Croatian State Budget • Instructions for conducting the spending review • Final Report on the Results of the Spending Review for the State Budget

5. Decision to Implement the Spending Review for the State Budget • Objective: to design a set of measures which will lead to reduced levels of government spending, while simultaneously increasing the efficiency of budget spending and having the minimum negative impact on the current level of public services. • The spending review of the state budget encompasses the following categories: • the wage bill paid from the state budget • subsidies • the health system • business operations of agencies, institutions, funds and other legal entities with public authority • tax expenditure

6. Decision to Implement the Spending Review for the State Budget • The Decision of the Croatian Government precisely defines the expenditure scope, each committee's scope of work, and it requests the adoption of measures which will result in at least 10% of annual expenditure savings in comparison to the current plan for 2014. • The current plan - the state budget, i.e. the latest amendments to the state budget which include additional reallocations • The Instructions define the methodology of conducting spending reviews for the state budget and the contents of the report on the spending review results.

7. Spending review committees • Five committees have been established for conducting the spending review, consisting of: • members from the Institute of Economics or the Institute of Public Finance, leading experts and scientists with expert knowledge and experience in other areas of public finances, • government and public officials, with one committee member required to be from the Ministry of Finance. • The Central Committee for the Spending Review of the Croatian State Budget has been established to coordinate and supervise the work of the committees. • Administrative tasks of the committees and the Central Committee are performed by the Ministry of Finance, and the presidents and committee members do not receive a fee for their work on the committees.

8. Expenditure covered by the spending review • Almost half of all general government expenditure for 2014 was included in the spending review. The state budget expenditure plan for 2014: HRK 128,015,914,408

9. 1. Wage bill analysis • The analysis included over half of the overall wage bill expenditures, and the identified weaknesses are applicable to the overall public sector wage bill. • Croatia has a relatively large share of wages paid to public sector employees at the general government level. • Bonuses in government and public services stem from collective agreements, ordinances, regulations or agreements (overall 300 bonuses). In the health care system, wage bonuses amount to 33% of the overall gross wage bill. • The identified gap consists of the same coefficients for the same positions, i.e. for the positions which entail a similar or identical job level complexity. This violates the basic principle of the wage system, namely equal pay for equal work, so that these public sector work positions with the same job description can differ greatly in the amount of awarded pay. • By introducing the Central Payroll we have created for the first time the basic prerequisites for continuous monitoring of public sector employees.

10. 1. Proposals of measures for fiscal savings • BASIC WAGE CORRECTION • Progressive reduction of the job complexity coefficient in the range of 0% - 10% • Reducing the length-of-service increments from 0.5% to 0.3% • BONUS AND COMPENSATION REDUCTION • Established mostly by collective agreements • Government regulations should stipulate the criteria for determining outstanding results and bonus payment methods • A COMPREHENSIVE REFORM OF THE PAY SYSTEM • Establish a new public sector pay system which will be implemented in all institutions whose employees are paid from the state budget. • Uniform the collective negotiation system - equal conditions for all services

11. 2. Spending review of subsidies, apart from agricultural subsidies • Subsidies are defined as current transfers of funds given to manufacturers to stimulate the production of certain goods and the provision of services, and they can be established on the production level and/or level of produced, sold or imported goods and services. • Subsidies form the largest share of government grants. • The subsidy amount is twice the EU average and has been recently growing. • Croatian government grants are still linked to ensuring the survival of loss makers on the market, and they rarely help all market participants, in the form of so-called horizontal grants (for research and development, environmental protection, training and employment, etc.) • The primary source of subsidy funding comes from general revenue and income, while other funding sources account for a small part. An increase in EU aid is also planned.

12. 2. Proposals of measures for fiscal savings • REDUCING SUBSIDY COSTS • Revising the Concession Agreement and the Annex to the Road Transport Agreement • Revising the Decision of the Croatian Government which establishes the requirement of providing domestic air transport • Closing unprofitable railway lines where the analysis shows that overall income covers less than 10% of costs and replace them with alternative modes of transport • Review concessions for specific ferry lines and close unprofitable shipping lines • Review the shipyard restructuring programme

13. 3. Spending review of the health care system • During the proposal of new measures, we gave as much consideration as possible to limiting the potential negative impact of certain measures on the quality and accessibility of the health care system, but we also made sure to increase the effectiveness of the system. • The committee established a lack of transparency when it came to expressing public expenditure for health care. • The amount of public expenditure for health care is comparably higher than the EU average. • The wide scope of rights to health care, the low amount of financial contribution and the inherited public finance system with low requirements for effectiveness are becoming an ever growing burden on the budget. • A lack of transparency in the payroll system and human resource management. • Irrational expenses of other kinds (there is room for savings on medicine by lowering the price of medicine and/or the margin on the factory price of medicine).

14. 3. Proposals of measures for fiscal savings • Centralizing procurement for standard goods and services, but also for medical materials, including relying on the government office for public procurement. • Control measures for the consumption of medicines and procurement of medical technology - estimating savings from new reference prices, analysing issued prescribed medicine per patient, assessing health care technology and its use. • Implementing clinical protocols to focus more on outpatient care. • Introducing the difference between acute care and long term care in hospital services, and separating long term care in order to transfer it to the social welfare system, with private means-tested cost participation. • Increasing participation for non-preventive services, along with raising the upper limit per person and per family annually. • Rationalizing the category of individuals whose supplementary health insurance is covered by budget funds, and introducing the means test for exceptions. • Reducing the physical space of hospitals which do not use even 50% of their capacity and leasing the extra space.

15. 4. Business operations of agencies, institutions, funds and other legal entities with public authority • Croatia has seen an increase in the number of agencies/institutes/funds. • The excess slows down the decision-making process and the provision of services (overlapping positions, minimum coordination and unclear competence of ministries, agencies and other subordinate state subjects). • The lack of a single regulation and legislative framework which would regulate the criteria for establishing agencies, setting wages and their management.

16. 4. Proposals of measures for fiscal savings • Widen the scope of the register of public sector employees to include legal entities which are financed pursuant to special regulations and their inclusion in the Central Payroll System. Introduce a unique collective agreement for all legal entities owned by the Republic of Croatia and introduce same rules for rewarding employees. • Implementing measures to reduce material expenditures: • renting office space • providing intellectual and personal services • business travel • expenses for personal vehicles • equalizing the fees for legal and representative bodies • Reducing the number of agencies by merging and transferring a part of the work to the competence of the ministry. • Pursuant to special regulations, all income of legal persons owned by the Republic of Croatia, apart from income from entrance fees, concession fees and strictly earmarked revenue, becomes a part of the budget revenue at the end of the year.

17. 5. Tax expenditures • Tax expenses are often used by the executive government in order to "favour" certain groups or categories of taxpayers (sectors, enterprises or individuals), to stimulate certain economic activities, branches or business activities and achieve a certain economic and social impact, by consciously renouncing their income. They come in numerous forms, from tax exemptions, deductions, exemptions or reductions of the tax base or tax due. • Apart from decreasing tax income, tax expenditures also: • violate neutrality, reduce transparency and complicate the tax system, • often violate one of the principles of taxation (equality, fairness, productiveness, effectiveness, stability or efficiency), • increase costs for the tax authority (more expensive administration), • are rarely monitored and systematically controlled, and often do not fall under the scope of internal control and legal authorities like some other expenses, • are often introduced without a cost-benefit analysis of their eventual impact.

18. 5. Tax expenditures in Croatia • Croatia did not publicly disclose the amount of tax expenditures or report it to the legislature. • Tax expenditures complicate the tax system, but also raise the cost of administration. Income tax alone has 29 different types of tax credits which reduce the tax burden for individual taxpayers. • Croatian tax expenditures are by comparison bigger than the OECD average.

19. 5. Proposals of measures for fiscal savings • Tax expenditures must have a precisely defined purpose, they have to be regularly selected and with defined targets, based on real needs and aligned with the state economic and social objectives. • They need to be included in the annual budget proposal and regularly audited by the National Audit Office. • Reports must be regularly prepared and drafted in order to consider the tax expenditure policy during the budget preparation process and to opt between tax expenditures and direct spending. • A special office should be established which would regularly monitor, control and assess the impact and amount of tax expenditures. • Tax credits for special branches, regions or categories of population should be analytically reassessed. • By eliminating the current unprofitable expenses and not introducing new types of tax expenditures, we could increase the consistency, transparency and stability of the tax system, while simultaneously adhering to the principles of simplicity, effectiveness and fairness. This would affect and reduce tax administration costs, but also reduce budget losses at all levels.

20. Recommendations for future spending reviews • The spending review of the state budget has been implemented in Croatia in this manner for the first time and certain conclusions and recommendations can be drawn from this useful experience in order to insure future spending reviews of the state budget achieve their purpose. • The spending review should be conducted systematically and continuously, taking into account all state expenditures which should be analysed together. • This process should be conducted within the framework of clearly defined public policies for specific expenditure types, and these policies should be aligned with the overall Croatian economic strategy. • The Central Committee recommends that a comprehensive and continuous spending review, i.e. the monitoring of all expenditures, should be done by an organizational unit for budget spending reviews within the Ministry of Finance, modelled on the Irish example. • Results of the spending review should include an improvement of the budget framework and midterm projections, and lead to amendments to the regulations which regulate the budget execution process.

21. Spending review results • Within the structural measures implemented by the Republic of Croatia with the goal of reducing excessive budget deficit, the Ministry of Finance has drafted Guidelines for establishing standard material costs for spending units and extrabudgetary users, based on the results of the spending review. • The aforementioned document sets the basis for standard material costs for the purpose of reducing state budget expenditures, which was also reflected in the limit setting, i.e. the amount of planned finances for the state budget spending units for the period 2016-2018, as well as for 2017-2019. • Materials can be accessed at the website of the Croatian Ministry of Finance here http://www.mfin.hr/hr/dubinska-analiza-rashoda, The Final Report on the Results of the Spending Review can be accessed here http://www.mfin.hr/hr/analiza-materijalnih-rashoda, the Report on the Implementation of the Guidelines for Establishing Standard Material Costs for the period I-XII 2016.

22. Lessons learned • Even a superbly conducted spending review will remain merely theory if it has no political support in implementation. • Spending reviews should begin at the start of the government mandate - so that there is enough time to implement the reforms. • The Committee for spending reviews should consist of the best civil servants - problem: these servants usually have the most work. • External experts should be combined with internal knowledge. • The Final Report should be published.

23. Questions 