The World Bank Bosnia and Herzegovina: Challenges and Directions for Reform

1. The World Bank Bosnia and Herzegovina: Challenges and Directions for Reform A Public Expenditure and Institutional Review Sarajevo March 2012

2. Profound political challenges pervade almost all aspects of life in BH. Resolution of these political problems offers the greatest promise for achieving greater efficiency in the provision of public services. Current policies – without the necessary structural reforms – will accelerate the country towards a position that is unsustainable. Political elites seem to have a different priorities. Introduction

3. Major Challenges Improve fiscal policy management by strengthening the Fiscal Council (FC) Reduce the magnitude of the tax burden, especially on labor Reshape public expenditures – excessively concentrated on current spending including (public wages, pensions and social transfers) Improved the efficiency of spending (esp. health, education)

4. Challenge 1: Improve fiscal policy management No autonomy of monetary policy Establishing an effective mechanism for coordinating fiscal policy is, therefore, critical Fiscal Council has a key role to play, but should be strengthened.

5. Challenge 1: Improve fiscal policy management Improve the Law on Fiscal Council Get more frequent and timely data Strengthen the analytical capacity Take the lead in key fiscal management issues, as stipulated in the FC Law: i) public sector pay management; ii) public investment coordination and management; iii) social expenditure policies and iv) public sector procurement.

6. Revenue Structure of General Government (% GDP) Challenge 2: Reduce the magnitude of tax burden VAT reform in 2006 Income tax reform 2006-09 Social Contributions unreformed Tax burden high overall at 38.2 GDP • Tax on income: 10% (PIT or CIT) • Tax on consumption: 17% (VAT) • Tax on labor: 41 or 33% (Social contributions) • RESULT: high labor informality (26-36%)

7. Challenge 2: Reduce the magnitude of tax burden Broaden the tax base by eliminating non-taxable exemptions and reduce social contributions to achieve revenue neutrality. Consider further reductions in health contribution rates, especially in FBH Replacing forgone with other revenues, namely excise and higher income taxes. Ensure that any reductions in labor taxes are balanced with other benefit reductions or other less distorting revenue increases in order to preserve fiscal sustainability.

8. Expenditure of General Government (% GDP) Challenge 3: Reshape spending GG Current Expenditure (% GDP) Large spending by general government Concentrated on current expenditure, at the expense of investment. Not laying foundations for future growth Public sector wages, pensions and cash transfers are main culprits.

9. Dependency Ratio - FBH Pension Fund Challenge 3: Reshape spending - Pensions Contribution Rates - FBH Pension Fund High benefits (10.2% GDP). High dependency ratios. Low contributor numbers. Large numbers of early retirees. Inappropriate scaling and qualification criteria for disability benefits. Significant unfunded “privileged” pensions.

10. Pension reform advanced in RS, while stalled in FBH (complete overhaul needed) Introduce strict curbs on early retirement. Establish actuarial pension reductions for those who do retire early. Eliminate double-dipping between war-related benefits and pension fund benefits. Revise the disability benefit formula to provide higher benefits for the fewer people who will qualify as disabled. Provide survivor pensions only at retirement age and withdraw them if remarriage occurs. Challenge 3: Reshape spending - Pensions

11. Social Assistance Spending in BH and ECA, % of GDP, 2008-10 Challenge 3: Reshape spending – Social Transfers Historically high and fiscally unsustainable. Also economically inefficient and socially inequitable. Dominated by programs for veterans and poorly targeted. Entity-level spending 4% GDP. Cantonal and municipal spending (up to additional 3%)

12. Challenge 3: Reshape spending – Social Transfers Develop effective targeting mechanisms for veteran benefits. Step up eligibility audit efforts. Diversify the support for veterans who would lose cash benefits as a result of reforms. Introduce design changes in the social assistance programs to eliminate work disincentives. Improve the cost-efficiency, transparency and accountability of benefit administration.

13. Wage Bill as % of GDP Expenditure on wages are high (13% GDP) and unsustainable Have been increasing faster than GDP and faster than revenues The growth has been due mainly to salary increases, but also due to increases in employment. Wages in the public sector are high compared to average pay levels Challenge 3: Reshape spending – Public Wages Annual Growth Rates of Revenue, Expenditure and Wage Bill

14. Challenge 3: Reshape spending – Public Wages Institute meaningful establishment controls. Reduce the cost of various salary increments: Abolish discretionary fees Eliminate universal entitlements to allowances Restrict allowance eligibility Reduce the number of auxiliary staff by outsourcing these functions or transferring these employees to labor law contracts. Increase flexibility in negotiations with public sector trade unions to avoid disorderly wage bill cutbacks in the future. Improve coordination in wage bill planning in the Fiscal Council.

15. Challenge 4: Improve Efficiency of Spending Over the longer term the authorities need to take account of demographic realities. Significant additional fiscal pressures from rising health and pension costs as the population ages and from a decline of the working age population. Declining enrollment rates in elementary and secondary schools. Need to provide better value-for-money in health and education.

16. Private Households' Out-of-Pocket Payment on Health as % of Total Health Expenditure, 2008 Expenditure growing rapidly (2008 -10.3% GDP), but poor outcomes. Financing of health sector is not equitable nor sustainable 50 percent of those covered are exempt from contributing High private out-of-pocket payments High drug costs Challenge 4: Improve Efficiency - Health Generic Drug Price Differential Between BH and Croatia

17. Challenge 4: Improve Efficiency - Health Expand the insurance risk pool related to hospital and pharmaceutical care. Reduce fragmentation and duplicate functions. Leverage family medicine reforms to increase Primary Health Care productivity and increase preventive medicine. Consider hospital financing reforms e.g. Diagnostic Related Groups. Centralize procurement of drugs to at least the entity level.

18. Challenge 4: Improve Efficiency - Education Overall spending is not excessive, but weak reasults Allocation of spending within the sector needs refinement and is affecting efficiency. Wage expenditures are crowding out non-wage spending. BH’s student performance on international test is poor compared to similar countries with similar amount of spending

19. Challenge 4: Improve Efficiency - Education Introduce per capita financing of schools to replace the existing the input-based financing system. Establish an Education Management Information System. Limit further teacher wage increases. Develop a more decompressed wage structure. Rebalance spending between school levels to enhance pre-school and tertiary education Address the quality issues in upper secondary that are at the root of low enrollment rates.

20. Strengthen institutions for effective decision-making • Public expenditures are large – especially current expenditures • Reshape the tax burden from labor taxes to other taxes • Service delivery is too-decentralized and should be transferred at a higher level • Public spending needs to provide better value-for-money in certain sectors Summary