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2 February, 2015  ▪  

Budget Code Amendments: In-Depth Reform or a Mere Facelift?

The benefits and concerns of the budget reform

During the budget escapade of December 28, before adopting the 2015 State Budget the parliament passed a number of laws designed to lay the foundations necessary for the budget to work. Among them is the new edition of the Budget Code that has a number of both positive and negative innovations.

The passed Budget Code amendments for the most part reflect the provisions of the draft law proposed back on August 8. However, certain provisions are changed, and new ones were added. Those among them that deserve particular attention are as follows.

Firstly, Kyiv is to give 60% of its Personal Income Tax revenues, the main source of revenues for local budgets, to the central budget, instead of 80% as proposed in the August draft law  (up from 50% before 2015). Thus the capital is not going to have as much of a problem with own budget revenues as was feared in summer. Secondly, local (oblast) budgets are to keep the rent payment for extraction of mineral resources of nationwide importance, excluding oil and natural gas in the amount of 25%, instead of 0% as was proposed this summer (before 2015 this share used to make 50%). Just like in the previous example, this is better than what was initially proposed, however, de facto this kind of redistribution is a factor of centralization of budget cash flows. Thirdly, local self-governments have been allowed to place their "development budget" funds in state banks (previously all local budget funds, excluding the temporarily free funds, were to be placed exclusively on Treasury accounts). However, if local bodies do decide to take that opportunity, they will lose the option to cover temporary cash gaps using funds at the Treasury's expense. Fourthly, the state and municipal higher education and cultural establishments have been allowed to accumulate funds for provided services, or the received grant money on their accounts in state banks, which simplifies the procedure of utilizing said funds.

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Positive changes

1. A number of provisions of the Budget Code approved recently are fairly progressive. While some of them have been formulated far from ideally, certain revisions can turn them into the basis for the new budget system. The positive innovations that deserve special mention are as follows:

2. Unspent subsidies and subventions are to remain at a local budget and can be used next year. Previously all unutilized funds used to return to the central budget. This mechanism was often used as an implicit sequester: the money for certain budget expenditures (primarily capital ones) would arrive in November or December when local governments did not have enough time to utilize it. Subsequently, the funds returned to the Central budget. From now on local communities will be able to plan some of their budget spending, especially the capital ones, more seamlessly.

3. Funds of regional development (which is to make at least 1% of the total central budget income) must be distributed no later than 3 months after the adoption of the central budget (this way local government bodies will have enough time to utilize them). The selection of projects is to be done by the Ministry of Regional Development (and not the Ministry of Economic Development). Local government bodies must fund 10% of the spending for these projects, which may become an incentive to develop better quality projects.

4. All cities of oblast significance (178) are now entitled to external municipal borrowing, up from 15 cities with the population of over 300,000 as before; at the same time the Treasury is being stripped of its right to give mid-term loans to the local budgets. This innovation should broaden access to financing for local communities. In the long term, however, it may lead to solvency problems in certain regions.

5. The law on central budget is to put a limit not only on the state debt, but also on the state-guaranteed debt. Total debt must not exceed 60% of the GDP, and to overstep this boundary the government will now have to be granted permission by the Parliament (previously the Cabinet of Ministers used to decide this internally). This will raise transparency of the debt management process, although in the long run it may lead to problems regularly experienced by the United States in the recent years, where there's a need to raise the debt cap.

6. The new Budget Code provides ground for mid-term (3-year) budget planning. The National Bank of Ukraine will now produce a 3-year forecast of "indices of currency exchange rate policy" (although it would make more sense to request monetary policy forecast)). Additionally, the Ministry of Economic Development is to provide a 1-year macroeconomic forecast.

7. Two special central budget funds have been eliminated: the fund that used to accumulate the import duty for petroleum products and automobiles, which was utilized for automobile road construction and maintenance (now a considerable portion of road network is to become the responsibility of local authorities), and the fund that used to accumulate payments from the tax for producing radioactive waste, which was utilized for processing of said waste, as well as for certain nuclear safety related facilities (currently these funds are part of the environmental tax which will mostly end up on the regional level). At the same time two new funds are created: one will accumulate 50% of the payments for registering property rights and 85% of the payments for obtaining information from the Single Register of Enterprises and other registers, this money will be used to maintain these registers; the other fund will receive 50% of the payments from execution fees that will be utilized to reward officials of the State Executive Service (this is necessary to improve the function of the Judicial system, although its biggest problem is the qualification of judges).

8. Defense and intelligence spending, which are financed from the reserve fund, have been added to the list of "protected" spending items.


Negative innovations

The bulk of the poorly thought through provisions of the new Budget Code is related to decentralization. In general the redistribution of income and expenditure between budgets before even the functions of the local self-government have been defined is not the brightest idea. The biggest negative aspect of the current centralized model of state governance is that decisions are predominantly taken by the local administrations (i.e. the local representatives of the central government) instead of the local councils (representatives of the communities). Since the law "On Local Self-Government" for now remains unchanged, this problem will be exacerbated due to the increased resources at the disposal of local administrations. Other negative traits of the new Budget Code are as follows.

1. Liquidation of the community as the bottom level of self-government. According to the current law, only two levels remain: the oblast (city of oblast/regional significance) and the county, or the "united community". Most other countries have three levels of local self-government: the community, the county and the region, and everyday issues of communities (including the organization of education and general healthcare) are predominantly dealt with on the community level. This is the level where one can witness democracy in its purest form, as it is much easier for people to influence the decisions taken by the village mayor, rather than those by the head of the county council. Formally the elimination of the community level contradicts the subsidiarity principle, according to which services must be provided to citizen at the most immediate level.

2. Depriving the members of local communities of the right to influence the most critical areas of their life: secondary and professional education and healthcare. These areas are funded from the central budget through education and healthcare subventions (although local budgets can also allocate funding), and the amount of funding depends on the number of students/patients and the population residing in the given oblast. This mechanism may seem to be able to roughly equalize spending per student or patient for the entire country. In reality, it preserves the status quo, where the decisions on the amount and quality of services provided are made at the level of central government. In a decentralized model it is the community that should be making the decision on whether, for example, the local school needs to be supported (and perhaps requires extra investment), or whether the road should be repaired for the school bus to take kids to the next nearest school. The permission for the local self-government bodies to fund schools and hospitals would also create competition, a factor that would boost the quality of local governance.

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Analyzing the Budget Code one can reach the conclusion that while at first glance it does make several steps forward towards decentralization, in reality without the respective amendments to the laws "On Local Self-Government" and "On Administrative Territorial System" these innovations may lead to even deeper centralization. This will depend on the distribution of powers between the local administrations and local councils in each given oblast or county.

The elimination of the bottom level of self-government (the community) means that the majority of citizens will not experience the effects of decentralization in their daily life. Just as before their voice will not be heard when it comes to organizing the basic services in their town or city district, since all the decision-making will happen at the higher level of the region or city respectively. This is likely to be so at least until "united communities" are created, which may take awhile. One can assume that such a course of events will first and foremost harm the residents of towns of county significance.

Nevertheless, the passed amendments do give a little more freedom to local self-government bodies, and therefore may become a starting point for the proper decentralization reform.

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