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While the speed of fiscal consolidation is on track, the “quality of consolidation” has still to be improved. Since a large part of spending is “mandatory” and therefore politically difficult to curb in areas such as public wages and social security transfers, cuts had to be effected elsewhere on an ad hoc basis, including in important public services and infrastructure investment. As total non-interest spending could be reduced only slightly as a share of GDP because of pressures from mandatory items, the bulk of consolidation came from tax increases effected on an ad hoc basis and with limited regard for the overall structure and incentive implications of the tax system. Many “temporary” taxes introduced for short term fiscal consolidation also tended to become entrenched. The authorities have now initiated an assessment of the existing tax policy and tax collection procedures, have launched a simplification of corporate and indirect taxes, and are projecting an important overhaul of the tax administration system along functional lines. They should continue to improve the quality of spending so that key public services and infrastructures are no longer crowded out and public resources are allocated according to economic and social priorities.
Public spending has not been managed in the past according to clear policy objectives and there has been no comprehensive accounting framework to measure actual costs and outcomes. But reforms are now under way. The Public Financial Management and Control Law of 2003 brings Turkish budgetary practices closer to international standards. It integrates all extra-budgetary and revolving funds in the budget, requires that functional areas are identified with their performance targets, and legislates a rolling three year budget framework. This system will become operational with the 2006 budget and will pose implementation challenges. The authorities should rapidly phase-in the specific technical training needed for its application in line ministries; adapt the public personnel regime to permit adjustments in government employment according to policy objectives; and establish the necessary conditions for effective auditing which should play a critical role in the credibility and performance of the new system. Since public expenditures and government employment are areas traditionally suffering from suspicions of favouritism, the authorities should make sure that the highest degree of transparency is applied during the implementation process.
In spite of a favourable demographic structure, the low rate of registration of workers, the underreporting of their incomes and drifts in spending are causing growing imbalances in the social security system with an expected deficit of 4 per cent of GDP in 2004. Important parametric changes legislated in the pay-as-you-go retirement system in 1999 increased the minimum retirement age for men and women to respectively 60 and 58, while no such minimum age existed before and workers completing 25 years of service could retire in their mid-40s. Yet the system’s fiscal balance will only improve gradually because of the inertia of grandfathered rights. Authorities should further increase the retirement age and implement the envisaged unification of the three components of the system (for wage earners, civil servants and self-employees), which would reduce the administrative costs and increase the efficiency of services. The government is also working on a thorough reform of the health system, based on universal health insurance and a full separation of the funding and provision of services. International experience and Turkey’s recent difficulties with containing public health spending notably pharmaceutical costs call for a careful design of the new system to avoid new spending drifts. The future costs of introducing universal insurance should be carefully assessed, and the health care package needs to be carefully designed to provide essential services of good quality while containing costs.
What are the expected benefits and risks of decentralisation reforms?
Turkey’s highly centralised public administration has been criticised as being not adequately responsive to user and local needs and creating cost-inefficiencies. The government decided to introduce an ambitious decentralisation reform transferring major spending powers to special provincial administrations, metropolitan municipalities and municipalities. Regional Development Agencies (RDAs) will also be formed in the 26 newly created regions, to co-ordinate regional infrastructure projects and lead local development initiatives. These reforms have the potential to better tailor public services to user and local needs but they also involve important risks that should be contained. Given the small size and limited human capital of many municipalities, diseconomies of scale may also be created. Amalgamations and service unions between municipalities should be encouraged to exploit scale advantages. The most important risk is, however, that the “tide” of decentralisation leads to spending drifts at the local level and a weakening of the budget constraint. It is therefore of crucial importance to fully apply the new fiscal and debt management framework to sub-central entities in order to limit their overall borrowing and prevent off-budget and quasi-fiscal spending.
In the past, serious gaps and deficiencies accumulated in core public services of justice, education, health, rural development and infrastructure planning and management, contributing to the governance trap for economic growth. The severity of these shortcomings is largely recognised and the government sees the introduction of functional budgeting as an essential technique to monitor and target the quality of services. Given the unavoidable delays in the full introduction of this new technique in line ministries, the government may wish to directly assess existing service quality, coverage and objectives in the most important core service areas. In order to focus attention at the highest government level and address the functional and fiscal aspects in an integrated manner, the approach utilised for the elaboration of the social security white paper is recommended. The paper evaluates the present situation and reform options through close co-operation between central economic agencies and line ministries and has been made available for public comment. The government should request similar assessments on justice, education, infrastructure development and rural development services. New policy initiatives should, wherever possible, create room for competition and private provision of services, under regulatory safeguards ensuring service quality and non-discrimination among users.
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