Economic Survey of Greece 2005: The fiscal challenge


The following OECD assessment and recommendations summarise Chapter 2 of the  Economic Survey of Greece 2005 published on 7 July 2005.

Fiscal consolidation is of vital importance

In the near and medium term, strong front-loaded fiscal consolidation needs to be pursued. Quite apart from the constraints imposed by euro-area membership, it is worrying that Greece has recently had one of the highest public debt and deficit positions among Member countries, despite also having one of the strongest real growth performances. The growth of public spending needs to be reined back sharply this year, with further consolidation over the medium term, at least as fast as envisaged in the most recent Stability and Growth Programme (SGP). The government has implemented measures aimed at reducing drastically the deficit in 2005 and has committed to bring the deficit below 3% of GDP through the 2006 Budget. OECD estimates suggest that further measures may be required to meet the 2006 target. The credibility of the consolidation effort, to a large extent, hinges on this target being achieved. The latest SGP foresees a further reduction in the cyclically-adjusted deficit of 0.5 percentage points in 2007, which would bring the actual deficit down to 2.2% of GDP. Prima facie, this may not be sufficient, given both the size of the imbalances and spending pressures that will emerge in a decade's time  as the baby boomer generation starts to move into retirement. An appropriate goal beyond 2007 would be to move steadily towards budget balance, while assuring that the ratio of public debt to GDP is firmly on a declining trend.  A more vigilant control of primary spending is required, concentrating on areas such as the public wage-bill (which has risen particularly rapidly in recent years), health and education.

Public sector balance and the debt-to-GDP ratio1
Per cent of GDP, 2004

1. A negative balance denotes a deficit. For euro countries the debt refers to the Maastricht definition.
Source: OECD, Economic Outlook 77 database.

Achieving debt reduction also requires dealing with off-budget transactions that create debt. Such transactions cumulated to some 11% of GDP over the 2001 2004 period, and slowed the pace of debt reduction, despite sizeable privatisation receipts. They still amounted to around 3% of GDP in 2004, and plans to reduce them gradually to 1% of GDP by end-2007 are commendable. They should be fully implemented and extended beyond 2007. The previous government's target of a 60% debt-to-GDP ratio (the Maastricht target) by 2010 has been tacitly abandoned, and the OECD estimates that it would not be reached before 2017 even if there were no further debt-creating transactions after 2007. If these were to continue on the same scale after 2007 as envisaged until then in the SGP, a primary budget surplus of some 4¼ per cent of GDP each year after 2007 would be required. By comparison, the primary balance over the 2001-2004 period averaged 1½ per cent of GDP.

Recent reforms improved the tax system, but there is unfinished business

Tax reform packages came into effect in 2003, 2004 and 2005, which lowered the tax burden on businesses and households, contained measures of tax simplification and reduced both compliance costs and the cost of tax administration. Further tax reforms should nevertheless be planned. Many more stamp duties could be eliminated. Revenue losses from additional stamp duty abolition could be offset by an extension of VAT on house construction and by an ending of the preferential treatment of some products, professions and areas. Further reforms should aim at the elimination of the many remaining exemptions and deductions in corporate taxation, and removing the bias in the taxation system in favour of the self-employed. Moreover, the large number of earmarked "third-party taxes" continue to distort resource allocation, are inequitable and reduce budgetary transparency and thus should also be phased out. Social security charges for the self-employed should be proportional to their net earnings, while high contributions on dependent employees should be reduced to cut non-wage labour costs. Further unfinished business includes the reform of the local tax system and the introduction of a coherent property tax system, with a prerequisite the implementation of a National Land Registry. Another area for tax reform would be to better design taxes to underpin policies directed towards environmentally sustainable economic development.

More determined reforms to improve the efficiency of the health care sector are needed

The health care system is a key area for restraining medium-term spending pressures. Reforms aimed at decentralisation and re-organisation of managerial control in hospitals are commendable. Further reform plans address the chronic lack of funding for public hospitals, the dearth of an effective national primary health care and prevention system, and the shortage of specialised staff. A clear timeframe for implementing these reforms, and monitoring their progress, is indispensable.

A radical reform of the public pension system is imperative

Further reforms to the public pension system also need to be implemented. The Greek pension system is one of the most generous and inequitable in the OECD, because of high statutory replacement rates, easy eligibility criteria, and large differences in pension benefits between pension funds. Without reforms, age-related expenditures would have risen by as much as 12 percentage points to over 22% of GDP between now and 2050. The reform approved by Parliament in 2002 unifies the current highly fragmented system, and gradually aligns civil service pensions with those of the private sector. These reforms will begin to have a fiscal impact starting only in 2017. However, the expected long-term improvements in pension financing appear to be more than offset in the short and medium term by increased minimum pensions granted at the same time, which apply to as many as two-thirds of all retirees. In any case, the 2002 reforms will not by themselves prevent pension spending from rising steeply after the middle of the next decade. Although it is neither necessary nor desirable to implement new reforms with immediate effect, further reforms will need to be implemented eventually to ensure long-run fiscal sustainability. It is desirable that such reforms be discussed and legislated for in advance, so that the current generation of workers can adapt to them.  Reform in Greece should aim to link pensions to lifetime earnings, as is increasingly the case in other OECD countries. Consideration could be given to indexing pensions only to prices, and statutory replacement rates should be modified to avoid pensions higher than the last salary (for full-time work), unless last salary levels are well below average lifetime earnings. The high minimum pension should be replaced by a means-tested benefit scheme. Although the normal retirement age is set at 65 for men in the main pension scheme, only around one in eight of them are still working at that age. Most of the early retirement occurs under disability schemes or under special provisions for people in "arduous" jobs, not always narrowly defined. Early retirement for privileged groups should be scaled back; in particular, the eligibility criteria for disability pensions and the definition of categories of arduous work should be radically scaled down.

Public administration reform should focus on raising the efficiency of public spending

Expenditure on public administration in Greece absorbs a much higher percentage of total government expenditures than in most other OECD countries, with no evidence that the quantity or quality of services delivered are superior. This suggests that important social, political and economic goals could be achieved with significantly fewer resources. A major deficiency in this area is the absence of a system of performance evaluation that would provide incentives for improved efficiency and accountability of public servants. It is thus commendable that the government introduced a new system of human resource management in 2004 aiming inter alia at enhanced evaluation procedures for civil servants and performance-based career development and remuneration. Given the apparent gap between legislated reforms and their timely implementation in a number of areas, public administration reform should focus on ensuring that policies are fully and efficiently implemented once the legislation has been passed.

An efficient public administration and a well-functioning legal system are crucial for the successful implementation of structural reforms once they are enacted. A recent Working Paper published by the European Central Bank, as well as anecdotal evidence, suggest that there is substantial over-staffing in areas of the Greek public sector, and    more importantly    misallocation of human resources; thus, the Greek public sector absorbs a much higher percentage of total government expenditures than most other OECD countries. In addition, poor administration, lack of accountability, political interference and corruption, especially in the past, seem to be key features which weaken public sector efficiency. A major difficulty in improving the public administration has been opposition by the public-sector trade union, which has sought to defend the vested interests of public sector employees, as revealed by frequent labour unrest that has frustrated reform efforts and led to high public wage increases in recent years. Hence, to strengthen public governance, it is necessary to continue efforts to build consensus for reform through the conduct of an open dialogue.

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