Four months into budget implementation, the State budget deficit amounted to PLN 31.7 billion, that is nearly 90 per cent of the total value planned for the year. It is almost certain that tax revenues will be lower than expected. The introduction of an amendment to the budget act, the first one since 2009, is however uncertain, as this is always a last resort measure for any government determined to protect its public image.
After the first four months of the year, tax revenues are about PLN 8.1 billion lower than in the corresponding period of 2012. Meanwhile, in this year’s budget, the government anticipated a PLN 18.7 billion increase in tax revenues as compared to last year’s implementation. Even if the difference between the income tax in the current year and the previous year does not increase in the coming months, it can be expected, with a high degree of probability, that tax revenues will ultimately be by about PLN 10-12 billion lower as compared to last year’s figure, and by about PLN 30 billion lower than initially planned.
The government was last forced to amend the budget act in 2009. In the summer of 2009, when it became clear that the economy was not growing as dynamically as planned, the government prepared a new budget, in which the planned revenue was cut by over PLN 30 billion. Are we facing a similar situation again this year?
We can expect an answer to this question in early autumn. The amendment of the budget act always creates an awkward situation, and therefore it is a solution adopted as a last resort by any government. We must remember that the revenue specified in the budget act is only a forecast, and the expenditure means a limit that must not be exceeded. The experience of recent years shows that the government has ample leeway in adjusting expenditure to the decreasing revenue.
Macroeconomic forecasts for the next year’s budget are usually made in the middle of the year, and therefore they are often imprecise − this is particularly true during periods of economic downturn, such as the present situation observed throughout the European Union. The current government has thus prepared budget acts for another six years. GDP growth forecast was overestimated four times (in 2008, 2009, 2012 and 2013), and it was underestimated twice (2010 and 2011). The inflation rate forecasts were underestimated on five occasions.
Given that the impact of inflation on the budget revenue is similar to the impact of GDP growth, the lower than actual inflation forecast served as a sort of a hidden reserve. The actual budget revenues were higher due to a higher inflation rate. Even in 2009, when economic growth slowed down considerably, inflation was higher than initially assumed. This year, for the first time in many years, inflation will be lower than forecast in the budget act. This is one of the reasons for this year’s budget problems.
Sensitive budget revenues
The deviation of forecast and actual GDP growth and inflation rates result in the actual budget revenues differing disproportionately from the assumed amount. Last year, the economy grew by 2 per cent instead of the planned 4 per cent, but the inflation rate was higher. In the 2012 budget act assumptions, the Minister of Finance assumed a nominal GDP growth of 6.7 per cent: from PLN 1,517.4 billion in 2011 to PLN 1,619.1 billion in 2012.
In fact, the nominal GDP grew by 4.4 per cent, from PLN 1,528.1 billion to PLN 1,595.3 billion. We should note that, when drafting the 2012 budget, the Minister of Finance underestimated the value of nominal GDP in 2011. Eventually, the nominal GDP in 2012 was 1.5 per cent lower than planned by the Minister of Finance. Meanwhile, budget revenues in 2012 were 2.1 per cent lower than assumed, while tax revenues were as much as 6.2 per cent lower than forecast.
The situation will repeat itself in the current year. When preparing the budget act for 2013, the Minister of Finance assumed that the value of nominal GDP would increase from PLN 1,612.7 billion in 2012 to PLN 1,688.3 billion in the current year, that is by 4.7 per cent. This time, the GDP calculated in current prices for 2012 was overestimated by Ministry of Finance experts. Assuming that the forecasts of the IMF and the European Commission regarding the Polish economy prove right, a nominal GDP growth will be 2.6 per cent. Expressed in current prices, GDP will reach PLN 1,637 billion, and will therefore be 3 per cent lower than assumed in the budget act.
However, if we extrapolate the current trend of budget revenues (after the first four months of the year), we can assume that tax revenues throughout the year will amount to PLN 230-240 billion, and thus will be 10-14 per cent lower than planned in the budget act.
Unsuccessful forecasts of the nominal GDP growth result in much larger deviations of the actual tax revenues from the budget plan. It is due to the overlapping of a number of factors related to the structure of the economic slowdown.
The same situation was observed in the previous two periods of economic slowdown, in 2001-2002 and in 2009. The contraction of domestic demand is offset by a strong increase in net exports. Imports decrease much faster than exports, or imports decrease while exports increase slightly. In the first quarter of 2013, the negative balance of foreign trade diminished by over PLN 12 billion (over 3 per cent of the GDP generated in the first quarter) in comparison with the first quarter of 2012.
It is worth noting that the growth of exports calculated in the Polish zloty is lower than in euro terms. Unlike 2009, exporters cannot count on the weakening value of the zloty. Just the opposite, the Polish zloty has appreciated in relation to the euro and the dollar over the year. For this reason, exporting firms have recorded a lower profitability level than three years ago, which is one of the reasons for the decline in CIT revenues.
Since the tax on goods and services − the most important source of revenue for the budget − is not levied on exported goods, improving the balance of trade means lower budget revenues.
One of the reasons for the economic slowdown is a decline in investment, in particular in publicly funded investment, with the highest VAT rate. A decrease in investments results therefore in lower VAT revenues for the budget.
In the period of economic slowdown, the structure of household expenditure changes. Fewer houses and apartments, household appliances, consumer electronics and cars are purchased − the maximum rate of VAT is imposed on all of these goods. We spend relatively more on food products, which have lower rates of the tax on goods and services.
After the tax on goods and services, the second most important source of state revenue is the excise duty. The government assumed that excise duty revenues would increase by PLN 2 billion in the whole year; after the first four months of the year, it is PLN 800 million lower than in the corresponding period of 2012. Revenue generated from excise duty on cigarettes and alcohol is between ten and twenty per cent lower. The tax burden on these products is rising, but budget revenues generated from them are falling. The reason is not the declining consumption, but a development of illegal trafficking in the substances. Forty years ago, American economist Arthur Laffer claimed that budget revenue grows slower if the tax burden increases, and, after having reached a certain point, it starts falling. It seems that the excise duty has moved to the other side of the Laffer curve.
Upward and downward deviations
Over the last five years, the Ministry of Finance managed to accurately predict budget revenue, including tax revenue, only twice: in 2010 and 2011. In both cases, nominal GDP growth was higher than planned, and nominal growth was even higher − due to higher than planned inflation. In 2010, nominal GDP growth was 5.4 per cent, as compared to the 2.1 per cent forecast in the budget act; in 2011, nominal growth amounted to 7.9 per cent, as compared to the 5.5 per cent forecast by the Ministry of Finance.
It thus appears that the higher than expected nominal GDP growth results in budget revenue being roughly in line with the plan. However, when the economic growth rate is lower than forecast, revenues dramatically deviate from planned by the Ministry of Finance.
It is worth noting that in 2009, a dramatic year for Polish finances, nominal GDP growth was 5.4 per cent, as compared to 7.9 per cent forecast by the Ministry of Finance. This relatively minor deviation from the expected value (2.4 per cent) resulted in a huge loss of revenue. Tax revenues were over 20 per cent lower than planned.
It seems that the Ministry of Finance systematically overestimates the value of budget revenues and overstates spending limits. Over the past five years, the actual budget expenditure differed from its planned level by less than 3 per cent only on one occasion.
Can the government avoid amending the budget act?
When working on this year’s budget, the government anticipated weak economic growth in the first months of the year, but hoped that it would rebound in the second half of 2013. Worse-than-expected results for the first quarter and a fall in GDP in Germany call into question this moderately optimistic forecast.
Nevertheless, it does not necessarily mean that the budget act will have to be amended. It seems that the Minister of Finance still has a few tricks up his sleeve.
Let’s look at last year’s budget situation. Revenues were over PLN 6 billion lower and tax revenues were more than PLN 16 billion lower than planned. However, it was not necessary to amend the budget act, and the final deficit was PLN 4.5 billion lower than initially planned.
Lower tax revenues were partially offset by higher non-tax revenue (by as much as PLN 10 billion). The National Bank of Poland contributed PLN 8.2 billion to the budget. Meanwhile, no payment from the NBP profit has been provided for in the budget act.
The government also made enormous savings. Several billion zlotys were saved on public investment, and another several billion − on the current expenditure of budget-funded institutions (purchase of materials, salaries). It should be emphasized that expenditure specified in the budget act should be understood as the upper limit of spending which must not be exceeded. The government is not obliged to spend the entire amount. If money is short; it can simply cut the spending of its subordinate units without asking the Sejm for its consent. It is important not to exceed the value of the deficit defined in the budget act. Last year, the government spent approximately PLN 10 billion less than anticipated in the act.
This year, the government is hoping to manage the budget in the same way, without exceeding the deficit and avoiding cumbersome amendment procedure. Although the revenue deficit is greater than last year, this manoeuver might prove successful.
According to unofficial reports, confirmed by Marek Belka, the President of the National Bank of Poland, last year’s NBP profit amounted to approximately PLN 5.5 billion, of which 95 per cent (that is approximately PLN 5.2 billion) will be transferred to the government’s accounts.
Incidentally, taking the NBP profit into account in budget revenue has long been a problem for the Ministry of Finance. The draft act is submitted to the Parliament in late September, when the NBP’s profit forecasts are very imprecise. Profit depends to a large extent on the exchange rate of the zloty against the major currencies at the end of the year. Therefore, the Minister of Finance usually does not include this item in the planned budget revenue, hoping for a nice “surprise” later. In this year’s budget, the Minister included a compromise amount of PLN 402 million. In fact, this sum is expected to be nearly five billion zloty higher at the end of the year. This result is good, but considerably worse than last year.
The government was planning that the amount of dividends paid from state-owned companies will provide the budget with approximately PLN 5.8 billion. As corporate profits have fallen, there is no indication that the income from dividends could significantly exceed the planned amount.
The Minister of Finance should look for savings on the expenditure side. In the first quarter, capital expenditure (investments) amounted to only 7 per cent of the amount planned for the entire year, and expenditure on purchase of materials represented less than 15 per cent of the total amount. If the government spends only 60 per cent of the forecast expenditure throughout the year, it will save approximately PLN 12 billion. This will, naturally, have its consequences, namely uncompleted investments, which cost more in the long run.
According to the budget act, interest on the incurred debt was to amount to PLN 43.5 billion, and as much as PLN 5-6 billion can be saved through reduced interest charges.
The loss in tax revenue may be offset by nearly PLN 20 billion of savings and the NBP’s profit of PLN 5 billion. We will have to wait a few months to see if the government has managed not to exceed the amount of deficit set in the budget. At the moment, it is still uncertain if the budget act will need amending.
In the long run, the methodology of budget preparation should be reconsidered in order to ensure that the forecasts of economic growth, revenue and expenses are more realistic.