In Armenia – More Bang for the Buck

Striking a balance between bolstering revenues and consolidating expenditure has historically been an important lesson for governments – and is one that is of particular importance to Armenia now as its economy finds itself on the path to growth, a recent report found.

Improving the efficiency of all aspects of public finance, including tax policy, tax administration and public expenditures, is crucial to Armenia’s planned fiscal adjustment, according to the latest public expenditure review for the country titled “Fiscal consolidation and recovery in Armenia: impact of the global crisis on a small open economy.”

The report tackles two important aspects of fiscal consolidation – revenues and public expenditure – and outlines how each area can be improved. It also serves to answer questions on strategic trade-offs on the fiscal policy front, best indicators to measure how sustainable Armenia’s external debt is, and public policy recommendations to re-balance the fiscal situation in Armenia given the slow recovery and low growth prospects.

The recommendations set forth in the study are critical for the country’s budget, said Vache Gabrielyan, Armenian Minister of Finance, adding that “effectiveness of public spending is a constant topic for the Cabinet.”

With fiscal consolidation measures on the revenue side, the report addresses:

• The tax system: With two parallel taxation structures (a regular one encompassing taxes such as VAT and a presumptive one to account for informal merchants), the tax administration needs “rethinking,” with reforms to its audit function and a reduction in tax compliance costs and elimination of tax privileges that force formal businesses to turn to the informal economy, according to the report.
• Excises and taxes on the mining sector: Reforming measures dealing with the excise rates and taxes in the mining sector could have a significant impact, according to the report.
• Revamping tax laws: Rethinking some tax laws that are revenue-reducing can be beneficial. One example is the law that raised the VAT exemption threshold for small and medium enterprises.

The study shows real consolidation should come from the revenues:

• The revenue potential from tax administration is estimated to be at least between 1.2-2.6% of GDP.
• The revenue potential from tax policy is estimated to be at least between 0.9 and 3.2% of GDP.

Aspects to be reviewed on fiscal consolidation measures on the expenditure side are:

• Boosting efficiency of public expenditure: This includes cutting poorly targeted subsidies, while still spending enough on key infrastructure like roads and healthcare.
• Rethinking healthcare spending: In the short term, the report suggests expanding programs to strengthen health, reduce poverty and making essential medicines accessible cheaply despite the immediate increase in public health expenditure. Over a longer period, the government must decide between expanding health coverage and cutting out-of-pocket spending for the general public and focusing on health care for the poor – both with their own set of financial constraints.
• Education spending in rural areas: Forty percent of children attend rural schools in Armenia but these schools deliver poor results at a high cost, so spending on rural education must be assessed and alternative ways to provide education and boost quality of teaching must be explored, according to the report.
• Maintaining roads: Armenia should adopt reforms to modify its road standards and adopt contracts that are performance-based and factor in road repair and maintenance to avoid high costs for travelers and the national budget.

Suren Poghosyan, PFM Consultant, pointed out that more ground had to be covered.

“One of the findings of the report is that the road sector does not receive adequate funding from the state budget. However it does not acknowledge the lack of proper performance monitoring. In some areas the roads have been rebuilt or rehabilitated again while in some other settlements – no investment made. The asset management in the sector should be strengthened, so that the real value for money is not underestimated, and this is where the World Bank should urge the Government to pay more attention to the effective utilization of scarce resources.”