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Cutting Deficits:
Lessons from Lithuanian Austerity
Kaetana Leontjeva
Senior Policy Analyst
Lithuanian Free Market Institute
INESS Cutting Deficits Conference, Bratislava
October 9, 2012
Presentation menu
• What austerity measures did we pursue in 2008-2012?
• How successful were they in cutting our budget deficit?
• What useful lessons can we learn from the Lithuanian
example?
Situation in 2008
•
•
•
•
•
Soft landing or hard landing?
New center-right wing coalition
Gaping hole in state finances
Currency Board
Focus on budgetary policy
“Overnight” Tax Reform of 2008
• A relatively stable and predictable tax system changed
overnight – 106 law articles amended
• Tax increases:
→ Corporate income tax – from 15% to 20%;
→ VAT “temporarily” from 18% to 19%;
→ Excise duties on alcohol and energy products;
→ For individual business owners;
→ 5% VAT rates on food, etc. abolished
After the Tax Reform
• Tax increases did not bring about the expected results:
→ Projections of corporate income tax revenues cut to 59%
of their original level
→ VAT revenues – to 73%
→ Excise duties’ revenues – to 82%
• Deepened recession: GDP contraction of 15%
• Surge in the shadow economy from 18% of GDP in 2008
to 27% in 2010, according to the Lithuanian Free Market
Institute’s survey
• Outcome in line with Laffer’s curve
Laffer’s curve
Further Tax Changes
• The government rolled back some of the tax increases:
→ corporate income tax and excide duty on diesel reduced
back to 2008 level
→ healthcare insurance contributions no longer levied on
dividends
• But, VAT was raised from 19% to 21%
Ways of cutting spending
Cutting planned increases in spending
• Spend 100 EUR this year
• Plan to spend 120 EUR next year
• Cut spending to 110 EUR next year
• Is this a spending cut?
Ways of cutting spending
Horizontal spending cuts:
→ easier to implement, but can be done up to a limit
→ lower the quality of service, result in customers’
dissatisfaction
→ doing the same with less money, so functions of the public
sector do not change
Ways of cutting spending
Vertical spending cuts:
→ most needed, but difficult to implement: require muchneed reforms in healthcare and social security areas and
elimination of unnecessary budget programs
→ reduce functions of the public sector
Conditional budget
• Spending should be made conditional on revenues
• Proposed by the Lithuanian Free Market Institute over a
decade ago
• Partially introduced in 2010
• True implementation would mean priority line assigned to
each budget program, for example:
→ Program A - Pensions: Spending not reduced
→ Program B – Roads: Spending cut by 20%
→ Program C – Social advertisements: Spending abolished
Spending cuts in Lithuania
• 2012 compared to 2008:
→ overall nominal state budget spending cut of 12%;
→ number of bureaucrats reduced by 10% ;
→ spending on bureaucrats’ salaries lowered by 17%
(progressive wage cuts of 8-36% on bureaucrats’ salaries).
• But spending on bureaucrats salaries’ is only 1/10 of the
state budget
Lithuania’s State Budget (excluding
EU funds, mln. Litas)
25000
20000
15000
Revenues
Expenditure
10000
5000
0
2008
2009
2010
2011
2012
State Social Insurance Fund
(mln. Litas)
16000
14000
12000
10000
Revenues
8000
Expenditure
6000
4000
2000
0
2008
2009
2010
2011
2012
Record-breaking deficits and no reform in sight. Transfers into
II pension pillar cut from 5.5% to 1.5% as a “savings cut”
Lithuania’s Total State Debt
(mln. Litas)
50000
45000
40000
35000
30000
25000
20000
15000
10000
5000
0
2007
2008
2009
2010
2011
From 17% of GDP in 2007 to 41% in 2012
2012
Another Budget Crisis in 2011
•
•
•
•
Economic growth of 5.9%
Bleak renewed growth forecasts
New budget gap of 3.8% of projected budget revenues
How should it be filled?
Dividends from
State-Owned Enterprises
Budget Hole
Stocks Owned by the State
Long-Term Material Assets
Owned by the State
Financial Assets
Owned by the State
Total Assets
Owned by the State
Filling 2012 Budget Hole
• No privatization pursued
• Spending cut fully filled the budget hole
• Politicians’ competition led to introduction of:
→ Residential property tax of 1% property market value
(with a significantly high tax-exempt value)
→ Copyright levy on devices
→ Land tax potentially raised from 1.5% to 4%
→ Raised taxes on natural resources, buses and cargo
vehicles
• Plans for more new and higher taxes
Lessons from the Lithuanian case
• Horizontal spending cuts of 2009-2010 were needed, but
were not enough
• State social insurance systems are very vulnerable to
negative economic changes and need reforms
• Lack of efficiency indicators means inability to prioritize
spending and pursue vertical spending cuts
Lessons from the Lithuanian case
• Inclination to raise taxes – something the private sector
cannot do!
• Reaffirmation of Laffer’s curve: tax hikes result in lower
revenues
• Prepare for contractions before they come: identify
wasteful spending, make priorities and be ready to cut the
less relevant spending
• Spending should not be rigid – it should be adjusted to
revenues
Thank you!