Tag: financial support

Can Farmland Market Liberalization Help Ukraine in its Reconstruction and Recovery?

Posted on March 20, 2024 | Policy Brief

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The Russian full-scale invasion of Ukraine has inflicted massive damages and losses on Ukraine, already amounting to more than 2.5 times Ukraine’s 2023 GDP. Despite substantial and continuing international political and financial support to help Ukraine in its recovery and reconstruction, it is becoming increasingly clear that it will need to mobilize its own resources and private financing as well – not just for the country’s reconstruction but also for its long-term development. From a government perspective, it is important for Ukraine to leverage scarce public and donor resources and to undertake necessary reforms to facilitate and crowd in private financing. Farmland market liberalization is one of the key reforms in this respect. Its scale, with farmland accounting for more than 70 percent of Ukraine’s territory, and capacity for private financing generation for agriculture and rural areas is, however, often underestimated.  

An Unbearable War Toll and the Need for Private Financing

The raging Russian war on Ukraine enters its third year, imposing an immense toll in terms of human life, economic stability, and regional security. About 20 percent of Ukraine’s territory has been occupied. More than 10 million Ukrainians have left their homes, including 6.45 million refugees that have resettled across Europe (UNHCR, 2024). Ukraine’s military casualties are reported to be approaching 200,000 (The New York Times, 2023) and at least 10,000 civilians have been killed (United Nations, 2023). Ukraine’s GDP plunged by 30 percent in 2022, and the documented total damages to Ukraine’s economy have reached US$ 155 billion, as of January 2024 (KSE, 2024). Similarly, economic losses amount to around US$ 500 billion (as of December 2023). At the same time Ukraine’s reconstruction and recovery needs are estimated at about US$ 486 billion (World Bank, 2024). This immense number make up more than 2.5 times Ukraine’s 2023 GDP.

While there is a substantial and continuing international political and financial support for Ukraine’s defense, recovery, and reconstruction, this will not be enough (World Bank, 2023). Ukraine needs to mobilize its own resources and private financing, not just for its reconstruction but also for its long-term development. The Ukrainian government must leverage scarce public and donor resources and undertake necessary reforms to facilitate and crowd in private investments. One of the crucial reforms in this regard is the ongoing liberalization of the farmland market. The scale of its impact and capacity to generate private financing for agriculture and rural areas is frequently undervalued.

Ukraine’s Farmland Market and Reform

Almost 71 percent of Ukraine’s territory (or 42.7 million ha, including occupied territories) is farmland and 33 million ha is arable. This is far more than in the largest countries in the EU. Ukraine also has one-third of the world’s most fertile black soils. This resource has however been heavily underutilized for agricultural and overall economic development (KSE, 2021). Over the last two decades, Ukraine has turned into an increasingly important global supplier of staple foods (von Cramon-Taubadel and Nivievskyi, 2023), but this has largely happened without a full-fledged farmland market in Ukraine capable of facilitating even further agricultural productivity growth.

The farmland sales market was virtually non-existent for over three decades, instead rental transactions dominated. The farmland sales market began operating only in July 2021, and in a very limited format. Only individuals could purchase farmland plots and with a 100-ha cap per person. The minimum price was set at the normative monetary land value, and tenants had pre-emptive purchase rights while foreigners and legal entities were excluded; state and communal farmland remained under the 2001 sales ban. The farmland sales market opening was part of a large-scale land reform to support an efficient and transparent farmland market. This included a legislation package aimed at preventing land raiding, decentralizing land management, introducing electronic land auctions, establishing tools for land planning and use, creating a national infrastructure for geospatial data, establishing institutions for supporting small scale farmers, and empowering small scale farmers capacity to compete for land (KSE, 2021).

In general, there are two broad benefits of sales and lease transactions. First, the farmland market, via transactions, sorts out more efficient farms from less efficient ones, thus increasing the overall sector value added. Another important benefit, specifically linked to the farmland sales market, is that a functioning farmland sales market makes farmland a collateral which can generate productive investments in increased agricultural and non-agricultural productivity growth (Deininger and Nivievskyi, 2019).

Early Reform Outcomes

Almost two out of the first two and a half years of the reform phase unfolded amidst the profound shock from Russia’s full-scale invasion of Ukraine. Following this, nearly 20 percent of Ukraine’s farmland has been occupied (Mkrtchian and Mueller, 2024), almost a third of the agricultural sector has been ruined – the total damages and losses to the agricultural sector amount to US$ 80 billion (Neyter at al., 2024). As a result, a very restrictive first-phase format of the market, on top of the war challenges, effectively limited the expected benefits of the market liberalization.

The war has put a sizable drag on the farm-land sales market development, effectively slashing the transacted volume almost by half (see Figure 1).

Figure 1. Cumulative market transactions and the effect of the war.

Source: Nivievskyi and Neyter, 2024.

Overall, about 1.1 percent of total farmland area, or about 1.3 percent of Ukraine’s total controlled farmland (equivalent of 200,000 sales transactions or 444,300 ha) has been traded since the opening of the market. Regionally, the outcome is quite diverse (see Figure 2).

This is nonetheless an encouraging outcome as it is quite comparable to developed countries benchmarks where, on average, roughly 1 percent (and up to 5 percent) of the total agricultural land area is transacted annually (Nivievskyi et al., 2016). Another important outcome is that the transacted farmland has remained in agricultural production.

Farmland price development is also positive, especially for commercial farmland (see Figure 3). Since the commencement of the farmland sales market in Ukraine, the capitalization has increased by US$ 5.5 billion (KSE Agrocenter, 2024).

In fact, farmland market capitalization might be even greater. There are indications that the actual market price should be much higher, on average, than the officially registered one, as transacting parties may try and evade fees and taxes (Nivievskyi and Neyter, 2024).

Figure 2. Transacted area as share of total oblast (administrative region) area.

Source: The Center for Food and Land Use Research at Kyiv School of Economics (KSE Agrocenter), 2024.

Continued Farmland Market Liberalization and Associated Expectations

As of January 1, 2024, legal entities gained the right to acquire farmland that had, from 2001, been under sales ban. Also, in this second stage, the farmland accumulation cap per beneficiary increased to 10,000 hectares. Other restrictions remain, including that legal entities with a foreign beneficiary still cannot purchase farmland.

The first results of the second stage are premature, and firm conclusions cannot be drawn, yet the preliminary results are quite encouraging. The new market participants have already increased the volume of transactions and corresponding price by 13 percent, on average (see Figure 3).

Figure 3. Average farmland prices, in thousands UAH.

Source: KSE Agrocenter (2024). Note: Demonstration and estimations are based on the State GeoCadaster Data.

Another encouraging result highlights that legal entities bring further transparency into the market. For half of the transactions involving individuals, the sales price did not exceed the minimum price by more than 1.5 percent, while in half of the farmland transactions with legal entities, the price exceeded the minimum one by more than 44 percent.

These early results provide insight into the market’s direction and the associated benefits. The expected economic benefits from liberalizing the farmland market for legal entities could amount to an annual increase of 1-2.7 percent of GDP over the next three years.  The scale depends on many factors, including the availability of financing and financial support for small farmers (KSE Agrocenter, 2023).

Rural and agricultural financing is of particular interest as land is generally considered a high-quality collateral which could be utilized to attract loans and investments. This is particularly important during the current wartime period, as agricultural producers are facing significant collateral damage and severe financial difficulties for the third consecutive year. Currently, despite its potential, only a meager share of all farming loans is secured by farmland – far below global benchmarks.

Under current registered farmland prices, the total farmland market capitalization is equivalent to roughly US$ 35.5 billion. This could potentially generate an additional US$ 12.4 billion of loans (under the current low liquidity risk ratio of 0.35), already much greater than the current agricultural debt of about US$ 3.5 billion. Adding legal entities to the pool of farmland buyers (as of January 2024), is expected to increase farmland prices by an additional 40 percent. Thus, the farmland market will grow to almost US$ 50 billion, and the volume of land-secured financing could amount to US$ 17.5 billion. Further liberalization of the farmland market, such as a strengthening of its transparency, boosting the market liquidity, and accumulating necessary market statistics, may allow the National Bank of Ukraine to reconsider the liquidity risk ratio for farmland – potentially considering it as collateral similar to other types of real-estate (see the National Bank of Ukraine Resolution #351, June 30, 2016). A liquidity risk ratio at the level of developed countries (0.6-0.8) could further increase the volume of potential land-secured financing available to agriculture and rural areas/landowners to at least US$ 35 billion. This would, in turn, close the more than US$ 20 billion current financing gap for agricultural reconstruction, recovery and development. It would also contribute to Ukraine’s nearly US$ 500 billion reconstruction and recovery needs.

Further significant strides toward liberalizing Ukraine’s farmland sales market are anticipated as part of the country’s journey towards EU membership (European Commission, 2024), aligning with Chapter 4 ‘Free Movement of Capital’. Specifically, this pertains to allowing foreigners (EU citizens and legal entities) the right to purchase Ukrainian farmland (Nivievskyi and Neyter, 2024).

Conclusion

Russia’s full-scale invasion of Ukraine have inflicted massive damages and losses to Ukraine, already amounting to more than 2.5 times Ukraine’s 2023 GDP. The recently estimated reconstruction and recovery needs measure at nearly US$ 500 billion. This is an unbearable burden for Ukraine alone. Despite substantial and continuing support from international partners and donors, Ukraine will need to heavily draw on its own resources and capacity to generate private financing, not just for the country’s reconstruction, but also for its long-term development. It is therefore essential, from the Ukrainians government’s perspective, to focus on necessary reforms and optimize policy decisions to leverage the scarce public and donor resources and facilitate and crowd in private investments. Continued farmland market liberalization is one such critical reform, providing hope to generate substantial private investment in the agricultural sector and rural areas.

The size of the farmland market is immense (with farmland accounting for more than 70 percent of Ukraine’s territory). The first two years following the opening of the farmland sales market demonstrate a substantial potential for private financing generation for agriculture and rural areas. The results from regular market monitoring and the early findings, as discussed above, suggest that further farmland market liberalization and increased transparency could generate about US$ 35 billion of financing for agricultural producers and rural areas/landowners. That could, in turn, close the current agricultural financing gap of more than US$ 20 billion for rebuilding and recovery, as well as partially close the nearly US$ 500 billion financing gap for Ukraine’s overall reconstruction and recovery. The expected economic benefits from liberalizing the farmland market for legal entities are estimated at 1-2.7 percent of GDP annually, over the next three years. A further liberalization of the farmland market, and a step towards EU membership, would include granting foreigners (EU citizens and legal entities) the right to buy Ukrainian farmland – expected to bring even further benefits.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

How to Sustain Support for Ukraine and Overcome Financial and Political Challenges | SITE Development Day 2022

Posted on January 9, 2023 | Policy Brief

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The Russian war on Ukraine has turmoiled Europe into its first war in decades and while the effects of the war are harshly felt in Ukraine with lives lost and damages amounting, Europe and the rest of the world are also being severely affected. This policy brief shortly summarizes the presentations and discussions at the SITE Development Day Conference, held on December 6, 2022. The main focus of the conference was how to maintain and organize support for Ukraine in the short and long run, with the current situation in Belarus and the region and the ongoing energy crisis in Europe, also being addressed. 

War in Ukraine, Oppression in Belarus

Starting off the conference, Sviatlana Tsikhanouskaya, Leader of the Belarusian Democratic Forces, delivered a powerful speech on the necessity of understanding the role of Belarus in the ongoing war in Ukraine. Tsikhanouskaya argued that Putin’s war on Ukraine was partly a result of the failed Belarusian revolution of 2020. The following oppression, torture, and mass arrestations of Belarusians is a consequence of Lukashenka’s and Putin’s fear of a free Belarus, a Belarus that is no longer in the hands of Putin – who sees not only Belarus but also Ukraine as colonies in his Russian empire. Amidst the fight for Ukraine, we must also fight for a free Belarus, Tsikhanouskaya added. Not only Belarusians fighting alongside Ukrainians against Russia in Ukraine, but also other parts of the Belarusian opposition need support from the free and democratic world and the EU. The massive crackdowns on opponents of the Belarusian regime today and the war on Ukraine are not only acts of violence, but they are also acts against democracy and freedom. The world must therefore continue to give support to those fighting in both Belarus and Ukraine. Ukraine will never be free unless Belarus is free, Tsikhanouskaya concluded.

Johan Forssell, Minister of Foreign Trade and International Development Cooperation continued Tsikhanouskaya’s words on how the Russian attack must be seen and treated as a war on democracy and the free world. Belarus, Moldova and especially Ukraine will receive further support from Sweden, Forssell continued, adding that the Swedish support to Ukraine has more than doubled since the invasion in February 2022. Support must however not be given only in economic terms and consequently Sweden fully supports Ukraine on its path to EU-membership, which will be especially emphasized during Sweden’s upcoming EU-presidency.  Support for the rule of law, democracy and freedom will continue to be essential and, in the forthcoming reconstruction of Ukraine, these aspects – alongside long term sustainable and green solutions – must be integrated, Forssell continued. Forssell also mentioned the importance of reducing the global spillover effects from the war. In particular, Forssell mentioned how the war has struck countries on the African continent, already hit with drought, especially hard with increased food prices and increased inflation, displaying the vital role Ukrainian grain exports play.

Andrij Plachotnjuk, Ambassador Extraordinary and Plenipotentiary of Ukraine to the Kingdom of Sweden, further talked about the need for rebuilding a better Ukraine, emphasizing the importance of involvement from Kiyv School of Economics (KSE) and other intellectuals and businesses in this process. Plachotnjuk also pinpointed what many others would come to repeat during the day; that resources, time and efforts devoted to supporting Ukraine must be maintained and persevered in the longer perspective.

Economic Impacts From the War and How the EU and Sweden Can Provide Support

During the first half of the conference, the Ukrainian economy and how it can be supported by the European Union was also discussed. On link from Kiyv, Tymofiy Mylovanov, President of the Kyiv School of Economics, shared the experiences of the University during wartime and presented the work KSE has undertaken so far – and how this contributes to an understanding of the damages and associated costs. Since the invasion, KSE has supported the government in three key areas; 1) Monitoring the Russian economy, 2) Analyzing what sanctions are relevant and effective, and 3) Estimating the cost of damages from the war. For the latter, KSE is collaborating with the World Bank using established methods of damage assessment including crowd sourced information on damages complemented with images taken by satellites and drones. According to Mylovanov, the damage assessment is crucial in order to counter Russia’s claims of a small conflict and to remind the international community of the high price Ukraine is paying to hold off Russia.

The economic impact from the war was further accentuated during the presentation by Yulia Markuts, Head of the Centre of Public Finance and Governance Analysis at the Kyiv School of Economics. Markuts explained how the Ukrainian national budget as of today is a “wartime budget”. Since February 2022, the budget has been reoriented with defense and security spending having increased 9 times compared to 2021, whereas only the most pressing social expenditures have been implemented. This in a situation where the Ukrainian GDP has simultaneously decreased by 30 percent. Although there has been a substantial inflow of foreign aid, in the form of grants and loans, the Ukrainian budget deficit for 2023 is estimated to 21 percent. Part of the uncertainty surrounding the Ukrainian budget stems from the fact that the inflow from the donor community is irregular, prompting the government to cover budget deficits through the National Bank which fuels inflation and undermines the exchange rate. Apart from the large budget posts concerning military spending, major infrastructural damages are putting further pressure on the Ukrainian budget in the year to come, Markuts continued. As of November 2022, the damages caused by Russia to infrastructure in Ukraine amounted to 135,9 billion US Dollars, with the largest damages having occurred in the Kiyv and Donetsk regions, as depicted in Figure 1.

Figure 1. Ukrainian regions most affected by war damages, as of November 2022.

Source: Kiyv School of Economics

The infrastructural damages constitute a large part of the estimated needed recovery support for Ukraine, together with losses to the state and businesses amounting to over one trillion US Dollars. However, such estimates do not cover the suffering the Ukrainian people have encountered from the war.

The large need for steady support was discussed by Fredrik Löjdquist, Centre Director of the Stockholm Centre for Eastern European Studies (SCEEUS), who argued the money needs to be seen as an investment rather than a cost, and that we at all times need to keep in mind what the consequences would be if the support for Ukraine were to fizzle out. Löjdquist, together with Cecilia Thorfinn, Team leader of the Communications Unit at the Representation of the European Commission in Sweden, also emphasized how the reconstruction should be tailored to fit the standards within the European Union, given Ukraine’s candidacy status. Thorfinn further stressed that the reconstruction must be a collective effort from the international community, although led by Ukraine. The EU is today to a large extent providing their financial support to Ukraine through the European Investment Bank (EIB). Jean-Erik de Zagon, Head of the Representation to Ukraine at the EIB, briefly presented their efforts thus far in Ukraine, efforts that have mainly been aimed at rebuilding key infrastructure. Since the war, the EIB has deployed an emergency package of 668 million Euro and 1,59 billion for the infrastructure financing gap. While all member states need to come together to ensure continued support for Ukraine, the EIB is ready to continue playing a key role in the rebuilding of Ukraine and to provide technical assistance in the upcoming reconstruction, de Zagon said. This can be especially fruitful as the EIB already has ample knowledge on how to carry out projects in Ukraine.

During a panel discussion on how Swedish support has, can and should continuously be deployed, Jan Ruth, Deputy Head of the Unit for Europe and Latin America at Sida, explained Sida’s engagement in Ukraine and the agency’s ambition to implement a solid waste management project. The project, in line with the need for a green and environmentally friendly rebuild, is today especially urgent given the massive destructions to Ukrainian buildings which has generated large amounts of construction waste. Karin Kronhöffer, Director of Strategy and Communication at Swedfund, also accentuated the need for sustainability in the rebuild. Swedfund invests within the three sectors of energy and climate, financial inclusion, and sustainable enterprises, and hash previously invested within the energy sector in Ukraine. Swedfund is also currently engaged in a pre-feasibility study in Ukraine which would allow for a national emergency response mechanism. Representing the business side, Andreas Flodström, CEO and founder of Beetroot, shared some experiences from founding and operating a tech company in Ukraine for the last 10 years. According to Flodström there will, apart from a huge need in investments in infrastructure, also be a large need for technical skills in the rebuild. Keeping this in mind, bootcamp style educations are a necessity as they provide Ukrainians with essential skills to rebuild their country.

A recurring theme in both panel discussions was how the reconstruction requires both public and private foreign investments. Early on, as the war continues, public investments will play the dominant part, but when the situation becomes more stable, initiatives to encourage private investments will be important. The potential of using public resources to facilitate private investments through credit guarantees and other risk mitigation strategies was brought up both at the European and the Swedish level, something which has also been emphasized by the new Swedish government.

Impacts From the War Outside of Ukraine – Energy Crisis and Other Consequences in the Region

The conference also covered the effects of the war outside of Ukraine, initially keying in on the consequences from the war on energy supply and prices in Europe. Chloé Le Coq, Professor of Economics, University Paris-Pantheon-Assas (CRED) & SITE, gave a presentation of the current situation and the short- and long-term implications. Le Coq explained that while the energy market is in fact functioning – displaying price increases in times of scarcity – the high prices might lead to some consumers being unable to pay while some energy producers are making unprecedented profits. The EU has successfully undertaken measures such as filling its gas storage to about 95 percent (goal of 80 percent), reducing electricity usage in its member countries, and by capping market revenues and introducing a windfall tax. While the EU is thus appearing to fare well in the short run, the reality is that EU has increased its coal dependency and paid eight times more in 2022 to fill its gas storage (primarily due to the imports of more costly Liquified Natural Gas, LNG). In the long run, these trends are concerning given the negative environmental externalities from coal usage and the market uncertainty when it comes to the accessibility and pricing of LNG. Uncertainties and new regulation also hinder investments signals into new low-carbon technologies, Le Coq concluded. Bringing an industrial perspective to the topic, Pär Hermerèn, Senior advisor at Jernkontoret, highlighted how the energy crisis is amplified by the increased electricity demand due to the green transition. Given the double or triple upcoming demand for electricity, Hermerèn, referred back to the investment signals, saying Sweden might run the risk of losing market shares or even seeing investment opportunities leave Sweden. This aspect was also highlighted by Lars Andersson, Senior advisor at Swedenergy, who, like Hermerèn, also saw the Swedish government’s shift towards nuclear energy solutions. Andersson stated the short-term solution, from a Swedish perspective, to be investments into wind power, urging policy makers to be clear on their intentions in the wind power market.

Other major impacts from the war relate to migration, a deteriorating Belarusian economy and security concerns in Georgia. Regarding the latter, Yaroslava Babych, Lead economist at ISET Policy Institute, Georgia, shared the major developments in Georgia post the invasion. While the Georgian economic growth is very strong at 12 percent, it is mainly driven by the influx of Russian money following the migration of about 80 000 Russians to Georgia. This has led to a surge in living costs and an appreciation of the local currency (the Lari) of 12,6 percent which may negatively affect Georgian exports. Additionally, it may trigger tensions given the recent history between the countries and the generally negative attitudes towards Russians in Georgia. Michal Myck, Director at CenEa, Poland, also presented migration as a key challenge. While the in- and outflow of Ukrainian refugees to Poland is today balanced, the majority of those seeking refuge in Poland are women and children and typically not included in the workforce. To ensure successful integration and to avoid massive human capital losses for Ukraine, Myck argued education is key, pointing to the lower school enrollment rates among refugee children living closer to the Ukrainian border. Apart from the challenges posed by the large influx of Ukrainian in the last year, the Polish economy is also hit by high energy prices, fuel shortages and increasing inflation. Lev Lvovskiy, Research fellow at BEROC, Belarus, painted a similar but grimmer picture of the current economic situation in Belarus. Following the invasion, all trade with Ukraine has been cut off, while trade with Russia has increased. Belarus is facing sanctions not only following the war, but also from 2020, and the country is in recession with GDP levels dropping every month since the invasion. Given the political and economic situation, the IT sector has shrunk, companies oriented towards the EU has left the country and real salaries have decreased by 5 percent. At the same time, the policy response is to introduce price controls and press banknotes.

Consequences of War: An Academic Perspective

The later part of the afternoon was kicked off by a brief overview of the FREE Network’s research initiatives on the links between war and certain development indicators. Pamela Campa, Associate Professor at SITE, presented current knowledge on the connection between war and gender, with a focus on gender-based violence. Sexual violence is highly prevalent in armed conflict and has been reported from both sides in the Donetsk and Luhansk regions since 2014 and during the ongoing war, with nearly only Russian soldiers as perpetrators. Apart from the direct threats of sexual violence during ongoing conflict and fleeing women and children risking falling victims to trafficking, intimate partner violence (IPV) has been found to increase post conflict, following increased levels of trauma and post-traumatic stress disorder (PTSD). While Ukrainian policy reforms have so far strengthened the response to domestic violence there is still a need for more effective criminalization of domestic violence, as the current limit for prosecution is 6 months from the date crime is committed. An effective transitional justice system and expertise on how to support victims of sexual violence in conflict, alongside economic safety measures undertaken to support women and children fleeing, are key policy concepts Campa argued. Coming back to the broader topic of gender and war, Campa highlighted the need for involvement of women in peace talks and negotiations, something research suggests matter for both equality, representativeness, and efficiency.

Providing insights into the relationship between the environment and war, Julius Andersson, Assistant Professor at SITE, initially summarized how climate change may cause conflict along four channels: political instability and crime rates increasing as a consequence of higher temperatures, scarcity of natural resources and environmental migration. Conflict might however also cause environmental degradation in the form of loss of biodiversity, pollution and making land uninhabitable. As for the negative impact from the war in Ukraine, Andersson highlighted how fires from the war has caused deforestation affecting the ecosystems, that rivers in conflict struck areas in Ukraine and the Sea of Azov are being polluted from wrecked industries (including the Azovstal steelworks) and lastly that there is a real threat of radiation given the four major nuclear plants in Ukraine being targeted by Russian forces. Coming back to a topic mentioned earlier during the day, Andersson also emphasized potential conflict spillovers into other parts of the world due to the war’s impact on food and fertilizer prices.

Concluding the session, Jonathan Lehne, Assistant Professor at SITE, reviewed how war and democracy is tied to one another, highlighting that while studies have found that democracies per se are not necessarily less conflict prone, it is still the case that democratic countries almost never fight each other. As for the microlevel takeaways from previous research, it appears as if individuals and communities having experienced violence and casualties actually reap a democratic dividend in some respects, such as greater voting participation. On the other hand, while areas with a large refugee influx also experience an increased voter turnout, voting for right-wing parties also increase with politicians exploiting this in their communication.

Book Launch – Reconstruction of Ukraine: Principles and Policies

The Development Day was also guested by Ilona Sologoub, Scientific Editor at VoxUkraine, Tatyana Deryugina, Associate Professor of Finance at the University of Illinois at Urbana-Champaign, and Torbjörn Becker, Director of SITE, who presented their newly released book “Reconstruction of Ukraine: Principles and policies”. Sologoub started off by giving an overview of the mainly economic topics covered in the book and pointing out that the main purpose of the book is to inform policy makers about the present situation and to suggest needed reforms and investments. Becker outlined the four key principles recommended to stem corruption during reconstruction; 1) Remove opportunities for corruption and rent extraction, 2) Focus on transparency and monitoring of the whole reconstruction effort, 3) Make information and education an integral part of the anti-corruption effort, and 4) Set up legal institutions that are trusted when corruption does occur. Deryugina focused on the energy sector and related back to what had previously been discussed throughout the day, the need to “build-back-better”. Deryugina mentioned that Ukraine, previously heavily reliant on coal and gas imports from Russia, now have the opportunity to steer away from low energy efficiency and bottleneck issues, towards becoming a European natural gas hub. The book is available for free here. There will also be a book launch on the 11th of January 2023 at Handelshögskolan.

Concluding Remarks

Via link from Kiyv, Nataliia Shapoval, Head of KSE Institute and Vice President for Policy Research at Kyiv School of Economics closed the conference by emphasizing the urgency of continued education of Ukrainians in Ukraine and elsewhere to avoid loss of Ukrainian human capital. Shapoval also stressed how universities can act as thinktanks, support policy makers in Ukraine and Europe to come up with effective sanctions against Russia and provide a deeper understanding of the current situation – a situation which will linger and in which Ukraine needs continued full support.

This year’s SITE Development Day conference gave an opportunity to discuss the need for continued support for Ukraine and the implications from the war in a global, European, and Swedish perspective. Representatives from the political, public, private and academic sectors contributed with their insights into the challenges and possibilities at hand, providing greater understanding of how the support can be sustained, with the goal of a soon end to the war and a successful rebuild of Ukraine.

List of Participants in Order of Appearance

  • Anders Olofsgård, Deputy Director at SITE
  • Sviatlana Tsikhanouskaya, Leader of the Belarusian Democratic Forces
  • Johan Forssell, Minister of Foreign Trade and International Development Cooperation
  • Andrij Plachotnjuk, Ambassador Extraordinary and Plenipotentiary of Ukraine to the Kingdom of Sweden
  • Tymofiy Mylovanov, President of the Kyiv School of Economics (on link from Kyiv)
  • Yuliya Markuts, Head of the Centre of Public Finance and Governance Analysis, Kyiv School of Economics
  • Jean-Erik de Zagon, Head of the Representation to Ukraine at the European Investment Bank
  • Cecilia Thorfinn, Team leader of the Communications Unit at the Representation of the European Commission in Sweden
  • Fredrik Löjdquist, Centre Director of the Stockholm Centre for Eastern European Studies (SCEEUS)
  • Jan Ruth, Deputy Head of the Unit for Europe and Latin America at Sida
  • Karin Kronhöffer, Director of Strategy and Communication at Swedfund
  • Andreas Flodström, CEO and founder of Beetroot
  • Chloé Le Coq, Professor of Economics, University Paris-Pantheon-Assas (CRED) & SITE
  • Lars Andersson, Senior advisor at Swedenergy
  • Pär Hermerèn, Senior advisor at Jernkontoret
  • Ilona Sologoub, VoxUkraine scientific editor (on link)
  • Tatyana Deryugina, Associate Professor of Finance at the University of Illinois at Urbana-Champaign (on link)
  • Torbjörn Becker, Director at SITE
  • Michal Myck, Director at CenEa, Poland
  • Yaroslava Babych, Lead economist at ISET Policy Institute, Georgia
  • Lev Lvovskiy, Research fellow at BEROC, Belarus
  • Pamela Campa, Associate Professor at SITE
  • Julius Andersson, Assistant Professor at SITE
  • Jonathan Lehne, Assistant Professor at SITE
  • Nataliia Shapoval, Head of KSE Institute and Vice President for Policy Research at Kyiv School of Economics (on link)

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

IMF’s New SDR Allocation—Why Belarus Is “Getting Money From the Fund”

Posted on September 9, 2021 | Policy Brief

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Why is the IMF sending $1bn to Belarus as the country is falling deeper into repression and authoritarianism? The short answer is that Belarus, together with 189 other countries, is a member of the IMF and the institution has decided to make a $650bn allocation of SDRs to its members in proportion to their quotas in the IMF. Belarus has a quota of 0.14 and will thus receive an injection of around $1bn to its reserves. In other words, this is not a decision to support the Belarus government as such but a general decision by the IMF members to support a global recovery after the Covid-19 pandemic. That said, it still means that the leaders of Belarus are given an asset worth $1bn that can be used without conditions, but the underlying reason to support the recovery in low- and middle-income countries still makes this palatable.

Introduction

On August 2, 2021, the board of the IMF approved the largest-ever SDR allocation to its 190 member countries. Belarus is one of the members that, by this decision, will get a boost of reserve assets of almost $1 billion. This has raised the question in some circles of “why is the IMF giving money to Belarus”. This brief provides a short background on IMF SDR allocations; how this may be used by the autocratic regime of Belarus; and why the general SDR allocation still makes sense.

SDR Allocations

For most people, an IMF “SDR allocation” is just another mysterious acronym that means very little. Therefore, a short introduction to the concept is warranted. SDR is short for Special Drawing Rights and is the IMF’s own reserve asset and unit of account, with a value that was first linked to gold but is now based on a basket of other currencies (IMF 2021). More specifically, the value of the SDR is based on a basket that consists of the U.S. dollar, euro, yen, pound sterling, and Chinese renminbi (since 2016). Table 1 shows the amounts of each currency and the value of the SDR based on exchange rates for August 26, 2021. In short, on that date, 1 SDR was worth approximately 1.42 U.S. dollars. Since the cross-exchange rates in the basket vary over time, so does the value of the SDR (see Figure 1).

Table 1. The SDR basket

Source: IMF (https://www.imf.org/external/np/fin/data/rms_sdrv.aspx)

Figure 1. SDR valuation

Source: IMF’s IFS database

The next issue is how SDRs are allocated among the IMF members. This is determined by the IMF’s Articles of Agreement and is done to provide reserve assets to its member countries. A new SDR allocation requires an 85 percent majority in the board to pass, and SDRs are then allocated to members based on their quotas. IMF quotas, in turn, are basically the stake the different member countries have in the Fund and are roughly based on the size of the economy of the country relative to other members.  Since several countries joined the IMF after the general SDR allocations in 1981, a special allocation was done in 2009 to allow new member countries to join the SDR Department on more equal terms. There was also a large general allocation in 2009 during the global financial crisis and in 2021 in response to the COVID-19 pandemic (Figure 2). The latter one is by far the largest and given the exchange rate in Table 1, the SDR456.5 billion is equivalent to around $650 billion.

 Figure 2. SDR allocations

The final issue to address in this section is why the SDR allocations matter at all. The answer is that SDRs can be exchanged for other currencies that, in turn, can be used to buy goods and services in international markets, including vaccines, other medical equipment, services, or food. When countries use the SDRs in this way, there is a cost in terms of the interest rate countries pay on SDRs. However, this interest rate is very low compared to other types of borrowing, so it is a cheap way of getting more foreign currency to spend (see Figure 3). In other words, for countries lacking access to foreign exchange at reasonable costs, the SDR allocation is a very welcome addition to their spending power.

Figure 3. Interest rate on SDR

Source: IMF’s Finance Department

Belarus and the IMF

Belarus became a member of the IMF in July 1992, shortly after the dissolution of the Soviet Union. Its quota in the IMF is SDR 681.5 million (or a share of 0.14 percent of total).

Belarus has had two IMF programs so far, the first in the early 1990s and the second in the wake of the global financial crisis in 2009. In the latter program, the IMF board approved a $2.5 billion loan “in support of the country’s efforts to adjust to external shocks” on January 12, 2009 (IMF, 2009a). The loan was then increased to a total of $3.5 billion in June 2009 (IMF, 2009b).

Despite the need for reforms and external funding, Belarus could not reach an agreement with the IMF on continued funding and instead repaid the loans to the Fund between 2012 and 2015. At the heart of this was the fact that for a country to get financial support in a regular Fund program, conditions will apply and will not always be stated explicitly, including on how to deal with human rights issues that are outside the Fund’s mandate. Therefore, the previous money from the Fund to Belarus was fundamentally different from the general SDR allocation described here, which is money without strings attached.

As the Covid-19 pandemic hit economies across the globe, Belarus approached the Fund in March 2020 to seek financial assistance. According to various reports, Belarus could not reach an agreement with the IMF due to conditions on how the pandemic was to be handled (IMF, 2020).

The new SDR allocation is however NOT subject to any conditionality but distributed to IMF members in proportion to their quotas. For Belarus, this means a new SDR allocation of 0.14 percent of the total SDR 456.5 billion, equivalent to around $900 million. As explained above, the SDR allocation can be exchanged for dollars, euros, or other currencies that can then be used to buy whatever the regime in Belarus likes. It could be vaccines, food, and medical equipment, but it could also be guns, ammunition, or tear gas to the security forces. In other words, this is money that can be spent in any way the government decides and the only price for this is a very small interest charge (see Figure 3) that comes with not keeping the SDRs as a reserve asset.

Concluding Remarks

The IMF is a member institution with 190 countries that is governed by its Articles of Agreement. This dictates that a new general SDR allocation should be distributed to its members according to their quotas. New SDR allocations are rare but have been used before to handle global economic crises. The current SDR allocation is designed to help low- and middle-income countries to deal with the economic side of the Covid-19 by making more foreign exchange available at a low cost. Helping countries with limited reserves to deal with the crisis and ensure that they can secure imports of vital goods and services makes perfect sense. The fact that this general support in certain instances will go to regimes like the one in Belarus that we currently think do not warrant the support of the global community is unfortunate. In a perfect world, the IMF would be able to impose conditions on human rights and democracy for any type of financial support, but this is not the world we live in. Therefore, the conclusion is not to stop helping a global recovery but to do more to support the alternatives to autocratic regimes across the world with other instruments.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Socio-Economic Policy in Poland: A Year of Major Changes in Benefits, Taxes, and Pensions

Posted on January 23, 2017 | Policy Brief

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2016 was the first full calendar year of the new Polish government elected to power in October 2015. The year marked a number of major changes legislated in the area of socio-economic policy some of which have already been implemented and others that will take effect in 2017. In this policy brief, we analyse the distributional consequences of changes in the direct tax and benefit system, and discuss the long-term implications of these policies in combination with the policy to reduce the statutory retirement age.

The Law and Justice party (Prawo i Sprawiedliwość, PiS) won an absolute majority of seats in both houses of the Polish Parliament in the parliamentary elections of October 2015. Earlier that year, Andrzej Duda of PiS was elected President of the Polish Republic. In both cases, the electoral victories came on the wave of pledges of significant financial support to families with children and to low-income households, especially pensioners. The new president pledged to cut back the pension age to the levels prior to the 2012 reform, which introduced a gradual increase from 60 and 65 to 67 for both women and men, and to nearly triple the income tax allowance. Following Duda’s victory in May 2015, PiS reiterated these pledges in the parliamentary election campaign and added the promise to increase the total level of financial support for families with children by over 140% through a nearly universal benefit called “Family 500+” and to hike the minimum wage by over 8%.

Despite a rather tight budget situation, the government went ahead with the “Family 500+” and successfully rolled it out in April 2016 (Myck et al., 2016a). The new instrument directs support of 500 PLN per child per month (110 EUR) to all second and subsequent children in the family in the age group between 0 and 17. Benefits for the first child in the family in this age group are granted conditional on overcoming an income threshold of 800 PLN (180 EUR) per person per month. Since April 2016, over 2.7 million families have received the benefit and 60% of them received the means tested support (if they have more than one child this is paid out in combination with the universal benefit).

The second key electoral pledge – to increase the tax allowance from 700 to 1,850 EUR at an estimated cost of 4.8 billion EUR – has so far been postponed (CenEA, 2015a). Increases in the allowance became a major policy issue in October 2015 when the Constitutional Tribunal ruled that maintaining its level below minimum subsistence, as it was at the time, was unconstitutional. To satisfy the Tribunal’s ruling, the allowance would have to increase to ca. 1,500 EUR at a cost of nearly 15 billion PLN (3.4 billion EUR, and about 0.8% of GDP, CenEA 2015b). Instead of a simple increase in the allowance, the government decided to implement a digressive tax allowance for 2017. This raised the value to the required minimum subsistence level for the lowest income tax payers, but since it is rapidly withdrawn as taxable income rises, the allowance will be unchanged to a large majority of taxpayers and will cost the public purse only 0.2 billion EUR (CenEA, 2016). This policy will be more than paid for by the fiscal drag given the decision to freeze all other parameters of the tax system, which will cost the taxpayers 0.5 billion EUR (Myck et al., 2016b).

The policies that directly affect household budgets will in total amount to about 5.5 billion EUR in 2017 (1.3% of GDP and 6.2% of the planned central budget expenditures) and will include also an increase in the minimum pension to benefit about 1.5 million pensioners. The cost of the “Family 500+” reform makes up the large majority of this value (5.4 billion EUR). Households from the lower income decile groups will benefit the most from this reform package, with their monthly disposable income increasing on average by 15.1% (ca. 60 EUR). High-income households from the top income decile will see their income grow on average by only 0.5% (see Figure 1). Overall, nearly all of the gains will go to families with children, with single parents gaining on average about 95 EUR and married couples with children about 84 EUR per month. Other types of families will, on average, see negligible changes in their household disposable incomes (see Figure 2). Thus, the implemented package clearly has a very progressive nature and redistributes significant resources to families with children.

Figure 1. Distributional consequences of changes in direct tax and benefit measures implemented between 2016-2017

Source: calculations using CenEA’s microsimulation model SIMPL based on PHBS 2014 data.

The pension age and public finances in the years to come

The most recent major reform, legislated at the end of 2016 and which will come into effect in October 2017, represents an implementation of yet another costly electoral pledge. This policy has overturned gradual increases in the statutory retirement age, initiated by the previous government in 2012. Despite the very rapid ageing of the Polish population, the new government decided to return to the pre-2012 retirement ages of 60 and 65 for women and men, respectively. This comes at a time when, according to EUROSTAT (Eurostat, 2014), the old-age dependency ratio in Poland, i.e. the proportion of the 65+ population to the working-age population, will grow from the current 24% to 27% in 2020 and to 40% in 2040. With the defined contribution pension system, the shorter working lives resulting from this change will be reflected in significantly reduced benefits (Figure 2). For example, pension benefits of men retiring in 2020 will on average be 13.5% lower than the pre-reform value. For women that retire in 2040, the pension benefits will on average fall by 15.2%, which corresponds to a 43% lower benefit than the pre-reform value, and with consequences of the reform becoming more severe over time. The reform will also be very costly to the government budget. In 2017, it is expected to cost 1.3 billion EUR and its full effect will kick in after 2021, when the cost of the reform will exceed 3.9 billion EUR per year (Figure 2).

Figure 2. Reducing the statutory retirement age and its implications on pension benefits and public finances

Source: Based on data from Council of Ministers (2016).

Conclusion

Since coming to power in October 2015, the PiS government has implemented a majority of its costly electoral pledges. Direct changes in taxes and benefits will cost 5.5 billion EUR in 2017 and benefit primarily those in the lower end of the income distribution and in particular families with children. The reduced statutory retirement age will add an extra 1.3 billion EUR in 2017 and as much as 3.9 billion EUR four years later. The very generous “Family 500+” programme has significantly reduced child poverty and may have important positive long-term effects in terms of health and education for today’s beneficiaries. However, its fertility implications are still uncertain and the programme is expected to reduce the employment rate among mothers. While the government maintains that its financing is secured, it is becoming clear that maintaining the policy will not be possible without higher taxes.

The government came to power claiming that the implementation of this programme will be based on reducing tax fraud and that only a small fraction will be financed from tax increases. While it seemed likely at the time when these declarations were made, the expected major shift in the reduction of tax fraud has yet not materialised. The government have withdrawn from the pledge of reducing the VAT and from assisting those with mortgages denominated in Swiss Francs, while its income tax allowance reform was nearly thirty times less expensive compared to that announced in its electoral programme.

With a very tight budget for 2017 based on relatively optimistic assumptions, the key factors determining further realisations of the generous programme will be the rate of economic growth and related dynamics on the labour market. Developments of the labour market will also be essential for the longer-term economic success of the implemented reform package. This relates both to the future level of participation of women and to the success of extend working lives of people who will soon reach the new reduced retirement age.

References

  • CenEA (2015a) Konsekwencje prezydenckiej propozycji podwyższenia kwoty wolnej od podatku (Consequences of the presidential proposal to raise the incoem tax allowance), CenEA press release, 3 December 2015.
  • CenEA (2015b) Co z kwotą wolną od podatku po wyroku Trybunału Konstytucyjnego? (what will happen to the income tax allowance after the decision of the Constitutional Tribunal?), CenEA press release, 13 November 2015.
  • CenEA (2016) Zmiany w kwocie wolnej od podatku za 800 mln rocznie (Changes in the income tax allowance at the cost of 800m per year), CenEA press release, 29 November 2016.
  • EUROSTAT (2014) Eurostat – Population projections EUROPOP2013, access 21 December 2016.
  • Myck, M., Kundera, M., Najsztub, M., Oczkowska, M. (2016a) 25 miliardów złotych dla rodzin z dziećmi: projekt Rodzina 500+ i możliwości modyfikacji systemu wsparcia. (25bn for families with children: plans for the Family 500+ reform and other options to modify the system of support.), CenEA Commentaries, 18 January 2016.
  • Myck, M., Kundera, M., Najsztub, M., Oczkowska, M., 2016b, Zamrożony PIT i utrzymane wyższe stawki VAT – jak brak zmian w podatkach wpłynie na budżety gospodarstw domowych? (Frozen PIT and higher VAT – how lack of changes in taxees will affect househod budgets?), CenEA Commentaries, 05 October 2016.
  • Council of Ministers (2016) Position of the Council of Ministers on the presidential bill proposal, Warsaw, 25 July 2016.

Financial Support for Families with Children and Its Trade-Offs: Balancing Redistribution and Parental Work Incentives

Posted on April 28, 2014 | Policy Brief

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Authors: Michal Myck, Anna Kurowska and Michal Kundera, CenEA.

Reforms of tax-benefit system of financial support for families with children have a broad range of consequences. In particular, they often imply trade-offs between effects on income redistribution and work incentives for first and second earners in the family. Understanding the complexity of the consequences involved in reforming family policy is crucial if the aim is to “kill two birds with one stone” namely to reduce poverty and improve incentives to work. In this brief, we illustrate these complex trade-offs by analyzing several scenarios of reforming financial support for families with children in Poland. We show that it is possible to create incentives for second earners in the family to join the labor force without destroying the work incentives of the first earners. Moreover, the same reform would allocate resources to families with lower incomes, which could result in a direct reduction of child poverty.

Financial support for families with children is an important and integral part of the broad family policy package, the goals of which fall into two basic categories of reducing child poverty and increasing labour market activity of parents (Whiteford and Adema, 2007; Björklund, 2006; Immervoll, et al., 2001). However, the particular policy aimed at one of these objectives may be detrimental to the achievement of other goals. For example, family/child benefits may directly increase family income and thus reduce child poverty. These same benefits could have a negative effect on parental incentives to work, particularly for so-called second earners, usually mothers (see e.g. Kornstad and Thoresen, 2007). However, employment of both parents often turns out to be crucial for a long-term poverty reduction (Whiteford and Adema, 2007).

The trade-offs implied by the different family policy instruments are often poorly understood or treated superficially in the policy debate. The effect of this lack of understanding may result in badly designed policy reactions to identified problems, which in turn may imply that one of the objectives is achieved at the cost of the other, or even that policies work against all of them in a longer perspective.

Using the Polish microsimulation model SIMPL, we simulate modifications of several elements of the Polish tax and benefit system to demonstrate the complex nature of trade-offs between income and employment policy, and within employment policy itself. The underlying assumption of the analysis is that any effective policy that aims at lowering child poverty in the long run ought to realize and address issues of parental labour market activities. Governments should therefore aim at a design of financial support for families to provide assistance to poor households and at the same time strong work incentives for parents.

The Polish system of support for low-income families, Family Benefits, consists primarily of Family Allowance (FA) with supplements. These are means-tested and are available to families with net incomes below 504 PLN (€121) per month and per person. The value of the FA depends on the age of the child and ranges from 68 PLN to 98 PLN (€16.40 to €23.60) per month. For eligible parents this is supplemented by additional means-tested payments to such groups as lone parents, families with more than two children, and those with school-aged children. Eligibility for Family Benefits is assessed with reference to a threshold, which once exceeded makes the family ineligible to claim the benefits. This point withdrawal of benefits implies very high effective marginal tax rates and has significant implications for average effective rates of taxes (see Myck et al., 2013). In addition to Family Benefits, financial support for families is also channelled through the tax system. Tax-splitting (joint taxation) is available to married couples and lone parents, and since 2007 parents can set their tax liabilities against the Child Tax Credit, which is a non-refundable tax credit, the maximum value of which is 1,112.04 PLN (€268) per year for every dependent child.

The starting point for our analysis, and a reference in terms of potential costs of the reform, is the move to tapered withdrawal of Family Benefits (System 1). For this purpose we use the rate of withdrawal at 55%, which is the rate used in a broadly studied in-work support programme in the UK, the Working Families’ Tax Credit (WFTC) in the late 1990s and early 2000s (see, e.g.: Blundell et al., 2000; Brewer et al., 2006; Clark et al., 2002). Application of the taper implies that with an increase of net income of 1 PLN beyond the withdrawal threshold, the total value of benefits is reduced by 0.55 PLN. Such a change would imply greater certainty and predictability of benefit receipt, compared to the current point withdrawal system. However, as it extends the availability of benefits to families who currently no longer qualify for them, it would carry additional costs. We estimate this cost to be in the range of about 1.04 billion PLN (€250mln) per year, an increase in the total value of family benefits by about 14%.

Changes in Family Benefits under System 2 involve simple increases in the values of Family Allowance, which is raised by 20% given the above cost benchmark of 1.04 billion PLN. The final reform to Family Benefits (System 3) combines introduction of the withdrawal taper (at 55%) with a bonus system for two-earner families with the specific aim of providing stronger work incentives for second earners. The bonus consists of an increase in the level of the withdrawal threshold by 50% for families where both parents work compared to the baseline threshold value.

The first reform of Child Tax Credit (System 4) assumes an increase in the value of the CTC by 19.8% (calibrated to cost same 1.04 billion PLN), while the second uses this tax credit instrument to reward two-earner status. In the latter case, double-earner couples are granted an additional value of the credit (92.70 PLN per month). The cost of this reform is again calibrated to the level of other reforms by adjusting the earnings requirement set for both parents to qualify as double-earner couples. This calibrated requirement is 2,324.50 PLN per month and per person, which is equivalent to 176.5% of the minimum wage.

The assumptions underlying the modelled scenarios are very clearly reflected in the (static) distributional effects of the simulated changes. The proportional changes in incomes among families with children by population decile groups resulting from the simulated reforms are demonstrated in Figure 1A for Systems 1-3 and Figure1B for Systems 4-5.

Figure 1. Distributional consequences of modelled reforms: Proportional changes in incomes of families with children by income deciles.
CenEA_fig1
CenEA_fig2 
Source: Authors’ calculations using the SIMPL microsimulation model on PHBS 2010 data.

Figures 2 and 3 show how the modelled reforms would affect incentives to work for first and second earners measured as average changes in replacement rates[1] (RRs) by centiles of the baseline distribution of replacement rates for modelled families. The RR for the first earner is the ratio of the family income when neither partners work and the family income when the first earners works full time. The RR for the second earner is the ratio of the family income when only first earners work and the family income when both partners work full time. Lowest values of RRs imply the strongest incentives and highest values reflect the weakest incentives to work. When the difference in RR between the Baseline and a particular System is greater than zero it implies that this System increases incentives to work for a particular earner compared to the Baseline. This approach provides evidence on the trade-off between improving work incentives for those facing strong and weak incentives in the baseline system. The pattern that emerges from Figures 2 and 3 reflects to some extent the distributional effects of the chosen reforms (Figure 1). This is because richer families are usually those with high labour market incomes and thus low RRs (high labour market incentives), while poorer families face weaker incentives given their low actual (or potential) earnings, and thus face higher replacement ratios.

Figure 2. Changes in RRs by baseline work incentives – first earners
CenEA_fig3
Source: Authors’ calculations using the SIMPL microsimulation model on PHBS 2010 data.
Notes: Based on a sample of couples with children. System 5 does not change first earner incentives.
 
Figure 3. Changes in RRs by baseline work incentives – second earners
CenEA_fig4
Source: Authors’ calculations using the SIMPL microsimulation model on PHBS 2010 data.
Notes: Based on a sample of couples with children.

Apart from the well-established trade-off between equity and labour market concerns, our paper draws attention to the need to balance out first and second earner work incentives as well as incentives by the degree of existing financial motivation to work.

Reforms at the two extremes of the distributional spectrum, namely an increase in the level of Family Benefits (System 2) and a Child Tax Credit bonus for two-earner couples (System 5), result in very different incentive effects. The former significantly weakens incentives of both first and second earners in couples, while the second, which specifically directs resources at second earners, produces important improvements in incentives to work for second earners. However, these gains focus on the part of the spectrum of the baseline distribution of work incentives where these are already strong. This contrasts with a reform in which a two-earner “bonus” is created as part of Family Benefits (System 3). This system increases the generosity of in-work support for first earners in couples in a similar way to the benchmark reform. At the same time, however, it improves the attractiveness of work for second earners by raising the level of income from which benefits are withdrawn for couples in which both partners are working.

This arrangement balances out the negative influence on second earner incentives of the income effect of making work more financially attractive for first earners, which does not happen under our benchmark scenario (System 1). Moreover, we demonstrate that trying to increase work incentives through higher levels of Child Tax Credit available to families would have a positive effect on the work incentives of a large number of families, in particular on first earners in couples. The flip side of this effect would be some negative incentive effects on second earners, but generally both types of effect would be very low given the assumed cost restriction of the modelled reforms.

Naturally, there is an endless number of ways in which a billion PLN can be spent on families with children. As we argued above, each type of reform will have a complex set of consequences on household incomes and incentives to work for parents. The breakdown of employment pattern in Poland suggests that to increase labour market activity, the family support policy should focus on trying to make work pay for second earners in couples, most of whom are women. As we demonstrated this can be done in such a way as to balance out incentives for first earners and provide strong incentives to those second earners who currently face the weakest incentives to work. At the same time, resources would be directed to families in the lower half of income distribution that could result in direct reduction of child poverty.

▪

References

  • Blundell R., A. Duncan, J. McCrae and C. Meghir (2000) The Labour Market Impact of the Working Families’ Tax Credit, Fiscal Studies, vol. 21(1), pp. 75-104.
  • Brewer M., A. Duncan, A. Shephard and M.-J. Suarez (2006) “Did Working Families’ Tax Credit Work? The Impact of In-Work Support on Labour Supply in Great Britain”, Labour Economics, vol. 13, pp. 699-720.
  • Björklund A. (2006) Does family policy affect fertility? Journal of Population Economics, vol. 19 (1), pp. 3-24.
  • Clark T., A. Dilnot, A. Goodman, and M. Myck (2002) Taxes and Transfers, Oxford Review of Economic Policy, vol.18 (2), pp. 187-201.
  • Immervoll H., H. Sutherland, K. de Vos (2001) Reducing child poverty in the European Union: the role of child benefits, in: Vleminckx K. and Smeeding T.M. (eds) Child well-being, Child poverty and Child Policy in Modern Nations. What do we know? Revised Edition; The Policy Press: Bristol.
  • Kornstad T. and T. O. Thoresen (2007) A Discrete Choice Model for Labor Supply and Child Care, Journal of Population Economics, vol. 20 (4), pp. 781-803.
  • Myck, M., A. Kurowska, and M. Kundera (2013) “Financial Support for Families with Children and its Trade-offs: Balancing Redistribution and Parental Work Incentives”, Baltic Journal of Economics, 13(2), 59-84.
  • Whiteford P. and W. Adema (2007) What Works Best in Reducing Child Poverty: A Benefit of Work strategy? OECD Social, Employment and Migration Woking Papers, nr 51, OECD, Paris.

 

[1]For the couples in the subsample we compute three sets of family-level incomes, conditional on employment either of the first earner (who is the person with higher expected earnings in a couple) or of both partners; Y(1,1) for the scenario where both partners are employed (full-time); Y(1,0) for the scenario where the first earner is employed (full-time); Y(0,0) for the scenario where both partners are not employed. This allows us to compute replacement ratios for the first earner (RR1) and the second earner (RR2) for each of the analysed tax and benefit systems (S): RR1(s,j)=Y(s,j)(0,0)/Y(s,j)(1,0) and RR2(s,j)=Y(s,j)(1,0)/Y(s,j)(1,1).

 

Increasing Resources for Families with Children Through the Tax System: Recent Reform Proposals from Poland

Posted on December 2, 2013 | Policy Brief

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This brief discusses the consequences of a recent reform proposal that aims to redistribute resources to low-income families with children through the income tax system in Poland. The proposed reform replaces the current child tax credit with additional amounts of the universal tax credit, and by changing the sequence in which tax deductions are accounted for, it increases resources of low-income families with children by about 1.7 billion PLN per year (0.4 billion EUR). The brief examines four possible ways of additional tax system modifications that would make the reform package neutral for the public finances, and presents distributional implications of the reforms.

The level and structure of financial support for families with children has become an important policy focus in Poland; a country that faces high levels of child poverty and one of the lowest fertility rates in Europe (Immervoll et al., 2001; Haan and Wrohlich, 2011; Eurostat, 2013). In this brief, we outline recent tax reform proposals that aim to increase financial support for low-income families with children through the tax system. A range of such potential reforms has been examined in Myck et al. (2013b); a report prepared for the Chancellery of the President of the Republic of Poland. One of the options became the key element of the President’s family support program Better climate for families proposed in May 2013. Below we discuss its main features and various options for financing the proposals.

The proposed modification of financial support for families would replace the current child tax credit with additional amounts of the universal tax credit conditional on the number of children, and increase tax advantages for families by changing the sequence in which tax credits are accounted for in a way that is favorable for families with children (Chancellery of the President of Poland, 2013). The main beneficiaries of this reform would be low-income families with children whose income is too low to take full advantage of the current child-related advantages. The overall cost of the reform would amount to about 1.7 billion PLN (0.4 billion EUR). In the final section of the brief we discuss potential ways of making the reform budget neutral.

The analysis has been conducted using CenEA’s micro-simulation model SIMPL on reweighted and indexed data from the 2010 Household Budget Survey (HBS) collected annually by the Polish Central Statistical Office (see Morawski and Myck, 2010, 2011; Myck, 2009; Domitrz et al., 2013; Creedy, 2004).

Financial Support for Polish Families in 2013

In Poland, financial support for families with children depends on the level of family income and the demographic structure of the household. The system consists of two main elements – family benefits on the one hand, and tax preferences for families with children on the other. Following Myck et al. (2013a), we define financial support for a family j (FSFj) as the sum of family benefits received by the family (FBj), and tax preferences that families with children collect in the PIT system is defined as the difference in the level of tax liabilities and health insurance contributions paid by the family (PITHIjD0 – PITHIjDn) supposing they have no children (D0) and on condition them having n number of dependent children (Dn):

FSFj = FBj + (PITHIjD0 – PITHIjDn)             [1]

Figure 1a presents the current level of the financial support for single-earner married couples and Figure 1b presents the same for single parents with one and three children in relation to the level of gross earnings.

Family benefits

Family benefits, which include family allowance with supplements, childbirth allowance and nursing benefits, are means-tested and related to the number and age of dependent children in the family and specific family circumstances. Family benefits are granted only to low-income families and are subject to point withdrawal once the family crosses the income eligibility threshold (539 PLN of net income per person). For example, the stylized married couples in Figure 1 lose family benefits when their monthly gross income exceeds 2,060 PLN if they have one child and 3,435 PLN if they have three children (for single parents these thresholds equal 785 PLN and 1,825 PLN respectively).

Figure 1. Monthly level of financial support received by families with one and three children dependent on their age and family gross income in 2013 (PLN/month)
(a) Married couple with one spouse working
b) Single parent working
figure1_vertical
Note: FB – family benefits; CTC – child tax credit; joint taxation preferences: UTC – additional amount of universal tax credit; IB – shift of tax income bracket. In case of the single parent alimonies from the absent parent are assumed at the median value from 2010 data, which is 410.50 PLN for 1 child and 724.67 PLN for 3 children. Gross income of the single parent includes income from work only. Alimonies are taken into account for FB income means testing. Source: Myck et al. (2013a).

Tax preferences

Taxpayers with children can deduct a non-refundable child tax credit (CTC) from the accrued tax, with the maximum values of the CTC related to the level of universal tax credit available to all tax payers (UTC is 46.37 PLN per month). For each of the first two children in the family, taxpayers can deduct up to two values of the UTC (92.67 PLN per month), for the third child up to three values (139.00 PLN per month) and for the fourth and following children up to four values of the UTC (185.34 PLN per month). The CTC is not available for high-income parents with one child (whose annual taxable income exceeds 112,000 PLN per year).

Further tax advantages are available for single parents through joint taxation, which translates into substantial gains in particular for high-income parents. As Figure 1 shows, single parents whose gross income exceeds the second tax income bracket (15,745 PLN per month) gain up to 1,044.19 PLN per month if they have one child and 1,368.54 PLN if they have three children. With the same income levels, the system grants nothing to married couples if they have one child and 324.34 PLN if they have three.

In the current system, the CTC can be deducted from the accrued tax only after the full amount of UTC and the tax-deductible part of health insurance (HI) contributions have been exhausted. As a consequence, there is a large group of low-income families whose income is too low to take full advantage of the CTC. As Figure 2 illustrates, the higher the number of children is in a family, the lower is the proportion of families who take full advantage of the credit. Although the percentage of those using the full CTC is 76.1% for families with one child, it decreases to 67.6% for those with two children and is as little as 30.8% for families with three or more kids. Over 40% of the latter use only half of the CTC they are entitled to.

Figure 2. Use of maximum amount of CTC by number of children

figure2

Note: Proportions of families with taxable income satisfying other conditions for CTC. Source: Myck et al. (2013a).

Recent Reform Proposals

In a recent report for the Chancellery of the President of Poland, we have analyzed several options for the reform of the family-related elements of the tax system (Myck et al., 2013b). One of these has become the key element of the presidential reform proposal (Chancellery of the President of Poland, 2013). The reform assumes that the CTC is replaced with the amounts of the Universal Tax Credit conditional on the number of children in the family in such a way as to maintain the current maximum advantages offered to families through the CTC system. The main purpose of the reform is to reverse the tax deduction sequence so that tax advantages related to having children are deducted from the accrued tax before considering credits related to health insurance contributions. Such construction would enable low-income families to make greater use of child-related tax advantages, while leaving the situation of higher-income families unchanged.

Figure 3. Monthly tax advantages from the reform among families with 1-4 children (PLN/month)

 figure3

Source: CenEA – own calculation based on SIMPL model and 2010 HBS data.

Figure 3 presents monthly levels of tax advantages resulting from the proposed reform conditional on the number of children in the family and the level of gross income. We note that families with children gain from the reform if their income exceeds 735 PLN per month. Tax advantages resulting from the proposed modifications are exhausted at different levels of gross income depending on the number of children (from 2,630 PLN for families with one child to 8,010 PLN for those with four children). The higher the number of children is, the greater is also the potential maximum gain – for example, families with four children and income of 4,010 PLN per month would gain up to 311.35 PLN per month.

The results of the analysis show that, overall, 2 million households with children would benefit from this reform (below referred to as System 1). The total annual change in households’ disposable income (equivalent to the total cost for public finances) would amount to 1.69 billion PLN (see Table 1 below).

Table 1. Average annual change in households’ disposable income by number of children in Systems 1-5 (billion PLN)

No children

1 child

2 children

3+ children

Total
System 1

0,00

0,39

0,60

0,70

1,69
System 2

-0,45

-0,20

0,04

0,55

-0,08
System 3

-0,65

-0,09

0,17

0,59

0,02
System 4

-0,66

-0,15

0,23

0,59

0,01
System 5

-0,86

-0,04

0,31

0,63

0,04
 
Note: Total annual change in disposable income includes change in tax liabilities and level of social benefits. Source: Myck et al. (2013b).
 

Table 1 shows that most of the resources would be beneficial for families with three or more children (0.7 billion PLN per year), while families with one or two children would benefit about 0.39 billion PLN and 0.6 billion PLN per year, respectively.

The distribution of total income gains by income deciles is presented in Figure 4. The gains are clearly focused in the lower part of the income distribution. For example, families with children in the second income decile would receive a total of 0.4 billion PLN, while those in the bottom and third decile would recieve approximately 0.25 billion PLN. Only 0.04 billion PLN of the total cost would be distributed to families in the top income decile.

Figure 4. Distribution of total annual gains in households’ disposable income by deciles: Systems 1-5 (billion PLN)

 figure4

Note: Total annual change in disposable income includes change in tax liabilities and level of social benefits. Source: Myck et al. (2013b).

Potential Ways of Financing the Reform

Concerns about the state of public finances naturally imply questions related to the potential ways of financing any additional tax giveaways. Myck et al. (2013b) presents four alternative modifications of the tax system that make the entire package of reforms neutral for the public finances. These are:

  • System 2 – CTC reform + limitations on joint-taxation preferences for married couples (both with or without children) and single parents;
  • System 3 – CTC reform + reduction of tax income threshold from 85,528 to 68,000 PLN per year;
  • System 4 – CTC reform + reduction of tax revenue costs from 1,335 to 475 PLN per year;
  • System 5 – CTC reform + reduction of tax-deductible part of health insurance from 7.75% to 7.45%.

The overall total outcomes of these proposals for household disposable income are illustrated in Table 1 and Figure 4. The implications in terms of the redistribution of the packages – with losses among childless households and gains among those with children – are clear under all of the proposed packages, although all of the reform combinations imply small losses also for families with one child.  Total disposable income of childless households falls by 0.45 PLN per year under System 2 and by as much as 0.86 billion PLN under System 5. By shifting the majority of the costs to households without children, the latter is simultaneously the most generous for families with children since income of those with two children grows on average by 0.31 billion per year, while of those with more children see a growth of 0.63 billion PLN per year.

Figure 4 illustrates that in all of the revenue neutral reform packages, the households from the highest two deciles are the biggest losers. That the financing of the shift of resources to low-income families falls on households from the top income decile is particularly evident in the case of Systems 2 and 3 where total disposal income for these households fall by 1.64 billion PLN and 1.52 billion PLN, respectively. Since changes to revenue costs and deduction of HI contributions apply to almost all taxpayers, Systems 4 and 5 are less favorable for households from the lower deciles and generate losses for the upper part of the income distribution. However, a large part of cost is also born by households from the tenth decile (0.26 and 0.39 billion PLN, respectively).

While the combinations of tax changes presented above would be neutral with respect to the current system of taxes in Poland, it is worth noting that the policy of tax increases through the tax-parameter freezing implemented in 2009 has increased taxes by far more than the cost of the Presidential reform proposal. As we showed in Myck et al. (2013c), this policy increased taxes by 3.71 billions PLN per year, of which 2.21 billions was paid by families with children. The recent proposal could thus be thought of as a way of redistributing these resources back to families with children.

Conclusions

Financial support for families with children is an important element of government policy with implications for child poverty, labor-market participation among parents, as well as fertility (Immervoll et al., 2001; Haan and Wrohlich, 2011). In this brief, we outlined the results of a recent analysis of direct financial consequences of modifications in the Polish system of support for families through the tax system with the focus on a reform proposal presented by the Polish President in the program Better climate for families. The reform would benefit lower-income families with children at the cost of about 1.7 billion PLN. As a result, annual income of the families from the three bottom deciles would grow by 0.93 billion PLN. A high proportion of the gains (0.7 billion PLN) would go to families with three or more children.

We also presented four additional modifications of the tax system that would make the CTC reform revenue neutral. Reform packages that withdraw joint-taxation preferences and decrease the threshold of the income tax to a higher rate would be most effective in ensuring redistribution of support for low-income households. It is worth noting though, that the recent approach of the Polish government to the tax system has implied substantial increases in the level of income taxes through the freezing of income tax parameters, and these alone would be more than sufficient to finance the proposed tax changes.

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References

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* This brief draws on recent research at the Centre for Economic Analysis in the projects financed by the Chancellery of the President of the Republic of Poland and the Batory Foundation (project no: 22078). The analysis has been conducted using CenEA’s micro-simulation model SIMPL based on the 2010 Household Budget Survey data collected annually by the Polish Central Statistical Office (CSO). The CSO takes no responsibility for the conclusions resulting from the analysis. Any views presented in this brief are of the authors’ and not of the Centre for Economic Analysis, which has no official policy stance.