EKIP– Expert Club for Economics and Politics A Different Opinion
This text was originally published in the collection " 2020: Inside and Beyond "
It was clear as early as March that 2020 would not be easy for Boyko Borisov's government. A state of emergency was declared just days after the first registered case of COVID-19. This was followed by a collapse in economic activity, a spike in unemployment and the number of bankruptcies. How could the situation get any worse?
Through mass protests against the government, completely unrelated to the pandemic. Protests that also led to the resignation (although far from voluntary) of Finance Minister Vladislav Goranov, replaced by Health Minister Kiril Ananiev. Thus, the fiscal policy of the ruling party was directed not only towards dealing with the health and economic crisis, but also towards massive spending of funds in order to reduce the risk of even more protesters. On top of all this, it quickly became clear that the line of thinking was strongly pre-election.
So similar, so different
The Bulgarian government's response to the economic consequences of the pandemic is in some ways very similar to that of other European countries, and in others very different. From an initial focus on supporting affected businesses and threatened jobs in the spring, the government's efforts have shifted entirely to measures in the public sector and the social sphere in the summer.
To a large extent, the focus of the later economic measures almost completely contradicts the earlier ones, although in both cases the government speaks of “anti-crisis” measures, the purpose of which is to mitigate the economic effects of the pandemic and the subsequent closure. In reality, these are completely different things. In the first half of this year, the focus of the economic measures was indeed anti-crisis, but in the second half it became almost entirely pre-election.
The government’s first economic measures were proposed and voted on in late March and early April. This was very soon after the appearance of COVID-19 on Bulgarian territory (March 8) and after the imposition of a mass lockdown to limit the spread of the infection (March 16). The initial set of economic measures at that time was very similar to those implemented in other European countries. In addition to measures to expand healthcare spending, as well as the remuneration of professionals in the sector, similar to the measures taken in other EU countries, the government first focused on directly subsidizing jobs.
The largest measure in terms of its scope and financial value that was introduced at that time was the 60/40 scheme, in which the state took responsibility for covering 60% of the wage costs of enterprises that had suffered from the pandemic and the government's restrictive measures. Although this is a very standard type of measure that has been implemented in various forms almost everywhere in Europe, its initial effectiveness on Bulgarian territory was very controversial. First of all, because in its initial form the measure covered only wages, without social security. This caused dissatisfaction from employers and a corresponding adjustment, which, however, delayed the full implementation of the measure. Its effective implementation turned out to be quite slow anyway, because for weeks, between April and June (when almost all restrictive measures had already been lifted), enterprises and employer organizations complained that the process for approving funding under the measure was taking too long.
When it comes to direct subsidies that require administrative approval, there is also a risk of corruption. Especially when it comes to countries with high levels of corruption like Bulgaria, the implementation of such financial assistance measures can lead to the leakage of huge amounts of funding to politically connected individuals and businesses that are far from the most needy. The list of the biggest beneficiaries of the 60/40 measure includes not only companies owned by businessmen notorious for their political connections, but also those who were even former deputies of the ruling GERB party. The lack of administrative efficiency and the risk of corruption were factors that some economists highlighted as an obstacle to the adequate implementation of such subsidy measures back in March.
Ultimately, by the end of 2020, the effectiveness of the 60/40 measure remains debatable. Many jobs have certainly been protected thanks to it, but the question is whether the fiscal cost was not too high. The measure was extended until the end of 2020 and will most likely remain active beyond that. The cost so far is 1.75 billion leva. The budget is huge, but it is being paid out very slowly – by the end of September, only 240 million leva of the initially set billion had been paid out. This is a problem because such measures to subsidize jobs are only useful in the short term, within the period of restrictive measures and up to 1-2 months after that. In the long term, their anti-crisis usefulness even becomes negative. There is a great risk that the government will commit to subsidizing enterprises that are long-term unproductive, and so, instead of supporting economic recovery, the measure hinders it, because scarce financial resources are being wasted.
BDB, VAT and another resignation
Beyond the 60/40 scheme, other, more indirect forms of state subsidy were also undertaken. The capital of the Bulgarian Development Bank (BDB) was increased by BGN 700 million, BGN 500 million of which was for targeted support to enterprises affected by the pandemic. Another BGN 200 million was set aside for interest-free loans to affected enterprises, which are granted through private banks. BDB also received a temporary right to buy shares in private companies and thus capitalize them. In addition, over BGN 200 million was redirected from EU funds to support enterprises that, due to the pandemic and the imposed restrictions, have experienced a drop in their revenues of at least 30%.
The pros and cons of these measures are very similar to those of the 60/40 program. In the short term, they can certainly have a positive effect, but in the long term, it is advisable to avoid their retention, including interest-free loans. A policy of artificially cheap lending, subsidized by the state, can easily lead to the formation of bubbles in the markets, which sooner or later burst and lead to a crisis.
As for BDB, the state-owned bank is notorious for its dubious activities. Although it is a bank that is supposed to specifically finance small and medium-sized enterprises, in fact, the majority of its loan portfolio in recent years has been formed by loans to companies owned by some of the largest and most politically connected businessmen in Bulgaria, such as Delyan Peevski.
Back in April 2020, at the height of the pandemic, a dubious loan of 75 million leva was made public, which the BDB granted without clear collateral to a company with no experience. In September 2019, a loan of 100 million leva was granted to a company of managers at Technomarket, which is owned by Delyan Peevski, and another of his properties – the Bulgartabac group – has received nearly 150 million leva in loans from the BDB in recent years. At the very least, this calls into question the ability of the BDB to provide financing to those enterprises that truly deserve it in the current crisis. The accumulation of dubious loans led to another “involuntary” resignation – that of Stoyan Mavrodiev, until recently at the head of the BDB.
In addition to these measures, the government allowed economically affected businesses and workers to defer the payment of taxes on their income. This is one of the most neutral and universal measures, which does not require any in-depth comment. Tax deferrals are relatively small measures, but highly effective, market-neutral and are accepted as a good idea by all experts. However, another tax measure was extremely controversial and even led to a conflict between the Minister of Finance and the Prime Minister – the introduction of a differentiated 9% VAT (from a total rate of 20%) for food, non-alcoholic and low-alcohol (wine and beer) beverages in establishments for the period July 2020 to December 2021.
Differentiation has turned out to be perhaps the most misunderstood anti-crisis measure. It is strange that it has turned out to be so controversial, given the fact that a similar measure, specifically for the restaurant and tourism sectors, was introduced in many places in Europe, at least temporarily, in response to the crisis. For example, in Germany, in addition to temporarily lowering the general VAT rate by 3 points to 16% until the end of 2021, VAT specifically on restaurants and tourism has been reduced to 5% from 7% previously. In neighboring Greece, VAT on transport services, drinks, tour packages and cinemas was temporarily reduced to 13% from 24%.
Why then this allergy to VAT differentiation in Bulgaria as an anti-crisis measure, even if only temporarily? One explanation that has been put forward is that in our country there is a single VAT rate for all goods, which is not a good idea to touch yet and is a dangerous precedent. This could create a risk of “decomposition” of the tax system. If one sector receives privileges, others will also demand them, and little by little the VAT tax base will be eroded and thus the largest source of tax revenue in the treasury will be eroded, which will force a rethinking of the entire tax system. The Minister of Finance (at the time) himself – Vladislav Goranov, opposed the idea with similar arguments.
The problem, however, is that VAT in Bulgaria has been differentiated for years for tour operator packages. There, VAT has been 9% since 2011, compared to the general rate of 20%. This is not a precedent, because it was set more than 9 years ago and since then there has been no “decomposition” of the tax system. Beyond the alarmism about the potential erosion of the overall tax system as a result of adding one or two (temporary) exemptions to VAT, there is practically no theoretical justification for the opposition to the measure.
The strong opposition is particularly puzzling given the fact that, objectively speaking, this is perhaps the most effective anti-crisis measure. First, tax cuts suffer from almost no corruption risk, because by definition they are applied in a neutral manner for all players in the relevant sector. Second, there is no way for a sluggish administration to delay the delivery of financial support to enterprises, because from the moment the exemption is written into law, enterprises simply start paying less tax. Third, the long-term fiscal risk is actually lower than with subsidy programs.
With myris on the fence
Alas, adequate anti-crisis measures were exhausted with the differentiation of VAT and since the summer their quality has declined sharply. In the second half of the year, packages of social measures were introduced that were presented as anti-crisis, but in fact seem to have a mainly pre-election focus. The first such package, which was introduced in July, consisted mainly of an increase in the minimum unemployment benefit from 9 to 12 leva, an extension of the payment period of these benefits to 7 months (compared to 3 previously), as well as the first appearance of the notorious 50 leva supplement to the monthly pension, which was then introduced supposedly for only 3 months. In addition, back then, in the summer, the salaries of civil servants, whom the government categorizes as being on the "front line" in the fight against the coronavirus, were raised by 30%.
The increase in unemployment benefits and the payment period can be categorized as an anti-crisis measure, but only in a certain sense. It should be emphasized that this is a measure that simply addresses the negative consequences of the crisis (unemployment), but does not try to prevent them. In this sense, the anti-crisis weight of this measure is far weaker than that of subsidizing enterprises, tax cuts and similar measures. And yet, this measure at least has some anti-crisis weight, which certainly cannot be said about pension supplements. They provide financial assistance to a class whose incomes have not been affected by the pandemic in any way.
Pensioners receive a fixed income (pension) from the state, which is not affected by the processes in the private sector and has not in any way decreased due to the pandemic and the economic crisis caused. Accordingly, there is no way that the provision of any financial assistance to them can be categorized as “anti-crisis”. The same logic applies to a large extent to those working in the public sector. Of course, those who are truly on the “front line” in the fight against COVID-19 should receive higher remuneration, at least temporarily, but the government has never published clear criteria for how it exactly defines “front line”. This creates a risk of wasting financial resources on increasing salaries “on a shoestring”, without clear prioritization for those areas in which the additional money is most needed.
In the preparation of the 2021 Budget, these errors were not eliminated, but deepened even further. The monthly bonus to pensions was extended at least until the 2021 elections, and all salaries in the public sector were increased by 10%, those of teachers - by an average of 17%, based on the promise made at the beginning of the government's mandate for the growth of teachers' salaries until 2021 inclusive. In addition, the income criterion for receiving child benefits was removed, which will practically double the coverage of this social assistance and the money needed for it. The minimum pension was increased by 20%, all pensions up to 369 leva increased by 10% and all pensions above 369 leva - by 5%. The pension ceiling was also slightly increased, and in addition to the above, all pensions will be updated and accordingly increased by an average of 6.7% in July 2021. The total value of all these social measures and pension increases amounts to 3.12 billion leva, making it one of the most generous purely social packages in the recent history of Bulgaria.
Some of these measures are largely reasonable, such as the annual indexation of pensions, but most of the others seem, to put it mildly, inappropriate in the current crisis conditions. Although these additional social payments are categorized as “anti-crisis”, in fact, almost none of them can be attributed to such a categorization with a clear conscience.
The key problem in a crisis is always the decline in investment, which leads to lower productivity and fewer jobs. Restoring investment and subsequently the natural creation of jobs should be the first priority of the government's fiscal policy. Especially when the NSI's own statistics show that the vast majority of the GDP collapse in 2020 is mainly due to a collapse in investment. Consumption has actually remained relatively stable compared to 2019. The data show that in the second quarter of 2020 (the worst of the year at the time of writing this text) final consumption fell by 2.2% on an annual basis, and gross capital formation – by 28.3%.
Moreover, consumption itself will naturally recover in the long run, when investment and hence jobs recover. However, focusing only on consumption is like treating only the symptoms of a sick patient without addressing the actual disease that causes them. The measures in the budget should have focused on stimulating investment, which can be achieved through various methods, the easiest of which is reducing taxes for enterprises. In the second half of the year, packages of social measures were introduced, which were presented as anti-crisis, but in fact seem to have a mainly pre-election focus.
Expenses and more expenses
The other key problem with the measures in Budget 2021 is that they envisage a huge increase in current expenditures in a number of sectors that need reform. Optimizations are imperative in view of the more vulnerable financial situation in which the treasury finds itself due to the crisis. A complete reform is difficult to undertake and implement in terms of the work and remuneration of civil servants, even less so in terms of the pension system, but at least it is possible to prioritize and consolidate expenditures. However, efforts in this direction are lacking.
Public sector wages are once again rising at a snail's pace, despite the sector's low productivity and bloated headquarters, the lack of decline in income and jobs in it, and the already higher level of wages compared to the private sector.
A sudden increase in current spending is always a risk to long-term fiscal stability, but this risk is particularly acute when the country is in an economic crisis. These higher costs are financed through deficits, that is, debt. Taking on debt to cover current spending rather than investment is an extremely dangerous idea, and it is this practice that leads to debt crises and government bankruptcies in the long run. Increased current spending, especially in sectors that are not reformed, cannot pay off the interest on the debt because it does not bring additional long-term returns through increased economic productivity.
Increasing pensions, besides not being such a big priority in a period of crisis, is also being done in the most inadequate way possible from a financial point of view. Those pensions below the average level (which in Bulgaria is 412 leva) are being increased sharply, and those above it are being increased far less. This, alas, is a common practice that is being exacerbated to the extreme in Budget 2021. The danger in this approach is that the minimum pension is growing much faster than the average and high levels of pensions, respectively, workers have a lower incentive to provide for themselves with real income.
Accordingly, the increase in pensions in Budget 2021 not only sharply expands the expenses of the National Social Security Institute, but also the way in which it does so creates an incentive for lower revenues in the pension system. This happens in a period of crisis, when revenues from social security contributions are falling anyway. If expenses are going to be raised so much, this could have happened through a recalculation that would update all pension levels with relatively equal weight. This would avoid creating an additional incentive for workers to avoid paying social security contributions.
In addition, the focus on pensions and incomes in the public sector in general, when the priority should be strengthening the healthcare system, is also puzzling. The additional spending foreseen for healthcare in the 2021 Budget is BGN 587 million, not all of which is specifically aimed at dealing with the pandemic. This pales in comparison to the BGN 3.1 billion for salaries, pensions and social measures.
It is no coincidence that, against the backdrop of all these problems, the 2021 Budget and the so-called “anti-crisis” measures in it were criticized by the majority of economic experts, including many former finance ministers. Even Simeon Dyankov, finance minister in the first government of the ruling GERB party, categorized the 2021 Budget as “electoral” in an interview with the Bulgarian National Radio, saying that it “lacks any thought about how we will deal with the crisis.” “Its only focus is to win as many votes as possible in the upcoming elections,” he added. Many others also called the 2021 Budget “electoral,” and it is easy to see why. Given that at the end of 2020 the government partially closed the economy again, there is another risk: the budget could prove inadequate just months after its adoption.
The focus on civil servants and pensioners is clearly aimed at winning the electoral sympathy of two of the largest social strata in Bulgarian society. The rough calculation shows that even if just over half of the pensioners in the country vote for a given party, it is the first political force. This "pre-election" focus on the fiscal does not bode well in the long term. No matter who the next government is, it is highly recommended that it rethink the huge increase in current spending that was undertaken in Budget 2021.
Yes, this means possible cuts to government salaries and/or jobs, and even pension cuts. Otherwise, however, the government debt will continue to grow and we can say goodbye to the long-term fiscal stability we have enjoyed since 1997. The risks that Budget 2021 poses with its record-breaking loose spending policy could quite realistically lead to a fiscal crisis.
