Poland’s budget deficit and public debt: Is the situation really as good as it looks at first glance?

By: Łukasz Janikowski, Fiscal Economist

According to the preliminary estimates published by the Polish Central Statistical Office on 4th of April, the general government deficit in Poland in 2017 amounted to 1.5% of GDP, which was the best result since 2007, while the public debt to GDP ratio decreased to 50.6% (compared to, respectively, 2.3% and 54.2% in 2016). The very low deficit to GDP ratio resulted mainly from a significant improvement in the balance of the central budget. Ministry of Finance noted on their webpage that this improvement “was primarily a result of a number of measures aimed at rebuilding the tax revenue and tightening the tax system.” But is the situation really so bright?

In 2017, the deficit of the central government amounted to PLN 25.4 billion (EUR 6 billion) and was lower by PLN 20.8 billion (EUR 4.9 billion) than in the previous year. The central government revenues increased by 11.4%, and spending increased by 4.2%. Together with a solid GDP growth rate (4.6% in real terms), it brought down the general government deficit to 1.5% of GDP.

Photo: Deputy PM and Finance and Development Minister (Prime Minister since January 2018) Mateusz Morawiecki briefs reporters on Poland’s budget at a news conference in Warsaw in 2017. FORUM

However, when assessing sustainability of public debt, one should not look at the headline budget balance, but at the so-called “structural balance”, which is adjusted for one‑off operations and business cycle fluctuations. One-off operations are extraordinary events that are not stable sources of income or regular, repetitive expenditures. For example, in 2017, a record high profit of the National Bank of Poland resulted in a contribution 
 of PLN 8.7 billion (EUR 2 billion) to the central budget. Profits of the central bank are primarily a result of exchange rate fluctuations and therefore are not a stable source of income. They should be excluded from the picture for the purposes of analyzing fiscal sustainability.

In order to properly assess the condition of public finance, one needs also to adjust the budget balance for business cycle fluctuations. When the economy is booming (or, more precisely, the output gap is positive), tax revenues increase faster than on average, and spending on welfare decreases due to growth of wages and reduction of unemployment. Polish economy is currently above its potential, the natural result of which is an improvement of the fiscal balance. 
 In other words, the deficit would have declined even if there had been no tightening of the tax system at all.

The most important source of revenue increase in 2017 was VAT, which grew by PLN 30.2 billion (or by 23.9%). This impressive result was possible thanks to the tightening of the tax system but also thanks to the composition of the economic growth, which was to a large extent driven by consumption (+4.2% in real terms). Another factor behind the growth of nominal VAT revenues, which accounted for approx. PLN 2.5–3 billion, was inflation. Even after taking these factors into consideration, the results of the tightening of VAT collections are impressive, but much lower than the increase of the revenues. According to the data published by the Ministry of Finance on April 5th, the VAT gap in 2017 was reduced by 6 pp. (from 20% to 14%), which accounts for approx. PLN 11 billion (EUR 2.6 billion), rather than PLN 30.2 billion (EUR 7.1 billion).

When we compare the data on the deficit in Poland and other EU countries, the headline numbers lose even more 
 of their appeal. The economy of the entire EU is on the rise, and budget balances are improving in nearly all the member states. Complete data for 2017 are not yet available, but in 2016, when Poland had a deficit of 2.3%, 10 EU countries had budget surpluses. This number almost certainly grew in 2017, and it will not be a surprise if it turns out that over half of the member states had a budget surplus. In this context, the deficit of 1.5% does not look good any more.

When it comes to the public debt to GDP ratio, beside the deficit and the GDP growth, it is influenced also by exchange rate fluctuations, which affect the value of public debt denominated in foreign currencies. Since over 30% of Polish public debt is denominated in foreign currencies, appreciation of the Polish zloty in 2017 also contributed to the decrease of the debt to GDP ratio. Moreover, the improvement in the debt to GDP ratio in Poland is relatively small compared to the rest of the EU countries. Data for the entire year 2017 is not yet available, but according to Eurostat, over the period from 2016 Q3 to 2017 Q3, the debt to GDP ratio decreased in 24 member states, in 19 of which the scale of improvement was higher than in Poland (including countries from the CEE region: Bulgaria, Czech Republic, Hungary, and Lithuania).

Fiscal policy is sustainable if it does not allow the public debt to GDP ratio to increase in the long run. Since the accession of Poland to the EU in 2004, public debt increased from 45% to 54.2% in 2016 (ESA 2010 methodology). What is more, a significant part of it was hidden in the Social Insurance Institution (ZUS), when the government bonds worth PLN 153.2 billion (EUR 35.7 billion) were redeemed after being transferred from open pension funds to ZUS in 2014. If this operation had not been performed, public debt to GDP ratio could have breached the constitutional limit of 60% 
 as early as in 2016. Despite its drop to 50.2% in 2017, public debt to GDP ratio has a clear upward long term trend, the source of which is excessive structural deficit. According to the calculations of the European Commission (AMECO), the structural deficit in Poland was equal to 2.2% of GDP in 2016 and was the fourth highest in the EU, after France, Spain, and the UK, and was the same as in Romania. The tightening of the tax system could have reduced the structural deficit, but additional expenditure on child benefits (500+), the lowering of the retirement age, and planned increases of the public spending on healthcare from 4.7 to 6% of GDP by 2025 by far offset these additional incomes, especially in the long run.

Summing up, the improvement of the fiscal balance can only partially be explained by the tightening of the tax system. Other important factors behind the low deficit are the high profit of the central bank, business cycle in the expansion phase, and the composition of the economic growth. Additional revenues from the tightening of the tax system are too small to compensate higher government spending in the long run, and, in the view of the recently announced generous social spending, long-term sustainability of public debt in Poland is questionable. In times of economic prosperity, the general public and politicians tend to forget that the expansion phase of the business cycle is the time to build up fiscal resilience against future economic downturns instead of using temporary fiscal leeway for increased government spending. One of the steps aimed at improving the quality of the public debate regarding the fiscal policy may be the establishment of a fiscal policy council, something that the European Commission has repeatedly urged Poland to do. Poland is the only country in the entire EU that does not have such a council.

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