Current Challenges in Georgian Financial System Improvement

Doctor of Economics TSU Associated Professor Revaz Kakulia Academic Doctor of Economics TSU Associated Professor Lela Bakhtadze

Dramatic scientific, technological, political and socio-economical transformations gave a rise to economic development globalization that originated huge changes in financial relations.

At the current stage finances are starting to play leading role in economic processes. Financial field in comparison with the other economical fields is developing on the fast track. Major financial institutions rapidly conquer economy of the developing countries and take determinant positions there. Modern global economy is a financial economy. It is a financial economy, where finances not only just participate in the processes, but are playing determining role in them.
A question arises: what future expects financial systems of former socialist countries’ in terms of globalization?
As no state can exist without financial economical space, it is essential to define its position in the global financial hierarchy. Therefore, it is necessary to take into account the role of three groups of socio-political and economical obstacles, without which it is impossible to talk about actual state of former socialist countries.
First – This is a confrontation between so-called “Civilized world” and Russia.
The second group covers existing problems between the centres and regions of former socialist countries. Specifically, great part of financial resources mobilized in centralized funds gathers in the state budgets of the countries. Development of local territorial entities bears just formal character that causes deceleration of economic development in the regions.
Third group covers the problems existing in the relations between state and citizens. This is connected with default on obligations by state and population’s confidence index disorder. These are: default on deposits, defects of privatization process and property rights.

What are the problems that impede economical development of Georgia?
Economical relations derangement, Russia’s imperialistic intentions that reflected in August events, territorial integrity problems, support of 400 thousand IDPs – these are the problems that impede market economy development.
In nineties of 20th century, economical reforms started without any kind of preparation or relevant experience. Consequently, they were fruitless and this continued up to 2004. For instance, in 1994 GDP amounted only 27.5 percent of 1990 year GDP volume, while in 2004 it made up 46.6 percent. In 2008, its volume increased nearly up to 65 percent. However, GDP in 2004 in Estonia and Turkmenistan made up 80%, in Latvia – 75 percent, and in Russia, Kazakhstan, and Lithuania it reached 65%1.
At the initial stage of independent state construction, failure in economic processes, hyperinflation, wide scale of corruption, and weak tax administration caused unprecedented decrease of state budget. Besides, up to 1995 Georgia even had not had approved state budget. Moreover, in 1991-2003 years, none of the budget revenue plans has been executed.
After 2004, the ways and means of transforming country’s financial system has been dramatically changed. In 2004, the volume of budget revenue and grants amounted to 2283 million GEL or it increased in comparison with the previous years by 69.2 percent. In the same period, revenue portion toward GDP increased from 14.2 percent to 23.3 percent. The same state is in 2005-2008 years. In 2005, the volume of budget revenue and grants amounted to 3256.8 million GEL. The sum increased by 53.3 percent in comparison with the previous year. The same index in 2007 amounted 6032.5 million GEL, while in 2008 it was 6578.2 million GEL.
Recent inflation pace has a negative impact on state budget performance. It is worldwide generally expected that inflation index must not exceed 6 percent in the developing countries.
Unfortunately, the mentioned index has never been less than 6% during last three years. Moreover, sometimes it even exceeded 10 percent. For instance, at the end of 2007 inflation pace was 11%, while in 2008 it amounted 12%2. We cannot disregard views of economist experts that official statistics are far away from actual condition and inflation has more rapid pace in truth that complicates Georgia’s social and economic state even more. Inflation is not only public enemy number one, but it is an enemy for economy, investment, savings, development… Inflation is the only form of punishment without legal cause. (M. Friedman).
Often in the country, funds are spent “without legal cause”. In any country tendencies of inflation growth develops in the government cabinets when planning budget revenue and expenditures. It seems that Nobel Prize laureate, greatest economist of the modern times Milton Friedman was writing about Georgia: “Governments never learn. Only people learn”. There is nothing to add here. This person was awarded with Nobel Prize for such ideas. Any government should properly plan and use public finances. Excessive budget revenue does not mean that one should find additional expenditures and cover them with the additional funds gained in the budget. It is a worldwide-expected practice that unexpected expenditures are not covered by excessive budget revenue. As a rule, government should plan the expenditures in the next year’s budget except of extreme cases like August 2008 events. The fact that instead of covering 2007 budget deficit by means of additional revenue in amount of 1.5 billion GEL, it was covered by international credit is inadmissible. Consequently, this increased national debt. Moreover, developed countries’ practice shows that when state’s revenue exceeds expenditures, the additional funds should be spent on state’s inner debts. This is a simple truth that in the future state will have to spend fewer funds on the debt that consequently helps to reduce taxes.
One cannot disagree with famous modern economist Leshek Balcerowicz’s statement:”Projects that require increased expenditures in order to make system active, gave no reasonable effect. These are antireforms, not reforms. Those statements and measures that require not only expenses, but also serious investments without giving any tangible effect are squared antireforms3.
Allow me to discuss another problem. Ministry of Finances organizes the works connected with the planning of budget estimates. It beforehand receives statement concerning future expenditures from the ministries and departments.
The actuality of the budget expenditure statements depend largely on relevant normative basis. Despite the fact that normative basis is being created for the part of economical and social fields, yet there is a lot of work to do in this direction.
I want to draw your attention to another aspect. Revenue gained from privatization has nothing to do in annual budget, as these funds are received by realization of basic capital. Maybe the time has come to establish investment foundation and place these funds there. It is unacceptable to spend funds gained from basic capital realization to cover the budget expenditures (As these expenditures are for a year).
To my mind, budget-planning process has serious shortcomings. During budgetary year, revenues and expenditures of budget adopted by parliament undergoes serious changes. For instance, adopted budget revenues of 2007 increased by 661 million GEL in May, 450 million GEL in September, while at the end of the year it increased by 430 million GEL. 20% increase of adopted budget revenue in not a sign of budget planning optimality. In addition, this process facilitates inflation growth in the country. Tax planning is the process of calculating taxes-and-duties for the next year by the state.
The aims and tasks of tax planning are different on micro and macro levels. As the interests of Treasury and taxpayers are opposing too. State tries to receive as much as possible tax revenue in budgetary and non-budgetary funds – for accomplishing common national tasks, while each physical or legal body tries to decrease own tax liabilities. It is essential to elaborate adequate conception basics under the country’s budgetary-tax system reforms. Besides, following aspects must be taken into consideration: state finances’ influence on every segment of economy, object assessment of the finances and tax balance, financial planning, plan accomplishment reporting and analyses, improvement of infrastructure formation and functioning, transformation of every level budgetary mechanism into country’s socio-economic political instrument. The fact cannot be denied that country’s economical progress is in direct connection with effective functioning of tax system. Theoretically and practically intelligent and scientifically grounded taxes can have positive influence on national economy, they can eradicate negative shortcomings and establish taxation constructed on economical and legal basis.
On July 2007, country’s parliament passed the law “Concerning amendments and additions in the tax code of Georgia” that solves quite a number of problems of national importance. Adoption of statute was defined by number of object circumstances. In order to maintain high pace of economical growth, it is essential to encourage investments and export, specifically increase of local products’ competitiveness by reducing manufacturing expenses and supporting re-investment. Therefore, further liberalization of direct taxes or in other words, decrease of indices of payroll and profit taxes is considered by the government as an important stage. Existing profit and social taxes by its nature were identical in many ways. They complicated business processes and created unequal conditions for many for many taxpayers. For instance, profit tax for entrepreneur physical bodies amounted 29.6% and for payroll tax, it was 26.7 percent. The overall reasons of changes in Georgian tax code were:
– Improving investment environment by most liberal tax code in the regions;
– Encouraging investments and export;
– Maintaining high pace of economical growth in a middle term period;
– Improving taxation balance state.
– Increasing effectiveness of agriculture;
– Simplifying tax payment process for tax payers;
– Increasing tax administration effectiveness;
Despite the abovementioned country’s tax code is still far from being perfect. This requires thorough examination and observation from the economical security point of view. As the studies show, honest taxpayers find it difficult to pay the taxes that becomes one of the factors of increasing scales of shadow economy. Shadow economy is most dangerous factors that threaten economical security. Reduction in taxes needs to be seriously considered also. However, this problem mustn’t be considered in such a tight scale as tax reduction.
Opposite action to the abovementioned regulations is the fact that from 1st January of 2008, profit tax index has been increased from 12 percent to 25 percent, while social care tax has been repealed. This considerably decreases employees’ net income and causes worsening of scale of living. In addition, consumer products and service prices are growing considerably. Imposing the part of social tax on employees and thus giving preferential taxes to entrepreneurs opposes the equity principle of taxation system. The optimality of imposing 25% income tax index and putting it into practice is clear. Legislative body is starting to work on reduction of the index from March 2008. In the course of ten years, the index should have been reduced to 15 percent. However, it was reduced to 20 percent from 1st January of 2009. Ungrounded and frequent changes in taxation have a negative influence on socio-economic development of the country. In comparison with the previous year’s tax income growth pace, 2008 year’s one was rather modest. Percentage ratio of income tax to GDP in the first half of 2008 has doubled (up to 6.6 percent)4 in comparison with the ratio of the same period in 2007 that was defined by doubling of tax rate.
Formation of local territorial entities’ budget is liable to serious consideration. It is unjustified to leave local self-administering budgets without actual source of income and finance their expenses by so-called transfers’ mechanism. The mentioned condition prevents social-economic development and economic balance ensuring in the regions.