PUBLIC FINANCE IN TRANSITION AND ADVANCED MARKET ECONOMIES
Vanessa Fry and Laszlo Urban
Winter - Spring, 1995
Department of Economics
CENTRAL EUROPEAN UNIVERSITY



Course Description

This course uses the economic theory of public finance to analyse current policy problems and options in transition and advanced market economies. The subject is very large and we have to select topics. The course is complementary to Prof Ahsan's option in Public Finance and Fiscal Policy: students may take either one or both without suffering either boredom or confusion as both the range of topics and their treatment differ -Prof Ahsan's option emphasises theory, without ignoring policy applications, while Urban/Fry analyses policy, which cannot be done while ignoring theory!

PART I. TRANSITION ECONOMIES

Dr. Laszlo Urban
Department of Public Policy
Budapest University of Economic Sciences

1. / (Monday Feb 20)

Introduction

Public finance: Taxing and spending activities of government.
Conceptual framework: market failures and government failures. Reasons for and costs of government redistribution

Fiscal problems and fiscal reform

Main features and problems of the inherited fiscal system. Public enterprises and various forms of subsidies. Budget deficit and debt management. Major reform areas. Simultaneity of fiscal reform and macro-stabilisation. Political feasibility of fiscal reforms in democratic regimes.

-G. Kopits: Fiscal reform in European Economies in Transition, in Paul Marer and Salvatore Zecchini (eds): The Transition to a Market Economy, vol II, OECD, Paris, 1991, pp. 359-388.

-S. Chand and H. Lorie: Fiscal Policy, in Vito Tanzi (ed.): Fiscal Policies in Economies in Transition. IMF, Washington DC, 1992, pp. 1-36.

-A. Cheasty: Financing Fiscal Deficits, in Tanzi [1992] pp. 37-66.

-M. Allen: Government Debt Management, in Tanzi [1992] pp. 67-79.

2./ (Wednesday, Feb 22)

Revenue: Tax reform.

Need for tax reform. Efficiency, fairness and other requirements for the new tax system. Need for accumulation of capital. Taxing income, profits and imports. Tax collection capacity and the problems of tax evasion.

-V. Gandhi and D. Mihaljek: Scope for Reform of Socialist Tax Systems, in Tanzi [ 1992] pp. 142-169.

-A. Harberger: The Other Side of Tax Reform, in R Dornbusch, Policymaking in the Open Economy, Oxford University Press for the World Bank, 1993, pp. 149-171.

-D. Newbery: Taxation and Development, in D Newbery and N Stern (eds), The Theory of Taxation for Developing Countries, Oxford University Press for the World Bank, 1987, pp. 165-204.

-P. Diamond: Optimal Tax Theory and Development Policy: Directions for Future Research, in Newbery and Stern [1987] pp. 638-647.

3./ (Monday, Feb 27)

Expenditure: Income transfers and safety nets

Share of social welfare redistribution. Adverse incentives. Holes in the safety net. How to contain costs? Universal entitlements vs. means-tested assistance. Diversifying supply. Why is the reform of the pension system so crucial? Political capacity for implementing substantial reforms.

-N. Barr: Social Insurance, in Nicholas Barr (ed.), Labor Markets and Social Policy in Central and Eastern Europe, Oxford University Press for the World Bank and LSE, 1994. pp. 192-225.

-S. Sipos: Family Support and Poverty Relief, in Barr [1994] pp. 226-259.

-R. Holzman: Safety Nets in Transition Economies..., in Marer and Zecchini [1991] pp.155-179.

-Dimitri Vittas and Roland Michelitsch: Pension Funds in Central Europe and Russia. Paper presented at the joint conference of CEU Privatisation Project and the World Bank on Corporate Governance in Central Europe and Russia. Dec 1994. p.47.

4./ (Wednesday, March 1)

Actual Developments in Public Finance during the last five years.

What has changed during the last years in the leading reformer countries in the region, in the field of public finances? Share of redistribution (revenue and expenditures), type of expenditures increased and declined, new taxation and revenue allocation mechanisms in place. Budget deficit and inflation. Political preconditions of successful budgetary reforms.

-Economic transition in eastern Europe and the former Soviet Union. Transition Report October 1994. EBRD. Chapter 6. Taxation and transition. pp. 78-98.

-Andras Semjen: Some Fiscal Problems During Economic Transition in Hungary, in Kalman Mizsei (ed.), Developing Public Finance in Emerging Market Economies. Institute for East West Studies, New York, 1994. pp. 19-58.

-Alain de Crombruggie: The Polish Government Budget: Stabilisation and Sustainability, in Mizsei [1994] pp. 63-128.

-Vera Kamenickova et al.: What is the Budget Reform in Czechoslovakia and the Czech Republic About? in Mizsei [1991] pp. 135-164.

PART II. ADVANCED MARKET AND TRANSITION ECONOMIES COMPARED

Dr. Vanessa Fry,
Department of Economics
University of Essex, UK.

I have set two types of reading:
1. my lecture notes
2. selected articles
Photocopies of both will be available; there is no set textbook.

The first section of my lecture notes contains a review of the fundamental principles of taxation; much of it is probably familiar, but it can be used for reference when necessary. The notes for each of the topics for weeks 3-6 (March 6 - March 31) are divided into two sections: I. Theory, and II. Policy. The emphasis in lectures will be on analysing policy, making use of the theory as we need it. The notes accompany the lectures - they are not the text of the lectures.

WEEK 3 {March 6 and March 9)
How to -and how not to -reform income taxes


In the 1980's, there were fundamental reforms of income taxes in a number of western market economies; among the most far-reaching were those under President Reagan in the USA and Prime Minister Thatcher in the UK. Both reforms aimed to make substantial cuts and structural changes and they were part of a revolution in economic policy-making towards 'supply-side' economics. More recently, in the 1990's income and social security taxes have been established in most transition economies in a variety of ways. We will consider the following issues:

* what are the characteristics of a "good" income tax?
* did the US/UK reforms introduce such characteristics?
* what additional factors should be considered for transition economies?
* how do the reforms in transition economies measure up - focus on Czech Republic and Hungary.

WEEK 4 (March 13 and March 15)
Poverty and income maintenance


How can a market economy best support the incomes of the poor? A wide range of policy practice exists in both advanced and transition economies and policy choices are political and social as well as economic. Economic analysis allows us to make clear the contradictions that sometimes exist between the aims of politicians and shows how to minimise the economic cost of particular social goals. We will look at a range of examples and the problems they raise. How can policy balance

* the welfare of the poor
* the tax burden on the non-poor
* the effect of welfare payments on incentives for the poor to work and save?

WEEK 5 (March 20 and March 22)
Indirect taxes: differentiating between goods


Since all money spent by consumers must first be received by them as income, some forms of tax are economically equivalent -eg a wage tax and a tax on all consumption goods: they differ only in the way they are administered and collected. We examine this more closely and ask:

* What is the point of taxing both wages and consumer goods?
* What are the economic advantages and disadvantages of a "VAT" system for both advanced and transition economies?
* What is the impact on effective tax rates of VAT systems in which the rate varies across goods?
* The European Union aims at 'harmonising' its indirect tax rates: why?

WEEK 6 (March 27 and March 29)
Corporate Taxes


Taxes on corporate profits can be very important in corporations' decisions both on how much to invest and on whether to finance their investment by borrowing, issuing new shares or retaining their profits instead of paying them out to shareholders. The effects of taxes are not obvious -alternative types of corporate profits tax can either decrease or increase the marginal return on investment, while "tax holidays" can decrease the marginal return. It is possible to design a "neutral" corporate tax -one that leaves corporations to make their decisions on economic criteria, not according to the tax advantages. We will analyse the corporate taxes of a number of advanced and transition economies, asking:

* Why tax corporations rather than persons?
* How do taxes affect the incentive to invest?
* How do taxes affect the financial structure of corporations?
* Could corporate taxes be reformed to achieve greater neutrality -focus on Czech Republic and Romania.

Reading for Part II:

J. Pechman, 'The future of the income tax', American Economic Review, 1990.

C. Giles and P. Johnson, 'Tax reform in the UK and changes in the progressivity of the tax system, 1985-1995', Fiscal Studies, August 1994.

C. Heady, N. Rajah, S. Smith, 'Tax Reform and economic transition in the Czech Republic', Fiscal Studies, February 1994.

D. Newbery, 'An analysis of the Hungarian tax reform', CEPR discussion paper 558, 1991.

G. Burtless, 'The Economist's lament: public assistance in America', Journal of Economic Perseptives, Winter, 1990.

R. Kanbur, 'Transfers, Targeting and Poverty', Economic Policy, April 1987.

Atkinson, A, 'On Targeting Social Security: Theory and Western Experience with Family Benefits', LSE discussion paper WSP/99, 1993.

M. Keen, 'The welfare effects of tax co-ordination in the European Community: a survey', Fiscal Studies, May 1993.

S. Smith, '"Subsidiarity" and the co-ordination of indirect taxes in the European Community', Oxford Review of Economic Policy, Spring 1993.

OECD, Taxing Profits in a Global Economy, 1991 (selected pages).



CRC-Curriculum Resource Center
CEU Budapest, Hungary
Modified: May, 1996

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