Draft_Scope_of_Work_to_be_published_for_comments.pdf

Fiscal Sector Reform

U S A I D B o s n i a a n d H e r z e g o v i n a

E c o n o m i c D e v e l o p m e n t O f f i c e

USAID

The purpose of this SOW is to identify and recommend activities to be carried out in the fiscal sector, with the ultimate goal of improving fiscal and public expenditure management, through a comprehensive approach that will ensure better coordination and management between all levels of economic government, increased compliance, and a simplified business environment and fiscal regulatory framework.

USAID/BiH Fiscal Sector Reform Draft Scope of Work

Table of Contents Objective

Scope of the activity

Country background and Development context

Problem Statement and Major Issues

Executive Summary

Relationship to the CDCS, and applicable agency policies

USAID Achievements in the Fiscal Sector to date

Other Donors in the Fiscal Sector

Recent achievements in support of the activity

Methodologies

Illustrative activities

Monitoring, Evaluation, and Learning

Sustainability Analysis

Environmental Analysis

Gender Analysis

Critical Assumptions and Risks

Funding Requirements ................................................................................... Error! Bookmark not defined.

Possible Implementing Mechanisms ............................................................. Error! Bookmark not defined.

Objective The purpose of this SOW is to identify and recommend interventions to be carried out in the fiscal sector, with the ultimate goal of improving fiscal and public expenditure management through a comprehensive approach that will ensure better coordination and management between all levels of economic government, increased compliance, and a simplified business environment and fiscal regulatory framework. Through the Fiscal Sector Reform (FSR) activity, USAID will support efforts that facilitate gains in fiscal space and public investment that, in turn, spur increasing private domestic and foreign investment in Bosnia and Herzegovina (BiH).

Scope of the activity The project will be implemented in five years, starting in fall of 2014. The focus area of the activity is a fiscal discipline, which entails comprehensive set of initiatives tackling coordination between the different levels of the BiH governments, and additional work with governmental institutions such as the tax administrations. The main activity tasks are:

A.1 Assistance for the Fiscal Council

A.2 Strengthening of the FBiH Treasury System and

A.3 Strengthening of the PIFC

A.4 Strengthening of the Public Debt

A.5 Increased compliance and improved business environment

A.5.1 Reducing tax evasion

A.5.2 Business environment

A.5.3 Elimination of nuisance taxes

Country background and Development context Some seventeen years after the 1992-1995 war BiH still struggles to perform basic governmental functions and has not transitioned to full sovereignty given the remaining outstanding conditions needed for closure of the Office of the High Representative (OHR). OHR is an ad hoc international institution created by the Dayton Peace Accords (DPA) and responsible for overseeing the implementation of civilian aspects of the DPA which ended the war in BiH. While OHR prepares to close, the European Union (EU) has pledged to increase its commitment to Bosnia and Herzegovina. The EU has recently confirmed this commitment with appointment of a European Union Special Representative

(EUSR). The EU Delegation will take on the fundamental duties for steering the country toward EU membership once OHR closes.

BiH remains deeply divided along ethnic lines. Divisive ethno-nationalist rhetoric exists at almost every political level, in the popular media, in the education system, and in more subtle aspects of social life.

The most recent examples are the confrontational discussions between Bosniak and Serb government officials regarding the indictments of two Bosniak military commanders from Srebrenica region, initiated by the court in Serbia. Republika Srpska officials threatened to abandon the joint state institutions because BiH state institutions refused to extradite the accused. These divisions inflame distrust and impede progress in virtually every socio-political and economic area.

The country consists of two entities and one district: Federation of Bosnia and Herzegovina (FBiH), the

Republic of Srpska (RS), and Brcko District (BD). All three entities have governments with almost identical, and often overlapping competencies (executive, legal and judicial).

The differences that hamper the harmonization between the entities and establishment of the single economic space are closely tied to the administrative structure of the entities: FBiH is a highly decentralized entity consisting of three levels of government, with shared competencies and a complex internal administrative structure; Republika Srpska is a highly centralized entity with two levels of government; the District of Brčko has a special status, it is jointly owned by the two Entities but not managed by either. The BD has fields of competence that are nearly the same as those of the Entities, as well as social systems that are shared with the entities (e.g. pension system). State legislation directly applies to the District. Federation of BiH consists of ten cantons. There are 80 municipalities in the FBiH and 62 municipalities in the RS. State-level institutions are very limited in their capacities, and there are only a few such institutions that have national-level competencies and authorities that merit support

(including the Ministry of Justice and State Parliament). What is highly problematic and presently unsustainable is the way in which the continued functioning of the state institutions and the exercise of exclusive state competencies can be undermined by Entity/constituent people-based quorum and voting rules. Furthermore, competencies shared between the state and Entities are configured in such a way that there are inadequate mechanisms to ensure Entity compliance with state or joint policy. This is a major problem given that policy-making and coordination capacities are also important for the

European Integration process. The EU’s Chapter 341 of the acquis requires EU aspirant countries to establish necessary bodies and mechanisms to be able to operate effectively within the EU. The EU’s

Stabilization and Association Agreement (SAA) requires BiH to ensure proper policy-making coordination between all levels of government.

SAA’s economic criteria for integration with the EU require the existence of a functioning and competitive market economy in BiH that meets strict EU standards and practices regulating the business environment. Between 2006 and 2010, BiH made significant efforts to improve its business environment and attract more foreign investment. The reforms implemented during this period targeted the regulatory/policy arena, and they were almost exclusively initiated and implemented by the international community. A significant slowdown in implementation, as well as in initiation of new reforms, has been noticeable in the last two years. Recent EU Progress reports (2012 and 2013) on countries from the region show that BiH made very limited progress towards meeting SAA criteria, while

Montenegro, Albania and Macedonia were praised for progress in almost all SAA areas. Croatia became a full EU member in July 2013, while Serbia was awarded candidate status enabling the country to access significant accession funds. Meanwhile, BiH continues to lag behind countries in the region in terms of the EU accession process. The EU Country Progress Reports for 2012 and 2013 concluded that

For the latest codification of the acquis chapters, see http://ec.europa.eu/comm/enlargement/negotiations_hr_tk/chapters.htm#Chapters

“Bosnia and Herzegovina has made little further progress towards a functioning market economy.” The same reports stressed that BiH needs to improve competitiveness and productivity, attract investment, and make economic policy reforms. According to the aforementioned reports BiH’s efforts remain insufficient in meeting many European standards criteria areas, including customs and taxation, public procurement, labor and employment, industry, SME business environment, food safety, veterinary and phyto-sanitary sectors, environment, transportation, energy, information and communication sector, fiscal and financial management, and statistics.

If the aforementioned problems are not addressed immediately, BiH will remain unattractive to investors, simply because other countries are advancing at a faster pace than BiH. The World Bank‘s Doing Business (DB)

Report starkly illustrates BiH’s development stagnation. In 2011, DB ranked BiH at 110th place out of

183 countries. Although positive reforms were implemented in BiH during the last three years, other economies improved at a faster pace than BiH. The slow pace of reforms in the last few years resulted in

BiH being pushed to 131st place in the 2014 World Bank’s DB report – the worst performance in Europe.

All other countries in the region are ranked below 100th place, and the closest ranked European country to BiH is Ukraine at 119th place.

Problem Statement and Major Issues In 2012, the economy contracted by an estimated 1.1%, after a slight improvement recorded during the previous two years. Declining wages and raising unemployment rates, coupled with decelerating lending, resulted in reduced consumption heavily affecting trading and service industries. At the same time, the economic crisis in the EU, BiH’s traditional export markets, led to a negative contribution of net exports to growth. Industrial production fell by 5.3% in 2012, compared with a 5.9% expansion the previous year. Per capita income, measured in purchasing power standards (PPS), decreased from 30% in 2011 to 28% of the EU average in 2012. The downturn in economic activity has shrunk the tax base with the budget revenue-to-GDP ratio falling to 39.9%, while public expenditures expanded further.

Thus, in 2012 the budget deficit increased to 1.5% of GDP, from 0.7% of GDP a year earlier.

Bosnia and Herzegovina recorded a current account deficit of 386.30 BAM Million in the third quarter of

2013, or -9.67% of GDP. The trade deficit increased by 1.2% and reached 32.7% of GDP, as exports fell by

1.9%, while imports stagnated. The surplus in services also decreased further adding to a higher current account deficit. The current account deficit was financed mainly by external borrowing and to a certain extent by foreign direct investment (FDI). As a share of GDP, FDI decreased year-on-year from 0.5 % to

2.2% in 2012, continuing its downward trend in 2013. (FDI has dropped approximately 80% since 2007).

Bosnia and Herzegovina snapshots

GDP growth - 1.1%

Government expenditures share of

GDP 45%

CAD % of GDP -9.67%

Public Debt of GDP 43.3%

Unemployment rate 28%

Budget deficit % of GDP 2.1%

The financing of the deficit increasingly relied on foreign borrowing, leading to an increase in public external debt. Bosnia and Herzegovina’s public debt increased to 43.3% of GDP in 2013 as compared with 40.9% of GDP a year ago (over 5.5 billion Euros). Of that, 68% is external debt to foreign creditors.

The external public debt expanded by an additional 7.4% to a total of 27.9% of GDP. Public debt servicing doubled since 2007 and reached over 3% of GDP in 2012. The World Bank group remains the largest creditor, while public international creditors (EIB, ERRD, IMF) account for over 90% of the country’s external public debt.

Unemployment remains very high and reached 28.6% in 2012 from 28% a year earlier (ILO measuring accounts for grey market). Total employment levels stagnated through 2012 and marginally decreased (-

0.6%) year on year in the first half of 2013.

Meanwhile, “unproductive employment” continues to be a problem. The number of employees in public administration continued to rise throughout 2012 and the first half of 2013, thus further increasing the overbearing size of BiH’s public sector. Unemployment was particularly high among youth (63.1% for people aged between 15 and 24-- by WB’s Labor Force Study). The very high unemployment rate and the huge difference between the registered and survey-based labor figures (44% vs. 28%) suggest the existence of a large informal labor market and significant structural rigidities culminating in extremely high rates of social security contributions.

The consolidated budget deficit increased to 2.1% of GDP, compared with 1.3% in 2011, due to higher public expenditure growth (2.4%). The share of general government expenditures remained relatively high at approximately 45% of GDP and revenue at about 44% of GDP. Social security contributions – accounting for over 1/3 of the overall revenues –remained the same, and, as noted above, at a relatively very high level.

The breakdown of public spending remained highly unfavorable with current expenditures representing

95% of total expenditures, while capital spending remained demoted. All main expenditure categories increased during the year indicating some loosening of fiscal discipline. Government purchases of goods and services grew by 3.2%, while expenditures on social benefits increased by 1.5%. Fiscal imbalances worsened in 2013 due to reduced revenues from indirect taxes resulting mostly from high VAT refunds.

Lower revenues were partly compensated by delays in the implementation of some capital/public investment projects. The general government balance in the first six months of 2013 turned positive and amounted to 0.4% of annual GDP. (Statistics provided from the 2013 EC Economy Report for Bosnia and

Herzegovina).

Executive Summary

The global economic crisis uncovered the weaknesses of BiH’s public finances and fiscal sector. Before the economic crisis struck, BiH’s consolidated budget-- considerably boosted by introduction of VAT in

2006-- resulted in surpluses (it was positively affected by high economic growth, increased investments and remittances). However, BiH’s weak economic governance, strongly influenced by irreconcilable political interests, instead of financing true economic growth-enhancing activities used earlier fiscal surpluses for unproductive purposes (e.g. irresponsible/politically motivated expansion of the public sector and increases in public sector wages). These were further compounded with generous social spending that targeted war veterans and other forms of privileged social categories to “buy” their electoral/political support. The sudden contraction of the economy during and following the global financial crisis resulted in declining revenues that forced expenditure cuts Impacting budgetary considerations.

The economic reforms implemented during 2006-2010, in which the USAID Mission in BiH had a significant role (ELMO, TARA, TAF), resulted in a gradual reduction of consolidated budget deficits.

Although some positive developments over the past several years helped streamline Bosnia and

Herzegovina's growing public sector, improving BiH’s public finances remains one of the key priorities identified by the USAID Mission, as well as the IMF and EU delegations. Presently, the quality of public finances remains low, even though public financial management was somewhat strengthened. Overall public sector coordination on economic and fiscal policy remains weak, thus impeding systemic reforms.

BiH’s large and inefficient public sector with multiple overlapping competences at the state, entity, cantonal (in the

Federation), and municipal levels continues to impose considerable fiscal risk. The management and structure of public spending in Bosnia and Herzegovina remain fundamental concerns. For that reason, fiscal reporting needs to be improved by enhancing the analytical quality of BiH’s fiscal policy design. Structural rigidities such as excessive labor taxation and poorly targeted social transfers need substantive reform to spur labor demand. Additionally, authorities in the Federation should proceed quickly with pension reform.

As already noted, BiH’s public finances is a focus area for the EU. Public Administration Reform, which entails public finance reform in Bosnia and Herzegovina, is necessary for establishing effective, accountable and financially efficient services for businesses and citizens. This reform is a precondition for integration into the EU. The EU acquis communautaire considers administrative capacities for

The IMF delegation that held meetings with the BiH Minister for

Treasury, Mr. Nikola Spiric on

February 25, 2014, again stressed the need for improved fiscal coordination and discipline at all levels of BiH government.

implementation of projects and EU reforms to be one of the most important criteria for EU membership.

Although the EU does not prescribe any specific budgetary model, the formation of national and entity budgets is closely monitored and analyzed in terms of capability, proficiency and transparency in management of budget funds. There are two major chapters in the acquis that evaluate BiH’s fiscal capacity to join the EU:

1. Chapter 17 of the EU acquis, concerning macroeconomic policy (fiscal and monetary policy), requires mid-term fiscal programming, and monitoring and evaluation of budgetary system results according to the Support for Improvement in Governance and Management (SIGMA) approach. SIGMA is a joint initiative of the European Union and the OECD that works with EU aspiring countries on strengthening public governance systems. SIGMA uses a comprehensive set of measurements to evaluate the quality of budget legislation, budget scope, medium-term expenditure framework, budget management of public investments, and budget execution, monitoring, accounting and reporting.

2. Chapter 32 of the acquis relates to the adoption of internationally agreed upon and EU-compliant principles, standards and methods of public internal financial control (PIFC), which essentially need to be in place to ensure transparent use of public funds.

As further reform of the fiscal sector is key for BiH’s sustainable economic growth, particularly given its decreasing revenues and diminishing budgets coupled with excessive government expenditures, USAID decided to design the Fiscal Sector Reform project. This comprehensive project will address the issues summarized above in the following matter:

1. An absence of national coordination of economic and fiscal goals has led to increased independent activities of the two Entities and Brcko District. These uncoordinated actions negatively affect fiscal and tax harmonization within BiH. They further negatively affect the creation of a single economic space by discouraging potential investors, who demand stability and harmonization at the country/sovereign level. The Fiscal Reform project will address these issues through capacity building with the Fiscal Council at the State level, and analytical units of the two Ministries of Finance at the Entity level, to increase their analytical expertise, introduce international standards, improve their coordination and create a common fiscal framework in which BiH’s public finances need to operate. (see under A.1)

2. To ensure a more efficient and transparent management of public funds, BiH’s treasury operations has to rely on real-time IT business transactions that include all budget users in the

FBIH and the RS. This project will incorporate currently outstanding municipalities in FBIH’s treasury system; upgrade the current IT system of all Cantons and explore the possibilities for creating and expanding the existing infrastructure for integration and consolidation of the existing and planned IT systems in Federation (BMIS, Treasury, etc.); and integrate RS’s Health

Sector transactions into the treasury system. This should significantly improve management of

BiH’s public funds in both entities. (see under A.2)

3. Public Internal Financial Control is a precondition by the EU, described under Chapter 32 of the

EU acquis. Public Internal Financial Control (PIFC) in Bosnia and Herzegovina (BiH) is still in the early stages of development. The State (BiH State), the Federation (FBiH) and Republika Srpska

(RS) are basically at the same stage. They coordinate technical development of legislation and methodologies through the Coordination Board (CB) for Central Harmonization Units (CHUs).

According to the SIGMA PIFC report for 2013 “FBiH arguably has the most challenging environment, which requires developments to be negotiated through government at the entity, canton and municipality levels”. USAID will work with the Entity Ministry of Finance to introduce the PIFC standards in entity institutions. USAID will also help In training and certification of the auditors. This will ensure increased transparency and internal control over the expenditures from the EU and all other funds. (see under A.3)

4. BiH still lacks a fully integrated public sector IT system for debt management. The State, two entities and Brcko district are using independent, old Access databases to record and trace external debt, while internal debt is recorded in Excel files. These are highly inaccurate and unreliable manual methods of recording and reporting on public debt, as they are often exposed to data input mistakes. Public debt risk management and analyses are very poor. To address the current situation, USAID will help the State and two Entity MoFs to implement a state-of-the-art IT system for debt management. Options would include off-of-the-shelf systems that incorporate best experiences and practices in managing public debt. The system will be tailored to accommodate the specific requests of BIH’s public governance. (see under A.4)

5. To address the issue of diminishing public revenues, USAID will assist the FBiH Ministry of

Finance and the FBiH Tax Administration to address tax evasion by helping establish an enforcement mechanism for debt collection from non-complying companies. The effort will focus on the gaming industry in FBiH, which is currently not adequately regulated. Due to weaknesses in tax administration, large amounts of taxes are being evaded every year in this sector. It is anticipated that this activity will increase public revenues from direct taxes by 20-30 million KM annually. (see under A.5.1)

6. The second tax-compliance related activity will target companies that evade publicly mandated collection of debt by transferring money through multiple bank accounts. USAID will assist the

FBiH MoF to implement the Single Registry Account IT solution that will register and link all bank accounts for all companies allowing for the “freezing” of bank accounts until the total debt collection is settled. An additional increase in revenue collection can be realistically expected from this intervention. (see under A.5.1)

7. In order to improve the business environment in FBiH, USAID will continue the reform initiated under the TAF project to simplify payroll processing for the private sector. The ultimate goal is to reduce the number of payment orders required for payroll processing down to one. This will result in savings estimated at 24 million KM for employers. (see under A.5.2)

8. To improve the business environment, increase transparency and reduce errors, USAID will assist the RS and FBiH MoFs to further improve tax related IT systems for direct taxes. This reform anticipates introduction and expansion of the E-services related to direct taxes, and expansion and sophistication of the existing IT platforms in two entity TAs. (see under A.5.2)

9. Cantonal and municipal councils in both entities often impose a number of fees and taxes on cars, incomes, etc., that are earmarked for financing community infrastructure such as water systems, education centers, sports facilities, and cultural venues. Often, the destination of the proceeds is off-budget, and the legality of these impositions and the transparency on the use of such resources are questionable. These para-fiscal taxes (AKA nuisance fees) are unsystematically imposed on all businesses without any clearly defined criteria. In order to increase the legitimacy of such taxes, strengthen their compliance with local tax regimes, enhance fiscal transparency, improve the business environment, and ensure their productivity, these fees/surcharges should be thoroughly reviewed, streamlined, and made explicit in the budget. The establishment of Registers for para-fiscal taxes is a very common practice for addressing this problem. USAID will assist Entity governments to adopt a systematic approach to resolving the issue of nuisance fees and, thereby, improve the local business enabling environment. (see under A.5.3)

Relationship to the CDCS, and applicable agency policies U.S. Mission Strategic Plan. The 2012-2016 CDCS for the US Mission in BiH identified economic growth and the strengthening of economic aspects of governance relevant to the business environment and private sector development as key foreign policy priorities for the United States Government (USG) in the country.

Development Objective and Crosscutting Linkages. The proposed Fiscal Sector Reform activity, that will be implemented under this PAD, Improving Economic Governance (IEG) Project, is designed to address critical needs identified in BiH’s CDCS. The overarching objective of this economic development project will indirectly address a number of crosscutting initiatives: 1) inter-ethnic reconciliation by supporting state and entity-level economic institutions that promote a single economic space through regulatory and legislative harmonization; 2) improved business enabling environment; and 3) anti-corruption measures by eliminating nuisance regulations, simplifying procedures, and reducing opportunities for regulatory abuse that deter private sector development.

The activity will also leverage USAID funded projects for strengthening BiH’s Parliament(s), and the relevant departments from the US Embassy in Sarajevo (Economic and Political Sections) to facilitate rapid and smooth adoption of the regulations and policies targeted by this project.

Linkages with the Results Framework. Development hypothesis: “An economy with competition and based on market forces will result in new and better enterprises and ideas that lead to more jobs and opportunities. Private sector‐driven economic growth provides the only means for a country to generate public and private resources it needs to address development challenges on its own and emerge from dependence on foreign aid. Economic growth provides the material basis for progress in all other dimensions of development and long‐term stability”.

The planned project falls under Development Objective 2: Economic Growth/Economic Opportunity, as identified in the 2012-2016 USAID/BiH Country Development Cooperation Strategy. The activities that will be implemented under this project will directly support Intermediate Result (IR) 2.2 “Improved economic aspects of governance relevant to business activity”, with a focus on Sub IR 2.2.1

“Regulations and policies which foster a single economic space and private sector development and investment”.

This IR was envisioned to improve business-relevant strategies and policies that will stimulate economic growth and attract investment. Regulatory and policy reform assistance proposed under Fiscal Sector

Reform will address harmonization of regulations and procedures in the fiscal arena across Entities.

USAID Achievements in the Fiscal Sector to date This section provides a brief overview of USAID funded activities related to the fiscal sector.

1. TAF Project (2010-2013): Completed the efforts for the Unified Collection System (UCS) in FBiH.

Implemented regulations and IT solutions for detecting stop-fillers and non-fillers of direct taxes.

Introduced a simplified payroll processing IT system by reducing the number of payment orders for the average of 10 orders down to five. Harmonization of Direct Taxation within Bosnia and

Herzegovina by focusing on Brcko District as the direct taxation differed there from the entities.

New Personal and Corporation Income tax laws drafted and enacted in Brcko District.

Development and Implementation of Audit software to automate the taxpayer audit processes and to avoid discretion among tax administration staff in the selection of returns for audit.

Developed the Fiscal Analyses Capacity in the RS and the FBiH by providing training on micro-simulation models using internationally recognized STATA software.

2. ELMO Project (2006-2010): Introduction of the Unified Collection System (UCS) in Republika

Srpska and FBiH for simplified, one-stop-shop registration/deregistration of employees for taxes and social contributions;

3. TARA Project (2006-2010): Reform of direct taxation in both entities. Harmonization of direct taxes by introduction of the Personal Income tax (PIT) and Corporate Income Tax (CIT) in RS and

FBiH, at unified/identical rates. Modernized TAX administration systems. Introduction of the

Property Tax in RS, and Brcko District (FBiH delayed the implementation).

Other Donors in the Fiscal Sector In addition to the USAID’s efforts in the fiscal sector, other donors recognized the importance of the sound fiscal management for the country’s economic and political stability.

European Commission

Given that the economic criteria for integration with the EU is prescribed in the SAA agreement, it is logical that the EU Delegation to BiH is one of the major donors in the reform of BiH’s public administration, including public finances and the fiscal system. In 2013, the European Commission allocated approximately 47 million Euros for IPA’s Component 1, focusing on Transition Assistance and

Institution Building. Of that, approximately 1.6 million Euros will be provided for assistance in public procurement reform. IPA projects funded in previous years are listed below:

• IPA 2007 project “Development and implementation of overall BiH PIFC strategy” designed to strengthen the financial control environment of public administration. It ended in April

2012.

• IPA 2009 project “Capacity building for the compilation of accounting data within the General

Government and statistics of public finance.” Its purpose is to support the Ministries of Finance of the

State and the Entities and the Brcko District Directorate in providing sound and inter-institutional harmonized data on public finance on the basis of accrual accounting in accordance with international, especially EU principles, standards and practices. It will end in early 2014.

• IPA 2010 project “Coordination of policy making capacities and public financial management” with the purpose of improving the quality of fiscal policy and the links between policy makers and budgeting procedures.

IPA 2011 fund: EC allocated approximately 4 million Euros for public finance restructuring, and financial management in compliance with EU standards. Component I of the project is related to the strengthening of treasury operations at the level of the state and the entities, and is currently in the drafting phase of terms of reference. (need to verify if some of the funds were cancelled due to failure to implement Sejdic-Finci ruling2).

PARCO (Public Administration Reform Coordinator’s Office) – Multi Donors

The Government of BiH, through the Council Of Ministers (CoM) and the Public Administration Reform

Coordinator’s Office (PARCO), is tasked with implementation of the public administration reform projects. Under PARCO, a Public Administration Reform Fund (PAR Fund) has been established as a source of financing for technical assistance in the implementation of the projects that were defined in the Action Plan (later modified and referred to as the Revised Action Plan – RAP 1). Main contributors to the Fund are international donors and foreign governments: Delegation of the European Union in BiH, Ministry of Foreign Affairs of Great Britain, Swedish International Development Agency (SIDA), The Royal

Netherlands Embassy, and Ministry of Foreign Affairs of the Kingdom of Norway. However, the reforms under PARCO are often implemented at a very slow pace and do not meet the expectations of the entity ministries.

IMF (International Monetary Fund)

The IMF Mission is a strong supporter of fiscal sector reform. IMF and USAID coordinated their activities in the fiscal arena in past years: USAID’s ELMO and TAF activities (Unified Collection System and Payroll

Processing System) were recognized by the IMF as highly important reforms, and were included in the negotiations for the Stand –By – Arrangement with BiH authorities. IMF is presently supporting the adoption of the FBiH Law on budget, and the State Law on public procurement. IMF also strongly supports work of all four Tax Administrations (TAs) in BiH, and conditions further monetary assistance for the country with direct assistance to the TAs.

GIZ (German Government)

Bosnia and Herzegovina failed to secure implement Sejdić-Finci ruling, human rights and electoral rights decision by the European Human Rights Court, and lost 45 million Euros in IPA funds. European Union deicide to slash funds for Bosnia and to transfer remaining part to Kosovo which will be used in infrastructure and development programs .

There is ongoing cooperation between the Governments of BiH and the German GIZ project for technical assistance for public administration reform. This project will introduce electronic processing in the public procurement system of Bosnia and Herzegovina.

DFID (ended in 2010)

The Project for Strengthening Public Expenditure Management in BiH addressed the process of budget planning and preparation at all levels, and has introduced the process of „Budget Planning in 10 Steps,‘ representing basic concepts of program budgeting and strengthened medium term budget planning and preparation.

Recent achievements in support of the activity

1. The new Law on Budgets for the Federation was adopted by the Federation parliament. The law was developed with assistance from the International Monetary Fund (IMF). The law is a critical step for promoting fiscal discipline in the Federation.

2. The IMF, under the Stand-By Arrangement (SBA) approved Bosnia and Herzegovina’s (BiH) request for a two-year SBA. The fourth review was completed in October 2013 after which 125 percent of funds have been disbursed. An additional 25 percent of funds have just become available after the fifth review was completed in January 2014.

3. The BiH government adopted a new draft procurement law for BiH—prepared with assistance from the EU. The new law harmonized local procurement framework with EU standards. The law will be adopted by the BiH parliament in spring of 2014. This directly impacts public expenditures.

4. The World Bank assisted FBiH authorities to develop a new pension system strategy reform. The Federation parliament has adopted the pension reform strategy that is based on increasing the number of contributors and raising the retirement age in order to ensure some sort of long-term viability of the existing PAYGO pension system. The expenditure for social benefit systems is the most critical aspect of public expenditures.

5. The Indirect Tax Authority (ITA) increased its transparency by starting to publish the names of the 100 largest tax debtors. A similar action was initiated in the FBiH where the Tax Administration for direct taxes went public with estimated figures on tax evasions. By increasing transparency, tax administrations are trying to reduce tax evasion and improve revenue collection.

6. The four tax agencies (ITA, FTA, RSTA, and BDTA) will start exchanging taxpayer information in January 2014. The tax agencies are working to complete the legal and technical steps needed to allow for automated and unfettered access to each other’s taxpayer data. This was a joint effort by USAID TAF and US Treasury, and finalized by the IMF. This will improve tax collection and fight tax evasions.

7. The Federation authorities will restart the privatization process with the aim to improve economic governance and encourage private investment. The assistance will be provided by the World Bank and the EBRD to prepare the action plan for submission to parliament by mid-2014 that will specify the candidate companies for privatization. This will provide additional revenues to support FBiH’s economic growth.

Methodologies

The overarching goal of the USAID/Bosnia and Herzegovina (BiH) 2012-2016 CDCS is to support BiH in becoming a more stable country closer to EU and Euro-Atlantic integration. The economic development objective in the CDCS is designed to create a competitive and market-oriented economy that will stimulate economic growth and improve living conditions for all BiH citizens.

In order to create a competitive market economy, EDO activities in the fiscal sector must focus on supporting harmonization of fiscal policies and procedures between the entities, creating a strong fiscal discipline, and improving fiscal coordination among all levels of the government.

USAID will take a three-prong approach to addressing the needs in the fiscal sector. This comprehensive approach will ensure a high level of coordination among the entities, as well as the horizontal and vertical integration in the fiscal management system. USAID design team believes that the adopted three-prong approach will reinforce the synergy and harmonization between the initiatives proposed under this reform. In that manner, the activities at the State and level of the entities will contribute towards the ultimate goal in the fiscal sector: Improved fiscal coordination, better compliance, more accurate fiscal planning, and standardized and harmonized reporting towards the EU.

Provided that Fiscal reform has a cross-cutting effect on all other sectors, and particularly in prevention of corruption, this reform is extremely important in the light of the BiH accession aspirations to the EU.

Besides adjusting the BiH legislative framework, improving fiscal discipline and management in accordance with the best EU practices, the reform will directly effect the collection of public revenues by increasing the tax compliance and reducing tax evasions.

1. The assistance will be provided to the State and the two Entity Governments. Higher level of fiscal coordination is expected. Activities described under: A.1, A.2, A.4, A.5.3; are contributing to this goal.

2. A wide range of governmental ministries and institutions will be included in the reforms.

Assistance will be provided to State, Entity, and lower levels of government (Federation of BiH).

Assistance will benefit public sector institutions, such as entity Tax Administrations.

3. The assistance will address issues related to both public revenues (A.1, A.2, A.3, A.5.1, A.5.2) and public expenditures (A.1, A.2, A.3, A.4). In addition, USAID will improve fiscal coordination and reporting, as well as the business enabling environment (A.5.2, A.5.3) in terms of reducing the time and costs of operating a business in the country.

Given that assistance will be provided to both entity governments, one must take into account their different levels of fiscal maturity. Having a more complex administrative structure, the Federation of

Bosnia and Herzegovina is lagging in fiscal reform implementation relative to the Republika Srpska (ca., a

2 to 4 years lag). Therefore, different kinds of assistance will be provided to the respective entities. In order to support the idea of a single economic space in BiH more assistance will be provided to FBiH.

The assistance provided under this project will range from short-term (estimated at around 12 to 16 months), which is expected to bring visible results and quick improvements to regulations, procedures and processes, to long term assistance, which will focus on more complex activities, such as reform of the public internal control, as well as other activities that require continued technical assistance and capacity building in accordance with the best EU practices and standards (around 3 to 4 years). Lastly, the Mission’s budget constraints had to be considered when prioritizing among the viable options for

USAID assistance. Given that the budgets for individual activity components are rough estimates, further scrutiny and prioritizing is possible.

All activities to be implemented under this activity are or will be coordinated with the relevant local authorities and international donors: Council of Ministers, Ministry of Finance and Treasury at the State level, PARCO, Entity-Ministries of Finance, European Commission, IMF, etc.

Proposed activities are coordinated with the PARCO Strategy of public administration reform, a document which contains guidelines for strengthening general administrative capacities of the government, and in consultations with the relevant ministries in both entities. Operational implementation of the PARCO Strategy is regulated by its Revised Action Plan 1, with precise deadlines and institutions in charge of the building, strengthening and harmonization of general systems in six reform areas, of which Public Finances, Information Technologies, and Policy and Coordination

Capacities were selected for EDO’s assistance.

Illustrative activities

A.1. Assistance for the Fiscal Council

Beneficiary: State of BiH (Council of Ministers, Fiscal Council), FBiH, RSBiH

Focus of assistance: Macroeconomic policy, fiscal discipline

One of the most significant public finance reforms implemented so far only at the State level was the introduction of a supreme policy coordination mechanism in BiH - the Fiscal Council (FC). The importance of the FC given BiH’s complex public administration structure is crucial. The high degree of fiscal interdependence among BiH’s multiple levels of government required fiscal coordination by a state level mechanism. Also, the EU negotiation process recognizes only one principal sovereign interlocutor, in order to command better coordination among BiH’s multiple levels of government in all areas, including the fiscal sphere, for prompt implementation of the acquis. Hence, the international community insisted on establishment of the FC. The FC was established in 2005 at the state level, but became operational in 2008 only after the negative fallout from the global economic crisis that started to affect BiH’s economy.

The main task of the FC is formulation of fiscal policy objectives. FC adopts a medium-term fiscal policy framework, which includes the fiscal goals of the State, Entities and the District, macroeconomic projections, and projections of indirect taxes and overall expenditures. The necessary decision-making information for members of the Fiscal Council includes two analytical tools: a macro-fiscal framework and a consolidated government account. The Fiscal Council is in charge of BiH’s Global Fiscal Balance and Policy Framework.

Recent developments related to the FC are positive: The Ministry of Finance and Treasury of BiH prepared and proposed to the Fiscal Council the Global Framework of Fiscal Balance and Policies in BiH for 2014 – 2016. Its adoption is pending. (need to check if approved by now). The adoption of the

Global Framework for Fiscal Policies will facilitate the timely preparation of public sector budgets. The authorities also plan to implement a number of measures regarding standardized fiscal statistics and harmonization of different budget reporting methodologies, both of which will increase the transparency of fiscal policy and strengthen fiscal analytics.

The Fiscal Council has six members: the Chairman of the Council of Ministers and Prime Ministers of the

Entities, as well as the Entity and State Ministers of Finance. The Governor of the Central Bank and a representative from the Brčko District Government are observers in the Fiscal Council. Decisions of the

Fiscal Council are adopted by a majority of five votes. In the case of disagreement on the fiscal framework, the different levels of government are required to submit a proposal for interim financing based on the previous year’s budget level. In the event of the budget exceeding the previous year’s level, the government that violated the budgetary framework should transfer 10% of the overrun at the expense of special purpose funds from which the repayment of internal debt of the government is financed.3

Weaknesses/Needs: The existing model of fiscal coordination has substantial weaknesses. The technical effectiveness of the FC is seriously diminished by inclusion of the entity Prime Ministers in the FC, as it opens a door for political agendas and debates. Cantons, municipalities and extra budgetary funds are excluded from the coordination system. The sanction mechanism is weak and represents only 10 % of the excess money for internal debt. FC member responsibility and/or penalties are not regulated, despite this being a standard element in fiscal coordination in other countries. There are different statistical methods in place for fiscal reporting purposes in the entities, where capital expenditures and receipts are not taken into account. The capacity for macroeconomic modeling is very weak at all levels of government. (State, Entities)

Illustrative activities include but are not limited to:

- Analysis of the current Law on FC: Identification of strengths, weaknesses, opportunities and threats (SWOT analysis)

- Drafting amendments to the Law on FC and relevant corresponding entity legislation to address the following issues: 1. Budget impasse due to non-adoption of Global Framework on Fiscal Balance; 2. Adoption of more rigorous penalties for non-compliance; 3. Reporting based on the same inputs, e.g. inclusion of capital expenditures in the consolidated expenditures should be a shared practice by both entities.

- Strengthen the formal internal technical support structure for the FC and the two entity Ministries of Finance in the areas of macro-economic modeling. Support the analytical unit (advisory unit) under the authority of the FC, and provide technical assistance/training to the selected staff from the two entity MoFs. (Macroe-conomic models are numerical representations of economic theory, intuition and data). Provide technical assistance to strengthen the analytical and reporting capacity of the Fiscal Council to harmonize statistical methods and reporting between the entities. Provide capacity building/training for the relevant authorities (Ministries of Finance art State, and entity levels). Explore possibilities for

3 Dinka Antić: multi-level fiscal system in Bosnia and Herzegovina: evolution and coping with economic crisis establishment of the entity FCs (workgroups) and assist them to select appropriate macro-economic modeling approach..

- Work with the FC to re-shape the public revenues and expenditures by increasing efficiency of spending and by achieving reductions in labor taxes (find fine balance with benefit reductions or replace labor taxes with other revenue resources.) Improving revenue efficiency, by implementing changes in the indirect taxation system and in the customs policy. Although the EU Country reports repeatedly stress the labor rigidities associated with the high labor taxes (contributions) as one of the main obstacles for economic growth, this issue is not addressed at all by the entity governments. The FC can be an efficient mechanism for addressing this issue.

Expected Results:

Result 1: Analytical input supporting legislative improvements Result 2: Amended or eliminated ineffective regulations/procedures of the FC, which will result in more efficient work of the FC Result 3: Reporting of public finance statistics harmonized between the entities, which will result in more transparent, accountable, and consistent reporting to the EU. The accounting standard harmonized, implemented and adopted for the purpose of FC reporting.

Result 4: Analytical capacity of the FC, FMOF and RS MoF strengthened, which will result in fiscal policies, budget planning and reporting in accordance with the EU standards.

Harmonized Macro-econometric models adopted and implemented at State, and the level of the entities.

A.2 Strengthening of the FBiH Treasury System

Beneficiary: Federation of BiH (Cantons and municipalities);

Republika Srpska (Health Sector)

Focus of assistance: Public revenue/expenditure, fiscal discipline

US Government has a long history assisting BiH’s Treasury system (TS). The first intervention efforts started back in 2000 with the USG (USAID and US Treasury) dismantling the Payment Bureaus (PB). The TS system was introduced immediately after that as a replacement for the socialist legacy PBs.

Created by the US Treasury and supported by USAID, the establishment of the treasury business operations was conducted in phases. In the Federation (FBiH), the treasury system was implemented at the Cantonal level, while Republika Srpska (RS) expanded the process of introducing local treasuries to include municipalities and cities. An identical Oracle platform was used in both entities. Since then the treasury system was introduced at several levels of government administration and budget planning.

This was a productive intermediate step. However, TS still does not cover all levels of public administration. The situation is particularly ineffective in the FBiH, where the vast majority of municipalities operate outside the TS system. Since TS is a service encompassing all public administration and important in formulating entity budgets, it is paramount that it integrate all levels of public administration and budget planning without exceptions.

Weaknesses/needs: Entering of transactions for budget users that are currently outside the system is done by filling in paper forms. This is a slow, non-transparent process of reporting, open to mistakes and delays, particularly when preparing consolidated statements.