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REPORT ON THE OBSERVANCE OF STANDARDS AND CODES (ROSC) Poland I. Fiscal Transparency Prepared by the Fiscal Affairs Department February 22, 2001 Contents Executive Summary Introduction Description of Practice Clarity of Roles and Responsibilities Public Availability of Information Open Budget Preparation, Execution, and Reporting Independent Assurances of Integrity IMF Staff Commentary

Executive Summary This report provides an assessment of fiscal transparency practices in Poland in relation to the requirements of the IMF Code of Good Practices on Fiscal Transparency—Declaration on Principles. It is based on the authorities' response to the IMF fiscal transparency questionnaire and other documents provided by the authorities. Over recent years Poland has made great strides in improving fiscal transparency, most notably by putting in place a modern budget process and more clearly defining the boundaries of the public sector. The Act on Public Finances of 1998 provided a major step forward in clarifying the responsibilities and activities of government. However, many challenges remain. The ongoing decentralization of government activities, various public sector reforms, and the prospect of accession to the European Union have made the need to resolve the remaining deficiencies more urgent. The staff has proposed a series of measures which build on the progress already achieved. The first priority should be to improve the clarity and timeliness of information on general government activities, in particular on the detailed revenues and expenditures of the extrabudgetary funds and local governments. Second, the quality of published statistics could be improved, for example in the reporting of budgetary arrears and net lending; and recourse to creative accounting procedures, intended to understate the central government deficit, should be strictly avoided. Finally, a number of further steps are suggested, including improvements in budget documents, tax administration, and dissemination of information on the use of privatization receipts and on expected debt issuance.

Acronyms
ESA	European System of Accounts
EU	European Union
GFS	Government Finance Statistics
GUS	Central Statistical Office
NBP	National Bank of Poland
NIK	National audit body
NFPE	Nonfinancial public enterprise
OECD/SIGMA	Organization for Economic Co-operation and Development/Support for Improvement in Governance and Management in Central and Eastern European Countries
SDDS	Special Data Dissemination Standard
SNA	System of National Accounts
UN	United Nations

I.  Introduction1 1.  This report provides an assessment of fiscal transparency practices in Poland. The assessment has two parts. The first part is a description of practices in relation to the requirements of the IMF Code of Good Practices on Fiscal Transparency—Declaration on Principles, prepared by the IMF staff on the basis of the authorities' response to the IMF fiscal transparency questionnaire and additional information provided by the authorities. The second part is an IMF staff commentary on fiscal transparency in Poland. II.  Description of Practice A.  Clarity of Roles and Responsibilities 2.  The boundary between general government and the rest of the economy is, for the most part, clearly specified. There is however some confusion on whether the activities of particular extrabudgetary funds and state agencies are of a fiscal character. The central government―making up around two-thirds of the general government―is defined by the authorities as comprising the state budget, 9 special purpose social security funds, 7 other extrabudgetary funds, and a number of budgetary enterprises, auxiliary units, cultural entities and public universities. Local governments comprise 16 regional voivodships, 308 county-level poviats, and 2,425 municipal gminas as well as a number of local extrabudgetary funds. Expenditure assignments and revenue authority are clearly specified in legislation.2 Transactions outside the budget and the extensive use of earmarking, mainly in the revenues for extrabudgetary funds, are tolerated; hence the universality of the budget as the principal instrument of fiscal control is not adhered to. The proliferation of extrabudgetary funds at both central and local levels serves to complicate transparency in the roles of various public institutions. In addition, the transparency of government operations worsens outside the state budget; this is of particular concern since Poland has undertaken a major decentralization of public sector activities. 3.  The government has a significant equity ownership of the private sector but is in the midst of a major privatization program. The government's equity holdings are widely reported. There is sizeable, but declining, state ownership of the financial sector including the largest retail bank and an agricultural bank, which together make up around 28 percent of banking system deposits from the nonfinancial sector, as well as the main insurance company. The government owns or part-owns around 3,000 companies―including the state oil company, the state airline, and the energy sector―which account for 25 percent of employment in nonfinancial enterprises and 30-40 percent of value added. 4.  There is clear separation of fiscal, monetary and public enterprise management. The central bank is an independent organization―the constitution provides that the National Bank of Poland (NBP) has "the exclusive right to issue currency and to formulate and implement monetary policy"―with policy formulated by a 10-person appointed board who serve six year nonrenewable terms. The government is unable to influence the policy of the central bank for fiscal purposes and the constitution (Article 220.2) says that the budget bill shall not envisage covering the budget deficit by incurring liabilities with the central bank. The government's holdings in nonfinancial public enterprises (NFPEs) are run on commercial grounds or with clear state subsidies. 5.  There is a clear legal and administrative framework for budgetary and extrabudgetary operations but, in practice, the framework is not always adhered to.3 Fiscal management is governed by a comprehensive law―the Act on Public Finances (1998)—that codifies the budget and reporting process, the types of public sector entities, financial management standards, the authority to borrow and the use of budgetary reserves, and provides sanctions for noncompliance. 6.  Taxes, duties and fees are levied under the authority of law. Tax laws are, however, complicated by a wide variety of reliefs, preferences, exemptions and privileges and are often vague or conflicting on many points. Some of these problems, including simplification of direct taxes, are being or have been addressed by new legislation. The tax authority has no explicit code of conduct for its employees but the rights and obligations of employees are specified in the Law on Public Service and the Law on Government Administration. Taxpayers rights and obligations are both clearly specified in the Tax Ordinance Act. There are clear rights of appeal or complaint both within the tax service and externally. There are, however, some weaknesses. First, taxpayer services, including the provision of information and assistance to taxpayers, could be improved. Second, due to the complexity of the tax code and the need to strengthen central guidance, basic tax administration procedures in practice differ among local offices, and local heads of tax offices have room for discretion. Third, in addition, there are no institutional arrangements to guarantee the independence of the tax service. 7.  Public employees are governed by a set of ethical standards. These standards are specified in the Law on Public Service of 1998. This law provides terms of conduct, employment, rights and obligations of civil service employees. The Civil Service Office audits compliance with this law. There is some uncertainty, in practice, about the distinction between the civil service positions that are occupied by political appointees and those occupied by career civil servants. B.  Public Availability of Information 8.  The annual budget covers all central government operations in detail while activities of the extrabudgetary funds are appended as annexes to the state budget. The gross flows through some public sector agencies are not reported in budget documents, but this accounts for a small portion of total spending. The budget also includes little information on the general government, and comprehensive budgetary information, particularly consolidated local government budgets, is not publicly available until well into the fiscal year. Information on the previous two years' outturns is presented with the budget although the recent structural changes4 make comparability problematic. 9.  The government provides information on the level and composition of gross debt at issue value both with the annual budget and on a quarterly basis. In addition, public information is provided on an ad hoc basis on the state budget's borrowing requirements during the course of the year. The budget does not contain a statement of the stock of contingent liabilities, the size of tax expenditures or on quasi-fiscal operations, although the government intends to report the stock of government guarantees as part of the budget (and, since May 2000, has published this information in quarterly reports). Chapter 2 of the Act on Public Finances requires the government to publish information on the main fiscal aggregates of central government on a biannual basis. Poland subscribes to the IMF's Special Data Dissemination Standard (SDDS). The government also publishes release date calendars for fiscal reporting, and the date calendar for SDDS is published by the Central Statistical Office (GUS); release-dates are usually adhered to. 10.  The deficit is reported and measured on a cash basis and some information is available on expenditure commitments. Central government accounts are published on a monthly basis with a six week lag, and annual reports are prepared and submitted to the legislature within five months of the end of the fiscal year. Reports on local government operations are available quarterly while information on the social security fund is available on an annual basis. Annual general government information is available in aggregate form from the ministry of finance seven months after the end of the fiscal year. Since 1999, there has been a serious problem in the provision of information from the social insurance fund due to the introduction of a new computer system and reforms to the pension system. C.  Open Budget Preparation, Execution, and Reporting 11.  The budget documents5 contain only a general statement of the central government's medium-term fiscal policy objectives and priorities and the objectives are not identified in a way that facilitates comparison with budget outcomes. The budget is set within the context of a description of economic prospects, and a medium-term forecast―for the budget year plus two years―of the fiscal deficit for the central government is available as part of the budget documentation; detailed disaggregated fiscal projections and information on the medium-term prospects for the extrabudgetary funds and general government are not available. 12.  There is, typically, little indication or analysis in budget documentation on the sustainability of fiscal policy or of potential fiscal risks. However, in the context of the government's medium-term plan―the Strategy for Public Finances and Economic Development―forecasts have been prepared for 10 years ahead for the general government and social security system. The government's budget cycle begins in March when budget calls are released but the final budget is usually not publicly available until February or March of the fiscal year (which begins on January 1). In addition, some spending authorizations do not expire at the end of the fiscal year6 and some spending is executed on the basis of the previous year's budget (although it is subject to a separate financial plan). Local authorities normally pass their budgets by end-year but in special situations the time limit can be extended to end-March of the fiscal year. These budgets are intended to be publicly available directly after they are passed, though in practice there is sometimes a lag. A report on the execution of the previous year's budget has to be submitted by the end of May. 13.  The central government is bound by two primary fiscal rules. First, the annual budget nominal deficit cannot be exceeded without parliamentary approval. This, however, has led to overly conservative revenue projections and the inclusion of spending reserves in the budget, as well as circumvention of the limit through complex accounting procedures.7 The nominal deficit rule may also lead to the build-up of arrears and nontransparent debt practices to show a lower cash deficit (e.g., by using discount instruments). Second, national public debt has a constitutional limit (Article 216.5) of 60 percent of GDP.8 In addition, local governments are required to maintain debt service-to-revenue ratios below 15 percent and debt-to-revenue ratios below 60 percent, though most local governments have little accrued debt. Local governments can borrow from local banks or branches only in domestic currency, but they can obtain foreign currency loans from international financial institutions of which Poland is a member according to the statutes of those institutions, with central government approval. 14.  As part of the budget process, existing commitments and new programs are systematically distinguished and program objectives are clearly specified in the budget documentation. Funds and agencies can unilaterally reallocate spending among budget items―although this authority has been limited in the Act on Public Finances―and some do so without informing the ministry of finance of their actions. It is not clear that the budget provides for the full cost of all programs (evidenced by past arrears and the systematic use of budgetary reserves) and complete information on costing assumptions is not included in budget documentation. 15.  The main indicator of fiscal policy currently used by the government is the consolidated general government `economic deficit'.9 The annual report on the budget includes a clear statement that reconciles central government budget execution with budget estimates and the sources of their deviation identifying exogenous shocks, policy changes, and forecast errors. Budget transactions are recorded on a cash basis with some information provided on expenditure arrears although no statement of accounting standards is presented with the budget. There is little attempt to provide information on budget outcomes and outputs of various programs, which makes it difficult to assess whether budget activities have met objectives except purely in the sense of financial compliance. 16.  Central government budget data are generally reliable, comprehensive, and broadly compatible with Government Finance Statistics (GFS) standards. However, there appear to be some material inconsistencies, such as problems in reconciling budget financing with the monetary data, and net lending being treated as financing of the deficit.10 Privatization revenues are dealt with inconsistently with only part of the total being shown in the fiscal statistics and with a portion―4 percent of gross revenues―being retained by the privatization agency and only the net flow being recorded in budgetary statistics. In addition, some shares of companies to be privatized are set aside for "restitution"―compensation for the expropriation of assets by the old regime―and other uses. It is unclear, ex ante, how funds will be used should privatization revenues exceed budget targets although, ex post, net flows to the budget are reported. There are numerous examples of net lending activities, mostly to off-budget funds, being used to reduce the deficit as measured by the government.11 There is also an inconsistent treatment of arrears between fiscal years12 and an unclear treatment in budget statistics of EU grants and cofinancing. 17.  The accounting system for the central government is reasonably comprehensive and generates adequate cash information on a timely basis despite the government not having a centralized treasury system. However, it is not clear that information of a comparable quality on expenditure commitments is also being generated. There are significant problems with the accounting system outside the state budget, particularly with respect to the social insurance fund, which is currently unable to generate timely information on its operations and revenue collection. 18.  There are clear rules for public procurement. Poland has developed, in cooperation with the OECD/SIGMA, a law on procurement modeled on UN best practices. The rules apply to the public sector as a whole.13 D.  Independent Assurances of Integrity 19.  Poland has a separation between accounting and audit functions within the government and a national audit body (NIK) that is constitutionally independent of the executive (Article 202). The NIK audits the accounts of the central government and extrabudgetary funds and reports its findings to the legislature on an annual basis. The head of the NIK is appointed by the legislature and serves a six year term that may be renewed once. The findings of external audits are examined by parliamentary committee and, if necessary, irregularities are addressed by internal procedures or referred to the prosecutor general. The audit body's primary mandate is to examine financial compliance with budget legislation, and staff are viewed as having good technical capacity. Weaker external audit controls by the NIK are in place at lower levels of government but are supplemented by controls from the regional clearing chambers which have broad powers to audit at the local level (although, unlike the NIK, these agencies are not independent of the executive). 20.  Macroeconomic forecasts are made available to the public without publication of the underlying models used by the ministry of finance. In addition, the ministry of finance produces internal assessments of the performance of macroeconomic forecasts but has no mechanism for the quality review of such forecasts. The Central Statistics Office is statutorily independent (under the Law on Official Statistics, 1995) and the fiscal statistics comply with the standards for integrity and quality set out in the SDDS. III.  IMF Staff Commentary 21.  Over the past few years Poland has made great strides in improving fiscal transparency, putting in place a modern budget process, and defining the boundary of the public sector. The Act on Public Finances provided a major step forward in clarifying the responsibilities and activities of government. 22.  While Poland has made significant progress in improving fiscal transparency, many challenges remain. The ongoing decentralization of government activities, various public sector reforms and the prospect of accession to the European Union have made the need for removing the remaining deficiencies more urgent. 23.  Perhaps the greatest problem in Poland is in obtaining information, both ex ante and ex post, on the activities of the general government on a timely basis. While reporting on the central government is good, the central government represents a declining proportion of the public sector. As a consequence, an improvement in the clarity and availability of information on general government activities is needed. In particular: the government should significantly rationalize the use of extrabudgetary funds and should integrate them into the state budget so that they are subject to the same scrutiny and prioritization of expenditures as other state budget entities. In addition, autonomous agencies and units should begin reporting in detail their gross activities to the ministry of finance (rather than merely their budget subsidy). For those funds that are retained, their budget allocations should be subject to the same discipline and rules over the use of and reporting on appropriated monies as are required for the state budget. In addition, there should be a significant curtailment of the extrabudgetary activities of the local governments. In areas where there is currently confusion,14 the government should clarify the limits of the public sector, the allocations of responsibilities between various levels of local government, and adjust their budget classifications accordingly; the government should urgently take steps, perhaps through the establishment of a specific task force, to address the information systems and reporting standards of extrabudgetary funds―particularly the social insurance fund--and the local governments. The government believes that the current difficulties with reporting on the social insurance fund is a temporary problem associated with the recent pension reforms, but actions are needed to ensure that is remedied quickly. More generally, quarterly data on the general government should be publicly available with no more than a one-quarter delay after the end of the reporting period; and third, general government statistics should adhere closely to international reporting norms such as GFS, System of National Accounts (SNA), or European System of Accounts (ESA)15 and consideration should be given to publishing disaggregated general government statistics; this will enhance the democratic process behind decentralization by giving local electorates information on the performance of their localities. 24.  The quality of published statistics could be improved. There is recourse to creative accounting practices―including reclassifying of expenditure transactions as financing and use of extrabudgetary operations to execute central government spending―in order to understate the central government deficit. The government should desist from such activities and strictly adhere to international reporting norms. Material deviations from such norms should be clearly specified in both the budget and reports on the fiscal outturn with clear explanatory annotations. In this regard, it is a welcome step that the government has recently begun judging the fiscal policy stance using the newly adopted concept of the general government "economic deficit." While it is understandable there is a separate budget for EU grants and cofinancing, these resources should be explicitly highlighted, perhaps as a memorandum item, in either central or local budget outturns, both as revenue and with a detailed description of their spending counterpart. There appears to be an inconsistent treatment of budgetary arrears as well as poor reporting of such arrears. So long as the government continues to report the budget on a cash basis, the clearance of arrears should be treated as an expenditure item. However, the government may wish to consider preparing fiscal statistics, at least for the central government, on a commitment basis; and indeed will be required to do so before EU accession. The gross operations of government funds and agencies should be fully reported in both budget documents and outturns including the gross flows of privatization receipts and nontax revenues. Where net lending operations from the budget are absolutely necessary, these transactions should be conducted at market interest rates; failure to do so amounts to a hidden subsidy to the loan recipient. In addition, given the international interest in Poland, the government may wish to consider publishing all of its fiscal information in English on its website, including the state budget law and accompanying documentation, as well as information on the fiscal outturn of central and general government. This would help increase the flow of information internationally and would be of limited cost and inconvenience to the ministry of finance. 25.  In order to comply more fully with the code on fiscal transparency, a number of further steps to reform the budget process would be needed. The budget outturn would need to contain a full reporting of general government expenditure arrears and articulate a strategy for dealing with such arrears. It would be preferable if the annual state budget could be finalized and published before the beginning of the fiscal year. The budget document would need to contain a clear statement of the fiscal risks the government perceives will apply during the year and, insofar as is possible, attempt to quantify those risks for the legislature and the public. The publication of local budgets ought to be accelerated. Although the process of transition entails many structural changes to the fiscal data, the government ought to ensure the projections and historic data, currently included in the budget documentation, are intertemporally comparable. Such data should include both a full specification of the macroeconomic environment and a clear presentation of revenue and expenditure components. The government could also consider publishing the working methods and assumptions used in producing its macroeconomic forecasts, highlighting the key assumptions that are implicit in the budget forecasts including the cost assumptions of budget programs. The government should begin reporting contingent liabilities, tax expenditures, and quasi-fiscal activities with the budget documents. The government could also provide an analysis of fiscal sustainability and information on its holdings in private sector enterprises as part of the budget. To facilitate ex post evaluation, the government should consider providing a more detailed statement of fiscal objectives in the budget law. In the annual budget outturn the government should begin reporting statistics on budget program outputs and outcomes to permit the parliament and public to judge how well the government has achieved its stated objectives. Consideration should also be given to reformulating the fiscal rule that limits the nominal deficit of the central government. The present formulation creates incentives for nonstandard accounting practices, covers a much reduced share of the government sector following devolution in recent years, and has rightly been overtaken as the overarching deficit target of the authorities by the concept of the economic deficit. While no single alternative is clearly the best, a replacement for the state budget ceiling needs to be considered in this broader context. It should also strike a balance between imposing sufficient constraint to enhance the credibility of fiscal policy, while giving some scope for counter-cyclical fiscal policy to operate. Transparency concerning how the target will be measured, using standard statistical and accounting measures, and the circumstances in which counter-cyclical policy will operate, will be crucial. 26.  Finally a number of other improvements are also recommended that would be relatively simple for the government to make yet could significantly enhance fiscal transparency. For example: there is some confusion over the size of the central government borrowing requirement and timing of debt issuance. The ministry of finance should improve the dissemination of their forecast of issuance of public securities to better guide market expectations. These forecasts should not be regarded as a binding commitment on debt issuance but the government should enter into a regular dialogue with financial markets to highlight the uncertainties in their forecast and, after the fact, explain the factors that led to deviations from these forecasts (e.g., early arrival of privatization receipts, market conditions, etc.); the use of privatization receipts could be more clearly specified. While nominally the budget earmarks privatization monies to particular uses, it appears these transfers will be paid irrespective of whether privatization receipts arrive or not. As mentioned before, the entire gross proceeds of privatization should go through the budget. Also, the government should specify what will be done with excess proceeds were privatization resources to come in above budget forecast. Finally, it may help to reduce volatility in the foreign exchange markets if the government were to state unambiguously in advance its strategy for dealing with privatization resources coming from nonresidents; the ministry of finance should ensure tax administration procedures are uniform across tax offices, give greater independence to the tax service, and increase the focus on the provision of taxpayer services.16 In addition, the government should continue its efforts to simplify the tax legislation, particularly for direct taxes in order to make the tax system more transparent. To this end, a new law is being prepared to restrict the use of tax preferences to exceptional circumstances; and legislation should make it clear that public procurement procedures apply to the entire public sector and the government should ensure the legislated procedures are strictly adhered to. 1Discussions on fiscal transparency were held in Warsaw during May 9-16, 2000, led by Mr. Nigel Chalk (Economist, FAD), with follow-up discussions in Warsaw during November 29-December 13, 2000, led by Mr. Michael Kell (Economist, FAD). The report was prepared by Mr. Chalk, with input from the staff of FAD, EU1, PDR, and the authorities. 2However there does seem to be some confusion within various levels of local government concerning the implementation of assigned tasks in the health sector. 3For example, funds used to pay for health sector salaries in 1998 were reported in the budget as loans when they amounted to nonrepayable transfers. 4For example, the recent pension reform and establishment of a defined contribution pillar to the public pension system or the devolution of expenditure responsibilities to lower levels of government. 5The budget documentation consists of both the budget law and also an accompanying budget substantiation document. 6In particular, spending financed by foreign credits, by foreign grants, or spending as specified by the Council of Ministers. 7For example, transfers of Zl 4 billion made to meet shortfalls in the state pension fund in 1999 were treated as financing, and thus did not effect the reported budget deficit on a cash basis. 8The debt limit is accompanied by a gradual increase in borrowing restrictions when the debt ratio rises above 50 percent of GDP. The limit applies to public sector debt including warranties and guarantees of the government. 9This represents the general government overall balance on a cash basis adjusted for transfers to the second pillar of the social security system, the sale of mobile phone licenses, and the payments to compensate workers for the loss of wages suffered due to past high inflation. 10GFS (1986) classifies net lending (lending minus repayments) as a component of the deficit. The proposed revision of GFS will show all transactions in financial assets as financing, but, where transactions are conducted in nonmarket terms, these should be identified and the cost implications indicated. 11For example, in 1999 the government needed to pay higher-than-budgeted amounts for miners' severance pay but, rather than seeking an explicit budget authorization, the spending was conducted by the Labor Fund lending the required amount to the Industrial Restructuring Agency who then made the severance payments. 12For example, compensation payments to pensioners and civil servants for previous nonpayment of wages and benefits (i.e., clearance of past expenditure arrears) are treated as financing despite the budget being presented on a cash basis. 13According to the Law on Public Procurement, the rules on procurement apply to all activities partially or wholly financed by public resources. 14For example, the distinction between the private and public activities of the health insurance funds and the division between the private and public parts of the social insurance fund. 15An amendment to the Act on Public Finances is pending which will adjust fiscal statistics to conform with ESA 95. 16To this end, it is a welcome development that the ministry of finance's tax administration modernization strategy includes significant emphasis on taxpayer services. Poland ROSC