Public Health Spending in Ukraine

Although several health indicators have been improving over the last five years (e.g., infant mortality, maternal mortality), others have remained stagnant or have deteriorated (e.g., mortality of males aged 25-39, incidence of tuberculosis and HIV). Moreover, Ukraine continues to face challenges with regard to broader health system outputs and outcomes such as improving efficiency in service provision, reversing the decline in life expectancy, reducing the incidence of catastrophic health expenditures, and reducing inequities in access to effective health care coverage. On balance, most of the indicators for Ukraine under-perform those for the new EU member countries (referred to in this report as the EU-10).

3.1 Public spending in Ukraine is high and has been increasing. The consumption orientation of the budget is crowding-out public and private investment. The allocation efficiency of public spending is also questionable, both in terms of its consumption orientation and because it is financing a variety of inefficient subsides and untargeted programs. Public expenditures in Ukraine grew steadily since 2001, reaching 44 percent of GDP in 2005 (4.6 percent of GDP higher than in 2004) (see Table 3.1). This is a record level for Ukraine and one of the highest in the region. This trend has been driven by hikes in recurrent spending. Pension payments grew from 9.2 percent of GDP in 2003 to 15.3 percent of GDP by 2005, while in parallel the pension system balance went from a small surplus in 2003 to a 3 percent deficit in 2005. Although not an outlier for the region, Ukraine’s public wage bill registered a record high for Ukraine in 2005 at 8 percent of GDP (from 7.4 percent of GDP in 2004). The public wage bill has been pushed by minimum wage hikes, and is likely to make up 8.4 of GDP in 2006 owing to further planned step-wise increases this year. On the other hand, capital expenditures, as listed in the budget, have remained low and decreased significantly in 2005 (from 6 percent of GDP in 2004 to 4.3 percent of GDP in 2005). However, just above half of those expenditures are comprised of the category called “capital transfers to enterprises.” Under this category, close to 65 percent are subsidies to SOEs, or transfers to spending units of the government (i.e., Ministry of Agriculture, Ministry of Energy) that in turn run subsidy programs with these resources.

3.28 Table 3.2 presents general government expenditures in Ukraine by functional classification for the period 2002-05. This section starts with an overview of trends and issues concerning the major categories of social expenditures (social protection and assistance,⁸⁷ health, education and social privileges), and then discusses the trends and issues with respect to public spending on economic activities (agriculture and energy). The section concludes with a brief analysis of the size and patterns of public expenditures aimed at the improvement of the business climate. Table 3.3 shows the recent expenditure trends for the broad functional classifications in the general budget.

3.29 From a functional perspective, the increases in public expenditures between 2003 and 2005 have been dominated by the social sectors. Throughout the period in question, social expenditures (that is, expenditures on health, education, culture, social privileges, social protection and social assistance) represent the bulk of total expenditures, and have been increasing steadily. The highest increase was registered in 2005, which took spending in social sectors to a record high for the country, and to the highest levels in the region.

3.30 Social assistance transfers comprise a small and relatively stable share of total social protection expenditures; however, moderate savings could be found by better targeting. Social assistance transfers are represented mainly by scholarships, family transfers (child benefits), poverty targeted transfers, and unemployment benefits. In 2001, changes in legislation introduced some income-testing criteria for eligibility into these programs. These programs have a relatively low coverage of the population, and two programs—poverty-targeted transfers and family benefits—show a significant focus on low-income populations. Further savings could be achieved by limiting social assistance to social pensioners and families with many children to those whose actual income is below the poverty line on the basis of proxy means testing (PMT) criteria.

3.31 Expenditure privileges are the rights of certain individuals to receive services and goods at discounted prices. The rate of the discount ranges from 50 to 100 percent. For example, those with disabilities as the result of war are eligible for free utilities (including gas, electricity, and hot and cold water), regardless of the size of their homes or the number of people living there. Chernobyl victims, on the other hand, are eligible for a 50 percent discount. Telephone bills are discounted by 50 percent for several categories of retirees (for example, those retired from the military services, the fire-fighting services, the police, and other groups). The parents of deceased service personnel are eligible for a 50 percent discount for intercity travel by train, air, ship or bus (but not for intra-city travel), whereas several other categories of people are eligible for a discount of 100 percent for intra-city travel by streetcars, buses, trolley buses, metro systems, ferries, and commuter trains -- or if they live in rural areas, by intra-oblast buses.

3.32 It is estimated that actual public expenditures for privileges are equivalent to approximately 1.6 percent of Ukraine’s GDP. But the total cost of these privileges, if they were fulfilled according to the law, is difficult to estimate. The consolidated 2006 budget provides nearly UAH 7.8 billion (US$ 1.55 billion equivalent). However, these are only the estimated costs explicitly financed through the budget. When entitled privileged persons execute a privilege (such as to get on a bus and not pay), any associated cost not explicitly covered by the budget becomes an implicit tax on the service provider. As the methods used to finance privileges are imperfect, with errors of overpayment and underpayment, the total cost of the privilege system in Ukraine is not actually known.

3.33 There are 13 types of privileges for three categories of the population The largest expenditure item is “Housing and Utility Services,” costing close to UAH 3.5 billion or 44.3 percent of the total budget for privileges, followed by “Free and Discounted Purchase of Food Products” (UAH 1.4 billion or 18.5 percent of the budget) and “Sanatorium Treatment” (UAH 1.25 billion or 15.9 percent of the budget). These three largest items absorb 78.7 percent of the total privilege budgets. In 2006, additional privileges for individuals born around the Second World War were approved (i.e., privileges for the “children of the war”). The funding of these privileges could raise the spending on this category in 2007.

3.34 Approximately one-quarter of the Ukrainian population enjoys some kind of privilege. Annex 3.1 summarizes the categories of privileged populations in Ukraine. The 58 different categories of privileged populations outlined in the Annex may be grouped into three major types: (i) those with special merits (e.g., accomplishment/recognition gained in conjunction with major historical and political events; approximately 760,000); (ii) those with certain social characteristics (approximately 10,500,000); and (iii) those with certain occupations (approximately 900,000).

3.35 In 2005, the Ministry of Labor and Social Policy (MoLSP) established a unified registry of privileged individuals. This was a major step forward and reflected the government’s serious intent to reform the system of privileges. However, this unified registry is still incomplete because it covers only the second category of privileged populations (social characteristics based). The special merit based and occupation based categories are not entered in the unified registry. Their numbers can only be roughly estimated by cross-checking the registry of different service providers, not all of whom keep complete and audited records of the use of privileges.

3.36 Privileges are de facto administered by service providers. Privileges in the Ukrainian context are not direct cash subsidies to individuals and households. To exercise a privilege, an individual must first be certified by a government entity defined by a legal instrument that provides for a specific type of privilege. For example, a retired military serviceperson with disabilities must obtain a special certificate of eligibility for certain privileges. A teacher living and teaching in a rural area must obtain a certificate of her/his status from the local education department.

3.37 Once the certificate is obtained, the eligible individual must register with the service providers. For example, the widow of a deceased victim of the Chernobyl accident is eligible for a 50 percent discount in rent, hot/cold water, natural gas, electricity, garbage collection, wastewater disposal and telephone service. She will have to register with each of the service providers separately – there is no one-stop shop. Service providers, upon her registration, start billing her at a discounted price.

3.38 Service providers, not the population with the privileges, receive the public funds. In terms of the flow of funds, explicitly financed privileges take the form of advance payments to the service providers from the government. These service providers receive payments from either the central government or local governments, depending on the type of privilege. The amount is determined largely on the basis of the historical figures, namely, the actual amount of exercised privileges during the previous year.

3.39 As a result, the service providers may be either under-compensated or over-compensated by public funds. In the case of under-compensation, the service provider may attempt to recover the loss by raising tariffs and/or reducing the quality of services. Since many of the tariffs are fixed by regulation, such as those for utility providers, a reduced quality of services is often the default financing mechanism, typically through reducing maintenance costs and/or not making needed physical investments. In either case, the non-privileged users of the services and taxpayers are paying for the services received by privileged individuals. In the case of over-compensation, public funds end up as de facto subsidies to the service providers.

3.40 Mechanisms to see if service providers are under-compensated or over-compensated are either nonexistent, or do not function well. In cases where service providers are overcompensated, it is natural that their tracking may be weak or nonexistent. Furthermore, auditing systems are generally weak in Ukraine, and therefore it is difficult to ascertain whether the service providers are correctly declaring the cost of honouring privileges.

3.41 The privilege system’s built-in cost control mechanisms are weak. Service providers have practically no incentives to control the cost of privileges because they have guarantees for loss-recovery (either through public funds or increased tariffs) and they often do not receive strict audits. From the point of view of privileged persons, incentives to ration the use of privileges are practically non-existent, particularly when the discount rate is 100 percent.

3.42 The legal foundation for privileges is complex and makes reforming the system challenging. The legal framework for privileges consists of over 60 instruments. There are 43 laws, two presidential decrees and 16 decrees of the Cabinet of Ministers that have entitled people to privileges, as well as decrees and normative acts issued by the Cabinet of Ministers and local authorities. Many of these legislative acts were established under the Soviet Union. However, after its independence in August 1991, Ukraine introduced 26 legislative acts and expanded the provision of privileges. This extremely complex legal framework grants various types of privileges to 58 different categories of persons.

3.43 According to the interpretation of the Constitutional Court of Ukraine, Article 22 of the Constitution prevents any reduction of the existing rights on the adoption of new social legislation. Unless this decision is adjusted, the reform of special merit-based privileges appears practically impossible. Means-testing, for example, apparently cannot be introduced for privileges under this category without violating the article. The Constitutional Court also made a judgment that limiting occupation-based privileges only to the “minimum subsistence” level (UAH 365 for 2003 and UAH 386.7 for 2004) -- a measure established with respect to the 2003 and 2004 state budgets -- was unconstitutional. For 2005 and 2006, the government replaced the minimum subsistence level based limitations with a salary cap, but this measure is also under threat of being declared unconstitutional. The fact that some privileges are essentially unfulfilled entitlements (e.g., invalids on a perpetual waiting list for a free car) appears not to have been considered on a constitutional basis. Privileges based on social characteristics are based on either laws or decrees of the President and/or the Cabinet of Ministers. It is constitutionally possible to eliminate these privileges, but political considerations make such reform unpopular in the absence of consultation and explanation, especially about who is actually paying the bills for the privilege recipients.

3.44 Confusion exists among privileges, employment benefits, social protection and loss/damage compensation. Existing sets of legislations and registries create confusion because they do not differentiate the purposes of providing privileges. It is possible that, owing to this confusion, debates over the system of privileges have been unnecessarily politically and emotionally charged. Moving forward, it would be better if they were based on rational examination of the following: (i) the societal merits of providing certain benefits to certain group of the population, (ii) the form of benefit provision that would be most adequate, and (iii) whether the costs justify the perceived benefits on a welfare basis, given that all privileged recipients have to be financed by other service users, service providers and/or taxpayers.

3.45 Conceptually, the Ukrainian system of privileges consists of four different types of target populations. The first group includes those who have earned a distinguished status by having made positive contributions to the society in the past. About half of the categories under “Special Merit” and some under “Social Characteristics”, namely, Heroes of Ukraine, Heroes of the Soviet Union and Heroes of the Socialist Labor, War/Military Veterans, and Labour Veterans would belong to this type. The second group includes those who have certain types of occupation that are considered to make positive contributions to the society at present. This group includes most of the categories under “Occupational Characteristics.” Privileges for this group should be considered as employment benefits and provided within the context of employment contracts. This needs careful consideration in the context of overall public employment pay reform, as judges, for example, receive several privileges but may not receive salaries consistent with their responsibilities and purview. The third group includes those who are exposed and vulnerable to negative shocks (poverty, illness, etc.) at present and require protection. These include some categories under “Special Merit” and “Social Characteristics,” including those with disabilities regardless of the cause, orphans, families with many children and certain types of pensioners/retirees. Consequently, privileges for this type of population have strong characteristics of social protection. Finally, the fourth group consists of those who sustained damage or losses in the past. Some are under “Special Merit” (those with disabilities as a result of war, Chernobyl victims Category 1) and others are under “Social Characteristics” (for example, Chernobyl victims Category II, pardoned people and their survivors, widow(ers) of military veterans, spouses of service persons missing in action and their children, and parents of deceased service persons). Privileges for this type of population should be regarded as loss/damage compensation.

3.46 Past attempts to address this problem have not been successful or sustainable. But over the years progress has been made in understanding the problem and proposing some aspects of a solution. Looking ahead there are opportunities for success through a comprehensive and stepwise process of measures, including consultation with the public as various actions are taken. Assuming that the decisions of the Constitutional Court would not be reconsidered, the following strategy might present a workable solution:

(a) The grandfathering of existing privileges could be secured. With Article 22 of the Constitution, and with political pressures, it would be difficult to eliminate or reduce the benefits provided to the existing privileged population. Consequently, any reform effort in the future could be based on the principle that the benefits to the existing population with privileges would not be subject to future reform in most cases. At the same time, there should be a clear commitment not to introduce new, un-targeted privileges outside the social assistance framework.

(b) There should be a clear separation of the purpose of providing the privileged benefits at the outset, and then the legal framework and record-keeping systems should be reorganized accordingly, to establish clear eligibility criteria. As part of this task, the Single Automated Register of Individuals Eligible for Privileges should be made comprehensive and operational. As discussed above, the current system of privileges (the legal framework and registries) does not provide a framework for debating the societal merit of providing special benefits to selected groups, or the form that these benefits should take. At minimum, work-related benefits should be provided only within the framework of employment contracts. And those benefits with strong social protection characteristics should be provided and administered within the legal and administrative framework of social protection, with clear eligibility criteria.

(c) The flow of funds should be shifted from “government to service providers” to “government to beneficiaries,” while avoiding the provision of in-kind compensations. As discussed above, the current flow of funds provides little or no incentives for expenditure rationalization. Shifting the flow of funds to the beneficiaries, possibly with a ceiling on the total combined benefit amount, is likely to result in a more efficient spending of public resources.

(d) If the shifting of the flow of funds is too difficult to accomplish in the short term, a system could be adopted in which service providers were compensated only on the basis of the service actually provided; the system would be evaluated by periodic sample-based audits. As discussed above, service providers may be over-compensated or under-compensated. For metered services (such as gas, electricity, and water), determining the amount of compensation to the service provider should be straightforward. For transport services and sanatorium use, the government could provide beneficiaries with vouchers of a certain cash value, and the service provider could be compensated on the basis of the vouchers surrendered. In any case, it would be important to audit service providers to ensure that compensation is aligned with costs.

3.51 Public health expenditures as a share of GDP are moderate by international standards. Public financing for the health sector has increased marginally since 2002 and reached 3.7 percent of GDP in 2005. Private spending (formal and informal out-of-pocket expenditure) is high; estimates suggest that it may be as high as formal expenditures. Thus, total health expenditure at least in the range of 5-6 percent of GDP, and is thus comparable to other countries of the same income level in the region. The relatively high share of out-of-pocket expenditures, however, suggests the existence of financial barriers in accessing health care, especially for lower income groups.

3.52 Inefficiencies in the provision of health are acute. Ukraine inherited an extensive hospital infrastructure and staffing system. Most of the limited resources are being spent on staff salaries and utilities (on average, between 80-90 percent). This leaves little room for needed supplies, adequate equipment, maintenance, and repairs to deteriorated infrastructure. The Ukrainian health care system is hospital centred, which consumes over 70 percent of public health spending. The number of hospital beds per 100 000 population is 716; this is 30 percent over the EU-10 average. The average length of stay (ALOS) in Ukrainian hospitals is 12.3 days (one of the highest in the region) compared with 7.5 for the EU-10 in 2003. This suggests considerable overcapacity in the hospital sector and significant efficiency gains to be made from preventive medicine and the adoption of modern ambulatory care based treatment modes. It is worth noting that the value of real estate, especially in city centres, and other freed up resources stemming from downsizing and improving health facilities could be indirectly used to finance the reform and improved delivery of health services.

3.53 Incentives in the current health financing system are not yet geared towards efficiency. The public health financing system is fragmented, combining funding on different levels of local government with vertical programs between local and national budgets and national institutions funded by the state budget. Providers are mostly paid by norm-based line-item budgets, which do not motivate cost-saving measures or improvements in service delivery.

3.54 In recent years the equalization formula in the intergovernmental fiscal system has been backsliding, with the reconsideration of input-based norms. In the 2000 budget, a first stage intergovernmental reform was introduced that integrated objective criteria for financial allocation based on local incomes and demographics. However, starting in 2004, health expenditure allocations again began to be dispensed on the basis of input, as opposed to output-based norms (for example, number of hospitals, number of hospital beds). The second phase PFR will therefore focus in more detail on this and related issues.

3.80 The following options for reform and recommendation should be considered:

(a) The public wage bill growth should be contained while the wage scale is decompressed. The public wage bill should be kept below 8 percent of GDP - the 2005 level. A decompression of civil service wages is necessary, but, to avoid an increase in wage spending and align worker incentives with program objectives, this policy should be coupled with the rationalization of positions in the civil service system (this would also allow more competitive salaries per position). To achieve these goals the government needs to revise and streamline institutional procedures and develop a new analytically underpinned remuneration system. Transparency in the pay system is important for creating positive incentives for, and improving the efficiency of, civil servants.

(b) A comprehensive and systemic reform of the systems of social assistance and social privileges is recommended. In its current design, these systems are non-transparent, costly and convoluted. They are ultimately an inefficient method of achieving the goals they appear to be pursuing. Up to 1 percent of GDP could be saved (without hurting needy recipients) through three related sets of measures: (i) phase out spa/sanatorium and telephone benefits; (ii) tighten the eligibility requirements for utilities subsidies, housing allowances, and other smaller social assistance programs and replace them with programs using proxy means testing (PMT)); (iii) target properly Chernobyl benefits, which are currently too often abused. Moreover, the introduction of new privileges outside the existing social assistance system should be avoided.

[…]

(g) Total expenditures in health and education are at somewhat reasonable levels compared internationally, however, attention should be given to make spending within the sectors more efficient. In particularly, fiscal space is needed to allow for capital investments in these sectors. The second phase of the Public Finance Review will examine these issues in detail from the sectoral perspective and within the framework of the intergovernmental fiscal and administrative relations in Ukraine.