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Chapter

6 Reforming Ukraine’s Social Safety Net

Editor(s):
Patrick Lenain, and Peter Cornelius
Published Date:
February 1997
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Author(s)
Sanjeev Gupta, Elliott Harris and Alexandros Mourmouras* 

Ukraine has experienced severe economic dislocations since its independence in 1991, following the breakup of the former USSR. High inflation and large declines in real wages and output have imposed severe economic and social hardships on the population, particularly on the vulnerable groups (Table 1). Beginning in October 1994, the authorities intensified their economic reform efforts, resulting in a slowdown of the decline in real GDP and a reduction in monthly rates of inflation. In 1995, the consolidated budget deficit fell to 5.0 percent of GDP, from 8.2 percent of GDP in 1994. The authorities’ economic reform program for 1996 aims at a further reduction of the fiscal deficit, to 3.5 percent of GDP, and includes, inter alia, measures to accelerate the privatization of enterprises and to increase the cost recovery ratios for housing and communal services.

Table 1.Economic and Social Indicators
1993199419951996

Projection
Real GDP (percentage change)–17–24–13–2
Average monthly inflation (December to December)47.114.49.02.5
Employment and wages
(In percent of population)
Average employment rate46.044.542.742.7
(In percent of labor force)
Average registered unemployment rate0.30.30.30.5
(In millions, at year-end)
Pensioners14.914.014.014.0
Pensioners/contributors0.620.610.640.64
(In thousands of Krb/month)
Average nominal wage155.11,375.17,347.813,377
Average real wage100.076.191.096.0
Minimum wage13.660601,500
Minimum income123.9214.31,368.0
Average pension66.0498.02,374.04,122.8
Minimum pension25.43891,9303,544
Average unemployment benefit21.6253.71,098.24,488.0
(In percent)
Major cash benefits
Average pension/average wage43363231
Average unemployment benefit/average wage13.919.815.333.6
Average child allowance/average wage9.26.46.15.0
Average housing compensation/average wage16.220.0
Sources: Data provided by the Ukrainian authorities; and IMF staff estimates.

Consists of minimum salary (itself a multiple of the minimum wage) plus the bread supplement.

Sources: Data provided by the Ukrainian authorities; and IMF staff estimates.

Consists of minimum salary (itself a multiple of the minimum wage) plus the bread supplement.

Ukraine inherited a well-developed system of social protection, comprising pensions, allowances for families with children, unemployment and disability benefits, subsidies for housing and communal services, and compensation to victims of the Chernobyl accident. It spent 17.4 percent of GDP on these programs in 1995; in 1996, these outlays are projected to rise to 18.0 percent of GDP (Table 2). Most social programs are financed through the taxation of wages. But tax rates amounting to 52 percent—a very high level by international standards—have raised the cost of labor.1

Table 2.Costs of Social Protection Programs
19951996 Projected
1994Preliminary estimatePayroll taxesBudgetOtherTotalPayrollBudgetOther
(In trillions of karbovanets)
Social protection expenditure186.1894.2589.1300.94.21,333.31,015.6295.722.0
Pensions192.0426–0424.11.9776.6729.430.516.7
Child, maternity, and sickness allowances13.569.354.411.23.6104.390.014.3
Unemployment-related benefits6.516.415.80.631.326.05.3
Cherrsobyl-related benefits24.094.794.7170.1170.1
Housing Subsidy Program2.92.986.986.9
Consumer subsidies50.1284.9284.9164.0164.0
Memorandum items
General government balance2–93.0–259.2n.a.n.a.n.a.–261.4n.a.n.a.n.a.
Revenue of state and local budgets504.02,049.7n.a.n.a.n.a3,332.0n.a.n.a.n.a.
Expenditure of state and local budgets608.72,308.2n.a.n.a.n.a.3,593.4n.a.n.a.n.a.
Extrabudgetary funds balance11.7–0.7n.a.n.a.n.a.n.a.n.a.n.a.n.a.
Wage bill312.01,763.5n.a.n.a.n.a.3,184.9n.a.n.a.n.a.
(As percent of GDP)
Social protection expenditure16.417.411.55.90.118.013.74.60.3
Pensions18.18.38.310.59.80.40.2
Child, maternity, and sickness allowances1.21.31.10.11.41.2
Unemptoyment-related benefits0.60.30.30.40.40.1
Chernobyl-related benefits2.11.81.82.32.3
Housing Subsidy Program0.10.11.21.2
Consumer subsidies4.45.55.52.22.2
Memorandum items
General government balance2–82–5.0n.a.n.a.n.a.–3.5n.a.n.a.n.a.
Revenue of state and local budgets44.339.9n.a.n.a.n.a.44.9n.a.n.a.n.a.
Expenditure of state and local budgets53.544.9n.a.n.a.n.a.484n.a.n.a.n.a
Extrabudgetary funds balance1.0n.a.n.a.n.a.n.a.n.a.n.a.
Wage bill27.434.3n.a.n.a.n.a.42.9n.a.n.a.n.a.
Data provided by the Ukrainian authorities; and IMF staff estimates.n.a. = not applicable.

Includes transfers from Chernobyl Fund for payment of pensions to persons affected by the disaster.

Includes the balance of extrabudgetary funds, other than the Pension Fund and the Chernobyl Fund, and the Employment Fund from 1996 (1.0 percent of GDP in 1994, and less than 0.1 percent of GDP in 1995).

Data provided by the Ukrainian authorities; and IMF staff estimates.n.a. = not applicable.

Includes transfers from Chernobyl Fund for payment of pensions to persons affected by the disaster.

Includes the balance of extrabudgetary funds, other than the Pension Fund and the Chernobyl Fund, and the Employment Fund from 1996 (1.0 percent of GDP in 1994, and less than 0.1 percent of GDP in 1995).

The problem with the Ukrainian social protection system is that its structure is quite diffuse. Benefits are currently extended to almost half of the population, while the burden of wage taxation is borne by some 20 million active workers. There is a plethora of overlapping benefits, combined with privileges for certain population groups for the use of publie services, which greatly complicates the assessment of benefit incidence. At this stage of transition in Ukraine, it is important to focus assistance on the population groups most at risk. A rationalization and improved targeting of the existing social protection system would help achieve this objective and support the ongoing economic reforms, since a system that pays benefits to the bulk of the population would undermine the reform process by exacerbating macroeconomic imbalances.

Targeting benefits to the truly needy is a challenge for the authorities because of the growth of the informal sector. A recent household income and expenditure survey indicates that reported incomes account for only half of reported expenditures. This suggests that the use of official incomes for determining benefit eligibility may lead to mistargeting. The growth of informal and private sector activity also has ramifications for the design and financing of social benefits: it has further narrowed the base for wage taxation, since much of the informal and private sector activity escapes the tax net.

Against this background, this paper presents a series of short- and medium-term options for enhancing the cost-effectiveness and social adequacy of Ukraine’s social protection system, in terms of both reducing the cost of delivering a given benefit and increasing the benefits that can be provided at a given cost. These reforms would enhance the effectiveness of Ukraine’s social protection system while delivering budgetary savings of about 3.5 percent of GDP.

Housing Subsidy Program

Ukrainian households paid very little for housing and communal services until the fall of 1994. The untargeted subsidies used to finance these services distorted domestic prices, prevented the emergence of a private housing market, and exerted a pressure on both the budget and the external balance. In 1993–94, mounting budget deficits and external payments arrears to energy suppliers (Russia and Turkmenistan) prompted the government to begin shifting the burden of financing housing services and utilities to households. Tariffs have been allowed to rise gradually, with the ultimate goal of achieving full cost recovery.

The reduction in generalized subsidies, while indispensable for supporting broad fiscal and macroeconomic stabilization objectives, creates an immediate need for a safety net for the most vulnerable, notably households with low incomes. In order to address concerns for these households, Ukraine introduced a housing subsidy program in May 1995. This program has sought to limit households’ expenditures on housing and communal services to no more than 15 percent of recorded family income.2 In determining eligibility, total reported income of all family members over 16 years of age in the preceding three months is taken into account. Households are eligible for compensation for expenditures on a specified list of communal services based on certain norms. The utilities initially included in the program were apartment maintenance, water, hot water, heat, and sewage. The scheme has gradually been extended to include liquid gas and coal (July 1995), and electricity (October 1995).

Since direct measurement of consumption of communal services (mostly energy-related) by households in Ukraine is not technically feasible at present owing to the lack of meters, individual assessments have to be made on the basis of norms. These norms relate the size of a household to the allowable expenses for granting targeted subsidies. Subsidy calculations are now based on a norm of 21 square meters per person, plus 10.5 square meters of common space—generous compared with the actual average amount of per capita space of 16 square meters in Ukraine. Since the budget cannot afford to make payments on the high norm of 21 square meters, subsidies are based on actual expenses up to the norm and receipts must be furnished in order to make payments.3

While the scheme is open to all Ukrainian households, the income criterion is expected to limit the coverage rate to about 25 percent of the households (Table 3). So far, actual coverage has been substantially less than expected. By end-February 1996, 13.9 percent of Ukraine’s 17 million households were receiving subsidies. This represents 83.8 percent of all households who had submitted applications. The 1995 budget allocated Krb 17 trillion to the Housing Subsidy Program, which was later revised to Krb 70 trillion. In the event, the actual cost of the program was very small (Krb 2.9 trillion or 0.1 percent of GDP). The 1996 budget envisages a reduction in outlays for housing and communal services to 3.4 percent of GDP from 5.5 percent of GDP in 1995, with outlays on the Housing Subsidy Program increasing to 1.2 percent of GDP Accordingly, the net budgetary savings from the targeting of generalized subsidies for housing and communal services are expected to be 1.0 percent of GDP in 1996. Available data suggest that so far the program has been effective in targeting the poor.4

Table 3.Coverage Rates and Housing Subsidy Program Expenditures
19951996 Jan.–Feb. Preliminary1996 Projection
Coverage rate (in percent)1813.720
(In thousands of households)
Monthly flow176488171.6
Average monthly stock6052,0582,626
End-of-period stock1,4072,3833,467
Expenditure
In trillions of karbovanets2.93.886.9
In percent of GDP0.10.41.2
Memorandum items
Number of households (in thousands)17,40617,40617,406
Threshold income rate (in percent)151515
Average monthly subsidy
In thousands of karbovanets5999312,680
In percent of average wage8.27.720.0
Sources: Ministries of Economy, Finance, and Social Protection of Ukraine: USAID/PADCO Inc., Kiev; and IMF staff estimates

Fraction of Ukrainian households covered by the Housing Subsidy Program by year-end.

Sources: Ministries of Economy, Finance, and Social Protection of Ukraine: USAID/PADCO Inc., Kiev; and IMF staff estimates

Fraction of Ukrainian households covered by the Housing Subsidy Program by year-end.

Despite the program’s success in targeting the poor, several problems will make difficult the achievement of its objectives:

  • The income threshold has remained at 15 percent even as the list of services covered by the Housing Subsidy Program was expanded in 1995.
  • The sanitary (health) norm benefits households living in housing units larger than the actual average. Most families in Ukraine live in homes smaller than the sanitary norm and subsidies increase with the amount of space occupied by a household up to the norm.
  • Several categories of persons and their families receive substantial discounts, ranging from 25 percent to 100 percent from ordinary tariffs for housing, communal services and fuel.5 The working group of the Council of Ministers in charge of limiting existing preferences estimated that 10.8 million (including 3.6 million war participants and invalids), or about 63 percent of all Ukrainian households, are not paying the full energy tariffs.6 Additional subsidies are being provided to some categories of persons and their families through a lower threshold for the Housing Subsidy Program of 8 or 10 percent in three oblasts, decided by the oblast itself on the basis of its financial position.
  • The Housing Subsidy Program’s low coverage rate in 1995 and the associated low budgetary costs are attributed in part to cumbersome administrative procedures. The monthly flow of applications and the task of recalculating subsidies for existing beneficiaries every six months are already straining the present administrative capacity. The system of eligibility determination still requires that calculations be redone for every housing unit when tariffs are adjusted. Since there are no computers, manual operations have delayed the processing of applications. Complicating matters, many households do not receive the revised utility bills immediately after a tariff increase, delaying their application for the benefit.
  • The current tariffs for housing services include only maintenance expenses, not rent. Since charges paid by consumers do not cover depreciation, the housing stock is deteriorating.
  • Unemployed persons not registered with the Employment Service are not covered by the Housing Subsidy Program. The only exceptions made are for mothers taking care of young children or persons taking care of the disabled. While a large proportion of those who have “vanished” from official employment rolls have found gainful employment elsewhere in the system, they are not covered by the Housing Subsidy Program.7
  • • Restrictions on labor mobility, such as Propiska, may be limiting access to the Housing Subsidy Program.8 The institution of Propiska could be hindering the Housing Subsidy Program from targeting the truly needy, because benefit eligibility is based on the officially listed place of residence. With housing in shortage and increased labor mobility, an increasing number of individuals living with relatives and friends are being deemed ineligible for Housing Subsidy Program benefits.
  • While the data suggest that the program is reaching single pensioners and other vulnerable groups, means testing is not without its problems in the presence of misreported incomes.
  • Official family income for the previous three months is used in the calculation of initial subsidies. Since tariffs for housing and communal services and wages and pensions have been typically adjusted at the same time, this practice tends to bias household incomes downward, leading to a larger number of households becoming eligible for subsidies.

Short-Term Reform Options

There are a number of short-term reform options, including the following:

  • Consider raising the threshold income rate by a modest amount. This would reflect the increasing number of services covered under the Housing Subsidy Program and the expanding share of unreported incomes.
  • Gradually eliminate all pricing preferences. It is estimated that in 1996, the elimination of all preferences would provide budgetary savings of about 0.7 percent of GDP.
  • Replace the sanitary norm with a social norm. This would encourage efficient allocation of available housing by creating incentives for smaller households to downsize. Such a system would also be simpler to administer, as families would not need to supply the housing subsidy offices with evidence of their payments. The social norm could be set at a level close to the average amount of space available in Ukraine. Subsidies would be calculated on the basis of the normative space for each family size; poorer families living in relatively smaller, overcrowded apartments would receive an income transfer.
  • Eliminate subsidy recertification for certain types of households, such as nonworking pensioners, disabled persons, and families with single parents and no other income earners. This would help ease the administrative load while ensuring that the vulnerable groups continue to receive benefits after the initial income test. The benefit amounts for these groups could be recalculated automatically as tariff or pension payments change.
  • Reduce lags in information on household incomes as much as possible. Subsidy calculations should reflect, to the extent possible, current incomes. Optimally, if the current three-month information lag for family income is maintained, wages should be increased three months prior to the scheduled tariff increases, to avoid distorting eligibility calculations.

Medium-Term Reform Options

Medium-term reform options include the following:

  • Include all economic costs in the calculation of tariffs and cost recovery rates. The user cost of housing services should be used to calculate the true costs to the households. A first step could be to gradually include housing depreciation in maintenance fees.
  • Replace the Propiska system with a national identity card. With increased labor and family mobility, replacing the Propiska system with an identity card would facilitate the authorities’ verification of citizens’ status and residence, for the purpose of establishing Housing Subsidy Program eligibility.
  • Given its temporary, short-term nature, the authorities should consider phasing out the Housing Subsidy Program over the medium term. After the Propiska system is eliminated and means testing is improved, the authorities should consider consolidating child allowances, social pensions, and the means-tested supplemental pension benefits with the Housing Subsidy Program, with the objective of establishing a broad-based poverty benefit.

Pensions

In January 1995, 14 million people, more than a quarter of the entire population, received benefits from the Pension Fund. While the number of pensioners declined by some 900,000 between 1993 and 1995, the number of contributors declined even more, raising the ratio of pensioners to contributors marginally, from 0.62 to 0.64 (see Table 1). About 12 percent (1.7 million) of retirees continue to work.

Ad hoc adjustments of pensions in the face of high inflation and difficult budgetary conditions have led to a significant compression of pension benefits, both in relation to the average wage and across contributors with different earnings histories (Figures 1 and 2). Thus, the replacement rate—the average pension as a share of the average wage—declined from 43 percent in 1993 to 32 percent in 1995. Over time, wage histories have played a declining role in setting pensions, as more and more pensioners have bumped up against the maximum pension; and the importance of the compensation payments in the total pension has increased (see Figure 3 and Appendix Tables Al and A2).

Table A1.Number and Amount of Pensions by Size1
Number of Minimum Pensions PaidAs of December 31,1994As of September 30,1995
Number of pensionersShare of totalAverage size (in thousands of karbovanets)Total amount (in billions of karbovanets)Number of pensionersShare of totalAverage size (in thousands of karbovanets)Total amount (in billions of karbovanets)
Total14,016,823100.078410,89813,995,994100.01,18116,523
<1420,2573.017473413,4303.0433179
1515,5203.7288148491,2553.5575283
1–22,751,59219.64481,2332,673,50119.17682,053
2–35,809,48241.47804,5305,862,51041.9–1636.817
3–43,557,80125.49973,5463,688,90126.41,4455,330
4–5633,9724.51,245789500,4563.61,642822
5–10285,3052.01,824520305,6812.22,351719
10–1537,8510.33.21512240,2230.33,852155
15–203,5944,685177,6370.15,75144
>201,4496,533912,4000.19,871122
>4962,1716.91,5151,458866,3976.22,1491,861
Source: Ministry of Social Protection of Ukraine.

The pension amounts exclude compensations.

Source: Ministry of Social Protection of Ukraine.

The pension amounts exclude compensations.

Table A2.Size of Pensions with Additional Payments(In thousands of karbovanets)
Starting DaleAdjustment Factor
1993199419951996199419951996
Dec. 1Oct. 1Dec. 1Jan.1Feb.1Jun. 1Oct. 1Jan. 1Oct. 1Dec. 1Jan. 1Feb.1Jun. 1Oct. 1Jan. 1
Average monthly pension3716249891,1572,0472,4873,0653,8392.221.201.171.771.211.231.25
Basic pension3276547859189189181,1522,2162.001.201.171.001.001.251.92
Additional payments44170204239239239290
Compensation payments8901,3301,6231,623
Minimum monthly pension2417809401,1001,4662,1002,5993,3003.241.211.171.331.431.241.27
Basic pension120240288337337337411790
Additional payments44170204239239239290
Compensation payments8901,3301,6231,623
Special purpose payment77370448525195275887
Maximum monthly pension4048901,0681,2502,1402,5803,1463,9932.201.201.171.711.211.221.27
Basic pension3607208641,0111,0111,0111,2332,370
Additional payments44170204239239239290
Compensation payments8901,3301,6231,623
Maximum size of pension (four minimum pensions)5241,1301,3561,5872,4772,9173,5574,7832.161.201.171.561.181.221.34
Social pension1816607969321,1001,2671,5842,0923.651.211.171.181.151.251.32
Basic pension60120144169169169206395
Additional payments44170204239239239290
Compensation payments445665812812
Special purpose payment77370448525195275887
Source: Ministry of Social Protection of Ukraine.
Source: Ministry of Social Protection of Ukraine.

Figure 1.Real Wages and Pensions

(In terms of December 1995 prices)

Figure 2.Average Replacement Rates

(As percent of average wage)

Figure 3.Pension Components

(As percent of average wage)

The growing compression between minimum and maximum pensions was achieved by retaining a ratio of 3 to 1 between the maximum and minimum basic pensions, and by instituting a variety of compensation payments to adjust pensions for inflation and protect the most vulnerable citizens. In December 1993, the maximum pension was some 66 percent higher than the minimum pension, and the average replacement rate was 43 percent. By end-1995, the maximum pension was 21 percent higher than the minimum pension, and the average replacement rate was 25 percent. The 92 percent increase in the minimum pension announced in January 1996—and the accompanying restructuring of inflation and low-income compensation—maintained the relationship between the maximum and minimum pensions, but increased the average replacement rate to slightly over 30 percent.

The policy of ad hoc pension adjustment combined with the pension compression has allowed the Pension Fund to continue to pay pensions on time without creating a severe imbalance in its finances. In 1995, the Pension Fund spent Krb 381 trillion (8.4 percent of GDP) on pension benefits; Krb 20.9 trillion (0.5 percent of GDP) on child allowances; and Krb 30.2 trillion on administration, bank and postal operations, and other expenses (Table 4). It received Krb 415.4 trillion (9.1 percent of GDP) in insurance contributions, Krb 13.1 trillion (0.3 percent of GDP) from state and local budgets, and Krb 8.7 trillion (0.2 percent of GDP) from the Chernobyl Fund. It ran a small surplus of Krb 6.0 trillion, or 0.13 percent of GDP. The Pension Fund’s budget is projected to be in balance in 1996 with revenues and expenditures distributed in roughly the same fashion as in 1995.

Table 4.Pension Fund(In trillions of karbovanets)
19951996
1994PreliminaryProjected
Revenues99.9437.2790.9
Insurance contributions93.4415.4729.4
Transfers from budget13.113.144.8
Transfers from Chernobyl Fund2.58.716.0
Other revenues0.40.7
Expenditures89.2431.1790.9
Pensions70.5313.3412.2
Child maintenance2.320.925.3
Children under 1.5 years of age1.09.711.0
Children between 1.5 and 3 years of age1.311.214.3
Inflation compensation11.364.4260.1
Assistance to low-income pensioners1.02.826.2
Administration0.64.14.8
Bank & post operations3.024.825.4
Lump-sum aid to low-income pensioners0.70.5
Other0.336.9
Balance10.66.0
as percent of GDP0.90.1
Memorandum items
Covered employment (in millions of persons)23.022.022.0
Number of pensioners14.014.014.0
Ratio of workers to pensioners1.671.571.57
Average wage (in thousands of Krb)1,375.17,347.813,270.4
Average pension (in thousands of Krb)498.02,374.04,109.1
Average pension as a share of the average wage36.232.331.0
Wage fund349.51,629.02,413.1
Sources: Pension Fund and Ministry of Finance of Ukraine; and IMF staff estimates.

Includes Krb 31.7 trillion in 1996 for paying benefits at the beginning of the year in anticipation of revenue collection.

Sources: Pension Fund and Ministry of Finance of Ukraine; and IMF staff estimates.

Includes Krb 31.7 trillion in 1996 for paying benefits at the beginning of the year in anticipation of revenue collection.

In the recent past, the performance of the Pension Fund has been affected by the following factors:

  • Certain aspects of the eligibility and benefit structure. The retirement age—60 for men and 55 for women—is low by international standards, and about 12 percent of pensioner recipients worked in occupations in which they became eligible for retirement at an even earlier age. Furthermore, about 12 percent of pensioners at any time are working but still receiving full pensions, in addition to a full wage and employer-provided benefits, and their pensions are recalculated every two years on the basis of their most recent wages. Finally, pension benefits are also accrued for years of service in such endeavors as higher education or caring for a young child, even though no pension contributions are made.
  • Provisions in current pension legislation of higher pensions for several categories of pensioners, especially in mining and metallurgy, but also including disabled workers and military veterans. This raises the lifetime compensation of these workers in relation to other pensioners.
  • The revenue uncertainty arising from a declining share of wages subject to payroll contributions. Despite the authorities’ efforts to keep benefits at a manageable level, the pension system faces a major problem in maintaining an adequate revenue stream in the near term, with rising open and “hidden” unemployment. Moreover, the share of wages subject to payroll contributions has declined markedly, as employers increasingly shift compensation into categories of remuneration not subject to the pension contributions—these include income in-kind; per diem expenses for business trips; relocation costs; the provision of free flats, communal services, fuel; and wages used to purchase shares in the enterprise. Were it not for the rapid growth of the share of wages in GDP, which partially offset the decline in the share of wages subject to pension contributions, the revenue situation of the Pension Fund would be far more precarious. Finally, the Pension Fund has increasingly suffered from contribution arrears, which rose to Krb 79 trillion (L7 percent of GDP) at end-December 1995, up from Krb 7.3 trillion a year earlier. This problem has been especially acute in mining and agriculture, but even budget organizations have accumulated significant arrears (7 percent of the total).

Short-Term Reform Options

Benefit Policies

The following measures would make the pension system more equitable, besides improving its cost-effectiveness:

  • Reduce pensions for working pensioners. Since the replacement rate is low, it is unlikely that pensioners who earn reasonable salaries would forgo that earned income if their pensions were reduced. Pensioners who must work simply to make ends meet, however, should not face the same reduction in benefits. Only those pensioners earning employment income beyond a threshold should face a reduction in their pensions.
  • Abolish the higher pensions for several categories of able-bodied civilian pensioners under the current pension law (mostly in mining and metallurgy) and establish a uniform maximum pension for these workers. This would reduce or eliminate the transfer implicit in providing these workers with higher lifetime compensation.
  • Raise the official retirement age. The pension age could be raised by five years in annual increments of six months, and eventually a uniform retirement age for men and women could be established. This increase would bring the Ukrainian system more in line with those in other economies. The fact that so many pensioners continue to work indicates that they are both able and willing to continue in the labor market.

Revenue Policies

The authorities have recently taken measures to protect the revenue base of the pension system by harmonizing the contribution rates;9 broadening the wage base;10 and ensuring that accrued contributions are effectively paid. Additional measures to improve compliance and widen the tax base should be adopted to strengthen the Pension Fund’s revenue base.

  • Widen the tax base. The authorities have already taken steps to ensure that appropriate pension contributions are made by enterprises that use a bank for paying wages. Similar safeguards should be applied to establishments that are able to trade in cash, and for which a bank authorization is not required to pay wages. The Pension Fund should also more effectively capture pension contributions on income in kind.
  • Eliminate the nontaxed threshold for material assistance. Under current law, the first Krb 20.4 million per worker per year of material assistance is not subject to pension contributions.

Medium-Term Reform Issues

The policy alternatives described above could substantially ease the financial pressure on the Pension Fund in the near term. If these policies are adopted, and when the macroeconomic situation in Ukraine improves, attention must be paid to the structure of the pension system in the medium and long term. Several issues should be considered in this evolution.

Benefit Issues

Pensions should be based on years of contribution, rather than years of service. This provision has little effect now, when most pensioners are at or near the benefit ceiling, but will inappropriately distribute benefits if and when the compression of pension benefits eases.

The elimination of privileged early pensions should be considered. Although the financial responsibility for these early pensions has shifted to enterprises, their mandated existence reduces labor market flexibility and, to the extent these workers actually retire early, reduces pension contributions. Furthermore, the enterprises do not now completely reimburse the Pension Fund for the full cost of early pensions and cannot be relied upon in the future to do so.

The initial pension is currently set on the basis of the wage experience in either the past 2 years or any 60–month period. This procedure ignores the bulk of a worker’s contributions to the system. As data on individual contribution histories are accumulated, the initial pension should be based on the worker’s entire contribution history, with early years suitably adjusted based on a price or wage index.

As real wages rise, allowing for more generous benefits, the role of compensations should be reduced, the spread among pensions increased, and the position of pensioners within that spread based on their contribution histories. In the long term, fully funded components might be added to the basic pension system; however, the medium-term transition costs would be substantial.

Revenue Issues

If the policies described above were implemented, and as fiscal pressure eases, a reduction in the payroll tax—currently among the highest in the world—should be considered. This would have to be carefully balanced against the need to increase benefits to restore the link between benefits and contributions and to ensure that vulnerable pensioners are protected, but a reduction in the payroll tax could be an important component of a program of structural reforms that would enhance economic growth.

There is also a need to reflect on the appropriate scope of the Pension Fund’s responsibilities. Under the current system, the Pension Fund shares the responsibility for determining benefits and for collecting and distributing benefits with the Ministries of Social Protection and Communications. It also acts as an agent for the state and local governments and the Chernobyl Fund in paying military pensions, child allowances, social pensions, and Chernobyl-related benefits. Consideration should be given to assigning to the Pension Fund the ultimate responsibility for the collection of pension contributions and the distributions of the benefits. Responsibility for the other programs could be reassigned to the Ministry of Social Protection (child allowances and social pensions) and to the Ministry of Defense (military pensions). This would avoid the duplication of effort and make it more difficult to redirect pension resources to other uses, as happens now when the Pension Fund is incompletely reimbursed for benefits that it distributes for other agencies.

Child, Sickness, Maternity, and Other Allowances

Child Allowances

An important element of the social protection system in Ukraine is the financial support provided to families with children. In addition to the lump-sum childbirth grants, maternity leave benefits, and parental leave provisions, a series of other benefits are targeted at children: there are 12 different child allowances and child care support payments, as well as allowances for specific categories of children, including the handicapped (see Appendix Table A3).

Table A3.System of Child Allowances, 1996
AllowanceNumber of Allowances(In thousands)Amount of Allowance(In thousands of karbovanets)Annual Amount(In billions of karbovanets)Paid at the Expense of:Type of PaymentMeans Tested
Childbirth: and maternity
Lump-sum childbirth allowance520.03,23020,155Social Insurance Fund1At place of employment; or at residenceNo
Additional lump-sum childbirth allowance2500.01,6209,720Social Insurance FundAt place of employment; or at residenceNo
Maternity leave1,500Social Insurance FundAt place of employment; or at residenceNo
Child allowances
Children up to age 3 of working parents1,332.81,50023,990Local budget3At place of employment or studyNo
Children up to age 3 of nonworking parents133.6470754Local budgetAt residenceNo
Children from age 3–16 (age 18 for students)3,439.560024,764Local budgetAt place of employment or study; or residenceYes
Invalid children419.21,330306Local budgetAt place of employment or study; or residenceNo
Temporary assistance to children for child support519.8470112Local budgetAt place of employment or study; or residenceNo
Child care allowancesLocal budgetAt residence
Single mothers—special category62.695030Local budgetA1 residenceNo
Single mothers—others399.04702,250Local budgetA1 place of employment or studyNo
Working families with three children156.08101,516Local budgetAt residenceYes
Nonworking families with three children12.0950137Local budgetAt place of employment or studyYes
Working families with four or more children45.01,620875Local budgetAl residenceYes
Nonworking families with four or more children6.01,890136Local budgetAt residenceYes
Persons providing foster care8.81,890200Local budgetAt residenceNo
Children of military personnel1.181011Local budgetAt residenceNo
Custodial parent who does not receive child support74.424013Local budgetAt residenceNo
Total6,60084,969
Source: Ministries of Labor, Social Protection, and Finance of Ukraine.

If employed and paying the payroll tax at the time of pregnancy; otherwise, paid for by the local budget.

Paid to women with natal complications whose maternity leave extends beyond 12 weeks.

The allowance for children up to 1.5 years of age is paid out of the resources of the Pension Fund and is deducted from the pension contribution payments of the enterprise where the mother works.

Payable to eligible individuals providing full-time care for invalid children.

Support to children whose parents do not pay the required alimony.

Including mothers who grew up as orphans, without parental care, or as wards of the state.

Allowance to parent who receives no or only part of court-awarded alimony.

Source: Ministries of Labor, Social Protection, and Finance of Ukraine.

If employed and paying the payroll tax at the time of pregnancy; otherwise, paid for by the local budget.

Paid to women with natal complications whose maternity leave extends beyond 12 weeks.

The allowance for children up to 1.5 years of age is paid out of the resources of the Pension Fund and is deducted from the pension contribution payments of the enterprise where the mother works.

Payable to eligible individuals providing full-time care for invalid children.

Support to children whose parents do not pay the required alimony.

Including mothers who grew up as orphans, without parental care, or as wards of the state.

Allowance to parent who receives no or only part of court-awarded alimony.

There is no limit on the number of allowances for which one family can be eligible. However, the tightness of the means test, together with the low level of the allowances, have narrowed the coverage of the child allowance to only an estimated 27 percent of children, and somewhat less than a third of the 668,000 families with three or more children. The means test is thus quite effective in limiting eligibility, but may have the perverse effect of excluding a large number of truly needy families.

Benefits are paid only to working parents and to nonworking parents registered as unemployed. The system thus excludes those who are not employed in the formal sector or not registered as unemployed, and may penalize parents who stay at home to raise a family. This effect is undesirable in the present context of declining employment opportunities and the contraction in the availability of child care facilities, and there is a growing likelihood that these people will fall through the safety net.

Child allowances have typically been adjusted according to the availability of general budgetary resources, and the budgetary constraints have led to their erosion relative to wages and other social benefits (see Figure 4). At the same time, cumbersome administrative procedures may lower the take-up rate. Moreover, the child allowances are paid from resources of the local budgets, which are not always able to ensure the timely reimbursement of payments made on their behalf by the enterprises and the Pension Fund, leading to arrears. In 1995, Krb 28 trillion (0.6 percent of GDP) was spent on child allowances. For 1996, total expenditures under the child allowance program are projected at 0.7 percent of GDP.

Figure 4.Comparison of Average Wages, Pensions and Allowances for Children Aged 3–16

(In thousands of Krb, at December 1993 prices)

Sickness, Maternity, and Other Allowances

Ukrainian workers in the formal sector are eligible for a series of short-term cash benefits for maternity and for temporary disability owing to sickness, which are paid through enterprises, but administered and financed by the Social Insurance Fund. The Social Insurance Fund provides wage replacement during parental leave for the care of a sick child under 14 years of age, a lump-sum childbirth grant, and funeral assistance; it also provides medical rehabilitation services at sanitariums throughout the country, as well as recreation and vacation facilities for children and families.

Since the Social Insurance Fund pays the replacement wage in case of sickness, there are incentives for employers and workers to misuse sick leave to avoid the use of administrative or unpaid leave. Moreover, the provision of medical rehabilitation/recreation services is inefficient—vouchers are often provided to workers at an average cost recovery rate of about 10–12 percent. The system increasingly provides highly specialized medical rehabilitation mandated by the supervising physician but paid entirely by the Social Insurance Fund, without any cost participation from the Ministry of Health.

The Social Insurance Fund registered a very small surplus in 1995, and its finances are projected to be in balance in 1996 (Table 5). While the Social Insurance Fund has paid all the cash benefits on time, financial balance has been achieved through the marked decline in the provision of medical rehabilitation and recreational services. Typically, allowances provided by the Social Insurance Fund have been adjusted according to the availability of budgetary resources—the available resources have had to be shared among the numerous allowances, preventing a substantial increase in any one allowance. Close to 90 percent of the Social Insurance Fund’s total expenditure is for temporary disability allowances and for the medical rehabilitation and recreational services (45–50 percent and just under 40 percent, respectively).

Table 5.Social Insurance Fund(In billions of karbovanets)
19951996
PreliminaryProjection
Revenues58,07890,032
Mandatory contributions of insurance premiums54,43390,032
Other revenues3,645
Expenditures55,35590,032
Temporary disability allowance25,51544,889
Maternity allowance5,1307,475
Lump-sum childbirth grant896920
Funeral assistance286390
Medical service at sanitariums and rehabilitation centers21,35734,517
Other expenses2,1711,840
Balance (as a percent of GDP)0.06
Sources: Social Insurance Fund of Ukraine; and IMF staff estimates.
Sources: Social Insurance Fund of Ukraine; and IMF staff estimates.

Finally, eligibility for these benefits is too closely linked to employment in the formal sector, with enterprises playing a pivotal role in their delivery, a holdover from the previous economic system. This system may no longer be appropriate in an environment characterized by declining employment in state enterprises and increasing private sector and self-employment activity.

Short-Term Reform Options

Child Allowances

The main objectives of the reform of the child allowances system must be to strengthen the adequacy of the allowances, and to ensure that the system does not exclude the truly needy. In this regard, there are two choices: reallocate resources within the given budget envelope to direct additional funds to child allowances; or raise the level of some of the child allowances by combining overlapping benefits and by rationalizing the benefit structure.

The reform options presented below are guided by the second consideration:

  • Eliminate allowances for older children. Limiting the benefit to children under the age of 12 would result in a 40 percent decline in the number of eligible children and generate savings that could be used to increase the allowance paid to the children under the age of 12 by as much as 58 percent.
  • Combine the child allowances and the child care support payments. This option, too, would facilitate an increase of some 40 percent in the child allowance and would enhance administrative simplicity. To this end, a centralization of the administration of child allowances under the Ministry of Social Protection would help.
  • Consolidate the four different allowances for families with three or more children into one flat allowance at the lowest level presently in effect. The resulting savings could be used to increase the benefit for over 70 percent of present recipients by as much as 25 percent.

Further, to address the possibility that the tight eligibility requirements and the limitations of coverage to those employed in the formal sector and formally registered as unemployed might prevent truly needy families from receiving protection under the system, it would be worthwhile to eliminate the eligibility distinction between working and nonworking parents, thus removing the current disincentive to parents who decide to stay at home to raise a family; and extend benefits to children of unregistered unemployed.

Sickness, Maternity, and Other Allowances

The short-term revenue position of the Social Insurance Fund could be significantly enhanced by the adoption of the revenue reform policies proposed for the Pension Fund. Furthermore, certain aspects of the benefits structure could be reformed to reduce the incentives to abuse the present provisions and to improve efficiency.

With regard to the temporary disability benefits, it would be worthwhile to:

  • Shift the cost of the first two weeks of sick leave to enterprises (up to an annual limit of four weeks per worker), after which the Social Insurance Fund would assume responsibility for the payment. This would reduce the employer’s incentive to save on the wage bill by shifting the cost of the worker to the Social Insurance Fund, and would encourage the employer to monitor more closely workers’ sick leave.
  • Introduce a flat wage-replacement rate of 80 percent. The sick leave benefit could replace wages at a uniform 80 percent for all employees, instead of the present system of differentiated rates ranging from 60–100 percent. This would reduce the employee’s incentive to take unjustified sick leave.
  • Extend maternity and childbirth benefits to unemployed, unregistered women. Consistent with the policy options for the child allowances, to prevent these women from slipping through the social safety net, the implementation of a flat-rate maternity and childbirth benefit not linked to a formal wage should be considered. This would be provided by the Ministry of Social Protection to all unemployed women, regardless of their registration status.

The savings generated by the benefit and revenue options could be used either to increase the share of the wage tax allocated to financing pensions, or to reduce the wage tax by up to 1.5 percentage points.

The system of medical rehabilitation and recreation should also be reformed along the following lines. There should be a proper determination of the economic cost of providing vouchers. This should be based on appropriately estimated occupancy rates and differentiated to reflect seasonal and regional demand patterns, as well as a gradual increase in the price paid by workers for the vouchers. In addition, the practice of extending the vouchers free to unaccompanied children should be eliminated, as it obscures the economic cost of the program.

Considerations for the Medium Term

Over the medium term, protection should be extended to all vulnerable families with children, which is difficult to achieve under the present system. One possibility would be to integrate child allowances with the Housing Subsidy Program with the objective of establishing a broad-based poverty benefit, as noted earlier.

Further, the pivotal role of the enterprises and the trade unions in the provision of social benefits is no longer appropriate. The social protection system must be gradually weaned from its dependency on the enterprise structure and trade unions, and the responsibility for social benefits should be centralized in the Ministry of Social Protection.

Unemployment Benefits

The role of the state Employment Service in Ukraine’s labor market is limited. As indicated above, Ukraine’s GDP has declined about 40 percent since 1992, yet officially measured unemployment has never risen above 0.5 percent. Nevertheless, Ukraine devotes considerable resources—0.5 percent of the wage bill, or about 0.2 percent of GDP in 1995—to the Employment Service. Wages paid to employees of the Employment Service and the Employment Fund have exceeded benefits paid to the unemployed in every year. In 1995, the 685 employment offices registered a total of 176,000 unemployed—about one person per working day per office. The Employment Fund had a small surplus (0.1 percent of GDP) in 1995 and is projected to be in balance in 1996 with revenues and expenditures projected at Krb 31.3 trillion (Table 6).

Table 6.Employment Fund
19951996
PreliminaryProjection
(In trillions of karbovanets)
Revenue16.431.3
Insurance contributions15.826.0
Other10.65.3
Expenditures9.531.3
Programs2.520.4
Unemployment benefits1.013.7
Vocational training and retraining1.16.1
“Job creation”0.40.6
Operational6.48.9
Wage payments to Employment Fund and Employment Service employees3.24.5
Premises and facilities3.24.4
Other0.62.0
Balance6.9
As percent of GDP0.1
(As percent of total expenditure)
Expenditure100.0100.0
Program spending26.365.2
Unemployment benefits10.543.8
Vocational training and retraining11.619.5
Job creation4.21.9
Operational expenses67.428.4
Other6.36.4
Memorandum items
Unemployment benefit (in millions of karbovanets per month)2
End-December2,2546,637
Monthly average1,0984,488
Replacement rate (in percent)2
End-December18.446.0
Monthly average15.334.9
Registered unemployment
End-December126,000262,174
Monthly average94,883199,761
Claiming unemployment benefits
End-December74,353215,010
Monthly average55,729163,825
Effective tax rate (in percent)0.90.8
Wage bill (in trillions of karbovanets)1,7643,185
Covered employment (in millions of persons)2222
Sources: Employment Fund of Ukraine; and IMF staff estimates.

For 1996, “other” revenue has been adjusted to bring the account into balance for the year.

Excludes severance pay.

Sources: Employment Fund of Ukraine; and IMF staff estimates.

For 1996, “other” revenue has been adjusted to bring the account into balance for the year.

Excludes severance pay.

Enterprises in Ukraine, perhaps dissuaded by the prospect of paying three months’ severance pay, are not explicitly firing workers; instead, workers are put on unpaid leave, sick leave, or involuntary part-time work, thereby creating hidden unemployment. In 1995, by official estimates, enterprises and organizations gave long-term unpaid leave at some time during the year to 18 percent of workers, and about 900,000 people worked an incomplete day. Official calculations show that hidden unemployment at end-1995 was equivalent to 2.4 percent of the labor force. The apprehension has been that hidden unemployment would suddenly convert to open unemployment. However, the experience shows that the Employment Service has always overprojected unemployment, an approach that has led to overbudgeting, a surplus, and the inefficient use of that surplus.

Furthermore, unemployment benefits are low in relation to the average wage. Workers who lose their jobs are presently entitled to 3 months’ severance pay, paid by employers.11 Following 3 months’ severance pay and a 10–day application period, the registered unemployed are eligible for 3 months’ unemployment benefits at a rate equal to 75 percent of their last wage, and 50 percent of their last wage thereafter. Unemployment benefits are normally limited to 12 months: 6 months in the first year of registered unemployment, another 3 months in the second year, and a final 3 months in the third year.12 Enterprises pressure workers to quit instead of firing them, so that the enterprises do not have to make severance payments. Because unemployment benefits for job quitters are less generous than for workers who are fired (50 percent rather than 75 percent of the last wage), workers who are pressured to quit lose both severance pay and part of the unemployment benefits to which they would have been entitied if they had been fired. Unemployment benefits are not indexed, so they erode rapidly in a period of high inflation. As a result of these factors, the ratio of the average unemployment benefit to the average wage at end-1995 was only 18.4 percent. Furthermore, unemployed workers who are sent for training receive a training stipend that may be less than the unemployment benefit would have been.

Credit programs currently being run by the Employment Fund constitute an inappropriate use of mandatory payroll contributions. A declining share of the Employment Fund’s resources are devoted to the “creation of new jobs and work places” through low-interest loans to enterprises and zero-interest loans to the unemployed for business start-ups. In 1994, these programs absorbed 24 percent of total spending, with most of the funds used for subsidized credit to state enterprises.13 In 1996, only 2 percent of total spending by the Employment Fund is budgeted for this purpose.

The fraction of employment spending devoted to loans for business start-ups for unemployed workers is rather small (0.6 percent of planned spending), but in 1996 this program is to be extended. At present, startup loans for small businesses are interest-free, inviting misallocation and corruption.

The Employment Fund is permitted by statute to support public works programs, and for 1996 about 10 percent of total Employment Fund spending is budgeted for this purpose. Unemployed workers who accept public works assignments are eligible for unemployment benefits as well as a wage, and the two combined can exceed the wage of a normally employed worker. This creates an incentive not to leave public works employment. The present structure creates perverse incentives, whereby public works programs compete with other sources of labor demand.

Short–Term Reform Options

The following short-term reform options are recommended:

  • Adopt the revenue proposals discussed for the Pension Fund to discourage erosion of the tax base.
  • Shift the burden of severance payments from enterprises to the Employment Fund. A proposal has been approved by the cabinet of ministers that would make enterprises responsible for severance pay equivalent to only one month’s wages. The next two months, payable at the average regional wage, would become the obligation of the Employment Fund. Following the expiration of severance pay, the registered unemployed would be eligible for three months of unemployment benefits at 75 percent of the last wage and seven months at 50 percent of the last wage.
  • Increase the replacement ratio. The ratio of average unemployment benefit to average wage should be increased. The 1996 budget assumes an increase in this ratio to 46 percent by end-1996. This would likely require significant changes in the benefit formula.
  • Develop a contingency plan for unemployment benefits. With two months’ severance pay the obligation of the Employment Fund instead of that of the enterprises, it becomes especially important to have a contingency plan in case the number of beneficiaries is greater than expected. One possibility would be for the cabinet of ministers to approve a decree that would automatically increase the employment tax rate by 0.25 percentage points if the number of beneficiaries increases beyond 130,000 before end-1996. This would avoid the problems of overbudgeting yet at the same time it would provide for an almost immediate increase in revenues if they are needed. In any case, the employment tax rate should be reconsidered at end-1996 as part of the 1997 budget exercise.
  • Reform “job creation” credit programs. Low-interest loans to enterprises for job creation should not be resumed. In principle, some directed credit to the unemployed for business start-ups is acceptable. However, directed credit to the unemployed for new business start-ups should be kept modest, and the interest rate should be higher than the rate of inflation and reflect the credit risk. The credit should flow through commercial banks—if possible, private ones—that bear the risk.
  • Strengthen public works programs. Public works programs may have a temporary, short-term effect on unemployment, and they may be a reasonable “last resort” for the long-term structurally unemployed and for women, who are likely to experience great difficulty in finding placement. The wage paid for public works should be harmonized with the unemployment benefit so that people in public works jobs are better off than if they did not work at all, but not as well off as they would be in normal jobs. This gives them an incentive to leave public works employment as soon as they can.

Chernobyl-Related Benefits

The Chernobyl Fund has an important role in Ukraine’s social protection system, helping to absorb the human and environmental costs of the Chernobyl accident of April 1986. The Chernobyl Fund provides benefits to the victims of the accident, including resettlement outside the contamination zone, specialized medical treatment and rehabilitation, and supplements to the wages of workers in the zone (see Tables 7 and A4). In 1995, the Chernobyl Fund ran a very small surplus, equivalent to 0.15 percent of GDP; it is projected to be in balance in 1996.

The financing of the Chernobyl Fund imposes a substantial additional tax burden on wage incomes in the formal sector, but several groups and sectors are exempt from this tax. Since few contributors benefit from these expenditures, this raises equity concerns, in addition to intensifying the disincentive to wage employment inherent in any wage tax.

A substantial share of overall expenditures is devoted to capital investment—housing, urban infrastructure, schools, and hospitals. However, while capital expenditures have generally exceeded the budgeted amounts, the actual implementation of projects has often fallen well short of the stated objectives, particularly in the social sphere. This situation raises questions as to the efficiency and scope of the investment program. Also, many projects, especially in areas not directly affected by the catastrophe, would typically be financed by the budget—it is not clear whether the Chernobyl Fund should be involved at all in these areas.

There is anecdotal evidence that the criteria for benefit eligibility may be unevenly applied, and that not all those actually affected by the accident have been registered. There may also be some laxity in the application of certification standards, as evidenced by the fact that the number of registered victims in most categories continues to rise. These problems may reflect difficulties with the regular and timely provision to the Ministries of Health, Social Protection, and Finance of comprehensive data on the number of registered victims or on the support actually provided.

It is also not clear that the Chernobyl Fund’s administrative structure is suited to manage appropriately the considerable resources at the Chernobyl Fund’s disposal or to deliver the services effectively, although there is no indication of excessive administrative overhead. There is evidence that some benefits are not delivered in an effective and timely manner to all eligible victims.14

Table 7.Chernobyl Fund
19951996
PreliminaryProjection
(In billions of karbovanets)
Revenues103,434170,125
Contributions103,434170,125
Expenditures194,907170,125
Capital220,96731,730
Voluntary resettlement from contaminated zone3,7518,000
Jobs in contaminated zone6,64413,269
Administration of the cleanup program6,1999,524
Social protection of the affected population57,346107,602
Of which:
Compensations and benefits34,922
Reimbursement of expenses to other agencies and levels of government334,535
Transfers to administration of contaminated zone411
Social protection13,685
Transfers to Social Insurance Fund, for short-term disability payments15
Administration of contaminated zone (rehabilitation)74
Children’s rehabilitation6,915
Adults’ rehabilitation5,707
Social protection fund for the disabled695
Pension supplements8,740
Balance8.527
as percent of GDP0.15
(As percent of total expenditure)
Capital investment22.118.7
Administration of the cleanup program4.05.6
Social protection60.463.2
Of which:
Compensation and benefits36.8
Pension supplements15.2
Source: Ministry of Chernobyl of Ukraine.

Cash expenditures throughout current year, including outlays committed in previous years and executed in current year.

Includes construction of housing facilities, medical facilities, and purchase of diagnostic equipment on behalf of the Ministry of Health for the treatment of Chernobyl victims.

Reimbursement and compensations through financial bodies.

Reflecting the “second wage.”

Source: Ministry of Chernobyl of Ukraine.

Cash expenditures throughout current year, including outlays committed in previous years and executed in current year.

Includes construction of housing facilities, medical facilities, and purchase of diagnostic equipment on behalf of the Ministry of Health for the treatment of Chernobyl victims.

Reimbursement and compensations through financial bodies.

Reflecting the “second wage.”

Short-Term Reform Options

Short-term reforms should aim at rationalizing the financing of the Chernobyl Fund, and enhance the efficiency of its investment program and benefit delivery. On the revenue side, the base of the wage tax should be made consistent with that of the other social funds by removing the exemptions specific to the Chernobyl Fund. This would eliminate the relative distortions in the cost of wage labor between the exempt and the nonexempt groups and sectors, and it would also widen the revenue base and could facilitate a reduction in the wage tax earmarked for the Chernobyl Fund. The following options should be considered:

  • Review the priorities and scope of the investment program. This should be done in close coordination with the activities of other ministries. However, the Chernobyl Fund’s investment program should be designed with the sole objective of meeting the victims’ needs, and not be allowed to substitute for general budget resources in the execution of capital expenditure;
  • Strengthen the targeting of the benefits. This could be achieved through a review of the eligibility criteria, their uniform application across regions, and occasional random audits of recipients to identify possible cases of fraud; and
  • Ensure consistency and equity between Chernobyl-related benefits and other social protection benefits.

Medium-Term Issues

Ten years after the accident, a comprehensive review of the structure of Chernobyl benefits seems called for. This review would allow the elimination of the overlap or duplication of benefits, or unnecessary payments. For example, health benefits could be reviewed in the context of medical and pharmaceutical aid already being provided free of charge to Chernobyl victims. Similarly, wage premiums for hazardous occupations currently paid by the Chernobyl Fund could be determined by labor market conditions in the contaminated zone and paid by the employers.

It would also be appropriate to consider the introduction of a more broadly based tax to generate the Chernobyl Fund’s revenues, in order to reduce the present disincentive to employ labor. Possibilities could include a broad-based taxation of consumption, to be phased out after a few years.

Finally, it is also necessary to reflect on the time frame for the expiration of the Chernobyl Fund’s mandate. Over time, and as the Chernobyl Fund fulfills its social objectives, the benefits to Chernobyl victims will be primarily health-related. It may then be appropriate to provide these benefits through the established health system, financed by general budget resources. This would allow the Chernobyl Fund to end its activity, reducing the tax burden on the economy.

Concluding Remarks

Ukraine’s social protection system has a critical role to play during the country’s transition to a market economy. While creating conditions for sustaining the economic transformation, it should not exacerbate macroeconomic imbalances. This paper’s discussion of the present system’s structure illustrated that it is too diffuse, with many overlapping benefits, privileges for certain groups, incomplete coverage, and inappropriate targeting mechanisms for shielding the vulnerable. The system in its present form is thus cost-ineffective and inadequately targeted.

Various reform options—identified in this paper—are available to the Ukrainian authorities in the short term for enhancing the cost-effectiveness of the social protection system, as well as for strengthening its coverage and adequacy. This alone, however, is unlikely to be sufficient. Measures would also have to be implemented to ensure that the revenue base for financing the social protection system is not eroded. At the same time, it must be recognized that the relatively high statutory rates of payroll taxes in Ukraine have raised the cost of labor and are acting as a dis-incentive to formal employment. In this context, the implementation of certain policy options also listed in the paper would facilitate a modest lowering of payroll taxes in the short term. Altogether, the suggested measures could yield up to 3.5 percent of GDP in expenditure savings and additional revenue.

Over the medium term, the design of the social protection system should be recast to make it better suited to the needs of a market-oriented economy. In this regard, it would be important to reduce the excessive role of enterprises, as well as to redefine the function of different agencies in the delivery of social benefits. It is equally important to find alternative sources for financing some benefits, such as those related to Chernobyl, which would also allow some reduction of payroll taxes.

APPENDIX

The appendix tables provide detailed information on the system of pensions, child allowances, and compensation of victims of the accident at Chernobyl in 1986.

Table A4.Population Affected by the Chernobyl Accident, January 1, 1996
Total

Number

Affected1
Of Which
WorkingPensioners
TotalPensionersTotalNonworking
Category I45.021.121.145.023.9
Category II350.9277.941.9114.973.0
Of which:
Participants in cleanup operations257.4216.132.473.741.3
Affected by the accident93.561.89.541.231.7
Category III561.5435.454.7180.8126.1
Of which:
Participants in cleanup operations71.964.912.219.27.0
Affected by the accident489.6370.542.5161.6119.1
Category IV1,242.3874.3131.1499.1368.0
Workers in the zone of Obligatory resettlement in 19961.61.40.20.2
Child victims of accident945.26.7
Total3,146.51,616.8248.8840.0591.2
Source: Ministry of Chernobyl of Ukraine.

Sum of total working persons and nonworking pensioners (columns 2 and 5)

Source: Ministry of Chernobyl of Ukraine.

Sum of total working persons and nonworking pensioners (columns 2 and 5)

Discussion

The papers presented in Session II of the seminar were discussed by Lutz Hoffmann and Michael Cichon.1

Commenting on the paper by Gupta, Harris, and Mourmouras, Hoffmann focused especially on the proposed reforms of the housing subsidy scheme, the pension system, and the unemployment insurance system. On the former, he emphasized the need to establish an efficient housing market as soon as possible. Rather than include depreciation in the household tariff schedule as suggested by Gupta, Harris and Mourmouras, he argued that there were advantages in moving quickly to complete privatization of the housing stock. Personal housing subsidies could be provided to those who were unable to pay their rents in a liberalized housing market. On proposals to reform the pension system, Hoffmann cautioned against a reduction in pensions for working pensioners, pointing at potentially high administrative costs and disincentives to work. Moreover, he argued that revenues arose from contributions rather than as a subsidy. In general, retroactive changes in pension commitments should be avoided and should be considered only to the extent that injustices had been built into the system in the past. In contrast, financial constraints should be removed primarily through changes on the revenue side.

On labor market reforms, Hoffmann said that the proposed reforms of the unemployment insurance system were likely based on false assumptions. The extent of hidden unemployment was likely to be considetably higher than suggested in the papers by Gupta, Harris and Mourmouras and by Fallon, Hoopengardner, and Libanova. In fact, about one-third of the labor force could have been redundant even before the reform process started. With firms facing genuine hard budget constraints and redundant labor shed in the public sector, open unemployment could be in the range of 25–30 percent. Furthermore, Hoffmann stressed, the unemployment insurance system should not contribute to financing job creation measures. While ensuring a minimum subsistence income, unemployment benefits should be markedly lower than the minimum wage if they were not to create work disincentives. Minimum financial support was necessary with regard to the long-term unemployed no longer entitled to receive unemployment benefits.

Focusing on Braithwaite and Hoopengardner’s paper on poverty, Hoffmann noted that the impact of rising costs for housing and public utilities towards full cost recovery on poverty—also advocated in the paper by Gupta, Harris, and Mourmouras—was largely ignored. He emphasized that currently the government was not even meeting its obligations with regard to wage payments. While he agreed with Braithwaite and Hoopen-gardner that since a large number of households were close to the poverty line, “… many Ukrainians will climb out of poverty if economic reform is successful in restoring growth,” (chap. 4, pp. 65–66), he argued that, in turn, moderate declines in real income could significantly increase the incidence of poverty and he expressed concern about the financing of poverty alleviation measures.

In that connection, Hoffmann stressed the need for the social safety net to provide adequate minimum income support. He noted that a number of segments of the population, such as the elderly living alone, would not experience an improvement in their well-being, even if economic growth accelerated and brought about more jobs and higher wages. While the state had an obligation to provide support for the needy, it was important to found and develop private charitable organizations. That was particularly important with regard to maintaining popular support of the transition.

While the authors of the papers presented in Session II agreed that better social protection, less poverty, and more employment could best be achieved through sustained economic growth, Hoffmann noted that it was unclear to what extent those papers were related to the macroeconomic outlook presented in the previous session. Arguing that the share of wages in GDP and the extent of unemployment were likely significantly higher than stated in Fallon, Hoopengardner, and Libanova’s paper, he noted that an increase in employment of 10–20 percent was plausible under certain growth assumptions; in contrast, there was no reason why economic growth should immediately result in higher real wages. That would depend on the process of wage determination, about which the paper had little to say. In that context, he noted that as long as many enterprises remained in the state’s hands without facing hard budget constraints, an unholy alliance between managers and employees could exist, whereby they would seek excessive incomes at the cost of the public budget.

Finally, Hoffmann noted that economic growth and employment would depend critically on whether wage increases were consistent with price stability and enterprise profitability. While the institutional structure of the labor market and the weakness of trade unions would suggest that excessive wage increases were relatively unlikely—at least in the foreseeable future—Hoffmann cautioned that according to Fund estimates average real wages in 1994–95 had risen by about 20 percent, compared with an average increase in productivity of only 8 percent. The actual gap between increases in wages and productivity was likely even larger. Until the privatization process was completed, a ceiling on real wage increases oriented toward macroeconomic or branch-specific productivity growth could be considered.

Michael Cichon noted that the recommendations on reforming the social safety net presented in the papers were largely consistent with those made by the International Labour Organisation (ILO) in early 1995 under a UNDP-financed technical assistance project, which emphasized in particular the need to (1) upgrade the social assistance scheme to provide basic income security to all members of the society without income from work and not otherwise protected; (2) consolidate the pension levels and benefit structures and increase the retirement age gradually to 65; (3) upgrade the health care system; (4) streamline and simplify the system of family benefits; and (5) review the benefits provided under the Chernobyl Fund. Under growth assumptions less optimistic than those suggested in chapter 1 of this volume, those measures could contain social expenditures to no more than 22 percent of GDP, while efficiently protecting the needy.

However, Cichon noted two important differences between the recommendations made by Gupta, Harris, and Mourmouras and those by the ILO. First, the paper by Gupta, Harris, and Mourmouras clearly focused on achieving social sector savings, potentially amounting to some iVi percent of GDP Cichon stressed that would be roughly equivalent to 20 percent of total nonhealth social expenditures. Such a drastic cut could result in a further escalation of poverty. Rather than aim at additional savings, more emphasis should be put on achieving greater efficiency in reaching the truly poor. Second, a more extensive discussion on the potential gains from improving the governance of the social safety net would be desirable. In that context, Cichon pointed to the contribution gap of the current pay-as-you-go pension system, where the legally collected contribution rate was 32 percent, compared with the actual costs of the scheme, which amounted to 22 percent of total insurable earnings. However, because of contribution exemptions granted to several state-owned enterprises, noncompliance, and the lack of efficient enforcement mechanisms, the pension scheme would realize at best a small annual surplus.

Focusing on Braithwaite and Hoopengardner’s paper, Cichon noted that the true extent of poverty was likely even higher than the 31 percent estimated on the basis of an absolute poverty line drawn at about 50 percent of the average nominal wage in 1995. First, there was a seasonal bias, as the paper had measured poverty during the summer. Second, the poverty survey presented in the paper did not take into account the considerable extent of wage arrears accumulated over the past one-and-a-half years. Finally, the survey did not cover the effects of gradually increasing the cost recovery for the provision of housing, public utilities, and transportation from 5 percent in January 1995 to 60 percent in early 1996.2 The effects on household incomes were only partly mitigated by the meanstested housing subsidy scheme. Against that background, Cichon strongly supported the proposal to conduct a poverty survey in regular intervals to create a more systematic poverty monitoring system.

Looking ahead, Cichon stressed the need for the international institutions, especially the World Bank, the IMF, and the ILO, and bilateral donors to work together in assisting the authorities to implement reforms. Notwithstanding some differences in emphasis, there was general agreement on the route those reforms should take. The major challenge ahead was to actually put into place a social safety net that would provide adequate poverty relief more efficiently.

In the ensuing discussion, Gerard Duchene asked how unemployment rates were consistent with the high mobility of the labor force. Roman Shpek added that serious reforms of the labor market could not be undertaken without reforms of small and medium-sized enterprises. Oleh Havrylyshyn noted that achieving full cost recovery inclusive of depreciation would be an important incentive to housing privatization. George de Menil noted that even at 3–5 percent unemployment was still low in Ukraine, given the depth of recession. Alexander Sundakov asked if unemployment and poverty were correlated regionally. Basil Kavalsky noted there was widespread agreement on the nature of the reform of social safety nets but that there had been little progress in actually implementing changes in policy. Daniel Kaufmann questioned the need for the government to deliver all social services itself given the overall limitation on expenditure, and wondered if small-scale enterprises could be relieved from taxes provided they undertook a social contract with their workers.

In response, Michelle Riboud noted that the low unemployment rate reflected largely the short duration of unemployment. Elliott Harris noted that until apartments were privatized, housing tariffs should include some indication of maintenance costs. He also said that the benefits to pensioners were not currently linked to their contributions and that the provision of a social safety net at 25 percent of GDP did not seem to take due recognition of the level of resources available. Tom Hoopengardner noted that the bottom third of the population was currently receiving only one-third of the social benefits; there was a need to retarget benefits toward the poorest groups. Michael Cichon noted that company-based social schemes were a deterrent to the mobility of labor, that a second-tier pension system could be desirable in the medium term, and that while there was little potential to raising the maximum pension, the age at which the pension was paid could be raised.

In his final remarks, Adalbert Knobl noted that there seemed to be much agreement on the desirable reforms to the labor market and the social safety net, though much work would still need to be done with the Ukrainian government to implement reforms in those areas.

**With the assistance of Robert Gillingham and Tom Hoopengardner. The authors would like to thank Ke-young Chu and Albert Jaeger for many comments and discussion on the issues raised in this paper.
1A 37 percent tax is levied on the wage fund of enterprises, supplemented by a 1 percent contribution from employees. The revenue collected is shared between the Pension Fund (88 percent) and the Social Insurance Fund (the residual 12 percent). Another 2 percent tax on the wage fund is collected for the Employment Fund. A principal reason behind the relatively high wage taxation in Ukraine is the need to finance benefits for those affected by the Chernobyl catastrophe—an additional tax of 12 percent of the wage fund is levied for this purpose.
2The Ukrainian housing subsidy program is discussed extensively in Roger J. Vaughan, 1995, A History and Overview of Ukraine’s Housing Subsidy Program (Kiev: PADCO Inc., November).
3Assuming a single threshold and no lag in information on incomes, a household with n members that occupy an apartment of z square meters and that has reported income yt would receive a monthly subsidy St in month t given by
In equation (1), π is the income threshold rate set by law, while Ct is the household’s cost of housing and communal services. There are different ways of estimating the costs of housing and communal services for the targeted subsidy. One possibility is to rely on the actual charge, Ca, for apartments no larger than a per capita space “norm,” where the norm is defined on the basis of health (or sanitary) considerations. The assumption is that there is a fixed relationship between space and consumption of housing and communal services. For households that live in housing units larger than the norm, the assessed cost would not exceed the sanitary norm. For example, the norm may include the estimated cost for a fixed amount of space, z, plus a per capita space allocation α. The cost may be written as
4In two Kiev-area samples, reported average household income in January 1996 for subsidy recipients was 47 percent, and the average subsidy about 20 percent of the average wage. Family income and subsidies seem to rise with family size; however, per capita subsidies decline with income, reflecting a measure of progressivity in the program. The distribution of families receiving support is heavily skewed toward one–and two-member families. Single pensioners are the largest and poorest group receiving support under the program. In the sample, over 42 percent of all recipients are single pensioners with an average income of a little over Krb 3,320,000 ($17.50) a month, or 28 percent of the national average wage.
5These privileges are derived from about 50 legislative acts, some of them passed under the former Soviet Union. Persons who performed “great service for the Motherland” and/or are war invalids (groups 1, 2, and 3) receive free housing services. Combat participants pay only 25 percent, and war veterans who served on the home front in World War II pay only 50 percent. Families affected by the Chernobyl accident (categories I and II) pay 50 percent. The norm for gas consumption allowed for families consisting only of disabled persons is twice the ordinary norm. Politically oppressed individuals also receive discounts. In addition to the tariff discounts for housing and communal services given to pensioners and disabled persons, discounts are given to those in certain occupations, such as police officers, the military and their families, judges, and firefighters.
6Free passenger transport is also extended to 28 categories of persons (17 million persons, of which 16 million are pensioners, children, or disabled).
7The changes introduced on January 10, 1996, allow families with persons on administrative leave from enterprises to participate in the program, provided they certify to the Housing Subsidy Office that the unemployed person’s monthly income does not exceed 50 percent of the minimum untaxable income. The law provides for recertification of the family and extension of benefits after the initial three-month period. This option is not open to the unregistered unemployed.
8A Propiska is a permit that designates a person’s place of residence. Propiskas are recorded directly in passports and labor books, and are prerequisites for the provision of state housing and most other allowances, benefits, and privileges.
9Contribution rates for specific sectors (e.g., the self-employed) were brought closer to the standard rate.
10Wages used to buy shares in enterprises were added to the base for calculating contributions.
11In fact, if they work at a financially troubled enterprise, they may not receive any severance pay at all.
12However, unemployed workers within 2 years of pension age are eligible for a total of 18 months of benefits.
13Between 1992 and 1994, 650 loans were given to enterprises that, according to the Employment Fund, created 35,500 working places, mostly at state enterprises and collectives. Late in 1994, the National Bank of Ukraine ruled that the Employment Service could not make such loans because it was not a registered bank. Since then, new subsidized loans to enterprises have been stopped, and only agreements reached before end-1994 are being fulfilled.
14For example, although the total number of registered victims has risen since 1993, the number of beneficiaries of the various support programs in rural areas has declined in most categories, and only 7 percent of eligible persons actually received priority housing from the state housing fund in 1995, down from 12 percent in 1993.
1The discussion was moderated by Adalbert KnÖbl.
2In fact, the cost recovery ratios were further raised to 80 percent in mid–1996 (Eds).

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