Acute Deficiencies in Iran’s Budgetary System

EghtesadOnline: Budget deficit, the mismatch between the government’s spending commitments and what it is projected to earn in oil revenues, taxes and other sources of income, has been a way of life for Iranian governments for most years since the early 2000s.

News ID: ۷۴۵۱۸۶

18 April 2018

Oil revenues depend on global prices, production and exports, which hinge on the economic and political state of the global economy. Hence, the government’s predictions about its oil earnings are usually inaccurate.

Tax revenues and expenditure are generally influenced by government decisions, though.

Ever since 2001, the first year of the Islamic Republic of Iran’s Third Five-Year Development Plan, the share of the government’s operating budget has overtaken that of capital expenditure. The gap grew alarmingly in favor of operating budget when oil revenues flooded the country between 2005 and 2013 under former president, Mahmoud Ahmadinejad, according to Financial Tribune.

About 76% of the total budget were allocated to operating expenses as per the Third Plan. The share dropped in the neighborhood of 74% under Fourth Five-Year Development Plan (2006-11), thanks to the surge in oil revenues. The government was forced to reduce its capital expenditure allocations during the Fifth Five-Year Development Plan (2011-16) due to international sanctions against Iran and consequently the dwindling petrocurrency as well as falling oil prices of 2015. The share of operating budget climbed to 81.6% during these years. In other words, the government was no longer capable of conducting development projects. (Table 1)

The share of capital expenditure in budget kept shrinking even after the removal of sanctions in 2016. Operating expenditure accounted for 83% of budget in the fiscal 2016-17. This is while a rise in development projects is synonymous with improved grounds for production and employment, particularly in underprivileged areas.

Financial restraints in the Iranian budget seem to be structural in nature and are linked to the significant aid the government extends to pension funds and the monthly cash subsidy it pays to over 90% of the population, a report by Persian weekly Tejarat-e Farda reads.

Soaring Budget Deficit

An army of state-run large-cap enterprises enjoy tax exemptions, including complete relief from paying their dues. Allocation of resources is an indication of the bargaining power of political groups to support special factions and this has placed a huge financial burden on the government.

Budget deficit fell to its lowest during the Third Plan when the reformist government was in office and grew the most under Ahmadinejad and the Fourth Plan. In fact, the budget deficit during the latter was twice that of Third Plan despite oil windfalls in those years. (Table 2)

Foreign Currency Reserve Account (known as Oil Stabilization Fund) was established as per the Third Plan to help reduce the economy’s dependence on oil and increase tax reliance.

Financial irregularities during Fourth Plan robbed the sovereign fund of its savings and widened the budget deficit. As part of the Subsidy Reform Plan, the government of Ahmadinejad removed food and energy subsidies in 2010 and paid 455,000 rials (about $10) to each and every Iranian on a monthly basis.

The flawed implementation of the plan, coupled with international sanctions against Iran and the plunge in oil prices, led to a massive budget deficit for the government in 2013, which continued into 2016.

Shrinking CAPEX

The implementation of development projects normally triggers growth in other economic sectors by increasing demand for construction materials and machinery as well as employment. To that end, the government increased the capital expenditure budget of the fiscal 2016-17 by 54.8% compared with the year before.

Given a 20.6% rise in the operating budget of the same year, the government ran an unprecedented budget deficit. (Table 3)

Public employees’ compensation accounts for the lion’s share of government expenditure followed by its consumer purchases, as well as rents and financial frictions. During the Third Plan, public employees’ compensation constituted 45% of the total budget while it fell to 35.7% during the curious years of Fourth Plan.

With the decline in oil revenues, the share of employees’ compensation in budget bounced back to 45%. Public employees’ wages had an average rise of 22.7% from 2001 to 2016 annually, equal to the average inflation rate in those years.

Given the fact that the number of government employees grew over the period under review, their compensation rate must have normally declined. However, in those years, the real wages of the employees of municipalities and Social Security Organization, when adjusted to inflation, saw an increase of 4% and 6.7%, respectively. The employees of SSO and municipalities were handed generous pay rises over the 15-year period despite the financial woes of their respective organizations. (Table 4)

Education, Health Budgets

To achieve maximum growth, the Organization for Economic Cooperation and Development recommends an increase in the budgets for education and health.

Figures show government spending on education and health reduced from 8% and 5.5% during the Third Plan to 7.1% and 4.1% respectively in the Fourth Plan (2006-11) due to an abrupt rise in military budget and economic services.

Under the Fifth Plan, particularly after President Hassan Rouhani’s 2013 election, the share of education and health increased significantly to 10.6% and 6.3%, respectively.

From 2001 to 2016, the nominal budget of education had an average rise of 32.3% while the budget for health sector grew by 33% annually (Table 5, 6). The real budget growth for education and health, when adjusted to inflation, stood at 10.1% and 10.4% respectively.

Despite the decline in the number of students and rise in the share of private schools, the expenditure of state-run education increased by an average of 32.2% annually from 2001 to 2016. Education expenditure accounted for 10.6% of the total budget under the Fifth Plan, up from 8% under the Third Plan.

Low productivity and the inefficient administrative structure of Iran’s education system are to blame for its ever-rising costs. With one million employees, the Ministry of Education has the highest number of people on its payroll among all state bodies.

Over 400,000 people are employed by the Ministry of Health.

From the beginning of Third Plan to the end of Fifth Plan, the budget of health sector expanded by 33% annually, thanks to the government’s efforts to ease the burden on low- and middle-income families. In doing so, the share of health expenditure in the budget increased to 6.6% under the Fifth Plan from 4.2% under the Fourth Plan.

Share of Social Welfare in Budget

The 11.6% share of social welfare expenditure in the budget during the Third Plan increased to 13.8% in the Fifth Plan.

What’s surprising is that social welfare expenditures from 2000 to 2015 saw an annual increase of 27.5% (5.4% when adjusted for inflation) but such spending failed to curb poverty or reduce inequality to a significant extent.

The government’s aid to the Civil Servants Pension Fund and Steel Pension Fund of Iran are the main reasons behind the increase in the government’s social welfare expenditure.

Pension funds’ expenditure will overtake the rest of government expenditure in the budget for the current fiscal (March 2018-19). A total of 646 trillion rials ($15.38 billion) will be allocated to the Civil Servants Pension Fund, Armed Forces Pension Fund and the pension funds of Islamic Revolutionary Guards Corps and the Foundation of Martyrs and Veterans Affairs, suggesting that the share of pension funds in the budget would reach 27.3% this year (Table 7).

The structure and composition of the government’s proposed budget for the current fiscal is not very different from those of previous years. Allocations to pension funds and the Ministry of Education make up 27.3% and 13.3% of the budget’s total expenditure. The government seems to have no effective plan to balance the budget.

The share of capital expenditure fell to 17% during the Fifth Plan from 24% in the Third Plan. When the operating budget grew larger than expected, the main solution by the government was to reduce capital expenditure budget.  Given the current circumstances of Iran’s economy, going down the same road would result in a deepening recession.