A strategy for reform.

In a move widely viewed as an attempt to win over the International Monetary Fund, Turkey's coalition government has recently outlined a strategy for revamping the social security and taxation systems. However, although the proposals advanced thus far could increase tax revenues and reduce actuarial imbalances in the social security system, they fail to address key deficiencies in both systems.

For more than a decade, the IMF, the World Bank and financial circles have urged successive Turkish governments to undertake three central economic reforms: privatisation of state-owned enterprises, and restructuring of the social security and tax systems. These reforms are widely regarded as necessary to shrink public deficits and reduce inflation, currently running at about 80 per cent a year.

Regarding the social security system, a rise in minimum retirement age is the chief reform recommended by the IMF and World Bank. Under the current pension system, which allows women to retire at 38 and men at 43, Turkey's three large state-run social security institutions posted a total deficit of about $5.2 billion in 1996. Monthly pension payments, which currently exceed monthly contributions by about $520 million, accounted for about 95 per cent of the 1996 deficit. Healthcare-related payments, which exceeded contributions by about $240 million in 1996, accounted for most of the remaining five per cent.

"Something has to be done to reduce the burden of these pension payments on the system," says Abdullah Karacik, a former adviser to the largest of the three institutions, the Social Security Administration (SSK). "Otherwise the system will have a yearly debt of $10 billion by year 2000 and $20 billion by 2010."

The SSK, which covers private sector employees, posted a $2.7 billion deficit in 1996. Two smaller institutions (Bag-Kur, which covers the self-employed, and Emekli Sandigi, which covers civil servants) posted a combined debt of about $25 billion.

These shortfalls, financed by the state, accounted for nearly a third of Turkey's estimated 1996 public sector borrowing requirement (PSBR). According to most analysts, the PSBR grew to about $19 billion, or 10 per cent of gross national product, in 1996. At the same time, Turkey's consolidated budget deficit widened to 1,218 trillion lira (about $15 billion) in 1996.

Regarding the tax system, the IMF and World Bank have pushed for a lowering of tax rates - particularly income rates - to discourage tax evasion and the bringing of unregistered income into the economy. Individual income tax rates run as high as 55 per cent in Turkey, higher than in most of Europe. Lower rates could help the state collect an additional $20-25 billion in tax revenue, a substantial portion of the estimated uncollected income tax in 1996, according to analysts. However, like other recent governments, the Welfare Party-True Path Party coalition appears reluctant to undertake these reforms.

Any move to raise minimum retirement ages would almost certainly put the government at odds with Turkey's powerful labour unions. And Finance Ministry officials have warned, probably correctly, that a cut in tax rates will expand the budget deficit, unless the base is broadened beforehand.

"It's a bit like the chicken and the egg," says Attilla Yesilada, director of research at Global Securities in Istanbul. "It's suicidal to cut rates without broadening the tax base. But you can't broaden the base until you lower rates."

Rather than begin controversial overhauls of the social security and taxation systems, the coalition focused until recently on privatisation, the third main structural reform urged by financial circles. Shortly after coming to power last July, the government set timetables for the sale of Turk Telekom and other state companies and properties. These efforts helped pave the way for the Privatisation Administration to negotiate the sale of $900 million worth of state assets (including three banks) in January 1997, more than the total value of assets privatised in 1996.

The government turned its attention to social security and tax reform earlier this year, after the IMF announced plans for a springtime fact-finding trip to Turkey. After its last visit, in October 1996, the IMF listed reform of both systems as a precondition for any future loan agreement with Turkey.

The government hopes the IMF visit, which began on 1 April, will result in a standby or extended fund facility (EFF) accord, Turkish officials, including central bank governor Gazi Ercel, say a medium-term loan from the IMF could stimulate the government to undertake difficult structural reform. Furthermore, an accord with the IMF could help restore Turkey's credibility in international markets, ease the high cost of foreign borrowing and draw funds needed for public projects. Five credit-rating agencies, including Moody's and Standard & Poor's, recently downgraded Turkish debt to sub-investment levels, citing lack of confidence in the political leadership and its economic programmes.

However, despite its desire to impress the IMF, a series of proposals unveiled in February and March reveal the government's continued reluctance to undertake real structural reform. The Ministry of Labour has prepared a social security reform package that focuses largely on short-term, revenue-raising schemes, while the Finance Ministry has prepared a tax-reform package that, so far, contains no proposals for rate adjustment.

The package contains no proposals to reduce the number of workers employed by the social security institutions. Successive governments have used the system as a source of jobs for friends and supporters. The system currently employs about 61,000 people, of whom about 27,000 are listed officially as "other workers". Nor is there any proposal for readjustment of retirement benefits. The current system allows some pensioners to receive 120 per cent of their final pre-retirement salary. In contrast, pensioners in most western European countries receive payments worth about two-thirds of their final salary.

Many analysts also think steps should be take soon to place pension and healthcare systems under separate umbrellas. Healthcare-related payments, which exceeded contributions for the first time in 1996, will place increasingly heavy pressures on the social security system's finances, particularly as the population begins to age. Roughly 37 million of Turkey's 65 million population are below the age of 25.

Unless the government raises the retirement age to at least 60, and takes steps to correct other fundamental flaws, the system's deficit will continue escalating. Many analysts forecast a 1997 deficit of $5.5-$6 billion. This projected deficit reduces the likelihood that the government can limit state spending to 6,200 trillion lira (about $43 billion), in 1997, a key target of its zero-deficit budget plan.

The tax package advanced by the Ministry of Finance includes proposals to simplify VAT rates, tax real estate rents and place an additional five per cent tax on luxury items including cars, tobacco products and alcohol. The Ministry has not announced how much revenue it expects to raise as a result of these measures.

The Finance Ministry has also drafted a series of proposals designed to reduce tax evasion and trim the size of Turkey's enormous unregistered economy. This package includes measures to abolish pay-to-bearer securities, requires banks to report all monetary transactions that exceed certain limits, and provide all citizens with a tax number that would be used in bank, real estate and customs transactions.

Another measure, aimed at minimising smuggling and ensuring realistic tax declarations, would require companies with annual turnover exceeding five billion lira to provide the government with inventory records. Also, as part of its attempt to heighten collection efficiency, the government recently hired the US Internal Revenue Service as a consultant, according to local media reports. The IRS may advise the introduction of harsher penalties, including prison sentences, for tax evasion.

Tax revenue could rise substantially in 1997, although it is doubtful that the government will be able to reach the 4,300 trillion lira target outlined in its 1997 budget. Economic growth, with gross national product widely expected to grow by at least six per cent this year, should boost tax revenue in 1997.

Implementation of tax-related measures outlined in the two revenue-raising packages unveiled last year - including accelerated collection of state tax on alcohol and tobacco products, a 10 per cent withholding tax on yields from government bonds and a tax on imported solvents - could also raise tax revenue. Furthermore, the increased computerisation of tax records and government crackdowns on evasion could boost collection levels. However, the government's unwillingness to undertake fundamental tax reform continues to act as an incentive for evasion.

The coalition government lacks the political will and cohesion to begin controversial but essential structural reforms. Consequently public sector borrowing is expected to remain high and the consolidated budget deficit may widen again in 1997.