Board of Governors of the Federal Reserve System

February 1992

Fiscal Implications of the Transition from Planned to Market Economy

R. Sean Craig and Catherine L. Mann

Abstract:

The transition from a centrally planned to a market-based economic system should change fundamentally the roles of government and public enterprises in the East-Central European countries of Hungary, Poland, and the Czech and Slovak Federated Republic (CSFR). The size of government should diminish, and that of the private sector increase, as subsidies, which are difficult to justify at market prices, are phased out. Taxes in centrally planned economies tend to be highly distortionary relative to those in market economies, making a restructuring of the tax system desirable to improve efficiency and growth prospects. These changes, in combination with competitive pressures and the objective of eventual membership in the European Community, should cause expenditure and tax systems in East-Central Europe to resemble the Western European model. This paper attempts to establish the extent to which these systems are moving towards the Western European model and the structure of taxes and expenditures likely to result. It also identifies risks to the reform process resulting from pressures on budget balances during the transition, as tax revenues decline and countries are reluctant to phase out subsidies to unprofitable enterprises.

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