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Containing fiscal deficit: Policy imperatives politically unpalatable
View(s):
The Treasury’s expectation of bringing down the fiscal deficit to 5.2 per cent of GDP this year and achieving a fiscal deficit of 3.2 per cent of GDP in the next three years is unrealistic, as the policies needed to achieve them are unlikely to be implemented. This is especially so if the objective is the reducing of the consolidated fiscal deficit that matters.
Bringing down the consolidated fiscal deficit to much below 5 per cent of GDP in the near future requires a strong resolve on the part of the Government to undertake reforms on the revenue side and on public expenditure. Although reducing the fiscal deficit is an economic imperative, the measures that need to be taken for its realisation are not politically expedient. This is particularly so in 2015, an election year.
Increasing revenue
The Treasury Secretary and the IMF have emphasised increasing government revenue as the means of achieving a lower fiscal deficit. The IMF states: “Fiscal consolidation and debt reduction need to continue, but the burden of adjustment needs to shift decisively to revenue generation.”
There are good reasons for this. Government revenue at 14.3 per cent of GDP in 2013 is below what is expected from a country with Sri Lanka’s per capita income level. Furthermore since public expenditure requires to be increased, especially for social infrastructure, there is a need to increase revenue to meet such expenditure.
Increasing government revenue is certainly important to reduce the deficit, but it is not sufficient. Reducing public expenditure through more prudent public expenditure on a basis of economic and social prioritisation is also necessary.
Exemptions and deficiencies
The low tax revenue is due to tax exemptions, inefficiencies in the tax administration, tax avoidance and tax evasion. It is also likely that the country’s tax-to-GDP ratio is low owing to an overestimate of GDP and the sources of growth, such as increased public sector wages, large infrastructure investments and construction not generating taxable incomes.
Treasury Secretary P.B. Jayasundera’s view is that tax holidays and tax exemptions should be done away with. He sees the elimination of tax exemptions and introducing an upper single digit tax rate as a means by which revenues could be increased.
Tax reforms should reduce past fiscal slippages significantly to increase revenue. The reform in trade and excise taxes, a broader tax base and more effective tax collection should be put in place to achieve higher revenue collection that would reduce the fiscal deficit.
Effective taxation
Institutional weaknesses of tax administration must be recognised as one that cannot be easily changed. Therefore, a tax regime that collects taxes automatically, such as by withholding taxes on transactions and incomes should be implemented. Much higher taxes on items of consumption by those deriving undeclared incomes, such as professional fees, should be implemented. These incomes can only be taxed through expenditure taxes on their investments and expenditures.
Increasing revenue depends much on the realistic nature of the tax reforms and the administrative capacity of the Department of Inland Revenue. A realistic taxation strategy should take into account the deficiencies and limitations of the tax administration and devise taxes that are automatically collected from high income earners.
Reforming SOEs
Reduction or elimination of losses in state-owned enterprises is vital to make a dent on the fiscal balance, as losses incurred by public enterprises are a huge expenditure. Reforms of public enterprises are a significant means of reducing expenditure. In the past, the privatisation of loss-making enterprises reduced public expenditure as well as brought in revenue from privatisation proceeds. Since this option is not available due to the Government policy, the Government must take immediate and substantial steps to reform public enterprises.
Drastic reforms of public enterprises are mandatory to achieve profits or reduce losses significantly. It is most unlikely that the Government would take substantial steps to reform public enterprises, as weaknesses of public enterprises are mostly due to political appointments of incompetent heads and other key officials, overloading with excessive poorly qualified staff and continuous interference with their functioning.
Treasury and COPE
The Treasury Annual Report and the Committee on Public Enterprises (COPE) have recommended reforms such as allowing greater commercial freedom, ensuring the appointment of competent managerial staff and improving corporate best practices and accountability through the boards of directors and senior management. Dr. Jayasundera himself has said the government needs to stop making political appointments and instead appoint quality candidates to run SOEs.
However, good managers alone will not be enough to improve performance. Proper management systems, autonomy to run the enterprises and non-interventions by politicians are necessary conditions. However, such a change in governance is most unlikely. Therefore, state enterprises will continue to be a burden on the budget and on banks.
Increase in expenditure
Public expenditure on salaries, pensions, subsidies and Samurdhi payments is likely to increase in the coming months. The salaries bill is likely to increase in 2015 due to both salary increases and further recruitment to the public services in an election year. Reduction of taxes to reduce the cost of living would increase expenditure or decrease revenue. For instance, the recent downward revision of electricity tariffs is estimated to result in a loss of Rs. 60 billion.
Conclusions
The containment of the fiscal deficits is undoubtedly difficult to achieve due to the limited revenue base, large debt servicing costs, huge expenditure on public service salaries and pensions, big losses in public enterprises; a large defence expenditure and wasteful conspicuous state consumption. The means for achieving a breakthrough in the country’s public finances are formidable tasks in the political setting, inefficient and corrupt tax administration and inadequate concern for prudent management of state finances.
Bringing down the consolidated fiscal deficit to 5 per cent of GDP in the near future requires a strong resolve on the part of the Government to undertake reforms and to spend public money carefully. This is especially unlikely in the months ahead leading to elections.