Budget 2007 – waiting for Godot?

By P. Guruge

The importance of the budget may be different for different categories of people. Those who cannot afford a decent living expect more benefits from the budget while those who are better-off also expect the government to be benevolent on them. In the meantime politicians also expect a lot of help from the budget to improve their living standards and the image!

On the other hand Treasury officials try to paint a rosy picture not only for Sri Lanka but for the whole world. In the process a lot of budget magic takes place in order to mesmerize the relevant sections. These magicians very often over estimate revenue and under estimate expenditure in order to show a mythical budget deficit which may suit the lending agencies and all powerful politicians to enable them to tell fairy tales to the gullible public.

The budget predictions in Sri Lanka have been so unbelievable and in many instances the budget estimates have not been realized!

The budget reality over the last so many years was that the lower revenue collections, expenditure over-runs and higher budget deficits led to galloping inflation and lower investments.

As a result of lower expenditure estimates and unrealized revenue targets very often the Treasury will have to go to parliament with supplementary estimates. It was very interesting to see that Minister Sarath Amunugama was taking a lot of pain to justify a massive supplementary estimate submitted recently. Whatever the reason for such supplementary estimates, it shows the utter inefficiency in the area of fiscal management.

Fiscal consolidation
One of the main goals of any budget should be to achieve a meaningful fiscal consolidation.

In Sri Lanka, over the years this has become only a window dressing! The relevant authorities have never considered this aspect seriously though they shout about it continuously. One important aspect in fiscal consolidation is the reduction in the Debt/GDP ratio. In other words to bring the government debt to a manageable level.

Under the Fiscal Management (Responsibility) Act No. 3 of 2003, the budget deficit must be reduced to 5% of GDP by 2006 and thereafter maintain at that level. That means a 5% deficit has been considered as acceptable. It further requires that the government debt should not exceed 85% of GDP by 2006 and 60% by the end of 2013. In order to achieve these ideal targets the government should not have adopted their “Wessanthara” fiscal policies.

There should have been restraint on government expenditure and engaged in a very active revenue mobilization strategy. But in practice what has happened was unbelievable. The government does not care about our fiscal situation and they carry on regardless with their unabated expenditure very often wasteful expenditure!

In reality, the rate of interest on government debt was always much more than the nominal growth rate of GDP. This situation will never help Sri Lanka to reduce Debt/GDP ratio to an acceptable level. In a situation like this there is no point in talking about any fiscal consolidation.

Budget strategy
An appropriate budget strategy should have been continued for the betterment of the country. Unfortunately this has not happened in Sri Lanka. Due to various political visions, the policy has been changed very often without considering adverse effects of such ad-hoc changes. During the PA government under former President, Chandrika Bandaranaike they put forward a programme titled “Vision 2010”. As explained by the relevant authorities this programme contained three main targets in relation to economic development. The first was the rapid development of infrastructure facilities. The second was the increase in production and the third was the eradication of poverty. Some may say we have achieved economic development (except in 2001 when it was minus) but no one can say we have developed the infrastructure facilities or eradicated poverty!

Fiscal strategy under “Mahinda Chinththana” has no difference on paper! In his maiden budget speech as the Minister of Finance, Mahinda Rajapaksa justified the presentation of the second Budget for 2006 as follows –

“ ------- my government during its 6 years term of office will implement policies towards building a New Sri Lanka with rapid socio economic development”. He further stated that “some pundits attempted to inflict fear on the people that such policies involve a journey backward. It was projected that my policies will lead to high deficit and inflation. They preached that the only way forward is the neo-liberal economic policies”.

Now what has happened? Even before the end of the fiscal year the so called pundits have become victorious. Unfortunately the president’s economic policies (so called home – grown policies) have not been able to reduce the deficit or contain inflation!

Therefore, what is important is to understand the real problems and find out practical solutions to such problems and remedy the situation without considering whether such remedies were home grown or follow the neo-liberal policies.

In our budget strategy we must try to reduce the deficit. But in the current political thinking this may not be achievable. If you look at the expenditure estimates for 2007 there are estimates for nearly 64 Ministries. A closer look at these Ministries can see really no purpose in having such a large number of Ministries. Better results could have been achieved by having a well co-ordinated small number of Ministries. We earnestly hope that under the latest alliance the UNP will not contribute to this national horror!

It may be interesting to look at some of these estimates and try to understand whether such expenditure will help any economic development at all. For example the vote for Ministry of Defence is a massive Rs. 107,231.5 million for re-current expenditure and Rs. 32,327.7 million for capital expenditure.

No one knows how much will be the relevant expenditure for the current year due to the escalation of hostilities. How can a development oriented poor country like Sri Lanka justify such a massive expenditure on defence? The relevant authorities should realize that this type of expenditure creates avenues for further expenditure in the name of re-habilitation, re-construction and nation building, etc, etc, I am not going to explain these estimates but any one should be able to understand the destructive nature of this process. How can the government divert any resources for a meaningful development when almost all the resources were spent on these unproductive areas?

Then look at the wastage of resources in the name of decentralization of administration. The decentralization of administration by creating Provincial Councils has not remedied the relevant problem but it has continued as an administrative nightmare. But the government has made a massive allocation for the maintenance of these Provincial Councils in 2007 as follow – Recurrent expenditure – Rs. 71,950 million and capital expenditure – Rs. 20,093.1 million.

The very high level of public expenditure obviously gives rise to massive borrowings. The borrowing strategy of the present government is also as bad as their expenditure policy.

Many political pundits in the government say that they do not want to borrow money from international lending agencies such as the World Bank due to so-called “conditions” imposed by them. But, anyone looking at these conditions will realize such conditions are really good for the future of the relevant country.

Most of these conditions deal with good governance and proper fiscal management. If Sri Lanka do not like these conditions that means we are not really interested in developing our country.

On the other hand the government happily goes for massive market borrowings obviously without any “conditions” but with very high interest rates. Finally, what happens? The country will have to pay more interest on these borrowings and the funds borrowed may have been wasted on unproductive but politically advantageous areas! Now, these “anti – international” politicians should realize the folly of their borrowing strategy, which will tighten our debt trap. If they do not review this we may not be able to reduce our national debt to a manageable proportion.

Some experts talk about paradoxical situations without realizing that they themselves had contributed to such situations. In relation to deficit and war related expenses the enlightened views expressed by Dr. P.B. Jayasundera in 2001, should be useful reading even for himself now! He said “During the 15 year period ending 2000, defence expenditure over and above the trend of such expenditure in the pre 80 periods, is around Rs. 480 billion. It is worth comparing the rise in domestic debt during the same period which is around Rs. 440 billion. Therefore, it is obvious that the country’s fiscal problems have clearly got compounded by continued war expenditure and the delay in finding a durable solution to the North-East conflict” – (Central Bank of Sri Lanka – 51st Anniversary Lecture).

The public of Sri Lanka may wish to know whether this position is valid even now!

In conclusion of his 51st Anniversary Lecture Dr. Jayasundera said – “The current issues in public finance are not new. They have been recognized over a long period of time.

As I have explained, problems relating to the National Budget which we discussed today (2001), have been discussed even in the 70s.

The need for public sector reforms has been recognized in the early 90s. Although, delays in translating thoughts in to action have made the task more difficult, the country’s economic success would depend on the successful management of much needed fiscal reforms over the next few years”.

Unfortunately, so called translating thoughts into action have not taken place, even by 2006! This lethargic attitude of all those responsible for taking such action has led Sri Lanka to the unfortunate situation faced by all of us today.

Revenue Policy
When there is no worthwhile expenditure management, it will be extremely difficult to maintain a useful revenue policy. In a country like Sri Lanka the most important and sometimes the sole revenue source will be the taxation because they can mobilize only very little non-tax revenue.

Taxation Strategy
The main purpose of taxation is to collect revenue for the government. But, in a country like Sri Lanka the economic development and social development may also be taken into consideration in the taxation strategy without compromising the revenue aspect. Unfortunately, due to various other reasons especially for political reasons we have complicated our system of taxation. In Sri Lanka there are taxes covering so many aspects of the economy. However, these various taxes and levies have not been properly designed in order to reduce the ill-effects of such taxation. Any taxation will be criticized by the people as nonsense due to various reasons.

Therefore, to have a successful taxation system the authorities should be able to sell their tax system to the public in a convenient manner. The situation today is quite different and the public simply cannot understand the large number of taxes and levies imposed upon them let alone the compliance with such taxes and levies. In the name of simplification the authorities have made the system more and more complicated. When the system is complicated and not understood by the public they always try to avoid such taxes. Then the authorities will have to enforce such tax laws and this will result in various problems to the tax paying public.

During the UNF regime some efforts were made to simplify the tax system. Many unwanted taxes were abolished and a few major taxes were promoted both for revenue and economic and social development purposes. But, now what has happened? In the name of social equity or to satisfy certain groups various new taxes and levies have been introduced thereby complicating the entire tax system.

VAT
Since the implementation of GST in 1998 the registration threshold has not been increased in the last 8 years. As a result the Inland Revenue has got an unmanageable number of VAT registered persons. This has increased the work load and the Department wastes a lot of resources for unproductive work. In the VAT system it is naïve to think that more and more registered persons will produce more revenue. Because in VAT the revenue comes from consumption expenditure. Some of these consumption expenditure may be covered by a few manufacturers or importers. If such large businesses were properly managed under the VAT system there is no need to waste limited resource on small scale businesses. On the other hand that will create problems to the SME sector which is pampered by the present government. Therefore, it is high time to consider an increase in the VAT registration limit may be to Rs. 1 million per quarter. This will reduce a lot of nuisance tax payers and the department may be able to collect more VAT revenue.

Another problem specially affecting economic activities is the taxation of capital investment. In a VAT system capital should not be taxed. Therefore, there should be a clear-cut system to relieve capital investments from VAT.

Recently due to the inability to manage the refund system numerous VAT deferments and suspensions have been introduced. It is very difficult to police such a large number of deferments and suspensions and the VAT base may have been eroded considerably due to these concessions.

Further, the relevant authorities should understand that the VAT registered persons act as the agents of the Commissioner General and the proper guidance and treatment of them is very essential. It is a tragedy that many officials do not realize or ignore this important aspect in their dealings with VAT registered persons.

It is high time to implement a proper VAT without going for hybrid system of VAT and Turnover Tax. If the government wants to have a system of Turnover Tax also they can amend the 13th Amendment to the Constitution and implement a Turnover Tax.

Otherwise, finally we may lose the revenue potential of both the VAT and Turnover Tax. Magical systems introduced under VAT have eroded the salient features of VAT.

Tax
The tax discount system introduced by this government as a concession to compliant tax payers has also been implemented in an inequitable manner. These discounts were offered only to self assessment tax payers! How about PAYE tax payers and withholding tax payers who pay their taxes at source very often on a monthly basis?

Then the Customs Duty concessions given to certain income tax payers were not only bad in law and inequitable but violate the equal treatment of equals as well. If a person pays income tax not less than Rs. 250,000 each year for 5 years continuously he is entitled to the duty concession but if one pays say this full amount (minimum Rs. 1.25 million) in one or two or three or four years such person is not entitled to the concession!

This type of ad-hoc decisions implemented in a very casual manner will not improve the income tax compliance but it will deteriorate the system.

Conclusion
Many budgets of the respective governments were not used as a vehicle for the development and growth of the country. They were very often used to achieve various political objectives from time to time which were not helpful for such a development.

Very often the budgets were full of nice words, misleading statistics and fiscal magic to fool the people! Now it is high time we change all these traditions and face the fiscal realities of Sri Lanka.

The public expenditure management has become a problem due to high defence expenditure, very large expenditure on the maintenance of unproductive public sector and increasing number of beneficiaries under non-contributory pension schemes and continued maintenance of unwanted public corporations including so-called “monsters”.

The government should not try to overlook these real problems in order to satisfy some “people” only neglecting the well being of the general public of Sri Lanka. Unless we establish a proper public expenditure management programme at least over a medium term starting from this Budget, Sri Lanka may become the poorest country in the world, by the next decade!

(The writer is a Tax Consultant, a retired Deputy Commissioner of Inland Revenue and a former Advisor – Fiscal Policy to the Ministry of Finance).