Budget 2015: A deeper look

By Priyanga Dunusinghe

Published in Ceylon Today on 2nd Nov. 2014

It is argued thatthe political party in office takes into account political economy considerations when deciding fiscal policy directions, namely expenditure allocations across sectors and revenue generation. Available literature provides evidence that the government expenditure is relatively higher in an ‘election year’ compared to a ‘normal year’. This time, it could be observed that the political party in power has carefully crafted the budget in such a way that it would significantly increase the probability of returning to the high office.

Budget 2015: Some Numbers

The budget 2015 was presented to the parliament on 24^th of October 2014 for seeking approval for spending around Rs. 2,210 billion and financing it through taxes, non-tax revenue, grants and borrowings. The total expenditure and revenue, relative to GDP, is 19.5 per cent and 14.9 per cent respectively. The budget deficit amounts to 4.6 per cent (Rs. 521 billion) in 2015and the government plans to borrow Rs. 251 billion from foreign sources and Rs. 270 billion from domestic sources to bridge this budget short-fall. Out of the total expenditure, the government plans to spend around 31 per cent as capital expenditure in 2015. Compared to 2014, total government expenditure has increased by 15 per cent in 2015.

More Funds for Human Capital Formation

This budget has allocated considerable amount of resources for human capital formation, namely forimproving education and health outcomes. For instance, the budget allocated around Rs. 96.5 billion for education (for the three ministries handling education related activities) in 2015 compared to Rs. 75.9 billion allocated in 2014. This allocation should be commendable given that stakeholders in the sector have repeatedly highlighted the need for more funds for education. As per the budget proposals, additional funds would be utilized for setting up new academic centers/faculties at national universities, higher payments for academic staff, new hostel facilities for university students, scholarships, recruiting teaching assistants to schools, and modernizing teacher training colleagues. Moreover, the government plans to launch fast-track skill development programmes for youth targeting both local and global labour markets.One of the issues in this regard is that it is not clear to what extent this investment helps in improving quality and the relevance of education and vocational training. Mere capacity build-up may waste the scarce resources.

Similarly, allocation for the health ministry increased from Rs. 117.6 billion in 2014 to Rs. 139.5 billion in 2015. As per the budget proposals, the government plans to develop a number of hospitals to cater to the needs of non-communicable diseases (NCDs) and other requirements. Similarly, funds will be made available for health check-ups to identify some of the diseases at their early stages. More funds to above mentioned areas are really significant given the fact that NCDs is widespread in the society and some of the diseases such as kidney related health issues are in rise in most dry zone areas. Moreover, it is commendable that the government identifies regular health check-ups for all citizens as a national priority in detecting some of the curable NCDs at their early stage. It is argued that regular health check-ups are not popular among most Sri Lankan. Hence, financing health check-ups at least for some years could educate and encourage people to be more vigilant about their health status on a regular basis.

Continue with Infrastructure Development

The budget 2014 has allocated a significant share of total expenditure for infrastructure developments. As per the budget proposal, it is planned to continue with constructing new highways connecting the capital city with major cities as well as with development of airports and sea ports for improving greater connectivity with the rest of the world. It appears that the government has identified exports and tourism as two major thrusts in driving the economy in the medium terms. When looking at these strategies, it is important that Sri Lanka sufficiently improve infrastructure because road connectivity between the capital city and some of the main cities still remain very poor. On of the biggest issues with previous infrastructure projects is that the costs of construction were really high because most of the tenders did not go through competitive bidding processes. Moreover, the government lacked proper planning in getting those facilities utilized though capacity development gave greater priorities. As a result, some of the infrastructure facilities remain still under-utilized.

Re-discovering Industrialization and Exporting

It seems that government has identified promotion of industrialization and exports is essential in achieving set targets set in 2020 vision document. This budget has given a number of concessions for Small and Medium entrepreneurs for setting up businesses and specifically it is planned to get private sector to set up 300 factories for promoting industrialization in semi-urban and rural areas. Similarly, a number of concessions have been extended to exporters for promoting export trade. For instance, it is proposed to set-up a one-stop place for export documentation and other requirement thereby simplifying the exporting procedures. Moreover, a number of concessions have been given for promoting research & development and innovation relating to export goods. According o some associations in the industry, these are some of the requests made by them for long years, hence, it is expected that above mentioned policies could make an impact.  

Less Attention on Public-funded R&D Activities

It seems that the budget has not sufficiently funded research and development activities. When looking at the allocations, the Ministry of Technology and Research has been allocated just Rs. 4 billion, which amounts to 0.23 per cent of total expenditure. Although the budget includes some incentive packages for incentivizing research and development activities, it is quite unclear to what extent those budget proposals could make a new research culture in the country. In recent month, a concerted effort was made by the ministry to draw the attention of policy makers for greater budgetary allocation for research and development, but yielded no returns. It is important to recognize that level of research & development activities carried out by firms is largely determined by the size of public expenditure on science and technology advancement. It is required to invest heavily in basic research by the government so that private sector takes initiatives to commercialize new ideas generated by public research institutes. It is quite obvious that private sector is not ready to under take costly R&D activities given the high risks associated and the presence of externalities.

Subsidy Leading to Trapping at Low Equilibrium

As many expected, there are a numbers of relief packages thinly distributed covering various segments in the society. It appears that the budget has covered almost all the social groups, such as children, women, differently abled, pensioners, private sector employees, public sector employees, some informal sector employees, farmers, fishermen, and the others segments in the society. By and large, there is something for each one in the budget. In this respect, it seems that the budget has carefully been crafted to get all on board.

One of the fears with certain subsidies for production activities is that such policies may delay the structural transformation in the economy thereby leaving resources trapped in unproductive activities. As economic theory argues it is imperative that an economy witnesses within-sector and between-sector resources reallocation in its economic growth process. It is required to move resources from relatively low productive sectors to high productive sectors so that growth gets accelerated. Specifically, the economy should witness resources moving from low productive agricultural activities to high productive agricultural activities (within-sector transformation) and moving resources from agriculture sector to manufacturing and services sectors (between-sector). Within-sector transformation is applicable any sector, i.e. moving resources from less productive activities to high productive ones regardless of the sector in which resources are previously employed. In Sri Lanka, agriculture sector accounts for 30 per cent of the total employment, however, its contribution to GDP is just 11 per cent reflecting low level of productivity in the sector.Over-emphasis on subsidies could hamper these processes thereby jeopardizing the medium and long-run growth prospects. It is imperative to note that certain subsidies do more harm than benefit in the medium to long—run though such subsidies could satisfy people in the short-run.

Taxation Leading to Moral Hazard Problem

One of the key revenue proposals in the budget is that the government plans to raise Rs. 40,000 million by extending a refinance facility for payment of tax arrears.According to the budget proposals, a special refinance facility scheme which is re-payable within 5 years will be provided at 6% interest rate to facilitate the settlement of arrears in EPF/ETF and arrears in taxes up to 31.12.2010. This raises a number of questions. First, is it fair to extend a loan scheme at a rate of 6 per cent for people who have evaded paying taxes and FPF/ETF contribution when poor people pay 12-14 per cent interest rate for housing loan? Second, is it fair for those who have complied with the state rules and regulations? Third, does this scheme create a moral hazard situation where tax payers avoid paying their dues expecting similar scheme in future? Finally, to what extent do tax evaders use this facility and settle the tax arrears? There are sufficient provisions in the Inland Revenue act in dealing with people who evade taxes. Hence, it is required to use such measures rather than creating moral hazard problem with respect to paying taxes.

As discussed in a previous article, existing tax regime in the country favors top income earning individuals and cooperates. Compared to early 2000, tax rates levied on top income brackets have come down over the years thereby violating the principle of fairness in taxation. The budget 2015 has not taken any step to tax top income categories sufficiently.It seems that government continues to raise income through indirect taxes while paying little attention to broaden the tax base as recommended by the presidential tax commission.

Several Ministries, But No Work

An analysis on the Appropriation bill highlights that nearly 72% of the total expenditure is allocated to seven key ministries where as 27.8% of total expenditure is spent by 53 ministries and other expenditure lines. A simple analysis on budgetary allocation shows that many ministries are maintained without a purpose. On the other hand, many ministries just attend to routine work rather than development related activities. Hence, the country lost a large sum of money by maintaining a larger number of ministries just to satisfy the personal ego of some politicians. It has witnessed in recent years that some key ministries such as the Ministry of Economic Development carrying out development activities which come under the purview of some other ministries. This clearly shows the waste of resources in terms of making idle some human and physical resources that were originally placed in carrying out such type of work. A simple calculation reveals that nearly 5-6 per cent of the total government expenditure wastes every year in maintaining ‘excess ministries’ which apparently have no work to attend.

Some Policy Inconsistencies

The budget 2015 proposes to provide motor cycles to certain categories in public sector workers at a concessionary price. At the same time, the budget reduced taxes on vehicles carrying school children and using in small business activities. Similarly, the budget reduced the taxes on Hybrid cars arguing that such reduction helps in reducing fuel imports and negative impacts on the environment. Vehicle ownership could be regarded as an asset; hence, public servants receiving above facility could be overjoyed. However, a deeper analysis shows that this policy of offering motor cycle is detrimental to the development of a sound public transportation system in the country. Such policy measures discourage public transport due to lack of demand for public transport services thereby resulting low investment for quality improvement. On the other hand, an increase in private vehicle use could pollute environment a lot and causes several health issues. Moreover, more vehicles mean more crude oil imports that in turn cause a heavy burden to the balance of payment. What is wrong in this regard is that the promotion of private vehicle use by the public policy when public transport generates a number of economic and environment positive externalities.

Pressure on Inflation and the Balance of Payments

In recent years, the economy has been on low interest rate regime, partly due to prudent fiscal and monetary policy management measures. The low inflation regime has helped the economy in a number of ways in improving business climate and competitiveness. However, it seems that certain budget proposals may have a up-ward pressure on inflation in the short- to medium-term due to an increase in consumers’ purchasing power. An increase in income due to various budgetary provisions may increase the aggregate demand in the short-run while there are chances in expanding credit to private sector. Similarly, there will be a pressure on the balance of payments if people decide to spend their additional income on imports. These possibilities should be factored out while taking into account the probability of holding an election in the next year. The balance of payment pressure may be contained to some extent due to falling oil prices in the world market and positive economic outlook in advanced economies.

Rising Labour Costs

The budget 2015 has proposed to increase the employer’s contribution to EPF by 2 per cent. This requirement certainly increases the costs of labour to firms thereby having negative impact on employment creation. It is argued that labour costs are relatively higher in Sri Lanka compared to her competitors and neighboring countries. Further increase could be detrimental to both businesses resulting slow growth of employment where firms decided to substitute labour with capital. One of the reasons for increasing this contribution might be that the government could invest such additional funds in productive areas in an environment where FDI are not flowing sufficiently to sustain a growth rate of 7-8 per cent per annum.

What Matter is Realization Not Provision?

While appreciating the allocation of additional funds for human capital formation, physical infrastructure development, and for other purposes, it is important to note that previous datashow that provisions do not necessarily translate to realization. At the end of the day, impact of the budget depends on what is spent not on the provisions. Financial statements of State Account Department show that a significant fraction of capital expenditure provision has not utilized in previous years. It is often highlighted that there is a delay in disbursement of funds promised in the budget. Hence, one should not be cautious in analyzing the impact of additional funds on the economy because the impact is determined by the amount actually spent not on the amount promised.

Conclusion

The budget 2015 has given something to almost every segment of the society. Hence, in the on-going budget discussions, many attempt to evaluate the budget from the perspective of what they received from the budget rather than from a holistic view. The foregone analysis attempted at discussing some of the implications of the budget from the perspective of national economy. Overall, it could be observed that there a number of positive features in the budget 2015 that could push the country towards the targets set by the ‘2020 vision’ document. At the same time, it is imperative to mention that there are some policy inconsistencies and lack of attention on certain areas which are essential in achieving the set economic targets. Specially, lack of sufficient drive towards structural transformation could be mentioned as one of the key missing areas in the budget. In recent years, it has become common that that most of the fiscal policy matters are decided outside the budget. Hence, it is important to be cautious in discussing pros and cons of this budget merely based on the presented data because it reveals a part of the fiscal operation for the year of 2015.

Overall, it seems that the budget 2015 has taken a new direction towards improving human capital (education and health) rather than developing infrastructure that had been the main trust in the fiscal policy during 2010-2014. This new direction is certainly welcomed by all segments in the society.