The Budget 2008

The Budget 2008:
A Critical Analysis
By Muttukrishna Sarvananthan

There appear to be shortcomings both on the expenditure as well as the revenue sides of the public finances of the country. The public expenditure programme of the
government seems to be welfare oriented than workfare oriented. On the revenue side of the budget, government’s tax policy appears to be regressive because of its
over dependence on indirect taxes. Nevertheless, there are some positive proposals made in the budget to stimulate the economies of the periphery, particularly the
Eastern Province.
The overall public expenditure will increase by 15% to LKR.925 billion in 2008 from LKR.805 billion earmarked for 2007. Similarly, the defence expenditure would
increase by 19% to LKR.166.5 billion (USD.1.5 billion) in 2008 from LKR.140 billion (USD.1.4 billion) earmarked for 2007. The actual expenditures would be
greater than the foregoing earmarked figures going by the past experience (for example, although the earmarked defence expenditure for 2007 was LKR.140 billion,
the actual expenditure is expected to be LKR.156 billion). Besides, the total public expenditure for 2007 and 2008 does not include public debt repayments, which is
huge. Public debt repayment was 41% of the annual total public expenditure in 2005 and 45% in 2006.
The twelve ministries account for about 90% of the total public expenditure based on the actual expenditures incurred in 2005 and 2006. There are 58 ministries at
present. Three largest spending ministries are Finance, Defence and Provincial Councils & Local Government, which in total accounted for over 67% of the total
public expenditure in 2005 and 2006. Finance ministry is the largest spender because of huge public debt repayments, accounting for 50% of the total public
expenditure incurred in 2006. Public administration, at the central, provincial and local government, consumed 15% of the total public expenditure in 2005 and 2006
(see Table 2). Hence, finance, public administration and defence gobble up almost 75% of the total public expenditure. Further, public debt repayments, public
administration and defence together consume two-thirds of the annual public expenditure. Moreover, three ministries (Finance, Defence and Samurdhi & Nation
Building) that come under the President accounted for over 60% of the total public expenditure incurred in 2005 and 2006, which is set to further increase in 2007
and 2008.
Four key messages emerge out of the foregoing figures. Firstly, the fact that over 40% of the annual public expenditure is spent on public debt repayments means that
the government is spending more for the past than for the future. This does not augur well for the future of the country. Secondly, there is concentration of financial
resources within a few ministries that have very little to do with human welfare. This reflects the wasteful nature of public expenditure in Sri Lanka. Thirdly, public
expenditures on social sectors (education and health) and economic infrastructure (power, roads, transport and railways) were just 11% of the total in 2005 and
2006. This means the government has got its priorities wrong. Fourthly, the President, who is not accountable or answerable to the Parliament and has blanket
immunity from the laws of country, is the custodian of over 60% of the public money, which is a matter of concern to the citizens of this country. Whereas the
Constitution of the country claims that the Parliament is supreme on matters of public finance, how come 60% of the public money entrusted to a person who is
neither accountable nor answerable to the Parliament? This is a serious lapse in the economic governance of the country.
The highest increases in public expenditure for 2008 are in the three ministries under the President, namely, defence, finance and nation building & poverty alleviation.
Thus, defence expenditure is increased by 19%, finance ministry expenditure is increased by 88% and nation building & poverty alleviation expenditure is increased
by 200% compared to the allocation for 2007 . The increase in budgetary allocation for defence is understandable given the security situation of the country.
However, what is the need for such huge increases in the other two ministries under the President?
It is also noteworthy that all the increases in ministerial allocations are less than the rate of inflation, except the three ministries under the President. In other words,
there have been declines in individual ministerial allocations for 2008 in real terms, except just three ministries. The increase in defence allocation in real terms is only
marginally higher than 2007. However, finance and nation building and poverty alleviation ministerial allocations are several fold higher in real terms compared to
2007.
In 2008, the government expects to spend LKR.456 million (USD.4 million) per day on defence and public security, which is huge for a lower middle-income
country. Besides, this figure is an underestimation, because lot of the armament purchases are made on hire purchase (instalment) basis and therefore the payments
are spread for a number of years in the future (perhaps with accrued interest). Further, since most of this expenditure is going to be financed by domestic and external
borrowings the cost of interest payments in the future years has to be added to the foregoing figure. Therefore, the compounded cost of defence expenditures would
be significantly greater than that shown in the annual budget outlays, which applies to other public expenditures as well.
The experiences of many countries have shown that higher military expenditures do not necessarily win wars, internal or external. While the United States has spent
over a trillion dollars on the Iraq war in the past five years there is no end in sight. The government has allocated LKR.8,536 per person for defence in 2008. This is
in contrast to LKR.2,974 per person allocated for health and LKR.2,359 per person allocated for education for the whole year.
It is also important to note that, according to the summary of estimated public expenditure for 2008 presented to Parliament on November 07th, out of the total
public expenditure earmarked for 2008 (LKR.1,516.3 billion), LKR.515.6 billion is for recurrent expenditure (34.0%), LKR.209.8 billion is for interest payments on
public debt (13.8%), LKR.417.6 billion is for capital expenditure (27.5%) and LKR.373.3 billion is for public debt amortisation (repayment of capital of public debt)
(24.6%). Thus, almost 38.5% of the total public expenditure is earmarked for public debt repayments (both capital and interest). On the revenue side, the
government continues to depend heavily on indirect taxes. In 2008, eighty four percent of the government revenue is expected to accrue from tax revenue (LKR.653
billion out of LKR.775 billion). Out of the total tax revenue 78% is expected from indirect taxes (LKR.512 billion out of LKR.653 billion) and 22% from direct taxes
(LKR.141 billion out of LKR.653 billion). Although the share of indirect taxes in the total tax revenue has been declining in recent years (from 85% in 2005 to 79%
in 2007) it is still too high.
In fiscal theory direct taxes (income/dividend tax, corporate tax, economic service charge, PAYE (Pay As You Earn) tax, etc) are deemed to be progressive and
indirect taxes (import/export duties/cess, regional infrastructure development levy VAT (Value Added Tax), excise duty, stamp duty, debit tax, motor vehicle tax,
social responsibility levy, etc) regressive, because direct taxes are on income but indirect taxes are on consumption / expenditure. Higher income earners pay greater
direct taxes and therefore progressive, but indirect taxes are the same irrespective of the income level of the consumer and therefore regressive. However, the other
side of the argument is that, marginal propensity to save is greater among higher income earners and therefore lesser direct taxes would increase savings, which in turn
would increase investments and thereby stimulate economic growth.
Indirect taxes are one of the main causes of inflation, because these taxes are passed on to the consumers by way of increasing the price of goods and services.
Therefore, attempts should be made to increase the share of direct taxes in the total tax revnue in order to contain the rising cost of living. In addition there is an urgent
need to decentralise the tax administration (levying and collection) in the country. The provincial and local governments should be given authority to levy direct and
indirect taxes at the provincial and local levels, instead of the central government levying and collecting direct and indirect taxes and then redistributing to the provinces
and local authorities through transfers.
For example, we cannot understand why the regional infrastructure development levy should be levied by the central government. Instead, the provincial councils
should levy this tax in order to pay for infrastructure development within their provinces. There is no evidence to show that the regional infrastructure development
levy collected by the central government in the past couple of years has been spent on infrastructure development in the provinces.
We would argue that the central government should levy only the taxes on international trade, and the provincial governments/councils should levy the direct and
indirect taxes from citizens and businesses within their respective provinces. By this way the provincial governments will be able to pay for public services provided
and development activities carried out within their provinces and there would be no need for transfers from the central government/ministries to the provinces. The
central government should be a regulator of economic and political affairs among the provinces within the confines of the laws of the country. The tax revenue
collected from international trade by the central government should be expended for defence (three armed forces and not the police) and external relations of the
country. The police force should be decentralised and paid for by respective provincial governments. The Central Bank should become independent of the central
and provincial governments and take on the role of regulator of the financial system, monetary policies and the currency.
This kind of innovative decentralised tax model would promote competition among provinces and stimulate regional economic growth and development. The
provincial governments should be able to compete in terms of fiscal, investment, business and public policies, with the central government being the arbitrator and
facilitator.
The government has presented the budget for 2008 amidst declining economic growth rate and rising cost of living. The growth of GDP is expected to decline to 6%
in 2007 from 7.4% in 2006. However, the anticipated 6% growth rate is remarkable in the context of a high intensity civil war. Moreover, inflation is expected to be
18% at the end of 2007, more or less the same as at the end of 2006. There is very little in the budget to indicate any deceleration of the raging conflict, which is one
of the prerequisites for acceleration of economic growth. However, five-year tax holiday for investors in the Eastern Province proposed in the budget has the potential
to stimulate regional economic growth and thereby contribute to national growth. The success of this proposal depends on return to democratic rule in the province.
Government’s public expenditure outlays, heavy reliance on indirect taxes and borrowing plan do not indicate any potential for abatement in the inflation. The external
factors are not conducive either for reduction in inflation. World crude oil price is fast approaching USD.100 per barrel and world prices of wheat and milk powder
are on the rise. Oil and wheat are entirely imported and over 80% of the milk powder is imported. Therefore, domestic and external factors are not favourable for
reduction in inflation. The tight monetary policy pursued by the Central Bank since the beginning of 2007 seems to have negatively affected economic growth whilst
not reducing inflation.
The writer is Principal Researcher, Point Pedro Institute of Development, Point Pedro.