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The political economy of the budget

John Maynard Keynes once stated that instead of seeking to balance the budget, the government should aim to balance the economy. What he meant was that the budget – as the principal statement of public fiscal policy – should embody an adequate response to the state of the economy. In the face of sluggish economic growth, a deficit budget was in order. In case the economy over-heated, a surplus budget was needed.

Understandably, the government has come out with a deficit budget for FY 2018. For several years on the trot, the pace of economic growth has been rather slow in necessitating the excess of public expenditure over public revenue. Although the economy is projected to grow by 5.3 percent in the outgoing fiscal year (FY 2017) – the highest growth rate in recent years – the total output needs to expand at a much faster pace for an economic turnaround.

For FY 2018, the target growth rate is six percent and forecasts for next two years put the GDP expansion at 6.5 percent and seven percent, respectively. However, against the FY 2017 projected fiscal deficit of 4.2 percent of GDP, the target for FY 2018 is 4.1 percent. In the next two years, the fiscal deficit will further be cut to four and 3.2 percent, respectively. As a result, the government aims to attain higher growth rates coupled with a lower fiscal deficit. This seems to be quite an ambitious target. If the past is any guide, the efforts to accelerate growth expansion will entail a rise in deficit financing.

The budget is not just an economic document, but also a political one that is used to reward, appease or penalise certain constituencies. Powerful constituencies are not only reluctant to contribute to the national kitty as per their income or wealth, but also insist on getting their pound of flesh in the form of big budgetary allocations, subsidies and tax exemptions. The result is a gross misallocation of resources as well as rampant tax evasion and avoidance. Both the economic and political aspects of the budget reflect the constraints within which every government works.

A narrow fiscal space is a perennial constraint on budget-making. A massive domestic and external public debt, which has reached 61.3 percent of the GDP, makes debt-servicing invariably the single largest item on the spending list. For FY 2018, Rs1.64 trillion – which account for 34.5 percent of the total estimated expenditure of Rs4.75 trillion – have been earmarked for the repayment of interest and principal on domestic and external debt. The sum allocated for debt-servicing is Rs220 billion less than the revised estimates on the same head for the outgoing fiscal year.

Defence will soak up Rs 920.16 billion, which accounts for 19.4 percent of total expenditure, while Rs 624.8 will be spent on running the affairs of the government – including the provision of salaries and pensions. Meanwhile, Rs 138.8 billion has been allocated for food and power sector subsidies. As a result, the four items – debt-servicing, defence, civil administration and consumer subsidies – which add up to Rs3.32 trillion, account for nearly 70 percent of the total expenditure. The government’s discretion to spend the public resources starts only after meeting these mega expenditure items.

For many years, the country has been facing an existential threat at the hands of terrorists. This has made it necessary to step up the security-related expenditure and also disrupted economic activity. Between 2001 and 2017, cumulative economic losses worth $121.13 billion have been caused by the terrorism menace. This figure is more than double the country’s total external debt of $58.4 billion and constitutes clearly more than one-third of the outgoing fiscal year’s total GDP. Economic turnaround is difficult in such circumstances.

For the first time in the country’s history, the size of the federal public sector development programme (PSDP) has touched Rs1 trillion – which is Rs285 billion more than the revised allocation for the outgoing fiscal year. The drastic increase in the PSDP size is understandable, as this is likely to be the last budget before the country goes to the polls. There is no doubt that the country needs to spend more on development to accelerate economic expansion and job creation. But if uplift projects are designed primarily with an eye to the elections, they become more of an instrument of political patronage rather than a means of increasing the productivity of the economy.

On the revenue side, a narrow tax base thwarts the government’s desire to enlarge its spending choices. The projected tax-to-GDP ratio for the outgoing fiscal year is 13.1 percent, which – though it represents an improvement in trends as compared to previous years – remains one of the lowest in the world. To plug the revenue-expenditure gap, the government has to resort to borrowing at home and abroad, which adds to the public debt. Not only that, the share of indirect taxes in the total taxes remains disproportionately higher. Out of the total Rs3.52 trillion in the revised estimates for FY 2017, the share of direct and indirect taxes is 1.37 trillion (39 percent)  and 2.14 trillion (61 percent), respectively.

The problem with indirect taxes is two-fold. First, they are inflationary as the price increases are conveniently shifted to the consumers in the form of higher retail prices. Second, indirect taxes are regressive, as consumers pay the same amount irrespective of their income. This is the reason that indirect taxes hit the low-income groups the hardest. Given the country’s political economy, a significant increase in direct taxes is always a difficult proposition. The government, as a matter of course, relies on indirect taxes – such as the GST or import duties – to rake up revenue.

For FY 2018, the overall fiscal deficit is estimated at Rs1.47 trillion, which will be met out of net external financing worth Rs511.4 billion and domestic borrowing that amounts to Rs968 billion. For domestic financing, Rs390.1 billion will be borrowed from scheduled banks while net financing from the central bank will be zero. The major source of domestic financing will be non-bank borrowing (Rs578 billion). Since government borrowing from banks tends to raise the cost of credit for the private sector, the use of non-bank borrowing as the principal source of deficit financing is a good decision.

The Benazir Income Support Programme (BISP) is the flagship pro-poor programme of the federal government. For FY 2018, Rs121 billion have been allocated for the BISP as compared with Rs111 billion in FY 2017. The BISP, which provides direct cash transfers, was started in 2008. It remains to be seen whether it is more of an instrument of poverty alleviation or poverty perpetuation.

However, for certain sections of society – those who are old and sick and can’t work – direct cash transfer is the only viable source of assistance. Salaries and pensions of government employees have been raised by 10 percent. The opposition believes that the increase should have been at least 20 percent. However, the treasury’s argument is that since inflation is in single digit, the pay and pension increase envisaged in the budget is adequate. Be that as it may, the government should have provided greater relief to low-scale employees.

The budget abounds in tax relief measures, whose major beneficiaries are likely to be powerful industrial and farming lobbies. The GST zero-rating for five export-oriented sectors – textiles, leather, carpets, sports goods and surgical instruments – has been retained. The duty-free import of textile machinery will continue and the import of combined harvesters will be made duty-free. Corporate tax will be reduced by one percent.

The writer is a freelance

Email: hussainhzaidi@gmail.com

Hussain H Zaidi, "The political economy of the budget," The News. 2017-06-15.
Keywords: Economics , Economical issues , Economic growth , Economic document , Revenues , Exports , Taxes , John Maynard Keynes , GDP , PSDP