Subsidies for the people are by the people
The responses to Budget 2006 have been varied. This is as expected, since political and other biases cloud assessments of budgets. What is, however, unusual is that many made the Budget a sacred cow no sooner it was presented by the President in Parliament.

Initially criticism of it was at best muted. Most comments were favourable. Even the main political opposition chose to be cautious in its comments and criticisms and to refrain from voting on it. Some prominent members of the UNP even praised it in front of television cameras.

The Speaker of the House chose a ceremonial function to shower praise on several of its proposals. Leading businessmen and industrialists have spoken well of the Budget.

One leading private sector spokesman said he was relieved that the budget deficit was contained at 7.3 per cent of GDP. Another thought that the higher corporate tax rate of 35 per cent was worth bearing in the interests of the pro-poor proposals.

These cautious comments and praise have unfortunately been made for the wrong reasons. They have also been quite superficial. They do not get to the fundamentals of a budget scrutiny.

The praise of the Budget from government MPs, ministers and sycophants is to be expected. How is it that opposition politicians (who generally tend to criticise everything that a government does) are quite sympathetic to the Budget proposals?

The reasons are easy to comprehend. A politician's eye is on the electorate. Popularity is their only concern; not the economics of the Budget nor the repercussions of budget proposals on the economy and society in the long run.

To speak against the welfare measures and subsidies is politically suicidal.
Opposition politicians despite their desire to oppose the government must not seem to oppose the welfare measures.

In fact they may soon say that more should have been given. The economics of the proposals are of no consequence to them. How could a politician oppose increases in Samurdhi payments when nearly half the population is receiving them?

How could they oppose the mid-day meal for school children and face the next polls? How could they oppose the recruitment of 50,000 youth, including 10,000 graduates into the public service?
These are valuable votes that they must garner.

Supporting the welfare measures at this stage is vital for political strategies. Criticisms of the defective implementation would be their strategy sooner or later.

Unmistakably there are other reasons as well. There may be a genuine feeling even among opposition members that some of the welfare measures and increased social expenditures are good. There is also a lack of understanding of the economics of the fiscal proposals.

The implications and impacts of welfare measures are not ones that many comprehend. Reared in a welfare state and socialist ideological mould, many believe that the state is able to dole out largesse on the people without adverse effects.

Fiscal imperatives and the impact of excessive expenditure are not understood. Milton Friedman's concept that there is no such thing as a free lunch is alien to them.

They and people on the whole do not understand the reality that subsidies of the government for the people are given by the people themselves.
In a country where income tax payers are few, the costs of the subsidies have to fall on the poor who pay indirect taxes or are affected by the inflationary impacts of the proposals.

It is likely that even the World Bank and the IMF may shower praise though with some caveats like the need to ensure that the Budget deficit must not be allowed to rise above the stipulated deficit indicated in the budget and that fiscal discipline is essential to avoid inflation. It is unlikely that they would make a more direct frontal criticism as it may be interpreted as opposition to pro-poor policies.

Poverty reduction being a foremost buzzword of these agencies requires that they be silent on the pro-poor expenditure proposals that are significant contributors to the deficit and therefore inflation. Whether they would adopt this approach in public is still to be seen.

For these reasons we are not likely to have much meaningful criticism of the Budget. This means that the fundamental weaknesses of the budget will hardly be discussed even in parliament, save by a few. Therefore the fundamental weaknesses of the Budget require to be stated very clearly. The budget deficit of 7.3 of GDP is deceptive.

The actual budget deficit in the budget is in fact 9.1 of GDP. There is no economic and financial sense in keeping the tsunami component separate, except to indicate that 1.8 per cent of the deficit is due to Tsunami expenditures.

Most assessments of the budget take the view that the final out-turn of the budget would be a higher deficit. If the expenditures proposed in the budget are carried out and the revenue expectations fall short, as has happened in every recent year, then the deficit must indeed reach two digit proportions. There is the likelihood that the expected revenue is unlikely to be realised.

A rise of about 2 per cent or more of GDP in tax collection is indeed ambitious and unrealistic with the given tax measures and the tax collection administration. It is more likely that revenue would be 16 per cent or less of GDP. On the other hand, there is every possibility that expenditure would rise above the budgeted figures, even without an escalation in defence expenditure.

Were defence expenditure to rise, a not unlikely prospect, then expenditure could rise by 1 to 2 per cent of GDP thereby raising the deficit by that extent. Another variable that has not been factored in is the possibility of further increases in oil prices. If current policies of subsidisation were to continue in the face of higher import costs of petroleum, then the expenditure would rise. The subsidy on fertiliser too would be more than that calculated at current price levels.

The increased corporate tax rate would yield an increase in revenue only if corporate profits rise. The tax rate itself will be a disincentive for this and it can well be that the revenue collection from corporate taxes would decrease rather than increase. Even if this were not to be so, the increased taxation implies that corporate investment would be reduced due to this disincentive effect, as well as the lesser funds available for investment.

It is unfortunate that corporate taxation rates were increased as a stable corporate tax rate of 30 per cent gave a much-needed certainty about taxes. This was a stabilising effect on investment decision-making. The reduced investment implies a slower growth in the future, even though this effect will not be immediately evident. Corporate investments could be further dampened if the higher budget deficit leads to inflation and in turn higher interest rates to curb inflation. What this implies is that there are factors in the budget that would slow down growth rather than increase the growth momentum.

The fundamental problem of Sri Lankan budgets has been the excessive costs on what may be termed unproductive expenditures. These include a huge expenditure on the salaries of an overstaffed public service and increasing pension payments, massive defence expenditure, large debt servicing payments, consumer subsidies and poorly targeted welfare measures.

The extent of expenditure on these is excessive. Some of these such as the Samurdhi and expenditure on salaries, that required to be pruned, have been increased substantially by this budget. The inevitable consequence is inflationary pressures, higher public debt and lower growth. There are also adverse implications of these expenditures on the trade balance, balance of payments and the exchange rate. These are well known by the economic advisors of the government, who have to work within the imperatives of the Mahinda Chintanaya.

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