New budget, old story
Budget 2004 was overshadowed by other political developments and a controversial statement of the Speaker. As expected it did not address the fundamental problems of fiscal consolidation to any significant extent.

It followed the pattern of previous Budgets in Sri Lanka that focus mainly on giving benefits to the people, not the costs and sacrifices that they must bear to bring the economy out of its current fiscal abyss.

The figures of the budget for 2004 were conditional on peace and the continuation of economic growth. Without a higher level of output, revenue shortfalls are inevitable. The containment of the budget deficit would be impossible and the much-needed fiscal consolidation for growth impossible. In any event several of the budget figures are suspect. The Finance Minister said the public debt would be brought down to 100 per cent of the GDP. This is unlikely given the increase in the debt this year and the shortfall in revenue that he admitted. The revenue proposals for next year too seemed shaky.

The Budget proposals increased salaries and pensions of public servants and the subsidy on fertiliser was increased substantially. Other subsidies are also proposed. It is not that these are not justified, but their costs add to the already burdened state of public finances.

The inadequacy of tax revenues has been at the crux of the problem of managing the public finances of the country. Revenue as a proportion of GDP has been declining in recent years. It decreased from 18.5 per cent in 1997 to 16.7 percent in 2001 and to a low 16.5 per cent in 2002.

Revenue collection this year fell far below budget expectations. This shortfall in revenue collection in the past few years is due to the ineffectiveness in the administration of the VAT, an inefficient Inland Revenue administration, tax loopholes and exemptions and concessions.

In order to correct this declining revenue collection trend, the Minister proposed several new measures. The two-tiered VAT rates of 10 and 20 per cent were to be consolidated into a single rate of 15 per cent. How this would increase revenue is not clear as the problem lay in the inefficiency of the collection process.

The withholding tax on interest income was to close a tax loophole. Implemented at a time when interest rates are low and with the same inefficient tax administration, this measure is not likely to yield much. Whether the 51,000 tax amnesty beneficiaries are likely to bring in anything substantial is yet to be seen.

They will most likely find ways and means of tax avoidance once again. Taxation of a larger number of companies, partnerships and proprietorships is likely to face stiff opposition from business quarters that it is a regressive tax and may even be dropped before implementation.

The threshold for income tax payers was increased from Rs. 240,000 to Rs. 300,000 and income tax bands were widened. This is indeed reasonable, though there may be a fall in revenue. Increased tax revenues are mostly based on the expectation of higher economic growth, that appears less certain with the political crisis and possible disarray of the peace process, reduced aid and lesser investment flows.

Equally important is the need to reduce government expenditure. Despite successive governments stating their intentions to reduce expenditure, they have failed to rein in public expenditures within the limits imposed by revenue collection. Current expenditure has been high and rising from 18.7 per cent of GDP in 1999 to 21.6 per cent in 2001.

The budget proposal to reduce the number of public servants through a Voluntary Retirement Scheme (VRS) may have an impact in the long run, but the generous VRS scheme nearly equivalent to salary expenditure, is not likely to be of much benefit in reducing expenditure in 2004.

The Fiscal Management Responsibility Act (FMRA) enacted in December 2002 sets a medium-term fiscal deficit reduction path. The Welfare Benefit Law (WBL) passed in September 2002 is expected to reform the welfare system with better targeting.
The government hopes to improve tax administration by the establishment of a Revenue Authority. These are good intentions but will they be implemented soon and effectively?

The current fiscal situation is alarming with the public debt continuing to be greater than the GDP and the debt servicing costs higher than the total revenue for the year.
The country is like a household that has to spend its entire income on repaying debts and interest costs and having to borrow more money to exist. It has become a vicious cycle. Unless some bold actions are taken to reduce the debt burden, the debt servicing costs would cripple the growth efforts.

This massive public debt absorbs a disproportionate share of public resources as debt service payments rendering fiscal management extremely difficult. In 2002 debt-servicing costs were Rs.284 billion, compared to total government revenue of only Rs 261 billion. In other words the entirety of government revenue was inadequate to service the debt.

The debt servicing cost exceeded revenue by about 10 per cent. Regrettably, the situation is not likely to be better at the end of this year, though the Finance Minister's expectations are more optimistic.

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