Much of the criticism of the interim budget has been based on it being a populist budget owing to its price reductions, relief measures, salary increases and some new taxes. The interim budget must be viewed within the context of a political strategy to defeat a regime that was characterised as corrupt and autocratic, and [...]


Short-term expediency unavoidable: Long-run economic governance imperative


Much of the criticism of the interim budget has been based on it being a populist budget owing to its price reductions, relief measures, salary increases and some new taxes. The interim budget must be viewed within the context of a political strategy to defeat a regime that was characterised as corrupt and autocratic, and one that had made the country heavily indebted.

The strategy to overthrow the former regime had to have an economic appeal. In as much as bribery and corruption and good governance were key promises in the election manifesto, bringing down the cost of living was an important promise that had wide popular appeal as the cost of living had become onerous to the common man, even though official indices repeatedly showed low rates of inflation.

Increased expenditure
Political expediency will determine the course of financial management till after the parliamentary elections later this year. The Government will continue taking popular measures the additional costs of which would be a financial burden, not only in 2015, but in the future as well. The increases in salary are a good example of this. Furthermore, some ministers are making rash promises that could impair public finances irreparably.

Weaken public finances
Imprudent built-in committed expenditures could render the proper management of public finances more difficult. In as much as these expenditure increases would create a dent in the public finances of the current year, they would have serious impacts on future public finances as well. The salary increase would have expenditure increases for future years.

The pertinent question is whether the interim budget and further relief measures would weaken prudent management of public finances and harm the investment climate. Undoubtedly, serious economic management of public finances would be possible only after the parliamentary elections are over and a new government that realises the crucial importance of good management of public finances is ushered in.

Such a government would have to ensure that the macroeconomic fundamentals are improved and business confidence is restored while there is efficient management of public enterprises.

Interim measures
Several significant corrective measures have been taken to improve the fiscal balance. They include cutting down wasteful government expenditure, such as the exorbitant expenses on the President, foreign and local travel, reduction of the number of ministers and likely reduced expenditure on government infrastructure projects.

State enterprises
Loss-making enterprises are a huge burden on the public finances. Most loss-making enterprises were managed by incompetent personnel, who were not concerned about the efficiency of the enterprises. SriLankan Airline and Mihin Lanka were glaring examples of such mismanagement.

Most state enterprises were incompetently managed and their efficiency could be improved to lessen the huge losses that are a heavy burden on state finances. The reports of the Committee on Public enterprises (COPE) provide a basis on which remedial measures could be taken. The replacement of incompetent persons from management of economic enterprises could reduce losses, but the reforms needed are far more extensive.

Efficient management within the public sector is inherently difficult to achieve. Privatisation of some state owned enterprises offers the best means of reducing losses as well as gaining from the proceeds of their sales. This is difficult owing to ideological reasons and its unpopularity. However, it is significant that the Chandrika Bandaranaike Kumaratunga’s government adopted a pragmatic policy of privatisation that improved public finances.

Increasing government revenue has been recognised by the Government as important. It should, however, be done in a systematic manner that ensures that there are no disincentives for investment. The taxation measures introduced by the interim budget were hastily drawn up violating basic principles of taxation. Some taxes may require reconsideration, adjustments and perhaps even change.

The taxation system must be reformed to increase the coverage of corporate, personal and indirect taxes in a progressive manner with heavy expenditure taxes on luxury consumption items rather than ad hoc and targeted taxes. A comprehensive taxation system consistent with the administrative capacity of the tax collecting agencies is much needed. The expected revenue to GDP ratio of 14 per cent in 2014 is below levels of countries with Sri Lanka’s per capita income. Tax exemptions, avoidance and tax evasion are important account for this shortfall in revenue.

Tax reform
The Government has recognised the need to increase government revenue and said so in its initial discussions with the IMF. A systematic and pragmatic system within the capacity of the administration to implement, rather than a theoretically sound system that advanced countries implement are needed. The simplification of the tax structure and the strengthening of the tax collection capacity are needed to achieve a higher tax to GDP ratio.

Taxes that can be collected at source and systems to avoid taxes must be devised. A well-known fact is that some of the highest earners are paying very little as direct personal taxes. A progressive system of personal taxation has to be complemented with progressive indirect taxes especially on conspicuous expenditures. The long-term perspective must be to devise a taxation system capable of raking in about 20 percent of GDP.

Concluding observations
The hastily compiled interim budget had to fulfil the promises made to reduce prices, increase wages and increase expenditure on education, health and welfare. It was part of the political strategy to regain good governance. These interim measures would continue to be costly beyond this year’s finances.

The expenditure on salaries and pensions, that is the second highest expenditure after debt servicing costs, would rise further from 2015 onwards and be a heavy burden. Fortunately, there were extravagant government expenditures that could be cut drastically to bring down public expenditure from the original estimates of the 2015 budget. Expenditure cuts on wasteful government expenditure has been drastically curtailed, Losses of public enterprises must be reduced through better management of these and expenditure on infrastructure has to be cost effective, carefully done with consideration of costs and benefits. All these are needed to ensure that the fiscal deficit is reduced well below its current levels.

Good governance of public enterprises, prudent and careful public expenditure and more efficient taxation is needed to ensure proper fiscal management. Such a comprehensive fiscal strategy is unlikely in an election year. It is the challenge of the government that prepares the Budget for 2016 later this year.

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