The most fundamental economic problem that must be resolved is the containment of the fiscal deficit. The increasing public debt, foreign debt and trade deficits are closely connected with, and arise to a large extent from, the continuing fiscal deficit. Bringing down the fiscal deficit to 5 per cent of GDP or below is essential [...]


Containing fiscal deficit critical for economic stability and growth


The most fundamental economic problem that must be resolved is the containment of the fiscal deficit. The increasing public debt, foreign debt and trade deficits are closely connected with, and arise to a large extent from, the continuing fiscal deficit. Bringing down the fiscal deficit to 5 per cent of GDP or below is essential for economic stability and growth.

Economic problems
Containing the fiscal deficit is vital as a high fiscal deficit has serious repercussions on the economy. It creates inflationary pressures, increases the public debt and foreign borrowing and leads to higher trade deficits. A large fiscal deficit generates inflationary pressures that increases the cost of living and causes severe hardships, especially to the lower end of wage earners and fixed income receivers. The increase in costs of living leads to demands for higher wages and industrial unrest.

Wage increases add to the costs of production and erode the country’s competitiveness in international markets. This necessitates the depreciation of the rupee to remain competitive with other countries that have lower rates of inflation. Otherwise, the lesser export earnings would increase the trade deficit and strain the balance of payments, as is happening currently. Then again, depreciation of the currency to restore export competitiveness leads to further inflation and increased hardships for people.

Debt servicing
Large persistent fiscal deficits lead to borrowing that increases debt and debt servicing costs. The public debt that was as much as 74.3 per cent of GDP in 2014 is likely to be higher this year owing to further foreign and domestic borrowing and slower growth in GDP.

Debt servicing costs absorbed nearly the entirety of government revenue last year when 95 per cent of revenue went for servicing the public debt. In 2013 total government revenue was inadequate to service the debt as debt servicing costs were 105 per cent of revenue. This distorts public expenditure priorities as there is little or no fiscal space for developmental expenditure other than by domestic and foreign borrowing.

Reduction of deficit recognised
Bringing down the fiscal deficit has been recognized as an economic imperative for a long time. Yet there haven’t been adequate measures on the revenue and expenditure sides to bring it to manageable proportions. Annual targets have been set but never attained. Although the fiscal deficit target of 5.2 percent of GDP was set in 2014, it turned out to be 6 percent of GDP, higher than that of the previous year.

Fiscal deficit 2014
As the Central Bank Annual Report for 2014 stated, “the government expected to reduce the budget deficit to 5.2 per cent of GDP in 2014 from 5.9 per cent of GDP in 2013 and to contain the central government debt to GDP ratio at 74.3 per cent by end 2014 compared to 78.3 per cent recorded at end 2013. However, a notable deviation from the fiscal targets was observed with the budget deficit in 2014 rising to 6.0 per cent of GDP, reversing the declining trend experienced in the past few years.” This outcome was due to a shortfall in tax revenue even though recurrent expenditure fell owing to lower interest costs on government financing and the curtailment of capital expenditure to cope with the shortfall in government revenue.

Prospect in 2015
With nine months of 2015 already completed there is little likelihood of this year’s deficit being 5 percent of GDP or below. The latest statement of the IMF has said that it is likely that the fiscal deficit would be about 5.5 percent of GDP. There is every possibility that it may even exceed this unless the new revenue measures are implemented soon to enhance government revenue.

New taxes
These are the imposition of a Mansion Tax, Migration Tax and the Super Gains Tax that falls on a company or individual whose profit before tax exceeds Rs. 2,000 million. This and six other bills aimed at raising revenue were presented to parliament by the finance minister last week. The amendment to the Finance Act provides for the imposition of Bars and Taverns Levy, Casino Industry Levy, Super Gains Tax, Mobile Telephone Operator Levy, Direct-to-Home Satellite Services Levy, Satellite Location Levy, Dedicated Sports Channel Levy, Mansion Tax, Migrating Tax and the Motor Vehicles Importer Licence Fee. The Direct-to-Home Satellite service levy of Rs 1,000 million will be imposed on every person in the business of providing Direct-to-Home services through satellite having more than 50,000 subscribers in Sri Lanka. The Migrating Tax will be charged from any citizen of Sri Lanka who permanently leaves Sri Lanka, at the rate of 20 percent of the foreign exchange released to be taken out of the country by such citizens.

How much these taxation measures would yield this year and in the long run is uncertain. These are wrong steps in the right direction. What are needed are tax reforms that are able to minimise tax avoidance and tax evasion and to rationalise tax exemptions. A more systematic tax structure that yields higher revenue is needed.

Summing up
Containing the fiscal deficit is vital for economic stabilization and growth. The huge accumulated debt and debt servicing costs are a result of persistent deficits over the years. It is important that revenue is increased substantially and unproductive and wasteful government expenditure is pruned down to contain the fiscal deficit. Bold taxation measures that fall on the affluent rather than regressive indirect taxes on the poor must be adopted. On the expenditure side, there is a need to cut the huge losses in state owned enterprises and where reforms are unlikely to succeed the option of privatisation must be pursued.

The recent ad hoc tax proposals aimed at particular sectors and types of firms and individuals must be replaced by comprehensive tax reforms. In as much as policies that eliminate or reduce tax exemptions, tax avoidance and tax evasion must be implemented, tax reforms must take cognizance of an inefficient tax administration and design taxes that can be collected.

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