Thursday, 29 May 2014

Meeting Expenditures

Published in Money Matters on 19 May, 2014

The government’s basic motive behind tax collection is the provision of certain facilities, such as national defence, public parks, roads, etc, but it is not necessary that it benefits every individual.

Another important motive of tax collection is redistribution of resources among the society. For example, government spends taxpayer money by providing free education and/or free health and/or better roads, and/or libraries, etc. Therefore, the ultimate objective of tax collection is to re-spend on the people living in the society.

Tax as well as expenditures, if equal, we can achieve a balanced budget, which according to common perception is the best policy. But is it? At micro or individual level is it possible to spend more than the income. For a salaried person the answer is “no”. Think again, can we spend more than our income? My answer is “yes”. One might ask how. The answer is by borrowing. So, the next question would be, how do we pay back and from where does the money come from. The answer lies in the mode of spending. If there is no pay back on our spending in future then we are in trouble. On the other hand if our income increases in future then we are maximising our utility.

Same is true for the overall economy. Capital expenditures payback, but current expenditures do not. Deficit financing through different modes of borrowing would be beneficial if it contributes to the future income. However, not all the current expenditures are bad because most of the current expenditures compliment capital expenditures, such as maintenance, cost of schools, hospitals, libraries, salary of teachers, doctors, nurses, and administration, etc.

Let’s go back to the original problem of having low tax revenues that lead to higher budget deficit, since government needs to spend more on various sectors. For now, the government is looking forward to increase education expenditures to four percent by 2018; as promised in the elections by the Pakistan Muslim League-Nawaz (PML-N). Currently we are spending only 2.2 percent of GDP. Our total tax revenues are 8.7 percent of GDP. This implies that we are spending 25 percent of our total tax revenues on education. 

For the sake of information, 25 percent of total tax revenues or 2.2 percent of GDP is Rs600 billion, which the government spent on education last year. In terms of per capita it is Rs3,243 considering the total population equals 185 million. Interesting would be to see the breakdown of the money spent each year on education and more interesting would be to see the effectiveness of that money.

The announced four percent requires another Rs500 billion if it’s spent today. This implies that it will become Rs 1,100 billion, which accounts for 44 percent of the total revenues. The question arises whether the promised four percent is possible when a higher share of budget is going to the national defence and debt servicing, since our total tax revenue as a percentage of GDP has been continuously declining for the last several years.

 If the ratio remained at 8.7 percent , then we are going to spend little less than half of the total tax collection. Is it possible? The answer would be why not? We can just increase our expenditures by 1.8 percent and achieve the target of four percent of GDP.

Budget 2013-14 allocates Rs3,985 billion expenditure for both current and development expenditures. Total FBR tax revenues estimate of the current fiscal year are Rs2,475 billion. Therefore to add Rs500 billion we need to borrow more. However, the payback for the extra Rs500 billion will depend on the mode of spending and effectiveness of spending. If increase in education budget leads to increased productivity in future, then we can spend more by borrowing more.

One way is to raise tax revenues. How? Putting more taxes; I believe there are enough taxes on the entire nation. Another famous way is to increase tax base; we have overall low average incomes and most of the people are not in the tax bracket. Moreover, increasing sales tax would penalise the average taxpayer.

Total current expenditure is around 80 percent of the total expenditures. Therefore, reducing current expenditures especially untargeted subsidies would help in creating more fiscal space. More importantly, we spend too much on the #PerksProtocolPlots which was coined by Dr Nadeem-ul-Haque few months ago and he has been continuously saying it on social media. Abolishing #PerksProtocolPlots will have multiple benefits; it will reduce the insignificant expenditures and more importantly it gives incentive to those who avoid paying taxes.

Consequently, by abolishing spending on #PerksProtocolPlots we are saving good amount of money to spend on education and other social and productive sectors. It will also help in achieving the actual goals of collecting tax revenues.
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