Mahoshada

Feudal Master or Servant to the People?

Even the language used in presenting and discussing the government’s budget tends to be misleading.  We speak of the government granting relief and providing benefits to the people, implicitly casting the government as a sovereign that essentially “owns” all of the income and property of the people of
Sri Lanka.  With such a perspective, we should be grateful for whatever benefits or relief might come our way.

The alternative view is that incomes and the property that is in private hands are owned by individuals.  The people, through their elected government, collectively decide what they activities they wish the government to undertake and how they intend to pay for these services.  According to this perspective, the government is in fact the servant of the people. 

The government has come to play such a major role in the economic life of the country that it is easy to overlook the fact that everything that it does is paid for by the income generated by the efforts of those working in the private sector.  Furthermore, every man, woman and child in
Sri Lanka is paying, in one way or another, to sustain the government.  Unfortunately, a great many people seem to fail to realize that with virtually every rupee they spend to purchase food, transport, clothing or the other necessities of life, they are paying higher prices so that some part of what they spend can be taxed to fund government. 

This mistaken belief rests on the misconception that if we do not “see” the tax, then we are not being taxed.  It is a fact that for every rupee collected through direct income taxes, almost five rupees are collected indirectly through taxes that are largely hidden in higher prices.  While only a relatively few people actually pay income taxes, everyone is a consumer and hence a taxpayer.

Perhaps if people were more fully aware of the taxes that they are actually paying and recognized that they are in reality paying for everything that the government is “giving” them, they might be less inclined to see the proposals being put forward as benefits and relief. 

Benefits and Costs: Who Gains?  Who Pays?

In every country politicians like to present themselves modern day “Robin Hoods” – taxing the rich and giving to the poor.  The reason is simple; there are more votes among the poor.  And this budget is no exception.  As the President said in the Budget Speech:

“…relief offered in this budget is essentially for those who deserve it.  Fertilizer is offered to paddy and vegetable farmers who earn much lower income than other agricultural producers.  Nutritional food and other relief are also targeted to the poorer segment of our society.  Fuel subsidy will be given to three wheeler operators, pubic transport and fisheries sector in order to ensure budgetary expenditure of Rs 3,000 million on such subsidies will provide relief to low income groups only.”

It would be laudable if in fact measures such as these actually benefited the very poor in some substantial way.  It is well known that subsidies, such as that provided for fertilizer, seldom reach the intended beneficiaries.  It is often the case that the benefits are absorbed in the marketing and distribution process – “unscrupulous middle men” are usually blamed. 

Another reason why the intended beneficiaries in the end fail to see much of promised value of the subsidy is because of the difficult and usually very costly administrative procedures imposed by the government in delivering the subsidy.  What sort of administrative controls are going to be required to ensure that subsidized fertilizer goes only paddy and vegetable farmers and not, say to coconut growers?  We cannot say yet what procedures poor farmers will be required to go through to actually buy the cheaper fertilizer, but it is a good bet that it will be both a time consuming and costly process.  (Such procedures are themselves good “fertilizer” for growing corruption.) 

Indeed, there seems to have been little thought as to whether the Rs 8.5 billion proposed for fertilizer subsidies is actually the best way to provide financial support to poor farmers.  Straightforward analysis shows that the relative cost of fertilizer as an input by paddy farmers is relatively low.  Ministry of Agriculture data shows that total fertilizer costs, for all types, amounts on average to about 8.5 percent of the value of paddy produced.  In other words, say the farmer is producing on average Rs 25,000 worth of paddy per acre.  Total fertilizer costs would be about Rs 2,130 per acre.  (Other production costs would be slightly more, about Rs 6,880 including power.)  As a result, the farmer makes about Rs 16,000 per acre.  Any changes in the fertilizer subsidy, even very large changes, will not have much of an impact on his income. 

 If look past the politics of this policy, the economics are reasonably clear.  This sort of subsidy costs a great deal to maintain, including very high implementation costs.  And in the end it delivers only very limited financial benefits to the farmer.  It remains in place as a policy only because of the perceived political benefits that it generates.

Higher Fuel Prices?  It is also worth noting that this budget has evidently retained the commitment to substantially reduce fuel subsidies in the new year.  The government proposes to provide Rs 3 billion in targeted subsidies for three wheel operators, public transport and fisheries.  It is, however, not mentioned in the budget speech that currently the government is spending an estimated Rs 20 billion per year in maintaining fuel subsidies – mainly for diesel and kerosene.  Cutting this by 85 percent can only lead to much higher fuel prices.  And since diesel fuel for buses and three wheelers can be utilized in other vehicles, there will also be considerable challenges in administering such a subsidy scheme, as in the case of fertilizer. 

No doubt to the farmers the fertilizer subsidy looks good.  And to the three wheeler drivers, subsidized fuel appears to be a useful benefit.  But the shine on these benefits lasts only so long as they remain under the illusion that they are not paying the cost of these benefits.  If they knew how much they were paying in hidden taxes, these benefits might not be nearly so attractive.

For the politicians seeking voters’ support, there are indeed many more poor people, prompting the outpouring of promised benefits and relief measures.  However, politicians are usually also seeking financial support.  And since the rich have more money and are not keen to pay taxes, governments also aim to provide them with ample benefits and relief – usually in the form of tax concessions and exemptions.  As a result, it is for the most part not the rich paying for these subsidies and schemes; it is generally the poor and middle class that bear a disproportionate share of the total burden. 

A High Growth and Development Budget?

One of the pillars of the economic promises included in Mahinda Chintana is achieving and maintaining an annual growth rate of at least 8 percent.  This is critical because it will be only through high growth that the numbers of new jobs needed would be created and the resources required to meet the country’s social and economic development goals could be generated.  And the only way to make substantial progress in reducing poverty is through sustained higher growth.  When all is said and done, the economic welfare for the people of the country derived from higher growth far outweighs the value of the benefits of all of the benefits and relief measures included in the budget. 

One way in which the budget should be judged is on the basis of whether it can be expected to provide a sound basis for higher growth.  Unfortunately, it appears that when assessed in this light, the budget fails for a number of reasons.  First, the projected deficit represents a significant increase over recent years.  When everything is taken into account, the projected deficit would be more than 9 percent of GDP.  (What sense does it make to consider the “non-tsunami deficit”?  One might as well consider the “non-security forces deficit”).  And it is a very safe bet that the actual deficit for the year will be even larger than the projections.

Financing this large deficit will absorb nearly Rs 200 billion of savings that could otherwise been used to invest in the country’s productive capacity.  Not only will those savings be lost, but the added public debt will be a burden on the economy for years to come. 

A second way that the budget will work against increasing the growth rate is that it proposes to increase taxes further on the productive part of the economy.  Examples include increases in personal and corporate tax rates and an increase in the rate of VAT on financial services.  These and other changes will make
Sri Lanka a less competitive location for investment as a result of what will be higher costs of doing business.

All of these factors suggest that under the policies embodied in this budget the country will find the challenge of increasing economic growth even greater than it has been in the recent past.  Even maintaining the current rate of growth may be difficult. 

International Score Card

 Coincidently, the results from country’s recent efforts to obtain a sovereign rating were announced the same day as the budget speech was presented.  Both Fitch and Standard and Poor’s provided ratings that can best be viewed as mixed – below investment grade level and short of a loud and clear endorsement of the financial strength and capacity of the government.  A Senior Director of Fitch was quoted as saying: 

 “Sri Lanka has proved resilient to adverse shocks over a long period of time, its institutions are strong and it has an unblemished debt service record.  However, weighing in the balance are concerns about public debt sustainability, weak coalition governments that have impeded fiscal consolidation and the absence of an enduring solution to a long-running civil conflict.”