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Political economy of the budget

Published on 27th Oct, Edition 43, 2014

 

Unrealistic revenue targets weigh on trade and industry growth

It rightly said that the budget is the most powerful fiscal instruments at the disposal of the government to implement political commitment and development agenda made public during electioneering campaigns; however the story takes a turn when a political party voted to power.

Almost every democratically elected government made promises rather tall claims to take care of Public Sector Development Program, health and education and never tired in advocating the significance of raising living standard of the masses through PSDP, education in building up the nation with ensured economic and political stability. It is unfortunate that the budgetary allocations for PSDP most of the time remain short to the target primarily due to lack of sincerity of the purpose. A major chunk of government spending goes under Larkana, Lahore, Gujrat and Multan packages!

Recently Dr. Ashfaq H. Khan former economic advisor to the federal government, special secretary to the minister for finance and spokesman on economic affairs and currently the Principal and Dean, School of Social Science and Humanities (NUST) while speaking at the launch of third edition of UNDP’s Journal Development Advocate Pakistan on “the political economy of the budget,” said projecting budgetary targets with a fair degree of accuracy is an essential element of sound fiscal management and therefore of maintaining fiscal discipline in the country. Pakistan has failed to do so for the last several years and has suffered all of the associated adverse consequences. The event was organized by SPDC in collaboration with UNDP in Karachi, last week.

Why has Pakistan been setting unrealistic revenue targets for so many years? Why has targeting revenue become an irrelevant budgetary exercise? The answer lies in the manner in which budgets are prepared, he remarked.

The budget deficit is a negative number because expenditure always exceeds revenue in Pakistan. The government finalizes its expenditure plan while preparing the budget, particularly the Public Sector Development Program (PSDP).

It may be mentioned here that while the PSDP is exclusively designed for development projects, a large chunk of the budget goes for meeting the political expenditures of the power based locations such as Larkana, Raiwind or other interests. It is unfortunate that the large scale industries especially linked with conduction and development sector keep on attaching hopes that the trickle effect of PSDP will help economic activity at the industrial level, yet the development plan most of the time is revised downward at the cost of industrial growth and economic activities vitally important for equitable participation in the national resources.

Coming back to Dr. Ashfaq vision about political economy of the budget, he said that the budget deficit is a negative number because expenditure always exceeds revenue in Pakistan. The government finalizes its expenditure plan while preparing the budget particularly the PSDP. Given the budget deficit target agreed upon with the IMF, it then derives revenues as residual item. In other words, the revenue target set by the government is invariant with respect to level of economic activity.

Budget making exercises in Pakistan are therefore expenditure planning exercises. The government finances its development spending by ensuing that projects support by influential leaders e.g. the Larkana, Multan and Gujrat packages, receive adequate funding in the budget. Current expenditures are quite inflexible once the PSDP is finalized. However, power sector subsidies are often grossly understated in the current expenditure.

Dr. Ashfaq said that the budget deficit, a figure agreed upon with the IMF. In other words revenue is treated as residual rather than dependent on projected economic activity. Interestingly, one speaks of tax to GDP ratios without realizing that tax target setting has little to do with economic activity level. The tax to GDP ratio remains unchanged by and large, irrespective of economic growth.

Unrealistic revenue targets, exacerbate fiscal indiscipline affect the quality of spending. What are the drawbacks of setting unrealistic revenue targets in the budget? First provincial budgets account for revenues allocated under the National Finance Commission (NFC) Award. Since transfers to the provinces are based on actual collection ‘ with the exception of Balochistan ‘ overambitious targets set by the Federal Board of Revenue (CBR) inflate provincial revenues as well. Expenditure plans are actually prepared on the basis of an inflated revenue picture. This means that massive revenue shortfalls begin taking place from day one, it becomes difficult for provinces to roll back or scale down expenditure plans in such a revenue situation. This may lead to fiscal slippages.

Second, the federal government is required to transfer funds to Balochistan under the NFC Award on the basis of projected revenue which is not actual collection. For example Balochistan’s share was calculated as Rs133.3 billion on the basis of an unrealistic revenue target of Rs2,475 billion in the budget for 2013-14. The federal government collected far less than the targeted revenue and likely paid the remainder from its own resources, shrinking them further.

Third, it has been observed that the FBR attempts to achieve these unrealistic revenue targets by holding refunds back, forcing commercial entities to pay taxes in advance. Such practices can have serious effects on companies’ liquidity and hamper business activity.

Fourth, budget deficit targets set by the IMF force the federal government to release resources in such a way that the provinces are unable to spend this revenue in time. Such a method of resource release is bound to affect social sector spending and Millennium Development Goal progress, now that the 18th Amendment to the Constitution of Pakistan has shifted social sector development responsibilities to the provinces.

Fifth, the federal government encourages the provinces to not spend money by giving them a three-month treasury bill interest rate on their cash balances. This is a perverse incentive with long term implications for human capital and economic growth.

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