Achieving a balanced budget  
Published by jamaicaobserver.com on Sep 16, 2005
Written by Dennis Chung
Sep 16, 2005

Dennis Chung

Last week the Sunday Herald carried an article entitled "Revenues $5 billion below target". Reference was made to an interview where Dr Omar Davies mentioned that in addition to the shortfall in tax revenues, April to July 2005, of $4.4 billion, there would be additional fallout of $500 million caused by the recent demonstrations.

The July fiscal numbers show that year-to-date, there was a revenue shortfall of $3.6 billion, whereas expenditure was less by only $2.3 billion. This contributed to a $1.3 billion higher than projected fiscal deficit.

The question we must ask is, what can we expect as we move towards the fiscal year -end and what must the Finance Minister do to ensure that we meet the much anticipated and needed balanced budget? If we do not meet the balanced- budget target then we will further delay much of the expected benefits. Dr Davies has also stated his intention to still balance the budget.

Understanding the numbers

In order to determine what is to be done, we must first understand the numbers. The $4.4 billion shortfall in tax revenues is mainly comprised of consumption taxes. This consumption tax shortfall amounts to $3.6 billion, or 82 per cent of total tax revenues. It is represented by shortfalls of $662 million of SCT, $1.6 billion of local GCT, $1.1 billion of GCT on imports, and $169 million on SCT from imports. The shortfall is an indication of activity in the economy. Whereas all other taxes, such as PAYE, lag behind economic activity, consumption taxes are more directly related to current consumption activity.

Consumption activity can be taken as an indication of growth in the economy. The reasoning behind it is that economic growth means more disposable income in the economy which fuels greater consumption, ultimately translating into added consumption taxes. The year-to-date budgeted total for all consumption taxes (SCT and GCT) is $21.99 billion while the actual collections were $18.415 billion or 16.26 per cent less than budget. The budgeted figure would have included the expected rise in consumption taxes due to April's budget increase to 16.5 per cent from 15 per cent.

Even if we were to adjust the figure back to the pre-increase GCT rates, we would have expected a budget of $19.99 billion ($21.99 billion / 110%). This means that even if budgeted at the old GCT rate we would still see a shortfall. This is even further indication that there has been some slowdown of consumption activity in the economy.

Economic activity needed

From this reasoning we can project that government revenues will be affected similarly going forward unless something is done to boost economic activity. In effect what we need to see is real growth taking place. The last quarter's performance of a 0.1% decline in real GDP means that we will have to redouble our efforts to achieve the much needed growth. This, however, is not going to be easy in an inflationary economy where real interest rates are lower than inflation, thus discouraging savings, which economics tells us equals investments. This is evident from the fact that last year when inflation was lower than interest rates we were experiencing greater confidence and economic growth.
In addition to negative real interest rates we still have a relatively stable dollar, which the government seems intent on defending, with good reason as significant depreciation will cause greater inflationary dislocations. Investors are also faced with the uncertainty of investments because of the crime landscape, which has a negative impact on the propensity to invest, especially when one has to deal with extortion. This dilemma causes investors to leave their capital idle while they are trying to make up their mind as to what to do.

To address this, the only logical thing for the government to do is bring inflation back to single digits. This is where the PetroCaribe deal can be of great benefit to us, as the government can use the savings to either (i) roll back the inflationary effects of oil prices; and/or (ii) start to pay down the debt, thus ensuring that more of the budget is freed up for non-debt expenditure. My proposal would be that the government creates what accountants call a sinking fund, where all the immediate savings would be channelled to the specific purposes of (i) accelerated debt repayment, (ii) targeted reductions in inflation, and (iii) a lesser portion for a social safety net, which is going to be essential going forward. It is going to be very important that this "sinking fund" be established and the savings not channelled to uses that do not have a positive future return for Jamaica.

Expenditure side

On the expenditure side of the budget it shows that there was a less than projected spend by $2.3 billion. I am wary of this number though, as I have always indicated that government accounting is based on cash-accounting, and so items committed to but not yet paid for are to be added to the expenditure, and so in reality we may not have ended up spending less than projected, if the accrual-accounting concept is applied. In any event, the implicit slowdown in economic activity means that revenue fallout should continue to outpace expenditure savings. The government will obviously try to save on the expenditure side, but will be hard- pressed to do so because of the nature of the majority of the expenditure.

We can assume that all of the wages, salaries and interest expenditure are going to be fixed over the remainder of the fiscal year. This is so primarily because in both cases commitments have been made to the expenditure, which are the MOU and obligations to creditors. Both these amounts total $52.3 billion. We can also safely assume that 50 per cent of programme costs are fixed, amounting to $6.7 billion.
The total fixed costs would therefore be $59 billion out of a total of $71 billion, or 83 per cent of total expenditure. This leaves little room for government to work with in terms of cost reduction.

Real options

The conclusion from all of this is that the only way to address our deficit problem, for the current fiscal year, is to increase revenues. Increasing revenues from greater taxes, however, is not the answer as it will only have a greater inflationary effect (wages and profits will compensate for increased taxes) and less money in the economy to drive growth. Already the increased GCT rate has reduced monies available for productive activities.

It is obvious also that government will not be able to practically give any tax concessions to the public sector workers or bring forward the increase in the income tax threshold, as is being demanded by the unions in the continuing MOU negotiations. The truth is that we simply cannot afford it. If the unions continue trying to get increases for all, while maintaining every job, and ignore the concept of productivity, then there will be much greater fallout in the near future. Additionally, if the unions renegotiate, because they accuse the government of breaching the MOU, then it means they are admitting the old MOU has failed and the government has the right to negotiate additional terms under a new agreement, which may mean some jobs lost to compensate for any increases (concessions) given, as they simply cannot afford to reduce any line of income or increase expenditure independently.

The harsh reality we face is that the only way for us to address the fiscal situation is to increase revenues, as not much can be done on the cost side. The only practical alternative for the government is to spur economic growth, as greater taxes will cause more problems. This is the chicken-and-egg situation we are caught in and must employ careful analysis and strategic thinking to overcome.