To extend or curtail subsidies?

The budget month is still with us. The federal budget presented on 11 June, followed by the three provincial budgets on 17th June, are now being debated by the people's representatives.
That the debate in our assemblies this year has been more lively relative to the past eight years, was to be expected, even though it is tempered by the fact that the coalition members are largely supportive of the budgets' shortcomings, which reflect the severe resource constraints that the country is facing.
Ironically, critics of the budget have focused on the one element that was considered by economic analysts as the major policy failing during the period July 2007-February 2008: subsidies that ate up not only domestic revenue but also forced the government to increase its deficit financing, borrowing from within, as well as reliance on foreign loans which, in turn, proved highly inflationary policies.
It is debatable whether direct subsidies for oil and wheat were less inflationary than the heavier reliance on borrowing - domestic and foreign - to fund the subsidies. Subsidies alone led to a 9.5 percent budget deficit - pared down by the newly elected government by two percentage points through slashing development expenditure.
Analysts, in the print and electronic media, have also almost exclusively focused on the amount of subsidies that would be extended in the forthcoming fiscal year. The reason for this overwhelming concern is obvious: the sense of deprivation in large parts of the population with respect to their inability to meet the food, clothing, utility and housing bills of their families has been severely aggravated in recent months. Critics have focused on two aspects of the federal budget as increasing the common man's burden: (i) increase in sales tax by one percent, a regressive tax that impacts more heavily on the poor, and (ii) withdrawal of subsidies.
The government's decision to reduce subsidies must be seen in the context of its overriding economic objective: to decrease its budget deficit which it is being pressured to do by international donor agencies, including the IMF, whose green signal is critical for the release of assistance by multilateral development banks. The green signal is expected to net the government 3 billion dollars worth of multilateral support in 2008-09.
Thus by slashing expenditure on subsidies the government is expected to reduce expenditure, but given the deficit the government also needs to raise tax revenue. The most efficacious way, albeit perhaps not quite equitable, is to increase the levy on existing taxes. The focus on existing taxes is because the mechanism for collection is already there.
Increase in income tax, tax on farm income, levy of new taxes like CVT on the stock market are all old and new taxes that could be resisted, and were resisted by pressure groups prior to the budget. Thus it is only the indirect taxes whose impact is diffused if you will throughout the population that there is more chance of success. The proposed rise of one percent in GST must be seen in that context.
It is also pertinent to note that sales tax was the largest indirect revenue source for the government in its budget estimates last year and the only tax item that actually achieved its budgetary target. The budgetary estimate for 2007-08 was 375,000 million rupees for GST and this was achieved in the revised estimates.
In contrast the 2007-08 budgetary estimates for tax on income was 388,000 million rupees while the revised estimates for the year gave the figure of 367,000 million rupees; customs duties were budgeted last year at 154,000 million rupees while actual collections were 148,000 million rupees. It is no wonder then that the government raised GST, rather than other taxes, as it viewed GST as the tax most likely to achieve its budgetary target within the forthcoming fiscal year.
The question that needs to be answered is what exactly has the government allocated for subsidies in its budget for 2008-09? There is some confusion in this within the budget documents. A chapter on subsidies in the documents reveals the disturbing fact that revised estimates for subsidies were 293,565 million rupees more than the budgetary allocation for 2007-08 or 3.5 times the budgeted total of 113,920 million rupees reflecting the gross mishandling of the economy by the Musharraf-led Shaukat Aziz government and the Musharraf-led caretakers.
This amount is not sustainable and even though the price of oil in the international market continues to rise there is no way that the government can continue with this scale of subsidies. The budget 2008-09 envisages total subsidy of 295,204 million rupees and the hardest hit in terms of the budget documents in comparison to last year's revised estimates would be the following: (i) WAPDA subsidy to decline by 39,046 million rupees, and (ii) KESC subsidy by 5,796 million rupees; thus electricity prices are likely to rise substantially during the year unless the international price of oil falls dramatically during the year - a fact that may well increase inflationary pressures as well make our output uncompetitive in foreign markets.
What has been ignored in the budget debate however and clearly indicated in the documents is that subsidies are targeted to rise in 2008-09 in comparison to revised estimates for 2007-08: (i) for ghee, pulses and atta sold in Utility Stores Corporation to the tune of 300 million rupees each, (ii) sale of wheat in FATA by 85 million rupees, sale of wheat, salt and sugar in Gilgit Agency by 65 million rupees, and (iii) DAP fertiliser subsidy to rise by 6500 million rupees while import of phosphatic and pottasic fertiliser subsidy will remain constant as would that of FFC Jordan in comparison to last year allocations.
And for those who lament the rise in absolute poverty levels in Pakistan during Musharraf's rein the budget had a proposal that is innovative for this country: the issuance of Benazir cards that seek to provide Rs 1000 to those falling below the poverty line of one dollar a day. Allegations that implementation would be a problem and that the Jiyalas alone would benefit is really putting the cart before the horse: if NADRA is to determine who will be eligible then at this stage it may be appropriate to give the benefit of the doubt to the government.
It is therefore relevant to note that the budget did not reduce subsidies on food items, in effect it raised them. The Ramazan subsidy package is also going to be the same as last year, 200 million rupees, though needless to say with inflationary pressures at an all time high the same amount would actually represent a smaller outlay in real terms.
Within the provincial budgets Punjab was the only province that proposed spending more on subsidies estimated at 17 billion rupees. This maybe a reflection of the fact that Punjab is led by PML (N) rather than a PPP led coalition and with Nawaz Sharif's popularity rating soaring above 80 percent (as against Zardari's 13 percent) one can see the political compulsions behind the subsidy given by the Punjab government. Be that as it may, what cannot be denied is that the Punjab budget is an exercise in politically innovative and economically astute policy planning.