Federal budget and pro-cyclical policy

The federal budget, due to come into effect in the next few days, has continued with the pro-cyclical policy approach, whereby as growth continues to remain stuck in a low economic growth equilibrium, taxes overall continued to be increased. Not only that the main thrust of taxes remains in the shape of indirect taxation, which burdens the low-income groups the most.

So, while on one hand stagnating growth means lack of provision of job opportunities in a country with significant youth bulge in overall population, increase in overall taxation not only decreases prospects of growth due to negative impact of this on both consumption-, and investment expenditure, it also puts upward pressure on inflation by enhancing cost-push inflation.

Worse, increase in taxes not only dents growth, but with it also reduces prospects for greater tax collection due to diminishing impact on consumption and investment where lack of investment means likely lesser imports – since growth is heavily import-led— and, in turn lesser imports-based revenues.

It then begs the question that the aim to increase tax-to-GDP ratio may be very difficult to achieve because of the above, and the ratio may likely not increase in any significant way therefore even if tax base is broadened significantly, and also indirect tax collection compliance is enhanced – especially in terms of collection of sales tax.

This is because both increase in direct taxes, and its enhancement in terms of sectors covered may overall produce little tax revenue due to the underlying diminishing impact of taxes applied in a pro-cyclical way, whereby austerity or aggregate demand squeeze policies in the shape of enhancing taxes during stagnating economic growth – when the drivers of economic growth need lesser taxes to allow growth to increase, and with it increase revenue and, in turn, tax-to-GDP ratio.

Moreover, lack of domestic resource mobilization would mean lesser public investment as well. This is important to attract private sector investment because high cost of doing business makes it difficult for private sector to go alone with investment needed to initiate and complete projects. An important element of cost of doing business pertains to cost of capital, which is unlikely to fall as a result of pro-cyclical policy approach being perpetuated budget after budget – with years showing some improvement in economic growth coming not as a fallout of increase in investment but mainly due to windfall gains; for example, a bumper crop due to friendly weather, positive external shocks like fall in commodity prices, especially oil’s – whereby lack of increase in aggregate supply means lack of domestic production with negative impact in terms of rising inflation, both through the channel of cost push and imported inflation at the back of lack of exports reducing prospects for enhancing foreign exchange reserves, and weakening domestic currency against the US dollar.

Hence, rising inflation once again resulting in putting upward pressure on policy rate and, in turn, increase in the cost of capital.

So, if the federal budget intends to increase domestic resource mobilization, exports, foreign exchange reserves, growth, and reduce unemployment, and inflation, then it needs to adopt counter-cyclical policy, which means reducing direct tax rates, slashing deeply indirect tax rates, removing petroleum levy, on one hand, while launching deep non-neoliberal institutional, organizational, and market reform, especially in the energy and SOE sectors to minimize subsidy expenditures, and reduce the need for increasing tariffs, on the other, as steps to both fill revenue shortfall during the transitory phase, while economic growth kicks in over the short-to-medium term, and lays a basis for higher growth, exports, and revenues.

Moreover, investment enhancement as a result of counter-cyclical policy – reduce taxes while growth is stagnating and is at a low level, in addition to enhancing tax base – will likely improve tax-to-GDP ratio in a sustainable, and significant way.

Pro-cyclical policy perpetuated in the announced federal budget, and its negative impact on economic growth, and likely fall or insignificant increase in revenues, would in turn, mean increase in debt distress. This is because lack of income, both in terms of domestic production, and through exports, would decrease capacity to repay domestic- and external debt, both of which are at an alarmingly high level.

Here, it needs to be mentioned a serious dent to exports likely at the back of severely sharp and deep increase in tax rate on exports.

Moreover, lesser growth would mean a greater number of people being pushed below the poverty line, while lack of any meaningful increase in revenues would mean lack of fiscal space to make needed development- and welfare expenditures, which are both necessary to support people specially those who are below the poverty line.

In addition, over-board austerity-based policy emphasis in terms of monetary- and fiscal austerity policies, as reflected through keeping more than needed level of policy rate, and requirement reportedly by International Monetary Fund (IMF) to maintain primary surplus further reduce fiscal space at the back of lower growth and likely reduction in development expenditure since it is difficult to curtail current expenditure in any significant way at the back of high inflation, and high debt repayment needs generated especially due to a policy of over-board monetary austerity being practiced over the years, including being reflected in the current budget by high proportion of current expenditures earmarked for debt repayment.

Copyright Business Recorder, 2024