News • December 07 2003

Bringing home the argument

Economist Edward Scicluna, argues that the way ahead is providing the tax payer with more cash to spend, here he illustrates his thoughts as he presented them during the Business Times Radisson SAS seminar held last Friday

“The Budget for next year is being criticised by various observers on the grounds that it is just an accounting exercise. It is said that it does not contain the so-called incentives necessary to stimulate the economy.
As an economist I want to show that I have no qualms about a budget being treated as an accounting exercise, a national accounting exercise, to be exact. In fact I want to show that the much requested stimuli to our economy would only come about from a proper restructuring of our public accounts figures.
As we can see and observe, the forthcoming debate in the political and industrial relations arena surrounding the much-awaited fiscal retrenchment, is breaking into a tiff. We shall hear lots of "why me and not you", "we told you so", "it is your fault".
There also seems to be serious disagreement about this autumn’s season, some say it is spring, others, winter.
But joking apart, it would be quite sad if we manage to distract ourselves from the reality the economy is in and lose sight of the road ahead of us.
Let us take taxation. Taxes are the only way open to governments to garner the necessary resources needed for social consumption. More than just the basic ‘law and order’, governments have built over time, comprehensive welfare states which provide social security for its members against certain risks, such unemployment, sickness and disabilities, old age, and other income reduction risks. The welfare state also corrects to some degree for income inequality, and alleviates social exclusion.
In so doing, however, we cannot ignore an important accepted tenet of public finance, namely that a tax however perfect it may be, will incur a burden on the economy. Not necessarily in terms of the pain of taking away one’s income, directly or indirectly, but real economic burdens such reductions in efficiency, work effort and economic growth.
There are no clear cut laws where the line should be drawn with regards to how much we opt to contribute out of our incomes. It is up to the electorate to say ‘enough is enough’. We have seen taxpayers’ revolts in many countries and states, other than California.
Let us bring the argument home. In Malta, taxation has for many years after the war, been trying hard and not so successfully keeping up with expenditure. Since the middle 80s to 1992 the expenditure growth has averaged some 12 percent per annum, while since 1992 it averaged 8 per cent per annum. Note that these annual rates were respectively 2.5 and 1.5 percentage points higher than the rate of GDP growth. Due to a slow down in the rate of economic growth over the last few years, the difference between the two rates widened between 4 and 5 percentage points. This result in an inevitable encroachment whereby, while say, in 1992 public expenditures were merely 38 percent of GDP, they have since crawled up to 45 percent this year. Next year they are estimated to reach just under 49 percent. (I am using the IMF classification of public accounting)
Government, the opposition and the social partners are generally admitting this problem but in the same breath they seem to say that
• Sacred cows are untouchable. Who would dare even think taking back student allowances, for example? Reducing the labour force in a government institution, impossible.
• The Welfare State is also an entrenched right, not to be dismantled.
• As for general government, heads of departments are still talking of shortages rather than surpluses.
In short very little seems can be done.
Perhaps we hope and pray the economy will pick up so that more taxation can be coughed up and the base on which the deficit is calculated will be bigger making the proportion smaller. Simple proportion stuff we learnt in our primary school days. Or so we think.
So let us now look at some data. First the shocking news about this year’s budget. If the 2004 Budget were to repeat itself for ten years against a continuing though highly improbable weak economic environment, government will be collecting one full lira for every lira we earn by 2014.
My simulation is based on the premise that the economy will in fact grow by 3.5 percent per annum in nominal terms for the ten years to come. The deficit ratios are the ones proposed by the government, while the public expenditure figure is allowed to grow by 10.6 percent, with no freeze or cutbacks on the public expenditure. This is perhaps too dramatic. We will certainly not allow it. But we are not far, and still are debating when, how, perhaps, just a minute and so on.
A more probable scenario is that the Maltese economy would grow by a slightly higher average rate of 5 percent per annum in nominal terms, while expenditure will be allowed to grow by some 8 percent, because of continued resistance. Under this scenario in 2014 we would find 65 percent of every GDP lira being taken by government.
If you think the 3 percent hike in VAT was too much, just consider it will only turn in Lm25 million. More taxes would have to be invented to catch up with this expenditure growth. A tax on property and not just property gains, a higher marginal tax on income, and more.
The ideal scenario is then is that we really put our heads to gather and restructure our whole expenditure package such that expenditure grows some 2 or 3 percentage points below the GDP nominal growth. In that case the taxpayers including businesses would see the tax ratio dipping to reasonable levels, say 34 percent in a decade’s time.
But which function of government needs pruning back? Can we leave it to the bureaucrat to tell us, or should the taxpayer have his say. What role should the social partners play? Is it really the Welfare State or is it general government, including the newly set up regulators and autonomous agencies, which are the high spenders?
The following chart shows how expenditure has grown by function. It is based on the IMF classification, and for this reason it takes us just to 2001.
As we can see also from the accompanying table each function has contributed towards the notching up the percentages of GDP, meaning they have grown more than the national cake itself. Interestingly, social protection has maintained its share, while general government has increased one percentage point each decade. But this is up to 2001. By next year the total goes up by 8 percentage points. Where has this gone? My hunch is that when this data is updated to the present, we will find general government which includes the environment and the various regulatory entities would have shot up by a few percentage points.
But what does this imply for competitiveness. Businesses talk of government-induced costs, economists of crowding out effects on the private sector by the public sector. The effect is the same loss of competitiveness.
The Real Effective Exchange Rate index gives a clear hint that the economy was gaining competitiveness up to 1993 and started to lose it since then. The GDP growth rates as expected responded to this burden by being more depressed in the latter period than the earlier one.
In conclusion, we need to start the job now. Every day counts. We need to employ our well-earned lira in the most efficient manner. We just cannot give it away without the full confidence that it will be employed in the most clever and prudent manner. On second thoughts in fact we should work hard to put back as many liras as we can where they belong, the taxpayer’s pocket.”