The Budget and the Case for Right-Sizing

The Budget and the Case for Right-Sizing
The Fiscal Year (FY) 2021-22 was prolific from a revenue collection perspective. Tax revenues grew by 9.2% from Rs.5.4 trillion in FY2020-21 to Rs.5.9 trillion while non-tax revenues nearly doubled from Rs. 1.1 trillion last year to around Rs. 2 trillion. The strong headway made by FBR in the collection of tax revenues accounted for gross revenue collection of Rs. 7.9 trillion. Total Expenditure during FY2021-22 was budgeted at Rs. 8.4 trillion and if one pits state revenues against the budgeted expenditures – and these are inflated expenditures committed to the policy decision of moving to an expansionary fiscal framework for growth – one sees that despite falling slightly short of the IMF tax revenue growth target for FY 2021-22, the government could cover around 95% of its total budgeted expenditure with revenues that it collected through indigenous means – that is, without indulgence in internal and external debt.

Pakistan operates in a low tax-to-GDP bracket with certain industrial and commercial sector entities evading large tax liabilities. However, the entire attribution of fiscal deficit to failure of the state (read FBR) to enforce taxation mechanisms is misleading. Tax collection is low and could be the lowest in the region, but Pakistan is also not amongst countries that spend extravagantly on development. Pakistan’s social spending is dwarfed when seen in comparison to the welfare states in the West – especially the Scandinavian countries that allocate disproportionately large parts of their budgets to social spending. What is thus important to underscore about Pakistan’s fiscal woes are factors that lead to the increasing indulgence in debt when the budgeted expenditure can be largely financed through indigenous sources of revenue collection.

While demand-side management principles that the IMF advocates for cash-strapped economies suggest expenditure control measures, a closer look at Pakistan’s federal budget shows that since gross revenues seem to cover a large part of the budget, the policy to control expenditures to balance the budget or stem growth in the fiscal deficit inevitably leads to retardation of growth. Controlling expenditure here implies curtailing that part of the expenditure that is either discretionary or that which the government can curtail through the operations of its policy and planning instruments. Expenditures that are non-discretionary and beyond the policy access of the government are expenditures that, while seemingly uncontrollable, need to be lowered through sustainable and broad-based reforms that successive governments have failed to design and implement.

What is included in the non-discretionary part of the budget and the fixed categories that the government is unable to change which limit its overall ability to redistribute, reallocate and make major readjustments to the composition of the overall expenditure?

The first non-discretionary expenditure head is pensions. The Pay and Pension Commission is mandated to propose certain amendments to government pension rules to make pensions more sustainable. However, until broad-based pension reforms are implemented, there is little that the government can do in limiting this head of the expenditure. What it can limit is the growth in pensions, which is also a difficult and unpopular decision to make given that the political costs associated with such a policy would almost always be considered to exceed the financial savings it will offer. The political economy effects of reforms are large especially if the incumbent government runs the risk of becoming unpopular with retired government servants and their families that make a large and in some ways powerful segment of the society. There is also little support for such thinking within the senior bureaucrats – many of whom are serving pensionable positions and nearing retirement! Civil and military pensions together account for 6.3% of the current expenditure and 5.6% of the total budgeted expenditure.

The entire attribution of fiscal deficit to failure of the state (read FBR) to enforce taxation mechanisms is misleading. Tax collection is low and could be the lowest in the region, but Pakistan is also not amongst countries that spend extravagantly on development

An expenditure head that the Finance division refers to as “running of the civil government” which includes disbursements in the form of salaries and other benefits to federal government servants also takes around 6% of the current expenditure and 5.5% of the total budgeted expenditure. After denying federal government servants an annual increment in the FY 2020 budget due to the financial distress caused by COVID, the government approved a 10% salary increase for federal government servants which, after adjusting for the inflation that happened in FY 2020 and FY 2021, rendered the federal government servants poorer than they were at the close of FY  2019. Salaries are non-discretionary but it is a head to which no reductions can or ought to be proposed.

As a policy decision made under the 18th amendment, 57.5% of the revenues have to go the provinces. Out of a total tax revenue of Rs. 5.9 trillion, around Rs. 3.4 trillion went to the provinces as their legitimate share under the 18th amendment. Understandably, a large part of what will go to the provinces will be allocated to current expenditure and naturally towards salaries and pensions of employees working or having worked in the provincial governments. Net revenue receipts – which is the total revenue of the federal government minus the provincial share – is Rs. 4.5 trillion. This is an inadequate sum to deal with an ever expanding expenditure base, given the persistent growth in the salary and pension bills of the government.

Another non-discretionary expenditure is interest payments that the government has to make in lieu of debt outstanding, accrued to both internal and external lenders. In FY 2021-22, interest payments nearly equal the provincial share in revenues and represent around 40% of current expenditure. Interest payments are a liability on the government that is non-discretionary but their size is derived from the size of other expenditures. The larger the size of non-interest expenditures, the greater the fiscal deficit. That means more debt, and thus, higher interest payments. Controlling other expenditures would automatically lower the interest liability on the government.

The two expenditure heads that the government can and does change through its policy instruments are (i) transfer payments including subsidies and grants to provinces and (ii) Federal PSDP. Together, the transfer payments and federal development expenditure account for less than 25% of the total budgeted expenditure and hence that is the part of the budget that the IMF directs the government to control each time the government enters into a finance facility or loan agreement with the fund. Since transfer payments and development expenditure are directly related to growth and development, curtailment of these expenditures retards growth and limits the capacity of the state to produce development outcomes like improvement in health, education and general standard of living.

While interest payments assume a large part of the current expenditure, they are non-discretionary because they cannot be curtailed directly by the government. Their curtailment is dependent on curtailment of other two heads of non-discretionary spending of the government; that is payments for salaries and pensions. While government servants must be provided salaries and benefits commensurate with level of compensation that exists in the private sector that allow them to arrest the rising rates of inflation and maintain good standards of living, the salary and pension bills of the government should be curtailed through a proposal that has been tabled for a long time now; that is to right-size the government.

The government is a big animal with many redundant offices and institutions that continue to function with large workforces despite the irrelevance of the work that they do. Many public sector organizations operate with junior staff that was hired without specific job descriptions as a left-wing populist measure to accommodate the unemployed segments of their electorate. The rationale to right-size is thus plausible and persuasive – it will provide good standards of living to the productive employees of the government while also curtailing the fixed part of the budget that pressurizes the government to curtail development expenditure each time it is pressed to curtail the fiscal deficit.

The writer is an economist and ex-Director of the Burki Institute of Public Policy (BIPP). He tweets at @AsadAijaz