The Government budget and welfare expenses
Dr. Anila Dias Bandaranaike
While glancing through my daughter’s Grade 8 government textbook on
the subject “Citizenship Studies”, I came across a chapter on “Public
Services” in which it stated that the Government provides certain public
services free to its citizens.
The textbook did not mention anywhere that the Government has to
collect revenue to meet the costs of all public services that it
provides.
This made me realise that Sri Lankan citizens grow up thinking that
public services require no financing! It also explains why so many adult
Sri Lankans mistakenly believe that the Government can provide free
services, jobs, school uniforms, textbooks and food stamps and give fuel
and fertiliser subsidies at will, and without any repercussions.
In fact, the Government earns very little money of its own. While it
levies charges (most of the time at a subsidised rate) to meet the costs
of some of these public services, such as train travel or postage, for
others, such as running hospitals, dispensaries, schools and
universities, it has to find all the monies required through other
means.
It therefore charges us taxes, whenever we buy any item in the market
or earn any income, to pay for these “free” services. Furthermore, if
the costs of public services are more than what the Government earns,
then the Government has to borrow money from somewhere to finance its
cost over runs.
This article is therefore written with the idea of throwing some
light, on how government finances public services, for any interested
member of the general public.
Let us first look at the Government’s revenue and expenditure, by way
of answers to some basic questions.
Revenue
* Why does the Government collect revenue? To meet its expenses
* How does the Government collect revenue? Mainly through taxing
citizens. It also earns income from some of its activities. These 2
categories are called “Tax Revenue” and “Non-tax Revenue”, respectively.
* Which is more important? Tax revenue. In Sri Lanka, over 85 per
cent of revenue is earned from taxes.
* What are these taxes? There are 4 main categories. These are: 1.
taxes on imports and exports, 2. taxes on local goods and services (VAT,
excise, etc.), 3. Licences and levies (on motor vehicles, etc.) and 4.
taxes on income and profits of individuals and companies.
* Who pays these taxes? Everybody, though at different rates. In Sri
Lanka, over 60 per cent of tax revenue is from VAT and Excise Tax, which
we all pay when we buy anything or use any service, even those who do
not pay income tax.
* What is “Non-tax Revenue”? These are all other government earnings
and profits from its businesses and assets, which amount to less than 15
per cent of its total revenue.
Expenses
* What are the main categories of government expenses? The three main
categories are recurrent expenditure, capital expenditure and repayment
of government debt. Recurrent expenses cover salaries and pensions of
government employees, other administrative costs of services provided by
government such as railways, electricity, police, education and health,
cost of state vehicles etc.
Interest payments on government debt are also recurrent. Capital
expenses cover investment for future development such as on buildings,
roads, training, etc. Repayments of principal on government debt form
the third category.
* Which is the largest cost? Recurrent expenses. In Sri Lanka,
recurrent costs have been over 50 per cent and repayment of debt over 25
per cent of total expenses. This leaves less than 25 per cent to be
spent for future development.
Usually, when the Government’s recurrent costs and borrowing costs
have risen, then capital expenses, such as road development, have been
cut down due to budgetary constraints, affecting future development.
* Do all government services that are not “free” earn enough to meet
their costs? No. They carry large numbers of employees and overheads.
Charges are usually not enough to meet expenses.
For example, public corporations such as the CEB, CGR and CPC have
lost billions of rupees for many years. They have to borrow or be
subsidised by government to meet their costs. At end 2006, their debt
stock had increased by Rs. 15 billion to Rs. 46.5 billion.
Budget
* What is a “Government Budget”? It is the Government’s plan for
collecting revenue and incurring costs, as well as for bridging the
deficit or using the surplus, if any.
* What happens when revenue is more than expenses? The Budget is in
“surplus”. The Government then has to make a plan to sue the surplus for
optimal benefit of the country.
* What happens when revenue is less than expenses? The Budget is in
“deficit”. The Government then has to make a plan to borrow money to
meet the deficit.
* What about Sri Lanka’s Budget? In Sri Lanka, Governments have
mostly been in deficit over the last 50 years, and had to borrow to meet
the deficit. In fact, during the last few years, government expenses
have been more than twice government revenue.
Borrowing
* Who does the Government borrow from? The Central Bank, local
financial institutions, citizens and foreign sources.
* What are the impacts of such borrowings? In the short-term, heavy
borrowing by the Government can raise interest rates, which will affect
investment.
Also, (a) borrowing from the Central Bank can raise prices by pumping
too much new money into the economy, (b) borrowing from local financial
institutions reduces funds available for private investment and, (c)
borrowing from foreign sources and conversion of such funds into rupees
increases money supply.
In the longer term, all borrowing will have to be repaid someday, and
will take away funds from future development at the time it has to be
repaid.
Otherwise, further borrowings have to be made to repay borrowings
made earlier. Also, the effective cost of foreign borrowings includes,
not only the foreign interest rate, but the exchange rate change as
well.
The Sri Lanka rupee has depreciated during most of the last 30 years,
making foreign borrowing more costly than just foreign interest cost.
* What about government borrowings in Sri Lanka? Currently,
government debt is a major problem for the country. Principal repayments
and interest payments account for more than 40 per cent of government
expenses. Over 80 per cent of all government revenue is used to repay
government’s debt.
In summary, government spends more than double its revenue. Nearly
all revenue goes to make payments on government borrowings. Hence the
Government has to borrow to pay for salaries, fuel for its vehicles and
to meet most of its day-to-day operations and development activities,
making the situation worse as time goes on.
Now, against this background, you may ask how, and at what cost, the
Government continues to provide subsidies and “free” public services to
us citizens. Let us now look at these two issues by way of answers to
some related questions.
Subsidies
* What is a subsidy? A subsidy is the difference in value between the
actual cost of production and amount paid for a good or service that is
provided at less than its cost. The actual cost reflects prices of raw
materials as well as overheads.
For example, fuel subsidies to the CPC cost the Government, Rs. 17.5
bn and Rs. 26 bn in 2004 and 2005 and Rs. 9 bn in the first half of
2006. Similarly, a 50 kg bag of fertiliser was sold at Rs. 350, but cost
much more, so the Government spent another Rs. 7 bn and Rs. 12 bn in
2005 and 2006 on the fertiliser subsidy.
* Who pays the true cost of a subsidised good or service? Since the
actual cost to the country has to be met by the Government, the subsidy
is paid for by government revenue or borrowings. Hence, ultimately we
citizens pay, through taxes or higher - than - cost prices
(cross-subsidies) for other items or higher interest rates or higher
inflation resulting from government borrowings.
* Does a subsidy benefit the country or citizen? Not when there is a
budget deficit. Citizens may think they have a direct benefit, when they
pay the subsidised price. However, as explained in the previous answer,
they end up paying the actual cost or even more, indirectly.
Free services
* Can a government provide free services to all its citizens? If it
can afford to do so it is fine. If it cannot, either the quality of the
service is poor for lack of funds or the government borrows to meet the
costs of these “free” services.
In the first instance, poor quality of service will not benefit the
citizen, whereas those same funds could have been used to better benefit
the citizen.
In the second instance, although the service appears to be “free”, in
reality, citizens pay a hidden cost by way of higher interest rates or
higher inflation resulting from the Government’s borrowings.
* Then, what can governments do to ensure that its citizens have
access to these basic human rights such as education and health? There
are many rational ways to overcome this problem. First, governments can
target free services to the really deserving, who cannot afford them,
while charging others to cover costs.
For example, even though government debt is rising, it continues to
provide free books and uniforms to all students, irrespective of the
income levels of their parents. Second, governments can maintain the
quality of free services within affordable limits, and encourage private
institutions to provide those same services for a fee.
In Sri Lanka, fee-levying hospitals and health services are run by
the private sector, in parallel with free, State health services.
As a result, those who wish to can pay for private services, thereby
reducing the demand for the free public services.
However, in education, currently, there is confusion between
“privatisation” and “private participation”, leading to pressure from
lobby group to prevent fee-levying private universities, even though
free State universities have budgetary problems and can only take in 14
per cent of students who qualify for admission.
* How can services be targeted to the really needy? By having a good
screening system to identify the deserving.
This will be easier if all citizens act responsibly and do not accept
welfare from the Government, if they are not entitled to it.
In Sri Lanka, while around 23 per cent of households were classified
as poor, Samurdhi welfare benefits are taken by households even in the
highest income groups, while less than half of the deserving poorest 20
per cent of households received these benefits.
Village committees should make sure that, in their own neighbourhoods,
those who are not entitled, but cheat the Government, are made to give
up such welfare benefits.
Village committees should also see that the really poor households
receive the benefits they are entitled to.
* How do we identify the really needy for welfare benefits? By the
poverty line. Government may limit welfare benefits such as Samurdhi and
free uniforms to families that earn less than the poverty line. This
value varies with costs of services from district to district and over
time.
In 2006, the national poverty line was Rs. 2,066 per person per
month. By December 2007, it had risen due to inflation to Rs. 2,668.
In summary, while citizens do not directly pay for “free” services
and subsidies provided by government, it is they themselves who
indirectly bear the actual costs, in the form of higher taxes, higher
interest rates or higher inflation.
Ultimately they will be worse off. All of us citizens need to
understand these trade-offs and neither expect nor demand miracles from
governments. After all, as Abraham Lincoln once said, governments too
are elected “by the people, of the people....”
(Sources: www.cbsl.gov.lk and www.treasury. gov.lk )
(The writer is a former Assistant Governor and Director of
Statistics of the Central Bank of Sri Lanka.) |