Wanted: increased revenues

THERE IS AN emerging consensus that having established greater stability in the level of inflation and the foreign exchange market, the major remaining macro-economic problem in Jamaica is the fiscal deficit. People who follow economic matters would be aware that where a large fiscal deficit exists the government is forced to borrow large sums, thereby exerting upward pressure on interest rates, other things being equal. Or it may choose to resort to printing money which, as we know, feeds inflation. In other words, a high fiscal deficit leads to interest rates remaining at higher levels than would normally be the case, or to price instability.

Jamaica is currently running a fiscal deficit which is targeted to be 4.4 per cent for the current fiscal year, according to the methodology used by the IMF. The economic programme which has been agreed by the government, the IMF and other parties, calls for this deficit to be wiped out over a three- year period and for us to return to a surplus position by the 2005/2006 financial year. It is anticipated that as this deficit is reduced, the extent of new borrowings by government will go down and hence, interest rates will fall accordingly. A fall in interest rates will bring significant benefits, both to the government in terms of lowering the cost of servicing the public debt, and the private sector by reducing the cost of working capital and financing for investment. So, on the one hand, financing the budget will become easier and eventually will allow for more resources to go into capital expenditure and essential services, while on the other, the private sector will find it easier to generate profits, improve the viability of their businesses, and expand. The end result of all of this is that the prospects for the economy to achieve faster growth will be enhanced. This is a chain reaction that should lead to more jobs and higher living standards if the other factors that affect investment and production are attended to.

With the correction of the fiscal deficit, it also means that more resources will be allocated to the private sector which must play an important role in expanding investment activity and increasing the production of goods and services for local consumption and exports. Yet another effect will be an improvement in the credit rating of the country, which would allow for loans to be raised overseas at lower interest rates. As the country's rating rises to investment grade, it would induce larger investment flows which are essential to generating strong economic growth and boosting export production which is vital if we are to meet our foreign debt obligations and provide for continuing expansion in the consumption of goods which cannot be produced economically in Jamaica.

FISCAL ISSUES

The explanations set out above appear straightforward and simple and the question may well be asked: "how did we get into a fiscal deficit"? Jamaica has, over the last three decades, recorded large fiscal deficits, particularly in the late 1970s, for most of the 1980s, and since the 1996-97 financial year. They have arisen for various reasons, including attempts by successive governments to boost public spending in an effort to solve various social problems and to increase investment in public works. There have also been periods when fiscal deficits came about because of pressures from workers and trade unions for increases in public sector wages and salaries in a bid to improve the compensation of the workforce as was the case in the 1970s and 1990s. And at these times revenues did not grow to cover the increased bills. In the mid and late 1970s and for the first half of the 1980s, oil price shocks, declining GDP growth and the fallout in the bauxite sector (1984), among other things, dislocated the economy and the fiscal deficit ran in double digits, which necessitated huge borrowing on the part of the government. Indeed, it was because of these problems that the country undertook massive foreign borrowings which amounted to well over US$4 billion in the 1980s. Because correction of the fiscal deficit nearly always necessitates unpopular tax measures and expenditure cuts, governments are reluctant to take the necessary action, hoping that growth in the economy will generate increased revenues which is, naturally, the preferred route. Unfortunately, where there are large deficits, unpopular measures must be taken before growth is stimulated, allowing for increased revenues.

Even developed societies like the USA have had to contend with this dilemma and the Bush Administration of the late 1980s imposed unpopular new taxes after promising not to do so. In the mid 1990s the fiscal issue reached a head when the Republican-controlled Congress clashed with the Clinton Administration after which expenditure cuts were carried out. These cuts did much to take the pressure off interest rates and create the environment for the subsequent record period of economic expansion that generated a big fiscal surplus.

Here in Jamaica in the mid-1980s, the then JLP government carried out large expenditure cuts and imposed heavy tax packages to turn around the fiscal deficit, and at the end of the period it had been reduced from a peak of 15.9 per cent of GDP to 4.1 per cent in 1988-89. They did, however, pay a political price. In the 1990s, the PNP administration itself imposed a big tax package in 1993-94 which converted the fiscal deficit into a surplus, even though the personal income tax rate was cut from 33-1/3 per cent to 25 per cent. This surplus position lasted until 1995-96. The subsequent meltdown in the financial sector did, however, lead to a sharp reversal in the position as the FINSAC intervention escalated debt-servicing costs, such that by 1998-99 the deficit approached double digits. Since then, by a combination of increased taxes, measures to improve tax collection and constraints on spending established on the capital side of the budget, in particular, the large deficit has been reduced to the point where, as indicated earlier, the projected figure for the current fiscal year is 4.4 per cent.

To move to a surplus position, which is what is required if interest rates are to be brought down to levels that will stimulate economic growth and reduce the debt burden of the government, further measures must be taken to increase revenues, both by better collection, increased taxes or by user fees. For in the short term, it is unlikely that growth of GDP will be strong enough to generate the increase in revenues that could correct the deficit. Of course, this is a prescription that is hardly likely to be welcomed by the public who, naturally, are always seeking to get the best of all possible worlds or who want contradictory things. Under-standably, our politicians who are competing for popularity are unlikely to associate themselves with unpopular measures in an election period. While they will be quick to promise increased expenditure in areas where everyone agrees greater attention is desirable, they will not easily put forward proposals as to how the money will be raised to pay for those things. Nonetheless, the media and other areas of civil society should help to ensure that clear choices are put in front of the voters with as full information as possible as to what they involve, both in terms of expenditure and how the money is to be found.

A good example of the dilemma we face is the recent imbroglio surrounding increases in the property tax, where it has been clearly identified that additional revenues are required to cover the bills for street-lighting and, for the first time, to provide modern waste disposal systems across the island. The demand for these services are made daily, yet it appears that, at the same time, there is strong opposition to any increases in the property tax. Certainly, the government is not in a position to borrow money to cover the cost of these services and, hence, those who use them will have to pay and the quicker we work out a rational system, the earlier the demands will be met. Equally, the call for 'free education' will involve significant costs which would have to be met by increased taxes and not by loans if we are serious about the debt problem and the level of interest rates. Waste reduction and efficiency gains can also make a contribution, although not great enough to cover the increased costs for 'free education'.

DEBT ISSUES

A big part of the build-up in our national debt has come about because of attempts to meet increased public expenditure by borrowing rather than taking on unpopular measures such as tax increases. In the period of Liberalisation in the early 1990s when several sectors of the economy contracted when they were opened up to international competition, it was understandable that the state could not impose new taxes without running the risk of deepening the problems in the economy, as was the case in 1985 when the economy contracted by over 4.0 per cent as a heavy tax package was imposed. And, hence, it is somewhat understandable that the fiscal stance was not as tight as it could have been but, nonetheless, there was room for tighter control of expenditure.

The debt burden has also come about because of the stabilisation measures which relied upon high interest rates to control inflation and bring about stability in the foreign exchange market. As I have indicated elsewhere, this particular aspect of the equation could have been less onerous had the sequencing of the liberalisation process been better. The more serious pressure on our debt position came about because of the FINSAC intervention which added an enormous amount to the public debt stock which stood at J$494.4 billion, or 133.1 per cent of GDP at the end of March 2002. In fact, it jumped from J$380.6 billion, or 113.1 per cent of GDP at the end of March 2001, which was due to the absorption of all remaining FINSAC liabilities.

It should be noted that an important change in the situation is that whereas the domestic debt accounted for the smaller part of the overall debt in 1994, it now represents 60 per cent of the total debt stock. It stood at J$300.2 billion at the end of March 2002, up from J$215 billion in March 2001, and stood at only J$48.7 billion at the end of 1994. This is important, because the cost of servicing the domestic debt is higher than that of the foreign debt, as local interest rates are higher than rates at which we borrow overseas. This is a crucial reason why we must do whatever is necessary to reduce local interest rates because, by so doing, the debt burden will become more tolerable. As was indicated above, if we are to have lower domestic interest rates, we must correct the fiscal deficit and government must decrease the level of its borrowing which is why we cannot run away from solutions to the fiscal deficit.

Jamaica is just one of a number of countries that has suffered problems in its financial sector, and countries such as Chile, the USA, and to a lesser extent Trinidad & Tobago, as well as the countries of East Asia among others, have all had to face the cost of intervention at one level or another. There are arguments about the reasons for the crisis in the sector, but there is no doubt that such situations come about when economic systems are liberalised, because of poor management of banks, etc., where economies are in transition, and as a result of macro-economic policies and regulatory weaknesses. Though we have paid a high price, there is clear evidence that, in terms of the macro-economic framework, the Jamaican economy is at an advanced stage of the reform process into a market economy and, with careful management, can now move to a phase of strong economic growth which will make possible an easing of the debt burden in the medium-term. However, the importance and urgency of taking the necessary measures to turn around the fiscal deficit cannot be overemphasised, and it is critical that the options be clearly understood. Once the choices have been made it will take a collective effort to achieve the desired result.

Our recent experience shows that it is possible to overcome these difficulties as in the 1980s, our pubic debt ratio had risen to as high as 169.8 per cent of GDP, coming from 70 per cent in 1980 and 33 per cent in 1977. By 1996, it had fallen to 94.5 per cent and this should be the first target for any administration in the future. This time around we will not be able, however, to count on generous aid assistance from the USA as occurred in the 1980s, for the world is a different place. Indeed, with the Cold War out of the way, we are not so valuable politically as to be able to extract political rent for supporting the USA. Neither will we be able to secure any large debt forgiveness or refinancing, as Jamaica does not, in spite of our self-denigration, fall into the category of "least developed countries".

We should all be aware by now that the world economy has slowed down quite sharply over the past two years and is, at this point, close to a recession. Unlike previous periods, all three major economic blocs - North America, Europe and Japan - are experiencing a downturn and, hence, this cannot be a time for any experiments or adventure. It will take prudent and sound management to work ourselves out of the fiscal and debt problems, and areas requiring the allocation of increased public resources such as national security and education, which are critical to the thrust for economic growth, will have to be met by a combination of expenditure cuts in other areas, increased taxes or user fees. What is up for debate are the priorities and the choice of policy options for taking care of those priorities. It should also be abundantly clear that there are no painless solutions or quick fixes that can be pulled from a hat. Other measures to generate strong growth are also critical, and these will be discussed later on in this series.