Budget must be incentives-free

While people expect some relief, best relief is cut in public spending

ISLAMABAD:

The federal government will be announcing its annual budget in a matter of days. As happens every year, there is a lot of interest and anticipation in the media about what the budget will entail.

The private sector and industrial lobbies are making their demands public and want incentives. Business associations have submitted their tax proposals and demand tax reliefs. The public is expecting a relief from the back-breaking inflation and wants prices to come down.

These expectations from the budget arise from an erroneous understanding: government’s budget and national economy are the same.

The budget is an exercise of state’s financial management and it cannot encompass the economy as a whole. It’s a document where the state declares its intent and plan to collect taxes and manage its expenditures.

Beyond a necessary level of tax collection required to run a limited and smart government, the budget exercise does not have the capacity to influence economic direction of the nation.

To give one parameter, let’s consider jobs creation. Our workforce is 80 million strong. Assuming a 15% rate of unemployment (PBS estimates it to be 8%, PIDE estimates youth employment at 31%), we have around 68 million people employed out of a population of 235 million.

From these 68 million people employed, the federal and provincial governments employ around 3.2 million people. In other words, the state provides jobs to hardly 5% of the population.

As 90% of budget resources (tax revenue, non-tax revenue and loans) will be spent on current needs, I make a straightforward inference: budget is essentially a statement of how the state intends to keep its infrastructure running, including work for 3.2 million people and pensions of those who have retired or died.

Now let’s talk about incentives. Each budget is expected to provide incentives and disincentives to selected industries and products, thus influencing consumer choice by using its financial and legal power.

The state can withdraw exemptions, can offer new subsidies and can raise tax rates on its own will. Obviously, in making these choices, it is influenced by stakeholders such as special interest groups as well as lending agencies and commercial banks.

In my opinion, the budget should be incentives-free. Instead of opening the possibility of changing the incentive structure, which then opens the door on rent-seeking, if not corruption, the state should close its doors on seeking suggestions and demands from the public and private sectors.

It should just focus on keeping its own economy – public finance in essence – in a good order. It should not default.

By making futile attempts to change incentives through budget, the state misallocates scarce resources. Even if it is done with good intentions (which may be a path to hell, if you believe in this idiom), such an exercise is done on a false premise of access to perfect information, which remains dispersed.

In practical terms, the exclusive focus of budget should be to minimise fiscal deficit while considering balancing budget as the ideal type. We may not be able to achieve the ideal, but we should always keep it as a benchmark.

While the state should enforce its writ on tax collection and take all legitimate measures to collect due taxes, it must always confine its expenditures to the revenue collected. Parliament should have powers to declare any unfunded expenditure as illegal and unauthorised.

To save itself from the complex exercise of calculating the rates of taxes and tariffs on millions of transactions and products, the government should come up with an average and single number where the current tax revenues are not compromised.

A single rate of general sales tax (GST) should be the starting point, as understandably we may not be able to achieve the uniform tariff rate instantly.

We should begin to confine the government to a size which the economy can afford without making unrealistic assumptions about growth. That should lead to an exercise where we may have to close some government departments and almost all commercial state-owned enterprises.

This should also include the rationalisation of defence budget. By moving in its direction, the state will save itself from default.

While the public anticipates some relief from the budget, the best relief is the reduction in public spending. All government expenditures are either funded by present taxes, present loans, future taxes or inflation taxes.

To allow this and future generations to earn their own livelihood and minimise the burden on their hard-earned income, the state should reduce its size and should free itself from the burden of allocating budgetary resources to specific sectors.

We should not view the budget as a substitute of growth strategy and should only view this as a plan to manage state finances.

To foster fair competition, the budget should be incentives-free as such incentives distort the market, create an uneven playing field for businesses and can become a breeding ground for lobbying and corruption. In a system without these distortions, firms compete on the basis of merit and efficiency.

The writer is the founder and executive director of the Policy Research Institute of Market Economy (PRIME)

Published in The Express Tribune, June 10^th, 2024.

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