Budget in Different Contexts

19^th October 2007

The Malta Independent - Friday Wisdom

You really would have to struggle to try to analyse the budget for 2008 presented this week in parliament out of the immediate context of the impending general election. Out of 93 pages of the Budget speech booklet there is only one page that attempts to put this Budget in a longer term context until 2010. All the rest speaks of performance so far, performance expected till the end of this year and measures to be applicable for 2008.

With a general election due in all probability somewhere in February next year, it is politically compelling for government to tailor the budget with the election in mind. Measures announced have been costed as putting an additional Lm21 million in consumers’ pockets and they have clearly been designed to address the laments of wide and narrow sections of the electorate that have been breeding discontent and sending signals of their readiness to switch their vote.

A second round of tax band widening is clearly addressed to reduce the tax burden of the middle to high income families that have been hit in previous years through fiscal measures such as fringe benefits taxation. The granting of the full cost of living allowance to pensioners meets a demand they have been making year in year out for as long as I can remember. Extension of the benefits under the children’s allowance scheme rolls back restrictions which had been gradually introduced rendering the application of the children’s allowance very narrow. Through the announced measures it has been extensively widened. A middle income family of four could find itself better off by about Lm7 a week through the cumulative effect of the budget measures.

Other specific measures have more telescopic impact although collectively they amount to considerable feel good generation. Exemption or reduction of VAT on selective sports and cultural activities, tax exemption of subscription fees to children’s sports club, measures aimed to ease the hardship of sick and handicapped irrespective of means testing cost little but mean a lot to those who start benefiting there from.

How all these measures are being financed without new tax measures and while continuing to reduce the budget deficit could initially be mistaken for some classic example of supply side economics. This is the economic credo of those who maintain that lowering taxes does not necessarily lead to reduction of government revenue as the reduction in taxes could generate economic growth leading the application of lower tax rates on a wider base resulting in a larger tax take for the exchequer.

A closer look at the revenue side of the budget however shows this is hardly the case. Ordinary tax revenue is scheduled to increase by 5.3 per cent well above economic growth rate and evidently contains a measure of better enforcement. Recurrent expenditure, including all budget measures is scheduled to increase by 3.3 per cent indicating substantial freezing of government operational expenditure to allow room for the funding of the announced measures from the projected tax revenue growth.

What has largely gone unexplained is the increase of revised estimates of Income Tax revenue during the current year 2007 which is projected to exceed the original estimate by Lm30 million. This increase in 2007 additional income tax revenue can by itself finance all the measures announced in the budget for 2008.

Government has been very scant in explaining this growth of income tax revenue. One liner stating “additional revenue is expected on various taxes on income” is hardly sufficient to explain more than 12 per cent increase in income tax revenue in 2007 over 2006 which is more than three times normal economic growth and this at a time when tax allowances were given by way of widened tax bands.

More detailed explanation is merited lest we start suspecting that there is an artificial exercise of shifting revenues across yearly divides purely to strike a pre-determined bottom line figure.

In the comments I heard following the presentation of the budget, there has been little or no effort to give significance to the long term context of the Budget; how will it lead to higher economic growth so that we can continue to enjoy improved standard of living based on real earnings rather than debt.

Our economy has grown by 3.6 per cent which though better than the 3.2 per cent of previous year is still the lowest of the new EU countries with the exception of Hungary. We have grown because Europe, our main trading partner, has grown. There are no measures in the budget which can make us optimistic that we can accelerate our growth to the same tempo of other new entrants. On the contrary there is total disregard of problems facing loss of competitiveness of important manufacturing units that with the strengthening Euro versus the US dollar are being forced to consider relocating fully or partially to dollar based economies in the Far East.

Mandatory cost of living increases payable in advance could in fact accelerate the pace of such relocation. This COLA business has grossly outlived its purpose and needs scrapping sooner not later except for its effect on the minimum wage. The unions must regain their role of negotiating one increase across the board with each employer taking into account efficiency gains that vary from workplace to workplace. The COLA is indiscriminate in this regard and could send a few industries to their grave prematurely.

It is healthy that in the medium term budgetary figures till 2010 government is planning to reduce its recurring expenditure from the current 35.1% of GDP to 32.2% of GDP by 2010. It is not so healthy that government is freezing the capital vote at current level during all this time. We need to continue investing in our infrastructure to render our economic outfits more competitive to withstand the challenges of a strong Euro we have de facto already adopted.