Spend Like a King, Collect Like a Pauper

A budget deficit occurs when a government spends more than it makes within a given period, usually a year. Since in developing countries, the public sector plays a dominant role in initiating and financing economic growth, the revenue always lags behind public spending, leaving large deficit in the focus. The government tries to finance the difference by boosting the tax base and borrowing from various sources. Moreover, a country experiences a budget deficit during economic down turns when a government attempts to stimulate economic growth with increased spending.

The growth in public revenues in developing countries is restricted by various factors such as low per capital income, limited direct taxation, income tax exemptions in the form of tax holidays, dominance of informal sector and a weak tax administration. On the other hand, public spending continues to grow mainly due to mismanagement, increased public participation in production and control of economic variables and sheer inability to control spending. Consequently, a long and persistent fiscal deficit has become characteristic of most developing countries.

Ethiopia, like many developing countries has spent consistently on public projects, leading the government to grapple with a persistent budget deficit. On the other hand, a reduction in public spending has never been a viable option as unemployment and poverty continue to be key economic problems of the country. Hence, public expenditure has been found to be detrimental to economic growth and social welfare.

The government is waking up though, and trying to peruse a fiscal policy where tax revenues are increased through strengthening tax administration and enforcement. Thus, the government has launched a sequence of tax policies and reforms since 1992. Accordingly, the government has raised its tax revenues as a percentage share of gross domestic product (GDP) from 5.6pc in 1992 to 13.4pc recently. Despite the improvements, it is still below the average level of Sub-Saharan Africa, and it is still by far below the level of finance required for financing public spending, depicting the inefficiency and ineffectiveness of tax collection and administration in the country.

This is exasperated by the government’s long term development plans, like the first and second Growth & Transformation Plan (GTP and GTP II), whose primary objective is to transfer the economy from agriculture-led into industrialization-led. A number of mega projects, mainly including the construction of hydroelectric power plants, expansion of industrial zones and development of social infrastructures such as roads, railways, universities and health centres have been planned. The ultimate prize would be attaining middle-income status and macroeconomic stability.

However, it has created a huge gap between government revenues and spending as the latter is rising at a high rate while the former is only gradually increasing.

On the one hand, the government’s efforts to implement its promising development plans have a tremendous effect on the overall economic activity of the country. It will improve social  infrastructures and provide public goods by stimulating and promoting economic growth.

On the other hand, the actions of the government to finance its expenditure and budget deficit through raising the tax base negatively affect the overall economic activity of the country. Recently, the government has been implementing a number of tax reforms without analysing and balancing the cost and benefits of its action and neglecting the far reaching consequence on the economy.

A macroeconomic variable used to measure the effect of tax on aggregate income, called tax multiplier, is a perfect indicator of the problem. The statistical figure of ‘tax multiplier’ in the case of our country shows it is around negative four, showing that when the government raises the tax by one Birr, it leads the aggregate income to be reduced by four Birr. The numbers paint a good picture of the adverse effects of rising tax on aggregate output based on the practically observed incremental rate of tax.

The unbalanced actions of the government to finance its budget deficit by imposing tax mainly on hard-to-tax businesses, negatively affect the aggregate income of the economy. It aggravates the long lasting problems of the country such as unemployment, inflation, income inequality and food insecurity.

From consumers side, when the government raises the tax, it directly affects their income and reduces disposable income. Subsequently, demand for goods and services will be affected, and they will be unable to satisfy their basic necessities. The largest proportion of the country’s population are either unemployed, dependent, have a low income or are subsistence farmers. Purchasing power is severely restricted as it is.

From the investors’ side, when the government raises the tax base, it directly and indirectly raises production costs, which will ultimately lead to a rise in the price of goods and services.

Just a month ago, the government imposed an unfair tax amount on small businesses, defined as level “C” tax payers as they have an annual turnover of up to 500,000 Br, after undertaking a new tax assessment. This move was faced by protests in some regions of the country, by retailers who complained that the assessors overestimated their daily incomes. The majority of these retailers, which hugely contribute to the economy, resorted in some cases to closing up their shops and aggravating the economic problems of the country.

All of these episodes show the narrowly defined tax reforms of the government, which merely aim to boost the government revenues without taking into consideration the social repercussions that follow, lead to fiscal policy to becoming a zero sum game.

Paradoxically, the fiscal policy has led to inflation, crowding out of productive private investment, deterioration of the living standard, aggravated rent seeking, unemployment, poverty, food insecurity and income inequality. But the purpose of a fiscal policy all the while should have been to create sustainable growth and ensure price stability.

Therefore, the government should not concentrate only on raising revenues to finance its public spending, but also to critically examine the consequences of its action and find out alternative sources in a way that does not affect private investment. The government should take measures to bring a self-sustained economic growth.

The state is not gaining the amount of revenue it should from tax due to the existence of poor tax collection and management systems. What has to happen is, modernisation of the tax regime. This could be through improving accountability, transparency, efficiency and effectiveness of the tax regime. Strengthening the institutional framework of the tax administration, including its procedures and organisational structure, by deploying well-educated manpower and employing state-of-the-art technology.

Awareness creation is another area the government is expected to work on. The importance of paying taxes should be imprinted in citizens, not as a burden they have to shoulder but, a duty they feel welcome to carry out.

The informal economy is also another ill that has to be discouraged with calculated policy measures and approaches that strictly prohibit the development of the sector. A legal framework that incentivises people to prefer the formal sector could enable the government to extract more tax revenues.

There is a need to re-define the fiscal operation of the government regarding the degree of correlation between government revenues and expenditures, taking into consideration the optimal level of government revenue when determining the aggregate level of government expenditure. The authorities should focus more on achieving a balance between government revenues and government expenditure. The fiscal policy towards stimulating government revenues should be accompanied by a strong expenditure management and control measure.


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