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Risks of running government on deficits

By XN Iraki | June 26th 2012

By XN Iraki
In the recent Budget Speech, the overall deficit is expected to be Sh279 billion. Simply put — we are spending more money than we are collecting. Finance Minister Njeru Githae says Government expects to close the financing gap through net foreign financing of 143.6 billion and 106.7 from domestic market.

On the face of it, there is nothing unusual about budget deficits; as individuals we have deficits and few Kenyans can boast of being debt-free.  It also makes economic sense to borrow — use other people’s money either because they have excess or have no clue what to do with it. There is nothing wrong with borrowing if the money is invested.

But the state invests with most revenue going to pay salaries and wages.
The only problem with borrowing is that it is costly. Banks charge you interest rates, the cost of using other people’s money. Shylocks do the same. In Kenya, the problem is exacerbated by high interest rates. The high rates can be explained by limited sources funding. The state competes with her people for the limited funding in the economy. This raises demand and by extension, the price — interest rates. High interest rates slow down the economy despite taming inflation.

In Europe, statistics from 2010 indicate that the largest government deficits in percentage of Gross Domestic Product (GDP) were recorded in Ireland (32.4 per cent), Greece (10.5 per cent), the UK (10.4 per cent), Spain (9.2 per cent, Portugal (9.1 per cent), Poland (7.9 per cent), Slovakia (7.9 per cent), Latvia (7.7 per cent), Lithuania (7.1 per cent) and France (7.0 per cent). Our deficit is around 6.5 per cent of GDP. Japan’s was 9.7  per cent last year and China  two per cent same year.

We are unlikely to balance our budget soon. On the revenue side, the main source is taxes. It has been suggested that if we collected more tax, we could substantially reduce our deficit.  The government has increasingly raised more revenues from taxes since the end of the Kanu era. But observers think lots of taxes still go uncollected or leak out. That is why electronic cash registers are demanded by KRA, and so are PIN numbers.

Increasing Revenue
We could increase the number of taxpayers, particularly those in the informal sector by formalising it.  However, a better approach would be to apply the laws of economics. Can we try lowering the taxes so that more people are willing to pay the taxes? Laffer’s curve indicates that there is an optimal tax rate that maximises the tax revenue.

We need to get that rate. Is it possible a VAT rate of 12 per cent could give KRA more revenue? Furthermore, lower taxes become an incentive to work harder and grow the economy.

A much better option to increase tax revenues is to make good use of that tax. That will make more people willing to pay taxes. In the last 10 years, there has been some evidence of good tax use through roads and other projects but more can be done.

Private public partnership could reduce our deficits by reducing the costs of collecting taxes. Can I build a road and the government offsets my cost through a tax refund? Too many people see taxation as an evil. The tax code is too complicated and the Government is keener on collecting taxes from you than helping you get more revenues. 

What of a discount for paying all taxes after auditing? Economic reforms would increase growth rates and taxes. On the expenditure side, it is unlikely that it will reduce. The demand for services   particularly in a country with ambitious growth targets and high unemployment rates is likely to remain high.  Ideally, we could reduce the deficit by just cutting down the costs. This apart from being politically unpopular would impoverish lots of Kenyans.   We could cut costs by being more efficient. 

Combining ministries will cut lots of costs. It is no secret that one cause of deficits is that the people who make decisions on how to spend public money are not the same people who generate that money! That is why electing the right people is important. Finally, we could make a constitution amendment and demand the Governments at both central and county levels balance their budget.

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