Fiscal Legacy – Why Taxes need to be increased
Bank Al Maghrib (BAM) has rounded up some interesting figures in its annual reports about growth and inflation over the next decade. These figures tell a lot about what they might know (and what we might not) on future budget policy.
First off, BAM economists believe the domestic economy will converge back to its potential/average trend level (great news for me, my own estimation of potential growth, 4.8% isn’t far off from BAM’s 5%) notwithstanding exogenous shocks. How an economy can sustain itself to a stable level such as this one is a matter of debate; The topic at hand is how government’s receipts evolve overtime, perhaps at a difference pace, depending on government fiscal policy.
What will be the next government’s challenge? First the 48Bn Compensation Fund cannot sustain itself indefinitely; not because of its social dimension, but because the accrued effect of supply-side economics and fundamentally Keynesian policy (supposedly supporting consumers’ standards of living) puts a dangerous strain on public deficit and debt. Sooner or later, budget will have to look for revenue enhancements and reduce the size of its subsidy, a hazardous move likely to trigger social unrest and discontent across the country.
Revenue efforts were intensified and higher than budgeted revenue were collected at end June 2011 –mainly from indirect taxes. These efforts should continue in the second half of the year and should enhance revenue collection by 1 percent of GDP compared to the 2011 budget. Consequently, total revenues are expected to remain almost unchanged compared to 2010, at around 25 percent of GDP. On the expenditure side, all budget entities have been requested to economize 10 percent of their budget allocations for some non-essential current expenditure items.
Cutting expenditure is not unsound economic policy: bureaucratic waste can be eliminated, structural reforms can be introduced to streamline government business. On the other side of government balance sheet, increasing taxes can also help rebalance the budget. But at the end of the day, there remains an additional burden on public finances no hocus-pocus measure can alleviate: service debt is likely to rise from 36.53Bn in 2011, to more than 45Bn in 2012. The next government cannot but pay back the debt (the risk of defaulting is very slim, and at this stage will do more harm than good) and, in the process, cut back on some its expenditure.
In a nutshell, government budget needs to increase taxes. It has no choice, and, really, it has systematically chosen a bad course when it comes to financing itself: Since they have been published in 2004, tax loopholes have been systematically less costly compared to debt service, an indicator of debt-financed expenses. And since debt service is likely to increase markedly in the next 2012 Budget bill (with all the sumptuous expenses going on these days) not only government finances need to be balanced by increasing receipts, expenses will be cut too. The next government only has to find a balance between these options: how much to cut and how much taxes to raise. The smart government would leap upon the opportunity and engage into serious structural reforms on taxation and expenses policy.
BAM forecast seem to indicate that the next couple of years will be devoted to paying back national debt; As a matter of fact, the Bank forecasts an increase in foreign debt in order to alleviate pressure on domestic debt markets, and keep inflation at an average of 2% throughout the decade. In order to do so, government finances will have to be solvent enough to attract investors, and that means slimming down the budget, cutting expenses, subsidies and increasing taxes too.
Subsidies: first, the finance ministry needs to manage more professionally its expectations on commodity prices; I understand the ministry has no specific team to price options and other derivatives (futures) on commodities markets. I understand there are reservations on these financial products, but up to now, the current cost is outweighed by any potential risk entailed in covering our imports with commodity options.
So the 48Bn compensation fund can be reduced to a considerably lower level without even increasing the price of strategic goods domestically, simply by looking at the curve of spot prices on commodities. Now ministry officials could be understandably nervous about using stochastic techniques in determining indirectly the amount of resources allocated to the Compensation Fund, but as far as short-term futures go, it would be better to consider hiring some commodities traders to do the job. Compared to the present 48Bn boondoggle, any remuneration would do and remain a cheaper option still.
The official argument behind the existence of a compensation fund is well understood, and, up to a point, valid. Since income and wealth discrepancies are almost impossible to bridge, subsidizing strategic commodities remains an option to consider; alternatively, the subsidy comes in lieu of real structural reform, and merely a temporary patch to contain social resentment and unrest. But the truth is, because of its indiscriminate setting, the fund actually subsidies those with a higher consumer standards: since the top 10% actually concentrate the third of nationwide consumption, the mere quantitative effect gives an unfair advantage in subsidizing the consumption of the wealthiest over the rest of the population.
For instance, subsidies on edible oil benefits more the richest households: the top 10% actually spend three times more than the bottom 20%, and 60% more than nationwide average. In absolute terms, and since wealthy households are smaller than other decile consumers, the subsidy, both from a pure quantitative prospect and because of consumption pattern, subsidy, as far as edible oil is concerned, benefits less than 5 Million Moroccans. (incidentally, Sugar also records pretty similar discrepancies between inter-decile consumers and relative to nationwide mean, again, in favour of the top 20%)
Debt vs Tax loopholes Management: as mentioned before, minister Mezouar has made up his mind over the tax-debt trade-off in favour of the latter. As long as economic growth was stable, the domestic debt market required low yields, total domestic public debt was allowed to steadily increase by 2008, perhaps to compensate the effect of tax cuts, especially on income taxes (it is also worth mentioning that short-term public debt has quadrupled ever since this government has been into office, late 2007. We now stand at a short-term domestic debt of MAD 60Bn, 1/5 of total public debt, a long way from the mere 5% (or MAD 13.8 Bn) in late 2007. And following the Central Bank’s projections, the trend is likely to be confirmed in paying back domestic debt, while compensating with an increase resort to foreign debt (quite a disturbing piece of news, considering our less-than-smooth history with such a financing vehicle)
On the other hand, tax loopholes have increased steadily over the years, with tax deductions that benefit the few, not the many. In an earlier post, I referred to the real estate sector as the main beneficiary: real estate developers capture 2/3 of total subsidies (that is, 2.5 Bn for developers against a 1.3 Bn devoted to social housing)
In addition, some MAD 14Bn cut on income tax have been granted to households over the last 4 years, thanks to the tax reform enacted in the 2008 Budget that oversaw the scrapping of the 42% marginal rate as well as . Now, contrary to what many would believe, the tax cut did not result in an increase in government receipts, since recorded GDP growth exceeded government previsions, up to 5.6%, contrary to the projected 2.5%. As for the real cost for the income tax cut from the bottom 10%, the expected cost would not exceed MAD 750Bn; Since VAT cuts have been designed to fit domestic consumption, any tax increase on those enjoying exceptionally high standards of living wouldn’t be such a bad policy.
To wrap-up, the current state of public finances calls necessarily for at least some re-alignment in debt and taxation receipts. These expected indicators brought by Bank Al Maghrib show that soon, the next government will have no choice but to pay back its debt at a higher rate in order to avoid high yields, both domestically and abroad. A further burden on public finances will also prompt them into considering serious ways to do away with the present subsidy scheme, hopefully by strengthening the purchasing power of some 4 Million households.