The Budget and Welfare Expenses

By Anila Dias Bandaranaike Ph.D.
While glancing through my daughter’s Grade 8 government textbook on the subject ‘Citizenship Studies,’ I came across a chapter on ‘Public Services’ in which it stated that the government provides certain public services free to its citizens. The textbook did not mention anywhere that the government has to collect revenue to meet the costs of all public services that it provides.

This made me realise that Sri Lankan citizens grow up thinking that public services require no financing! It also explains why so many adult Sri Lankans mistakenly believe that the government can provide free services, jobs, school uniforms, text books and food stamps and give fuel and fertiliser subsidies at will, and without any repercussions. In fact, the government earns very little money of its own. While it levies charges (most of the time at a subsidised rate) to meet the costs of some of these public services, such as train travel or postage, for others, such as running hospitals, dispensaries, schools and universities, it has to find all the monies required through other means. It therefore charges us taxes, whenever we buy any item in the market or earn any income, to pay for these ‘free’ services. Furthermore, if the costs of public services are more than what the government earns, then the government has to borrow money from somewhere to finance its cost over runs.

This article is therefore written with the idea of throwing some light, on how government finances public services, for any interested member of the general public.

Let us first look at the government’s revenue and expenditure, by way of answers to some basic questions.

Revenue

• Why does the government collect revenue? To meet its expenses.
  
• How does the government collect revenue? Mainly through taxing citizens. It also earns income from some of its activities. These 2 categories are called ‘Tax Revenue’ and ‘Non-tax Revenue,’ respectively.
  
• Which is more important? Tax revenue. In Sri Lanka, over 85% of revenue is earned from taxes.
  
• What are these taxes? There are 4 main categories. These are: 1) taxes on imports and exports, 2) taxes on local goods and services (VAT, Excise, etc,), 3) Licences and levies (on motor vehicles, etc.) and 4) taxes on income and profits of individuals and companies.
  
• Who pays these taxes? Everybody, though at different rates. In Sri Lanka, over 60% of tax revenue is from VAT and Excise Tax, which we all pay when we buy anything or use any service, even those who do not pay income tax.
  
• What is ‘Non-tax Revenue?’ These are all other government earnings and profits from its businesses and assets, which amount to less than 15% of its total revenue.
  
  Expenses
  
• What are the main categories of government expenses? The 3 main categories are recurrent expenditure, capital expenditure and repayment of government debt. Recurrent expenses cover salaries and pensions of government employees, other administrative costs of services provided by government such as railways, electricity, police, education and health, cost of state vehicles etc. Interest payments on government debt are also recurrent. Capital expenses cover investment for future development such as on buildings, roads, training, etc. Repayments of principal on government debt form the third category.
  
  Which is the largest cost? Recurrent expenses. In Sri Lanka, recurrent costs have been over 50% and repayment of debt over 25% of total expenses. This leaves less than 25% to be spent for future development. Usually, when the government’s recurrent costs and borrowing costs have risen, then capital expenses, such as road development, have been cut down due to budgetary constraints, affecting future development.
  
• Do all government services that are not ‘free’ earn enough to meet their costs? No. They carry large numbers of employees and overheads. Charges are usually not enough to meet expenses. For example, public corporations such as the CEB, CGR and CPC have lost billions of rupees for many years. They have to borrow or be subsidised by government to meet their costs. At end 2006, their debt stock had increased from Rs. 15 billion to Rs. 46.5 billion.
  
  Budget
  
• What is a ‘Government Budget?’ It is the government’s plan for collecting revenue and incurring costs, as well as for bridging the deficit or using the surplus, if any.
  
• What happens when revenue is more than expenses? The budget is in ‘surplus.’ The government then has to make a plan to use the surplus for optimal benefit of the country.
  
• What happens when revenue is less than expenses? The budget is in ‘deficit.’ The government then has to make a plan to borrow money to meet the deficit.
  
• What about Sri Lanka’s Budget? In Sri Lanka, governments have mostly been in deficit over the last 50+ years, and had to borrow to meet the deficit. In fact, during the last few years, government expenses have been more than twice government revenue.
  
  Borrowing
  
• Who does the government borrow from? The Central Bank, local financial institutions, citizens and foreign sources.
  
  
• What are the impacts of such borrowings? In the short term, heavy borrowing by the government can raise interest rates, which will affect investment. Also, a) borrowing from the Central Bank can raise prices, by pumping too much new money into the economy; b) borrowing from local financial institutions reduces funds available for private investment and c) borrowing from foreign sources and conversion of such funds into rupees increases money supply. In the longer term, all borrowing will have to be repaid someday, and will take away funds from future development, at the time it has to be repaid. Otherwise, further borrowings have to be made to repay borrowings made earlier. Also, the effective cost of foreign borrowings includes, not only the foreign interest rate, but the exchange rate change as well. The Sri Lanka rupee has depreciated during most of the last 30 years, making foreign borrowing more costly than just foreign interest cost.
  
  
• What about government borrowings in Sri Lanka? Currently, government debt is a major problem for the country. Principal repayments and interest payments account for more than 40% of government expenses. Over 80% of all government revenue is used to repay government’s debt.
  
  In summary, government spends more than double its revenue. Nearly all revenue goes to make payments on government borrowings. Hence, the government has to borrow to pay for salaries, fuel for its vehicles and to meet most of its day-to day operations and development activities, making the situation worse as time goes on.
  
  Now, against this background, you may ask how, and at what cost, the government continues to provide subsidies and ‘free’ public services to us citizens. Let us now look at these two issues by way of answers to some related questions.
  
  Subsidies
  
• What is a subsidy? A subsidy is the difference in value between the actual cost of production and amount paid for goods or services that are provided at less than its cost. The actual cost reflects prices of raw materials as well as overheads. For example, fuel subsidies to the CPC cost the government, Rs. 17.5 bn and Rs. 26 bn in 2004 and 2005 and Rs. 9 bn in the first half of 2006. Similarly, a 50 kg bag of fertiliser was sold at Rs. 350, but cost much more, so the government spent another Rs.7 bn and Rs.12 bn in 2005 and 2006 on the fertiliser subsidy.
  
• Who pays the true cost of subsidised goods or services? Since the actual cost to the country has to be met by the government, the subsidy is paid for by government revenue or borrowings. Hence, ultimately we citizens pay, through taxes or higher- than - cost prices (cross-subsidies) for other items or higher interest rates or higher inflation resulting from government borrowings.
  
• Does a subsidy benefit the country or citizen? Not when there is a budget deficit. Citizens may think they have a direct benefit, when they pay the subsidised price. However, as explained in the previous answer, they end up paying the actual cost or even more, indirectly.
  
  Free Services
  
• Can a government provide free services to all its citizens? If it can afford to do so it is fine. If it cannot, either the quality of the service is poor for lack of funds, or the government borrows to meet the costs of these ‘free’ services. In the first instance, poor quality of service will not benefit the citizen, whereas those same funds could have been used to better benefit the citizen. In the second instance, although the service appears to be ‘free,’ in reality, citizens pay a hidden cost by way of higher interest rates or higher inflation resulting from the government’s borrowings.
  
• Then, what can governments do to ensure that its citizens have access to these basic human rights such as education and health? There are many rational ways to overcome this problem. First, governments can target free services to the really deserving, who cannot afford them, while charging others to cover costs. For example, even though government debt is rising, it continues to provide free books and uniforms to all students, irrespective of the income levels of their parents. Second, governments can maintain the quality of free services within affordable limits, and encourage private institutions to provide those same services for a fee. In Sri Lanka, fee-levying hospitals and health services are run by the private sector, in parallel with free, state health services. As a result, those who wish to can pay for private services, thereby reducing the demand for the free public services. However, in education, currently, there is confusion between ‘privatisation’ and ‘private participation,’ leading to pressure from lobby groups to prevent fee-levying private universities, even though free state universities have budgetary problems and can only take in 14% of students who qualify for admission.
  
• How can services be targeted to the really needy? By having a good screening system to identify the deserving. This will be easier if all citizens act responsibly and do not accept welfare from the government, if they are not entitled to it. In Sri Lanka, while around 23% of households were classified as poor, Samurdhi welfare benefits are taken by households even in the highest income groups, while less than half of the deserving poorest 20% of households received these benefits. Village committees should make sure that, in their own neighbourhoods, those who are not entitled, but cheat the government, are made to give up such welfare benefits. Village committees should also see that the really poor households receive the benefits they are entitled to.
  
• How do we identify the really needy for welfare benefits? By the poverty line. Government may limit welfare benefits such as Samurdhi and free uniforms to families that earn less than the poverty line. This value varies with costs of services from district to district and over time. In 2006, the national poverty line was Rs.2,066 per person per month. By December 2007, it had risen due to inflation to Rs. 2,668.
  
  In summary, while citizens do not directly pay for ‘free’s services and subsidies provided by government, it is they themselves who indirectly bear the actual costs, in the form of higher taxes, higher interest rates or higher inflation. Ultimately they will be worse off. All of us citizens need to understand these trade-offs and neither expect nor demand miracles from governments. After all, as Abraham Lincoln once said, governments too are elected “by the people, of the people…”.
  
  Sources: www.cbsl.gov.lk and www.treasury.gov.lk
  
  The author is a former Assistant Governor and Director of Statistics of the Central Bank of Sri Lanka.