The Financial Express

Public spending: Trends in Bangladesh

| Updated: June 10, 2021 21:56:14

Public spending: Trends in Bangladesh

Taxation has traditionally dominated the public discourse on public finance, and public spending has received far less attention. The term public spending is most commonly used to refer to the aggregate sum of money spent by the government.  Two issues primarily influence the growing interest in public spending - ( 1) impact of public spending on the level of national income (GDP), and  (2) how various types of public spending such as on infrastructure, health care and education etc. affect the economy and society.

The responsibility for spending money raised from taxation and other sources has become a central issue of the modern concept of government. In fact, public spending has become an important  instrument of macroeconomic management. The public sector now forms a large part of the economy like Bangladesh and as such public spending has a major impact on the macro-economy  and the day to day quality of people's lives.

Since the early 1980s there have been arguments in favour of reducing government intervention in economic activity. One of the principal critique of public spending centres around the idea that increasing public spending  causes negative "crowding out" effect, thus squeezing out private sector economic activity.

Harvard economist Robert J. Barro found that "growth and the  size of government are negatively related when the government is already very large". Also, the government is to manage tax collection and public borrowing and then, money and goods thus created have to be distributed to the people. This is the general view of the functioning of the government. As  such governance system requires a huge bureaucracy to run the system which needs to be answered at every step.

It is needless to say that this bureaucracy comes at a very high cost called the "transaction costs". Odds are that a huge amount of public spending can be attributed to transaction costs which do not provide much  value. Such costs amounted to 2.2 per cent of Bangladesh  GDP in 2020 or 13.8 per cent of total public spending including capital expenditures  during the same year.

Also, financing budget deficits through banking system causes inflation because there is a long-run relationship between budget deficit and money supply. Inflation always creates poverty through income redistribution.

On the other hand, those who argue for increased public spending argue that public spending is a key factor in economic growth and development. It is an essential driving force, providing universal services for human development- health care, education, social security as well as  essential infrastructure  such as water, electricity and roads making other economic activity possible. They further argue that the overwhelming increase in public debt has been due to economic crises caused by the private sector. 

It is further argued that that tax system over time has become very regressive so much so that governments are increasingly relying a whole lot of indirect taxes such as VAT which hit lower income groups hard. Therefore, the taxation regime now in place no longer works as an effective fiscal instrument for income redistribution or to reduce poverty.

The taxation regime that is in place now in Bangladesh is highly reliant on consumption based taxes (VAT, SD and import duty). These taxes together, over the last few years, averaged around 65 per cent of total tax revenue. Income taxes are mostly collected from corporate profits rather than individual tax payers,  averaged around 35 per cent of total tax revenue. Only close to 2 per cent of the population pay personal  income tax. Such a high reliance on consumption based taxes (i.e. VAT, SD and tariffs) is regressive - the poor lose a higher proportion of their income than the rich.  In fact, the share of VAT is  one percentage point higher than  that of income tax in total tax revenue. Such a tax violates the very criterion of 'fairness'' in taxation  and  fairness is the means that ensures the distribution of tax responsibilities.

A tax regime which is weak in its enforcement capability naturally leads to rethinking on adopting measures so that the tax system can be made capable of raising sufficient revenue to fund expenditure. It is widely believed that a huge amount of income and wealth is stashed away in overseas tax havens and  also invested in properties in countries  such as Canada and the US and European countries.

Dealing with such issues, it is generally suggested that introducing financial transaction taxes (The Tobin tax which is a tax levied on spot currency conversion named after economist James Tobin) should be a part of this process. But the Tobin tax may have very limited applicability in the Bangladesh context  as most financial transfers to overseas countries  take place through  illegal channels such as "Hundi".

However,  the key argument in support of public spending  still remains valid as was propounded by John Maynard Keynes that public spending should be increased when private spending and investment are inadequate.  Since the 1930s, using public spending to stimulate economic activity has been the key option for governments around the world.

Leaving aside the arguments for and against public spending, there has emerged a general "consensus politics" since the end of the WW II, to use public spending as an instrument of macroeconomic management. There may be differences in opinion in spending priorities-- some favouring more spending on redistribution and others may like to see more spending on infrastructure, yet others may like a more balanced spending  between the two.

As with most economic methods, there are many different ways of measuring public spending.  In national income accounting when government spends money for  acquisition of goods and  services (G), such acquisitions are treated as part of the final product. All government purchases are a proxy measure for government output.

However, G does not include transfer payments and  interest payments on public debt. Transfer payments are a part of private income and are not linked to any economic activity. Also, no goods or services are received in exchange for such payments. As such it will be captured in private consumption ( C ), thus avoiding double counting.  Interest is the income earned on capital. Interest payments by the government is not usually for purchasing capital equipment, therefore not connected to production. Thus,  the amount for government spending  ( G ) on goods and services is smaller as a percentage share  of GDP  than if the amount of total government spending including transfers and interest payments are included. 

Public spending is undertaken for a variety of reasons and  enables the government to produce goods and services or purchase goods and services needed to fulfill the government's social and economic objectives. In particular, the government steps in to supply goods services that the private sector would fail to do so. These include public goods such as infrastructure like roads and bridges  and defence and merit goods like health care, education and social security benefits such as unemployment and disability benefits  and old age pension.

Public spending on infrastructure, health care and education provide external benefits to the rest of the economy which can have long-run effects in comparison with using monetary policy instrument like interest rates which are often short-run. Since the end of the World War II, public spending has increased quite remarkably when governments all over the world started spending more money on education, healthcare and social security.

Public spending is broadly classified into two groups-- ( I ) current spending: which is expenditure on wages and raw materials etc.; and ( II ) capital spending: which is expenditure on physical assets like roads, bridges, hospitals etc. Bangladesh also follows the same  broad two classifications for public spending i.e.,  (1) current expenditures include wages and  salaries paid public servants, purchase of goods and services and transfer and interest payments and capital expenditure and food account expenses, and ( 2 )  capital expenditures where the Annual Development Programme (ADP) and non-ADP expenditures constitute two major categories of capital expenditures.

Current expenditures accounted for  56.7 per cent of total budget allocation for the year 1918-19 of which almost a quarter that was spent on pay and allowances and 22 per cent on interest payments. The remaining 43.3 per cent of the total  budget outlay went to the capital expenditures account. Bangladesh has one of the lowest public spending to GDP ratio in the world which stood at 15.1 per cent in 2019. Two neighbouring countries of Bangladesh -- India and Nepal had much higher public spending to GDP ratio at 27.1 per cent  and 30.5 per cent respectively during the same year.

Faced with financial crisis, global economic stagnation and now the pandemic, governments around the world including Bangladesh have felt the importance of fiscal intervention to maintain the momentum of economic activity thus holding back the worst effects of economic slowdown. But it is the issue of addressing rising income inequality that remains the core of  public spending.

In 2020, unemployment rate in Bangladesh was at 4.15 per cent but the youth unemployment rate stood at 11.56 per cent in the same year. In fact, 85 per cent of Bangladesh workforce  are found in the informal sector as self-employed or wage earners. Also, the benefits of growth do not look like shared by the poor and very low income wage earners like RMG workers.

The national poverty rate for Bangladesh is estimated at 20.5 per cent and the extreme poverty rate at 5.6 per cent. Now the poverty rate is estimated to have risen due the impact of the pandemic to 29.5 per cent and the extreme poverty rate to 10.5 per cent.

It also an widely accepted view that all the growth of GDP - all the increases in national income, have accrued to the wealthiest 5 per cent of the population in Bangladesh, the remaining 95 per cent of the population hardly benefitted at all, and in many cases their share has been shrinking. By 2015, the richest 5 per cent of the population were 121 times richer than the poorest 5 per cent in Bangladesh. Now the  Covid-19 pandemic is likely to further widen that gap.

The Gini coefficient, a measure of income inequality rose from 0.458  in 2010 to 0.482 in 2016 indicating worsening income inequality. As a result of the pandemic the coefficient is now estimated to have gone up to 0.52. Income inequality typically implies inequality of opportunity also. Income inequality and poverty are directly interrelated as such even small changes in income distribution can have profound effect on poverty.

According to the Medium Term Macroeconomic Policy Statement, 2021-22 to 2023-24, "Reduction in poverty and inequality, and ensuring inclusive development has been at the core of the government's development agenda". The Statement points out that the government expenditure for poverty reduction went up to 10.5 per cent of GDP in 2020-21 compared 9.12 of GDP in 2008-09.

While governments pursue redistributive goals using a wide variety of instruments like taxation, transfers but it is well recognised that public spending remains the powerful mechanism to accomplish redistribution of income. But when public spending  on education, health care, unemployment benefits, welfare services and pensions on a universal basis to its citizens is combined with progressive taxes with better government effectiveness, it can not only achieve more equitable distribution of income but also reduce inequality of opportunity. It has been observed that revenues gained from taxes, when redistributed to lower-income earners in an attempt to improve the equitable distribution of income, it lowers income inequality by around one third on average or equivalent to around 0.15 Gini points.

Bangladeshis  now is not only faced with the fight against the pandemic but also has to deal with economic fallouts of the pandemic in addition to the issues of poverty and rising  income inequality. The government has adopted fiscal stimulus  measures to mitigate the economic and social effects of the pandemic. Given a low debt/GDP ratio which now stands at about 35 per cent, there is a scope to sustain a higher fiscal deficit and increase the level of public expenditure. Obviously, such a policy is guided by Keynesian policy prescription for macroeconomic management.

But the current economic crisis is more than a viral pandemic induced crisis  and  attempts to  fit it into the mainstream narrative  of  crises caused by an  external shock and to deal it with  counter cyclical Keynesian measures is unlikely to resolve the crisis except giving it a band aid.

The pandemic induced economic and social crisis provides a unique opportunity to fundamentally rethink how macroeconomic policy is developed  in  prioritising economic and social objectives.  A transition to the post Covid-19 world  will, therefore, requirere orientation  of public  spending priorities as well as overall economic governance with different approaches to taxation, public debt, monetary policy and managing  inflation.

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