DFID Public Expenditure Workshop

DFID Public Expenditure Workshop

Good practice in dealing with uncertain revenues and unpredictable expenditures and seasonality

I. Introduction

This paper addresses the issues of seasonality and uncertainty with respect to revenue and expenditure. These are important as they impact on expenditure management from a macro economic stability perspective as well as the efficient delivery of services that the public sector provides.

Seasonality in public revenues concerns the rate at which revenue flows reach the government coffers at different points in the financial year. If payments for the main taxes (and non-tax instruments) are required to be made on a regular basis throughout the year, the corresponding revenue flow to government is likely to be smooth, with similar amounts of revenue being received at different points in the financial year. If payments for some (or all) major tax and non-tax instruments are bunched at particular points in the financial year, revenue receipts by the government are unlikely to be smooth.

Likewise, seasonality in expenditures concerns the rate at which expenditures are required to take place at different points in the financial year for the efficient, effective and economic functioning of government. For a variety of reasons, some expenditure requirements are likely to be much more ‘lumpy’ than the revenue receipts they are to be paid from. It is likely to be the case, for example, that a Ministry of Health would wish to make bulk purchases of drugs to take advantage of economies of scale in such purchases. Expenditure on schoolbooks is linked to the school year and these should be provided at the start of the year rather than during the year to be of use. In the absence of appropriate and advantageous credit arrangements with suppliers, availability of a particular budget line for an entire year may be required to achieve economy in the use of resources.

Besides planning for the consequences of foreseen cycles in the revenue raising efforts of the tax collection agencies, governments also have to contend with uncertainty. In terms of expenditure, governments may have to accommodate the consequences of random and unpredictable events such as those resulting from the weather, both drought and floods, and from other natural calamities. In many countries there is also the impact of political unrest in neighbouring countries, the consequences of which adds to defence spending in excess of normal levels. Although the impact of these events would not be described as ‘seasonal’, the potential disconnect that may result between expenditure requirements and cash flow is similar in effect to that associated with seasonality. As well, there is the impact of exogenous shocks to the economy such as trade shocks from the collapse of external markets or from the fluctuations in the price of commodities that the county may import and export. These may have an adverse impact on revenues.

Where donors, through programme aid, support governments and this aid is funding recurrent expenditure, the timing of the transfers is also important for good expenditure management. Delays in transfers for whatever reason can have an adverse impact on provision of services.

Scope

The scope of this paper is confined to examining the extent of seasonality and uncertainty in both revenue and expenditure[1], how these impact on macro-management and service delivery and how a government could cater for these foreseen and unforeseen fluctuations of revenue collection and expenditure. To the extent that donor funding from programme aid is included in revenue projections, the timing of donor funds is also important and crucial.

Many countries make a distinction between a recurrent budget (usually funded by domestic revenue and programme aid) and a development budget covering projects (funded in the main by donors with some domestic counterpart funds). It is not uncommon for actual development budget expenditure to be just a fraction of planned development budget expenditure. There are many reasons for this to do with project implementation, but there are often delays in both donor funds and counterpart funds to projects. However, this issue is not addressed specifically in the paper.

The annex tables to the paper provide evidence of the seasonality issue in five countries (Uganda, Rwanda, Sierra Leone, Papua New Guinea and the Province of Sindh in Pakistan) as examples. A point of note about the countries is that the respective revenue bases are substantially different. Papua New Guinea has a significant amount of mineral related revenue; Sindh is dependent on transfers from the Federal Government for 80% of its revenue while Rwanda and Uganda, and to a lesser extent Sierra Leone (at the time the data relate to) rely on revenue from more traditional taxes. These latter three countries have also initiated adjustment programmes with the IMF and the World Bank where control of the fiscal deficit is a key policy objective.

II. The New Orthodoxy

Fiscal prudence has become the accepted mantra of the UK Treasury and beyond. There appears to be two underlying principles embodied in the “Golden Rule” relating to fiscal prudence. Firstly, an average target balance for the budget should be achieved over the course of a business cycle. In boom years, surpluses should not be given away and in years of slump, deficits should be accepted such that the average deficit for the period of the business cycle would be that of a ‘normal’ year. Built in stabilisers should be allowed to cushion the effects of the cycle. Secondly, the public sector debt ratio should be kept to an acceptable level.

Maintaining a balance over the cycle is desirable as it means that frequent changes in tax rates with unnecessarily negative impacts on incentives can be avoided. Tax rates can therefore be kept stable over the medium-to-long term according to given revenue requirements and desirable tax policy (via its impact on consumer and producer behaviour).

In the context of a developing country, however, how appropriate are these rules? In developing countries, typically tax to GDP ratios are much lower than developed countries due to the much narrower tax base, (which itself is a function inter alia of the nature of the formal economy and its relative size vis-à-vis the informal non cash economy). This means that government expenditure is subject to greater constraint than in more developed countries and prioritisation of expenditures becomes more crucial.

Donors adding to domestic revenue to generate a resource envelope can achieve a higher expenditure level beyond that funded by domestic taxes. Even in this context, the golden rule is appropriate. Where such prudence is not adopted a structural fiscal imbalance is created, which is likely to be unsustainable in the long-run. Prudence in the context of a developing country might be defined as keeping within a deficit agreed with the IMF.

III. Issues in Developing Countries

Governments are expected to use tax receipts (and other) revenues in the delivery of public services to the citizens of the country. However, in the context of government spending and revenue raising, other considerations relating to the macro economy are also important. Depending upon how this is funded, ‘too much’ spending relative to revenue will have an effect on the money supply, price stability, exchange rate, private sector credit availability and other macro aggregates. Raising revenue by imposing penal tax rates on a narrow group of easy targets will have a detrimental effect on incentives and could ultimately reduce revenue by causing non-compliance.

There are trades-off between macro stability and the delivery of services. Typically, revenue collection is not evenly spread throughout the year, but a large component of expenditure in developing countries (e.g. wages and salaries) has to be paid monthly. As well, the efficient delivery of government services requires a mix of inputs for expenditure to be effective in delivering these services. The personnel that the wages and salary payments support cannot function effectively if they do not have resources for associated inputs (books for teachers and pupils, fuel and transport for extension workers, medicines for doctors, etc.).

Where borrowing on non-concessional terms is undesirable (or is proscribed by the IMF as part of an adjustment programme), it is not usually possible to smooth out the seasonality of revenue receipts vis-à-vis expenditure requirements by borrowing. Moreover, it may not be desirable from a macro economic stability objective particularly if the borrowing is significantly large in relation to revenue. Therefore, cash flow becomes an issue. A shortfall in tax revenues over expenditure levels has to be met by an adjustment in expenditure rather than borrowing to maintain expenditure. Monthly revenue availability leads expenditure rather than the expenditure plans expressed in the budget. This means that the efficient delivery of services is in turn impaired as cuts, (which usually impact on non-personal inputs) are exercised.

An alternative response would be for the government to charge (increased) user fees to cover some of these items, but user fees are unlikely to apply to all. This action would help maintain the overall levels of service provision, but transfer the responsibility for additional payment to the private sector. The feasibility of this response will depend on the existing level of user charges and whether it is acceptable politically to have increased charges given social objectives and affordability by the poor. Changing the level of user charges on a relatively frequent and irregular basis in response to seasonal shortfalls is not likely to be acceptable or feasible. Therefore, although increased user charges may limit the effect of seasonal (and other random) shortfalls (in that the proportion of expenditure relying on the public purse is smaller and is therefore likely to vary less with such shortfalls) it cannot be presented as a short-term device for managing variations in cash-flow.

The sometimes-conflicting demands of the macro economic stability objective and the efficient delivery of services objective can be summarised as follows

Macro economic stability and need to reduce borrowing / Sectoral spending efficiency
·  Needs to balance receipts and expenditure / ·  Needs consistent flow of funds
·  Needs Cash Management System / ·  Needs releases per budget spending plans
·  Needs good revenue (overall resource envelop) forecast / ·  Needs expenditure consistent with revenue forecasts

IV. Country Information [2]

Seasonality

The evidence from all the countries that data are presented is that on a monthly or quarterly basis there are fluctuations in the amount collected as revenue. That this is so should not be a surprise as there are different times of the year that certain taxes are collected (company taxes) and indirect taxes related to consumption with have a seasonality factor (linked to major festivals) even though they will be relatively constant.

The monthly and quarterly expenditure figures associated with these revenues will be dependant upon the seasonality of expenditures as constrained by: the seasonality of revenues; the effect of exogenous shocks on revenue; and the permitted fiscal deficit as determined by the government’s macro-economic targets. This assumes that the Government abides by the target (without or without the blessing of the IMF where this is relevant).

Monthly expenditures are described in the various tables. While these tables give an indication of the seasonality of expenditures, it should be noted that the effect of existing fiscal and cash-flow constraints on the pattern of expenditures is likely to result in the tables not providing a fully accurate representation of the underlying seasonality in expenditures[3]. In this sense, it is impossible to assess from this information whether the monthly expenditures are at a level that efficient service delivery would dictate. However, it is clear from the figures that monthly and quarterly non-wage recurrent expenditure (excluding interest) does vary.

To be able to assess the extent of seasonality of expenditures, a different set of expenditure figures is needed. These figures would cover the monthly or quarterly budgeted expenditures that reflect the timing and seasonality of input provision to achieve efficient service delivery. It is important to note however that budgeted data will reveal the provision required for the efficient delivery of services only if the underlying budget process allows this. In many cases (Sindh, for example) it does not. Nevertheless, variations in budgeted versus actual each month will reveal more about seasonality – as well as revealing symptoms of a good or bad budget process. A comparison of actual monthly/quarterly expenditures with budgeted monthly/quarterly expenditures would reveal the extent of the impact of revenue seasonality on expenditures. Figures on actual expenditure, therefore, while providing much information, are of limited use in assessing the problem of seasonality. Thus, while the expenditure figures are themselves interesting they are of limited value for the purpose of this paper. Actual revenue figures do indicate the nature of the problem of seasonality.

Unforeseen Fluctuations

An assessment of the extent of unforeseen fluctuations can be made by comparing actual revenue and expenditure with budgeted revenue and expenditure. If these are wildly out of line, it may be inferred that something unforeseen has taken place.

Uganda from 1995/96 to 1997/78, as an example, shows that while overall actual expenditure and revenue are within a reasonable range of the budgeted amount, there are fluctuations within components that make up the totals. What cannot be deduced from the figures is why there were these fluctuations.