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Public Finance for Child Rights. The Child and State in Development. Perspectives on the persistence of child labour and lack of universalisation of primary education
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The Child and State in Development • Perspectives on the persistence of child labour and lack of universalisation of primary education • More recently a tendency to argue that poverty makes child labour inevitable and resource constraints make universalisation difficult. • Concern here largely the latter issue.
Public finance policy • Defines the choices made by government in mobilising resources and allocating expenditures to meet its several obligations. • By determining the origin and application of public financial resources, the annual financial statement of the government, the national budget, reflects the real priorities of a government and its performance relative to its commitments.
Fiscal stance • The “fiscal stance” reflected by the budget is given by the levels of resource mobilisation and expenditure as well as the extent of government borrowing undertaken to bridge the gap between revenues and expenditure) • Through it, public finance policy is linked to the government’s overall macroeconomic and social policies.
Fiscal policies and their impact • Tax or expenditure policies that impose a proportionately greater burden on the lower income groups than on the upper income groups — in relation to their consumption, income or assets — are regressive in the sense of worsening various existing inequities and/or creating new ones. • On the other hand, policies that lead to more favourable distributional outcomes for the lower income groups are progressive.
Trade offs and priorities • Since there are always competing demands on public resources, the budget incorporates trade‐offs between different spending priorities. These trade‐offs are implicit value judgements. • Apart from being a technocratic record of revenues and expenditures, the budget also reflects a government's social and economic policy priorities.
Implications for child rights • The priority given to children by a State is reflected in the share and size of resources allocated and spent in realising children’s rights in the annual national budget. • Such allocations have to be made taking cognisance of the multidimensionality of poverty faced by children. • The task is to identify and assess the adequacy of such allocations.
Budget analysis from a rights perspective • How are budgetary resources raised, and what are its distributional implications? • How are budgetary resources allocated and whom do they benefit? • What would it cost to realise rights that are currently unrealised? • Can and how should the additional resources for funding these costs be mobilised equitably?
Tax and non-tax revenue • In the past, most countries derived the greater part of their revenues from tax sources. • Public sector surpluses are often presented as “normal” surpluses, as earned by private firms. But there is a difference. Prices charged by the public sector have to be seen as instruments in the tax-cum-subsidy regime.
Change in perspective • Change in perspective regarding public sector prices a part of economic reform • In many countries non‐tax revenues have been increased through increases in user fees/charges since the 1980s. Often occur as part of privatisation of public utilities. • Can result in reduction in the use of child-centric services by low‐income households.
Capital receipts • In addition to revenues, governments can use capital receipts of various kinds (receipts from sale of government assets, borrowing from the central bank, the open market or abroad) to fund expenditures. • While borrowing involves commitments to meet interest and repayment obligations in future, sale of government assets involve loss of income from retrenched assets. • Development assistance in the form of grants also do not involve future commitments.
Direct and indirect taxes • Taxes are broadly classified into two kinds: • Direct taxes levied on incomes (such as personal income and corporate profit), property and wealth; and • Indirect taxes levied on goods and services such as consumption taxes (general sales tax/value added tax) and trade taxes (export taxes/import taxes or tariffs).
Incidence • In the case of direct taxes, levied on the income a person earns, the burden of the tax normally falls on the entity that is being taxed. • In the case of indirect taxes, the burden of the tax is almost always passed on by producers (on whom they are levied) to the consumers of the goods and services concerned, in the form of higher prices.
Progressive taxes • In a progressive tax regime, the tax rate increases as the taxable income increases. People with more income pay a higher percentage of that income in tax. Thus progressive taxes are based on ability to pay. • The term “progressive" is also used to signify the distributive effect of a tax on income or expenditure. Such taxes are more favourable to the poor.
Which taxes • Direct taxes are normally progressive. However, the distributive effect of a progressive income tax can be significantly diluted with tax exemptions. • Indirect tax rates can vary across goods, but are the same for any particular good irrespective of who is buying it. Indirect taxes levied on essential consumption goods such as rice or wheat, which are consumed by rich and poor alike, are regressive.
Public finance and child rights • Thus the choice between different tax strategies for revenue mobilisation has significant implications for equity. • Progressive taxation is clearly an appropriate means of raising public revenues (and therefore government expenditure) without adversely affecting the poor. • Tax policies that reduce the real incomes of poor households, often undermine the realisation of children’s rights.
Tax-GDP ratios • Tax-GDP ratios reflect both the share of surpluses and the share of those surpluses appropriated by the government. • Tax‐GDP ratios vary substantially across countries. Not always true that tax‐GDP ratios will be higher in richer countries. • This ratio can be relatively high even when tax rates are relatively low, if the coverage of taxation is large and administration efficient.
Reasons for low tax-GDP ratios • Low tax rates on corporate profits and low taxes on luxury/imported goods, etc. • Exemptions and loopholes, which permit legal “tax avoidance” that make a “progressive” income tax less equitable. • Inadequate adjustment of the tax structure to take account of structural changes in the economy such as an increase in the share of service incomes.
Expenditures • Budgets classify expenditures differently: • Administrative (or Organisational) Classification: identifies the organisation responsible for administering various government programmes. • Economic or Line item Classification: identifies objects or types of expenditure. • Functional Classification: according to their purpose such as health, education, independent of the government’s organisational structure. • Programme Classification: groups together activities with common objectives.
Public finance policy • Public finance policy defines the macroeconomic stance of a government in terms of its emphasis on fiscal policy. • Such policy neutral, expansionary or contractionary, as seen from the level of expenditures relative to GDP and the size of the budget deficit/surplus and, consequently, the extent of government borrowing relied on to finance those expenditures.
A common perception • There are tight limits on governments’ total expenditure– and therefore on social spending • Set by the financial resources that can be mobilised through optimal taxation. • Constant refrain in policy discussions related to government spending on children that there is no fiscal space or fiscal room for such discretionary spending.
Presumptions • Expenditures can be financed only with current government revenues. • The latter are limited because increased taxation would result in disincentives for private savings and investment.
Sources of ambiguity • Wide differences in tax‐to‐GDP ratios even in countries with similar levels of per capita income make it difficult to decide the threshold at which such disincentives are created. • A government’s spending in any period need not be limited to its revenues, because it can run a fiscal deficit.
The fiscal deficit • The fiscal deficit is the excess of the government’s total expenditure over its revenues and consists of the following components: • The revenue deficit or surplus, which is the difference between the government’s current (revenue) expenditure and total current (revenue)receipts (that is, excluding borrowing and other capital receipts); and • Capital expenditure.
Are fiscal deficits always bad? • Deficits are not always “bad” though there are three main arguments often used to caution against an excessive level of the deficit: • A fiscal deficit could fuel either inflation or larger external deficits. • It may “crowd out” more desirable private investment by reducing resources available to the private sector and the interest rates on borrowing. • It could fuel the accumulation of public debt and render the level of debt unsustainable.
Counter arguments: 1 • Since Private Investment ‐ Private Savings + Government Deficit = Current Account Deficit • It is possible to have an increase in the government deficit without a larger current account deficit if the private sector saves more than it invests by the same amount.
Counter arguments: 2 • Fiscal deficits will lead to inflation only if public expenditure does not create multiplier effects that cause output to expand, because of supply bottlenecks. • Such supply constraints do exist in many developing countries, but they are less evident in a world where imports can be used to bridge the gap temporarily.
Counter arguments: 3 • “Crowding out” argument based on two assumptions • Government demand for borrowed funds will cause a rise in prevailing market interest rates • A rise in such rates will in turn depress private investment. • Both assumptions are problematic.
Interest rate determination • The government indirectly administers interest rates through the central bank discount or repo rate, which is the floor for other rates. • A rise in this is a policy choice made by the central bank or the government, such as when such a move is seen as required for attracting foreign savings. • In financially liberalised economies interest rates tend to rise not because of demand for credit from the government but because of the need to attract investors and maintain investor confidence.
Desirable deficits • Fiscal deficits that consist of public investment may be desirable if they create the physical and social infrastructure that contributes to the long run growth of the economy and the well‐being of the population. • Fiscal deficits composed entirely of public capital investment are not a problem, as long as the rate of return from such investment exceeds the rate of interest. If these investments are socially productive, they will result in higher government revenues in future, because of the growth generated over time.
Social and monetary returns • Even when there are no monetary returns, the social returns may be high. • If such investments involve monetary returns lower than the projected interest rate, they should be financed out of government revenues rather than through borrowing.
Sustainable public debt • Besides absolute levels of debt in relation to GDP, the flow payments associated with stocks of debt should also be examined. • Countries should avoid exploding aggregate levels of public debt, and the debt-to-GDP ratio must converge to a finite level. • For external debt, medium-term equality between the rate of interest and the rate of increase in foreign exchange earnings, should be maintained
Liberalisation and fiscal policy • Trade and financial liberalisation can also influence a country’s fiscal position. • Cuts in import tariffs and elimination of licensing fees reduce government revenues. • Many countries offer competitive tax incentives to foreign investors in the form of tax holidays and explicit or implicit subsidies, in order to attract foreign capital, avoid capital flight or promote exports.
Trade Liberalization and taxation • In poorer countries public finances are dependent on trade tax revenues. • So trade liberalization immediately affects tax revenues adversely
An IMF study • Use panel data covering 125 countries over the period 1975–2000 • Results • High income countries have recovered revenues with ease, but middle income countries have recovered only about 35–55 cents for each dollar of trade tax revenue they have lost. • Low income countries have recovered essentially none. Nor is there much evidence that the presence of a VAT has in itself made it easier to cope with the revenue effects of trade liberalization.
Consequences • If the loss in trade taxes is matched by a cut in social spending, it can adversely affect access to food, health care, education and other rights of children. • The effects will be felt more acutely by poor women who tend to consume more goods and services that benefit family nutrition, health and education. So such policieses (often unknowingly) can result in gender bias.
Openness and financial liberalisation • Worsen the problem by encouraging beggar-thy-neighbour tax policies • Financial dependence makes the stock market an index of success requiring specific tax concessions
The cost of incentivising private investment • There are two principal ways in which income is garnered from private investment: dividends and capital gains. Both have them have benefited from recent tax concessions. • On the grounds that corporate taxes are already taxed so that taxing shareholders’ dividend income would amount to a form of double taxation, it is argued that dividends paid-out to share holders should be made tax free. • Special tax concessions are given to attract foreign investments.
The fall-out • An extremely revealing analysis by B.G. Shirsat (Business Standard, July 14 and 22/23, 2006) of 1,050 major dividend-paying, listed companies has found that dividends paid out during the three years ending 2005-06 amounted to Rs. 29,532 crores. • Assuming the beneficiaries of these dividends are in the highest marginal tax bracket, the revenue forgone by the government over these three years would have been around Rs.10,000 crore (assuming the dividend pay out rate would have been the same even if the tax was effective).
Corporate taxes • Despite having a scheduled corporate tax rate, which is comparable with developed countries, the effective tax rate for the private corporate sector in India continues to be low due to myriad exemptions. • Corporate taxes formed 62.27% of total direct tax collection in 2004-05, amounting to a total of Rs. 82,680 crores. However, the effective tax rate for the private corporate sector in India is pretty low (despite scheduled rates being comparable with developed countries) because of tax concessions. • While the compound annual growth rate of corporate assessees has been 3.28 for the period 2000-01 to 2004-05 the corporate tax/GDP ratio has only increased from 1.71% to 2.66% (based CAG Report No. 8 of 2006 (Direct Taxes), Tables 2.4 & 2.8. pages 18 and 21).
