Budget and Beyond

Nepal’s fiscal policy has failed repeatedly in implementing an inclusive-growth agenda; this budget is no exception

Finance Minister Ram Sharan Mahat has tabled a budget of Rs 618 billion (one-third of the GDP) for the upcoming fiscal year. Nepal has daunting economic problems, comprising stagnation, inequality, unemployment, corruption, deindustrialisation, trade deficits, no rule of law, low returns on public investment, and so forth. Yet, instead of adopting bold policies to redress these issues, the budget repeats the course and follows the usual ritual. The budget, which should aim to strengthen domestic resource mobilisation and allocate it efficiently to accelerate economic growth and promote equity, has once again failed.

While formulating a budget — ie, fiscal policy — the selection criteria for programmes and tax provisions should be efficiency (making sure society is getting the most from its resources) and/or equity (distributing prosperity fairly among citizens). This requires seven steps. First, in the absence of market failures let the private sector work. Second, government programmes should generate better results than if left to the markets. Third, the programmes should directly tackle the sources of problems. Fourth, their completion should be cost-efficient. Fifth, there should be accountability. Sixth, equality of opportunity should be adhered to. Seventh, utmost efforts should be made to finance those programmes by domestic resources raised through progressive taxes.

Since none of the above seven steps are followed in Nepal, there are problems ranging from programme selection and implementation to value preservation and equity considerations. Regrettably, this budget is the outcome of the same modus operandi. As a result, it fails on both sides of the ledger; it has no framework to achieve higher return to government expenditure, and it has no policies to strengthen revenue bases. As evident in its some signature programmes, the policies outlined in the budget are too timid, too indirect, too open for misuse, or outright wrong.

Expenditure side

The budget aims to graduate Nepal from least developed to a developing country by 2022. In the last 20 years, the per capita income of China increased annually by 9.3 percent, that of India by 5.1 percent, and that of Nepal by only 2.5 percent. Nothing is more urgent than acquiring higher growth for a stagnated economy, but this graduation is not possible.

In 2013, the per capita income required for graduation was $1,214 which, adjusted for inflation of 2 percent, will be $1,423 in 2022. Given Nepal’s per capita income of $730 in 2013, a 9 percent annual growth (10.3 percent GDP growth) rate will be necessary for graduation. What can lead growth to quadruple? Growth acceleration requires increased employment, investment, an educated work force and a business-friendly environment. The budget has no programmes to harness these inputs, making the aim mere wishful thinking rather than an action plan.

Regarding employment, every day, about 1,100 people enter the job market and 1,500 leave for unskilled jobs in foreign countries (not counting those going to India, which could be as high as 38 percent based on the 2011 population census). Still, one in five is unemployed. To retain youth in villages and provide employment, the budget proposes agriculture loans at 6 percent interest and has allocated Rs 1 billion for interest subsidy. But the policy is blunt, as it neither reduces unemployment nor retains youth. The main reason for leaving is not loan-related but the size of land (54 percent of farmers have less than 0.5 hectares of land), its low productivity and the lack of options in the country. The youth have lost hope with visionless political parties.

Moreover, considering the magnitude of the problem (3.5 million are already in foreign countries and annually, 0.4 million enter the job market), the measure is too narrow. It requires consolidated efforts from the government, universities and the private sector. The government should launch massive infrastructure projects along with friendly policies for businesses, not a loan subsidy which most likely will end up with unintended beneficiaries.

Growth requires private investment, which is very low in Nepal. Furthermore, because of low effective tax rates and other advantages, most private investment flows in land, homesteads and houses in urban areas, in private schools and health. The property tax is only 0.01 percent of tax revenue and 0.003 percent of GDP. By comparison, in developed countries, the property tax is up to 4 percent of the GDP. Investments in these areas lead to wealth transfer (not wealth creation) and services duplication (not services expansion). They do not create jobs or increase output. To divert investment from these to productive sectors, the property and investment income tax rates should be on par with the developed world. But the budget is silent in this regard.

The public education system remains a fiasco. Of the students enrolled in grade one 10 years ago, only 4.4 percent completes the SLC without failing; 95.6 percent are victims of an inefficient government system. It is an enormous waste of resources and also a mockery of equality of opportunity. A responsible finance ministry would not decrease the budget but focus on developing regulatory frameworks that increase return to government investment in public education.

Revenue side

No governments in Nepal have been serious about generating revenue; they all enjoy having more foreign aid. In the budget, revenue covers only two-thirds of the budget. And 73 percent tax is indirect. There is an urgent need to build our own revenue capacities that are based on progressive taxation. A radical tax reform that raises the contribution of direct tax and is capable of balancing the flow of investment in different sectors of the economy is long overdue.

Rather than focusing on this important but difficult task, the budget scatters the revenue on different subsidies favouring size, raises the tax exemption limit, continues to pour money into bankrupt public companies and appoints lawmakers as managers.

Take the last issue. Even a good set of policies will not help develop a country like Nepal where there is no rule of law and corruption is rampant. Think for a moment, if there were strong accountability rules, would the lawmakers take the responsibility of the nitty-gritty of implementing the Constituent Development Fund? They probably would have declined even upon request. But they are fighting for a larger chunk. Is it because of their love for the growth of their constituencies or because of zero accountability? The public is outraged, and who else knows better. The fact that lawmakers, who should be fighting corruption, have stooped so low in demanding the fund and the budget entertaining it, is demoralising, to say the least.

The budget has a provision of providing a full tax exemption for five years to production-related industries having investment of over Rs 1 billion and the tourism industry having investment of over Rs 2 billion. If this measure is intended to address Nepal’s deindustrialisation (falling share of industry output), it is misplaced. Nepal’s hollowing-out of industry is a result of massive inflow of remittances, corruption, energy shortages and unruly labour markets. The solution requires fixing them, not compensating corruption by expanding tax holidays. Furthermore, eligible investors for subsidy in tourism will likely be big hotel chains, mostly foreigners.

Bottom line

Past fiscal policies, more than anything else, are responsible for creating the almost insurmountable challenges that Nepal is facing today. No policy has done as much damage to the country as the fiscal policy. The upside, by the same token, is that no other policy has as much leverage to make Nepal a prosperous and just nation.

A successful fiscal policy should enforce rules and maintain institutions while allowing the market to operate; should uphold the equality of opportunity to let everyone contribute with full potential in nation-building; and raise employment and productivity for all workers to make Nepal a prosperous nation. Unfortunately, Nepal’s fiscal policy has failed repeatedly in implementing this inclusive-growth agenda, and this budget is no exception. The fiscal system continues to await a full-scale revamp.

This article was originally published in The Kathmandu Post on Monday, 21 July 2014 and can be accessed at
http://www.ekantipur.com/2014/07/21/opinion/budget-and-beyond/392453.html
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