Public Debt As An Alternative To Taxation…Causes And Consequences

Public debt is the debt owed by a central government. By contrast, the annual government deficit is the difference between government receipts and spending in a single year, that is, the increase of debt over a particular year.

The debt of a central government can be categorized into internal debt (owed to lenders within the country) and external debt (owed to foreign lenders). Governments usually borrow by issuing securities and government bonds. Less creditworthy and developing countries sometimes borrow directly from multilateral corporations like the World Bank and the IMF. Sovereign debt is also another form of government debt. They usually refer to government debt that has been issued in a foreign currency.

Public debt enables governments to invest in critical areas of the economy where the capacity of tax revenue to undertake these projects may be limited or in situations where printing additional money will disrupt the stability of the economy. It permits an equitable alignment of benefits and costs for long-gestation projects by shifting taxation away from current generations (Gill & Pinto, 2005).

In the 1970's and 1980's Ghana experienced massive economic decline characterized with negative growth rates, hyperinflation, food shortages, unprecedented levels of unemployment, weakening health and social welfare systems. In order to deal with these challenges, the government undertook expansionary fiscal policies which were reflected in the growing public expenditures. With revenues lagging behind these increased expenditures, government resorted to borrowing to be able to undertake these expansionary policies.

These periods were really the government's involvement with excessive borrowing. From 1990 to 2012, the debt-to-GDP ratio of Ghana averaged 61.8% reaching an all time high of 123.4% percent in December 2000 and a record low of 26.2% in December of 2006 (source: IMF - 2011 World Economic Outlook). Government debt-to-GDP ratio measures the amount of debt a country has as a percentage of GDP.

The fiscal imbalances resulting in debt-to-GDP ratio of over 120% were as a result of the collapse of commodity prices resulting in worsened terms of trade, significant shortfall in donor budgetary support and the general elections at the time which was the third after the country returned to constitutional rule in 1992.

In year 2000, the country's debt level became unsustainable and was hovering above the threshold established by the IMF thereby qualifying the country as a highly indebted poor country under the HIPC initiative and debt financing. The public debt of Ghana at the end of 2012 stood at $18,832.77 million equivalent to 49.4% of GDP up from $15,350.08million representing 40.8% at the end of 2011.

Taxation plays a crucial role in the development of a country and without adequate tax revenue the development of a country will be hampered. Adequate tax revenue can significantly reduce the over-reliance of a country on public debt. Taxation also increases the participation of citizens in nation building. Tax revenue saw significant improvement under the World Bank/IMF sponsored Economic Recovery and Structural Adjustment Programs in 1983.

Initial expenditure cuts and improved tax collection reduced the budget deficit from 6.3% of GDP in 1982 to 0.1% by 1986. Tax revenue has been improving steadily in recent years after major reforms such as the integration of the revenue collection agencies into a single body was undertaken.

The total tax revenue in 2010 was GHC 5,978.2 million representing 12.9% of GDP and this increased to GHC 8,894.2 million representing 16.7% of GDP (source: Bank of Ghana monetary policy report vol. 2 No.1/2012). In the 2013 budget statement presented to parliament it was reported by the finance minister that the tax revenue amounted to GHC 12,517.3 million in 2012 representing an increase of 40.36% over the previous year's outturn.

Despite these increases in tax revenue, the dependence of the nation on public debt has also been increasing.

A number of reasons could be advanced for the causes of the ever increasing public debt. However this article will assess the causes of the high incidence of public debt in Ghana by using the causes proposed by Gill and Pinto 2005 as to why governments borrow. In their paper, "Public Debt in Developing Countries: Has the Market-Based Model worked?" They proposed number of reasons why governments borrow. This article will limit itself to 5 of those reasons. The reasons are tilting, smoothing, stability, political budget cycles and deferment of difficult but necessary reforms.

They explained tilting to be a situation which allows for a more equitable manner in which a country can exploit investment opportunities with long gestation periods. According to them, it would be inequitable to tax current (poorer) generations to pay for investments that will benefit future (richer) generations in a growing economy. Most of the capital projects with long gestation periods undertaken by government are funded by sovereign and other external sources of debt such as borrowing form multilateral and bilateral sources.

Tax revenue goes to finance the recurrent expenditure of government. For instance the government utilized about 70.2 percent of tax revenue to pay emoluments of public sector workers. According to the 2013 budget statement, the government raised loans to the tune of about $2,286.49 million in an effort to bridge the gap in infrastructural development.

The government has also committed itself to various loan financing arrangements to undertake various capital projects. These include the Western Corridor Gas Infrastructure Project under the CBD of china, Bui Hydro Dam Project by EXIM China, the water projects by EXIM Turkey and Korea and Tamale Airport project supported by the PROEX facility.

According to the World Bank the government of Ghana spends $1.2 billion per year on infrastructure equivalent 7.5 percent of GDP. Paul Victor Obeng, Chairman of the National Development Planning Commission (NDPC) has hinted that the government is pinning its hope on the capital market to fund its 25-year National Infrastructure Plan to bridge the country's infrastructure deficit. All these projects enumerated above are projects with long gestation periods which are financed by debt capital instead of tax revenue.

This is to ensure a more efficient manner for conducting counter-cyclical policies or meeting emergency spending needs. Raising and lowering taxes frequently may entail efficiency losses and it generates economic uncertainty. Keynesian economics advocate for taxation as a counter-cyclical tool. However relying so much on taxation may cause uncertainties in the economy and thereby make business planning and investment difficult. The government instead of decreasing taxes during recessionary periods as an expansionary fiscal policy during periods of recession resorts to borrowing from external sources to boost economic activity in order to avoid efficiency losses and economic uncertainty. Governments also borrow to meet certain emergencies since levying taxes to may take a relatively longer period of time to undertake.

The energy crisis in 2006 which was unanticipated caused a fiscal imbalance that was not in line with what had been budgeted for. The energy crisis which threatened economic activity increased government expenditure significantly and this contributed the high public debt. The Golden Jubilee celebrations in 2007, the African Cup Of Nations in 2008 and the increased world market price of crude oil led to increased government expenditure than was budgeted creating a fiscal imbalance equivalent to 11.5 percent of GDP at the end of 2008 as compared to a budgeted rate of 4 percent. A similar situation occurred in 2012 led to a budget deficit of 12 percent and a debt to GDP ratio of over 49 percent.

Excessive reliance on printing money could lead to high and volatile inflation, which obscures the information content of relative prices and hurts investment. Economic theory has it that when there is a continuous and rapid increase in the supply of money (creation of new currency) without a corresponding growth in the output of goods and services can result in hyperinflation which may seriously affect foreign investment and business planning.

For example in Brazil between 1987-1994 when there was 1,350 percent growth in money supply, their inflation was 1,323 percent, Bolivia 1984-1995 money growth was 4,208 percent and their inflation over the same period was pegged at 6,515 percent, Argentina 1988-1990 money growth was 1,264 percent and the inflation rate was 1,912 percent. In order that the nation does not suffer from hyperinflation, the government does not print new money to fund capital projects but rather borrow since tax revenue may not be enough to fund capital projects.

The stage of the election cycle affects fiscal policy. The incumbent government tries to hold on to power by spending on identifiable and observable consumption expenditures rather than on investments. Alesina and Perrotti (1995) argued that politicians will normally follow expansionary fiscal policy in pre-election years since voters do not fully understand the implications of expansionary policies in post-election years.

This view is consistent with what has happened during elections since the country returned to constitutional rule in 1992. Election years are often characterized by increased government expenditure and budget deficits which are always financed by public debt. Ghana made significant gains in terms of its budget deficits situation as the country recorded budget surplus from 1986-1991(Loloh 2011).

However these gains could not be sustained in 1992 when the nation made preparations to return to constitutional rule. The total external debt of Ghana stood at $4,499million in 1992 compared to $3,873million in 1990. The domestic debt stood at GHC 4.498million and this rose sharply to GHC 12.288million in 1992. These huge budget deficits and increased government borrowings in 1992 pre-elections re-emerged in subsequent elections.

For instance, at the end of December 2000, Ghana had a nominal stock debt amounting to $5.9 billion. At the same period, the NPV of debt-to-export ratio was 152% while the NPV of debt-to-revenue ratio was 557%, both above the HIPC initiatives thresholds of 150 and 250 percent respectively, and was above 77percent of GDP (Loloh FW, 2005).

In 2008, gross public debt rose by about $600million to an end of year position of $8,002.5million, which is about 8.1% increase over the 2007 position of $7,405.5 million (source:2009 budget statement). Even though the country suffered from external shocks as a result of the global economic crises however there is no doubt that a significant portion of the debt was as result of the elections that year.

In the 2012 fiscal year another election year, government borrowings amounted to GHC 8,648.7million against a budgeted amount of GHC 4,669.0 million (Source: 2013 budget statement). The above goes to prove that the government usually spends excessively beyond its means during election years to woo votes from the electorate and are financed with domestic debts.

Government borrows in order defer difficult but necessary reforms such as the imposition of taxes which might be necessary to generate revenue for development. The government in the recent past spent huge sums of money on fuel, electricity and water despite calls from the World Bank/IMF to remove them. The subsidies become very prominent during election years as the government uses it as a campaign tool to "buy" the vote of the electorate.

According to Dr. Wampah the Governor of the Bank of Ghana, the nation spent GHC1.2 billion on fuel subsidies in 2012 despite calls from the IMF to eliminate these subsidies. Postponement of difficult reforms and borrowing during delays are directly connected to bettering once chances in the next election rather than improving the long term welfare of society.

Sovereign debt can help developing countries. It enable governments to facilitate growth take-offs by investing in a critical mass of infrastructural projects and social sectors of the economy where taxation capacity may limited, or when the alternative would be to print money and compromise macroeconomic stability.

Debt also facilitates tax smoothing and counter-cyclical fiscal policies, essential for reducing output volatility; and it permits an equitable alignment of benefits and costs for long-gestation projects by shifting taxation away from current generations (Gill and Pinto 2005). This article will restrict itself on the negative consequences of high public debt on the economy. The consequences considered are enumerated below as below

Large public debt implies high interest payments and these are borne by tax payers. Tax revenue needed for development is used to finance the interests. Interest payments from public debt, cost the tax payer GHC 2,436.2 million in 2012 which was higher than 51.2 percent of the outturn for 2011.

The interest payments for 2012 fiscal year constituted 19.89 percent of tax revenue (revenue including oil). Almost 20 percent of taxes collected last year were used to settle interest on government debt. The high interest payment was mainly as a result high domestic borrowing (domestic financing of the budget amounted to GHC 7,018 million against a budget target of GHC 2,760.6 million in 2012).

The government depends on investors' continuous purchase of Government of Ghana long-term bonds to fund its spending. If the bond market gets nervous about the excessive borrowing of the government as a result of the high default risk and the demand for the government's bonds falls, their price also declines as a result.

The fall in the price will cause the yield on the bond to rise. This means the nation pays more in interest for every penny borrowed. When the government borrows more from the domestic market through sale of treasury bills it increases the interest rates paid on them and this risk-free interest rate forms the basis for borrowing cost.

The 91-day Treasury bill rate at the end of January 2012 stood at 10.9 percent and this rate shot up to over 22 percent at the end of December 2012 as a result of increased domestic borrowings.

Government borrowing increases the total demand for credit in the economy, driving up the cost of borrowing in the process. Higher borrowing costs make it more expensive to finance investment in equipment, stock and other capital goods in the private sector. This increases the cost of doing business in the private sector.

Government borrowing from the domestic market also creates a 'crowding out' effect making it difficult for private businesses to raise funds for business activities as funds are channeled away from the private sector for investment to the public sector to finance budget deficit.

Government debt is in itself not 'evil' because it enables the government to undertake infrastructural and social projects where taxation capacity is limited. Public debt only becomes a burden when it goes beyond a certain threshold making them unsustainable. The government must put in place major policies to ensure that the countries reliance on debt is minimized.

Over the years various tax reform programmes including the bringing together of the revenue collection agencies and review of certain sections of the tax laws of have significantly increased tax revenue. More needs to be done if Ghana wants to minimize her dependence on public debt to finance development projects.

A significant portion of Ghanaian businesses are found in the informal sector making it difficult for the tax authorities to track their activities and also to tax them appropriately. Even though their activities contribute significantly to the GDP of the country, their contribution to government revenue is very minimal.

For the nation to be able to derive the needed tax revenue from the informal sector, the following measures could be pursued by government

Providing informal sector businesses with permanent trading sites and infrastructure and making it illegal for these businesses to trade outside of the designated sites.

Identifying and registering informal sector businesses. This can be achieved where a dedicated tax administrator works at the grass roots or on the streets to identify and register such businesses as has been done in Tanzania.

Ghana also loses huge amounts of money through transfer pricing manipulation by multinational businesses operating in the country. The Minister of finance in presenting the 2012 budget statement stated that studies in the mining sector showed the nation lost about $36 million through transfer pricing manipulation. The government has responded appropriately by the introduction of the Transfer Pricing Legislation (LI 2188) which among other things requires multinational businesses to use the arm's length transaction principles and also file returns on transfer pricing activities. However many concerns have been raised by experts about the capacity of our judiciary, tax administrators and the police to enforce these legislations. The government must increase training programmes for these bodies to increase their capacity and in-depth audit of multinational businesses must be conducted to stem transfer pricing abuses.

Tax incentives given out to businesses especially foreign businesses must be reviewed because a cost - benefit analysis of these incentives will reveal that the nation loses than it gains. For instance, mining companies are allowed to carry over their losses for a period of 5 years and are exempted from the payment of import duties on materials and equipment used in their operations.

Their huge capital investments also mean that they enjoy huge capital allowances which virtually erode all their profits leaving the nation with nothing in terms of corporate taxes. Many of these foreign mining companies have entered into stabilization agreement with the nation for a period not exceeding 15 years where they are not adversely affected by changes in tax legislation such as increase in corporate taxes. All these incentives must be reviewed and more taxes imposed to ensure the nation gets as much revenue as possible.

The government of Ghana first published its first Medium Term Debt Strategy in December 2010, covering the financial years 2011-2013 with the main objective being the formulation of an optimal mix of external and domestic financing at the least possible cost. In line with this, a financing strategy where non-concessional terms were highly restricted to projects with high expected risk-adjusted rates of return was pursued in 2012 fiscal year (2013 budget statement).

These are commendable strategies but the government must also commit itself to reducing dependence on short term borrowing from the domestic market which has a 'crowding-out' effect on economic activities and rather pursue the issuance of long-term borrowings and bonds which has a longer repayment period and can go to develop the capital market.