January 30, 2006	Monday	Zilhaj 29, 1426

The budgetary system of a country reflects its norms, priorities and modes of public spending and revenue collecting. A wide diversity can be observed in the type of fiscal systems adopted by countries across the globe. However, a majority of the world budgetary systems and those of developing countries in particular have common features which are reflected in the relatively uniform definition of economic and social objectives pursued by these systems.

Such objectives generally include achievement of high growth rate of real GDP, reduction in the levels of unemployment and poverty, control of inflationary trends and reduction of inter-personal and inter- regional disparities of income and wealth.

The budget which is presented at the beginning of each fiscal year is a reflection of the nature and structure of the overall budgetary system pursued by a regime.

An optimal budget could be defined as the one which uses the available fiscal instruments to help achieve the maximum number of the socio-economic objectives and to the maximum extent but within the minimum time frame.

The formulation and implementation of an optimal budget is beset with numerous constraints, especially in case of developing countries. These constraints emerge on account of two reasons.

First, some of the objectives as defined earlier are mutually competitive in nature and therefore require a trade-off. The second but the most compelling constraint arises from some of the built-in features of the socio-economic systems of the developing countries which impose serious limits on their budgetary frontiers.

These constraints can be identified as the limited resource availability in the form of tax and non-tax revenues, the historical burden of economic (mis)-management of the past, the heavy weight assigned to the preferences and aspirations of the political elites, the conditionalities of external lenders both bilateral and multilateral and lack of harmonization between the budget policies on the hand and the monetary, trade and exchange rate policies on the other.

The juxtaposition of the objectives viz-a-viz the constraints of the economy as identified earlier transforms budget formulation into an exercise of linear programming at the macroeconomic level.

This implies that every budget would aim at optimizing the social welfare function and the related objectives depending upon the severity of the constraints. This linear programming deals with the fundamental questions about the budgetary choices such as what should be the optimal size of the budget and its optimal composition between the current and development expenditures?

What is the optimal level of taxation and its best combination in terms of direct and indirect constituents? What is the optimal level of development spending and how to finance it optimally i.e without creating economic distortions?

These questions can be summarized under the basic question of what is the optimal size of a state?

The structure of an optimal state in terms of the basic functions it must perform has been outlined by W.W. Rostow in his classic “Politics and the Stages of Growth”.

He allots three basic functions to a state namely, (a) ensuring national security i.e. the protection of society‘s territorial integrity, (b) provision of welfare and growth (i.e. the general economic well-being of the people and creating the right environment for investment and sustained economic growth), and (c) establishing the constitutional order (i.e. to provide justice, and to maintain public order).

Following the Rostowian model, the industrial countries have come to assign to the state some critical and broad-based responsibilities in the socio-economic sphere with the result that these countries have to undertake exceptionally large budgetary outlays enabling them to perform these responsibilities effectively.

In terms of the size of the budget, industrial countries can be divided into three broad categories A, B and C. In category A, there are countries such as Sweden, Denmark, Finland, France and Belgium which have the size of their budget higher than 50 percent of GDP, while in category B, countries such as Germany, Netherlands, Italy, Great Britain, Canada and Spain have their budget size equal to 40 percent of GDP or above but less than 50 percent of GDP. Countries such as United States, Japan, Australia and Ireland are included in category C, which have a budget size between 35 to 38 per cent of GDP but less than 40 per cent.

The average size of the budget for the Euro-area for the year 2003 was estimated at 47 per cent of GDP and with total receipts at 45 per cent, the average deficit came to be two per cent of GDP.

In the same year, out of 18 industrial countries only three countries had a balanced budget, four countries had a surplus while eleven countries had a deficit ranging from two per cent to eight per cent of GDP.

Hence the concept of the optimal budget is not tied with the idea of a balanced or a surplus budget. In practice, a deficit budget could be a norm rather than an exception as is established in the case of the industrial countries.

It is axiomatic to identify the industrial countries as the laissez-faire, free enterprise economies where private initiative and profit maximization are the driving forces. But the large size of the budget in these countries is driven by massive spending by the state on health care, education and other social services, infrastructure and related economic and environmental services, as well as research and development (R&D).

These countries spend 25—30 per cent of their budgetary outlays on capital formation and economic development, even though none of these countries have any separate and independent planning commission or development bodies. Each ministry has the responsibility to demarcate their budgetary allocations for the current and the development purposes depending upon the need assessment by the ministry.

As a basic principle of budgetary linear programming, an optimal budget can be evolved only by those countries which are able to develop and operate a system of optimal taxation.

A tax system is optimal when it meets the universally recognized criteria of equity, elasticity, efficiency, transparency and progressivity. However, a large number of developing countries have tax systems in place which fail to meet any of these criteria.

As a consequence, these countries suffer from sub-optimal budgetary systems characterized by an opaque, iniquitous and inelastic tax system resulting in an abysmally low tax-GDP ratio.

Defined in terms of total tax collection and its composites, each budget is a barometer of the psyche of a society as it helps in measuring the level and the extent to which its affluent and the wealthy segments are prepared to make sacrifices for the public good.

Paying or collecting taxes to the optimal level is the hall-mark of a civilized society. Avoiding or evading taxes symbolizes the passive, unjust and dormant societies which operate at a threshold which is not far from the line of barbarism.

Only by paying and collecting the due tax liabilities in full, a developing country can meet the diverse objectives of achieving sustained economic growth, ensuring price stability and eliminating unemployment and poverty.

If the average propensity of the common tax payer to evade taxes far exceeds his propensity to redeem his tax liabilities and at the some time if the average propensity of a tax-collector to enrich himself exceeds his propensity to enrich the state, the resulting collusion would usher in an economic system where a vast majority of the population will be kept out of the budgetary orbit and which is forced to make all the sacrifices to sustain the system.

(The author is a former joint chief economist, Planning Commission).