The FINANCIAL — Last week the treasury service of the Finance Ministry published the report of the state budget of 2013, which stated the gap of tax revenues to be at almost exactly 9%.
The results of the fiscal year 2013 appear to be problematic and set to have negative repercussions for the following fiscal year. Without the reserves (so-called government demand deposits at the central bank) from previous years, domestic indebtedness of GEL 355 M and international grants of GEL 145 M weren’t able to fulfil the expenditure obligations of 2013, but in the economy every kind of reserve is characterized by scarcity, and those reserve opportunities have already disappeared, especially because of the scheduled increasing level of debt services for the fiscal year 2014.
The negative outcome of the fiscal year 2013 comes down to two main reasons:
1) In 2013 the economy made less growth than was needed for the financing of all envisaged obligations – hence the Government experienced deviation in the forecasting of growth parameters – their macroeconomic targets became irrelevant and unrealistic;
2) Mistakes in the planning of the budget have been down to skill really – in the budget of 2013 the Government changed only the expenditure components (less infrastructural projects, more subventions for agriculture, rapid increasing of social obligations) in comparison to 2012, but without any appropriate adjustments on the revenue side.
As a result, the government earned less from the economy. In summer 2013, as it sensed the revenue slumps, it was forced to stop the infrastructural projects, which only helped with the saving of disposable financial resources and throughout the fulfilment of social obligations on the pump, but missed the achievement of growth targets, as well as fiscal objectives on the revenue side in particular.
The Government constantly explained the lesser growth as being the result of international shocks (the Turkey crisis, high volatility and debt crisis on European capital markets, potato price inflation), but first of all, the political tensions in 2013 (the so-called cohabitation failure) as the crucial cause of the unsatisfied performance of the national economy. The accusation of the international environment for the domestic problems equals self-deception, a passing of responsibility, which at the least might be classified as unprofessional conduct. On the other hand, the Finance Ministry boasts about the improvement of export capacities in 2013 in comparison with previous years, which would not be implementable if the world economy and foreign partners were undergoing “shocks”. The world economy is healthy enough to avoid the “shockwaves” in the direction of Georgia. On the basis of fair competition, world consumption will always be in a condition to absorb Georgian commodities (goods and services). Even the venture of the Georgian wine industry from 2008 to 2012 confirms that despite the Russian embargo they could discover and develop chains in new markets in Europe, Asia and elsewhere.
Political risks have existed, but the cohabitation had two parties, and one of them was the current government. I think that the main risk has been associated with the Government’s inefficiency in the honeymoon months (November-December 2012). It had a really bad start. In summer 2012 the opposition bank criticized the then acting government for the weakness of the economy, but if they could recognize the ongoing underdevelopments, they should better prepare for government responsibility. It was exactly November-December 2012 that could have been the most important period of strategic planning for the fiscal year 2013 in order to work out the stimulus package (tax reduction, fiscal decentralization, the reducing-oriented restructuring of the state sector). Regretfully, the same problem appears to be recurring currently.
Also, in the same way the opponents might have predicted the political risks, which are connected with the inefficiency of the coalition-based form of government regarding reforms initialization, consideration and decision-making. The governing coalition is colourful and especially in the definition of the role of the state in the economy (small vs. large state, higher vs. lower taxes) there exist different views among the coalition members, but also within the so-called “economic team”.
Generally, the practice of coalition steering always implies political risks for the economy, because it disturbs the principal-agency-vertical, and requires the highest level of discipline and professional behaviour. Italy, Israel, but also some Eastern European countries offer the best examples of how refusal of such a political constellation (the government coalition vs. oppositional coalition) is working on the macroeconomic stability and sustainable growth.
Tax reduction is the measure which would be most helpful for recovery. The Government always emphasizes that the most effective level of taxation lies between 18-20% in Georgia, which is plainly under the international average.
When corporate tax is 15%, private consumption is to be taxed at 18%, and the state consumption and other expenditures are making out almost 35% of the GDP, there is econometrically no room for the calculation of the effective taxation in the range of 18-20%. Regretfully, in 2010 the previous government neglected to shrink the state sector, but the current government is obstinately repeating the same mistake.
Theoretically, tax revenues and tax rates are two different terms with an inverse relationship to each other. If the Government wants to fulfil the financing of all obligations, instead of raising debt, a reduction of tax rates is inevitable. The reduction of rates should concern direct but also indirect taxation. In addition, the transformation of VAT-payments from an offsetting to sales method is seriously recommended.
If in 2013 we had had lower tax rates, the situation now would be less critical. Meanwhile, for 2014 I’m not sure that a reform of the taxation system would be a sufficient measure for recovery. Sustainable growth is unimaginable without structural reforms on the supply side, but also without the development of capital infrastructure.
Let’s also ask about the increasing liability in the fiscal year 2014. How realistic is the national debt crisis, especially when since for the last 5 years the European debt markets have been suffering from a so-called liquidity trap (i.e. the money is cheap, but the countries with the need for money are facing some access constraints on the capital, are dependent on the rescue plans of high-investment-grade countries, which might be helpful only for the avoidance of debt crisis, but with less impacts on economic growth).
As it is known, from 2003 to 2013 the debt-GDP-ratio decreased from 55% to 40%. So, the term of an upcoming “debt crisis” is completely overblown and its use in regard to the increasing level of debt services makes no sense, especially when the debts, which might be served now, initially contributed to the economic growth of past years.
More important would be the question, how is the Government going to master the increasing challenges?
The neoclassical paradigm of macroeconomic policy has a clear answer to that: “If the Government needs more funds, it should not raise more debts, but should instead decrease the tax rates. A rates reduction stimulates the economy and the Government will collect more money from the economy.” So, once again, a decrease of tax rates would be inevitable, but only a necessary precondition for the recovery. In addition, the optimization of the size of the state sector should be a sufficient precondition for the achievement of the recovery aims.
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