Friday, February 17, 2012

Government Spending, Deficits and Inflation: Confusion Reigns Part I

Today’s headline made me do a double take (excerpt):

Lower deficit brings boost to the economy

PUTRAJAYA: There is more good news for the economy. Revenues have increased while the fiscal deficit in 2011 eased to 5% of GDP, compared with 5.6% in 2010…

…Second Finance Minister Datuk Seri Ahmad Husni Hanadzlah said the reduced deficit exceeded the Government's expectations of bringing it down to 5.4% as stated in Budget 2011.

Ahmad Husni said the reduced deficit followed stronger financials of the Federal Government.

“Revenue rose 16.1% to RM185.4bil in 2011 compared with RM159.7bil in the previous year,” he said in a statement yesterday…

…“The rise in revenue came with a 29.4% increase in tax collection by the Inland Revenue Board. It collected RM102.2bil last year compared to RM79bil in 2010,” said Ahmad Husni.

He added that the amount was also the highest collection recorded by the board.

Indirect taxes collected by the Customs Department also increased by 7% to RM32.6bil from RM30.5bil, while non-tax revenue rose 0.8% to RM50.5bil from RM50.1bil in 2010.

Back in my old job, we used to list under positive factors for the economy “continued public fiscal deficit”.

When government tax collection increases – unless they actually spend the increase – it’s net negative to the economy since the money’s taken out of circulation.

Now that’s not all too bad in our current situation as, with unemployment low and capacity utilisation up, a faster consolidation in the fiscal deficit is certainly warranted – “boosting” the economy some more means higher inflation to go along with the higher growth. But confusing fiscal consolidation with a “boost” to the economy…I have to shake my head.

In the context of the economy last year, whether the numbers look better or not is completely irrelevant, because its been and gone. And in the context of the economy this year, it doesn’t mean a whole lot at all.

Also, anybody note that the numbers don’t quite add up? Total net borrowings for 2011 stands at RM49.6 billion. If that’s the gap between revenue and expenditure, given that revenue came in at RM185.4 billion and total nominal GDP for the year of RM852.7 billion, we get an estimate of RM228.0 billion for total expenditure.

Which happens to be RM16.5 billion above where it ought to be based on 2011 budget projections. I remember that spending plans were boosted another RM10 billion in the early part of 2011, but I don’t know what the other RM6 billion is supposed to be for.


  1. I thought the same when I read the front page earlier in the morning. I thought, wow, an almost "neoliberal" point in the Star until I realized there was none of the usual argument used in the 1990s, and instead it was just some plain word twisting.

    I was about to blog about it until I read the argument that lower fiscal deficit this year could allow more spending next year (sounds Euler-like?), at which then I decided to give the whole article some benefit of the doubt. But I thought given the economy gonna be worse next year (thus possibly worse deficit/GDP ratio compared to government's target), that would give less spending opportunity if the Euler-like logic is used, thus only a little case for a boost and definitely undeserving of the screaming headline.

  2. Got to ask a stupid there some form of correlation between govt revenues n GDP?How is the it 16% or 22%?Or is there a treshhold that once crossed will give higher revenues?

  3. It's actually a close relationship. The elasticity works out to about 1.1, or taxes increase or decrease faster than GDP by about 10%. The average over the last ten years is about 21% of GDP.

    But to get a bigger tax yield, we just need to up the income tax rate, or widen the tax base (tax more people), or implement GST or all the above.

    Even better, cut expenditure - like cut petrol subsidies, which alone explain nearly a third of the fiscal deficit.

  4. @Hafiz,

    Remember that the corporate tax yield is based on last year's profits, not this year's. Even with PAYE, companies and individuals will have to top up the difference come tax time.

    I suspect we're going to see another revenue "surprise" this year. It'll be closer to, if not over, RM200 billion. And that probably means expenditure will go over RM240 billion, and they'll still hit the deficit reduction target.

  5. It's a battle between the numerator versus the denominator then. May the best man win?