Reaping benefits of a realistic budget

One of the biggest tasks for every government is to prepare and pass a budget that has two characteristics: (1) Ensure that the size of the deficit and its financing are appropriate for the macro-economic position of the economy. (2) Reflect the policy objectives of the government. This policy is manifest in the new projects initiated, any new major programmes of the government and changes to the laws and rules that govern revenue collection.
A brief note on the American budget is useful as an example of what not to do. First, the size of the deficit is established by a lack of discipline in choosing along alternatives. As a result, the government chooses everything and the deficit expands. At a time when the economy is strong, a good economic policy is to run a surplus, not a deficit. At least the deficit should be reduced. But no, the deficit is expanded to accommodate all of the "vital" expenditures. The revenue code had been substantially changed to reduce taxes, the opposite of what is needed. The macro-economics of the US budget are a disaster, increasing the deficit when the economy is growing strongly and when increasing the debt is exactly the wrong direction to go. Last month, the President and the Congress gave up all sense of responsibility and led the US economy towards ever-growing debt levels.
On the second point, the President and the ruling party were unable to obtain the expenditure levels that they wanted. In essence, the US military establishment received a big increase while many of the social programmes were continued although these were not part of the President's economic and social agenda. Democracy is a matter of compromise but in this case, the compromise was to take everything and abandon any fiscal discipline. If all of these projects and programmes were necessary then taxes should have increased not decreased.
How about Bangladesh? The proper way to prepare the budget is to work on changes to the revenue code in order to provide a realistic estimate of the level of collections. Then one decides what deficit is appropriate given the macro-economic situation. This step also requires consideration of the foreign assistance that might be available. After these two steps, the total size of the budget is determined. A good rule is that the deficit should be 70 per cent of the foreign aided development budget and 50 per cent of the self-financed part of the development budget. The Government deficit is then covered by borrowing from domestic resources or sale of bonds to foreigners (or borrowing and grants from foreigners). This rule provides reasonable revenue resources for the development budget.
The economy is growing strongly and a lot of work is needed to improve infrastructure, hence going to foreign finance is appropriate. Once the rule is applied, the Ministry of Finance then has to decide if this is a reasonable deficit level to incur.
There should be an Office of Fiscal and Tax policy in the Ministry of Finance with two jobs: (1) Determining the impact of proposed tax changes on the economy and revenue collections, and (2) Advising the Minister about the appropriate deficits taking account of the macro-economic situation and the long-term debt situation. Tax policy should be separated from tax collection.
For the Bangladesh political system, there is no question that the ruling party will be able to choose what it wants to do and implement that programme. The British parliamentary system joins the Executive and Legislative power together. Objectives may need to be postponed due to a shortage of resources, but not due to conflicts over what should be done. The one area where the Prime Minister (PM) may not be able to have her way is in the revenue system and banking rules. We have seen the influence of business leaders on these matters. If one examines the American budgetary system it works very badly in comparison with the British parliamentary system.
Budget problems in Bangladesh come from two sources: First, excessive ambition in revenue collection. The last few years have seen the announcement of ambitious targets for the tax collectors, only to be cut back when it proved impossible to achieve these. In 2017/2018, the revenue estimates originally included expected increases in collections from the VAT reforms. When this was dropped from the programme, there was no significant correction to the revenue target. Of course, it has proved very difficult to reach the target without the VAT modifications. But the impact of assuming that the revenue targets can be reached was to start up too many projects.
Entering projects into the Development Budget should be rigorously controlled by proper benefit-cost analysis and sector studies. How many projects are rejected due to benefit-cost ratios that are below the acceptable threshold [e.g. return of 12 per cent]? Not many; the tradition for benefit-cost analysis is to make it work, whatever the project. Many think of this as one more piece of paper that they have to complete to get the money to do their favourite project.
Benefit-cost analysis used to be serious business, but as time passes, it is becoming a pro-forma exercise. But it is a versatile means of analysis to help one understand a project's impact and to shape the project to achieve maximum economic returns. It also provides the means to understand the difference between the financial and economic returns of a project and to seek means of cost recovery, through user fees.
The costs of these procedural shortcomings to the society are huge. If too many projects are initiated then they are all delayed due to insufficient funds For example, instead of taking three years to complete a project, it may take six years. The project becomes more expensive the longer it takes to complete due to rising costs of materials. But worse, the benefits coming from the projects are delayed. In case of delays, there may not be benefits over costs coming these projects and the value to the economy from the project may decline sharply.
For example, consider an infrastructure project that costs $150 million at current prices and when it goes into operation produces net benefits of $40 million benefits per year for 20 years. If completed in 3 years with construction costs increasing at 10 per cent per annum and a discount rate of 12 per cent, the project produces a total net value for the present of $90 million after paying the $150 million and interest of 12 per cent per annum on the cost of the project. This is quite a good project. But if it takes six years to complete, then the value declines to $26 million. The delay costs the economy $64 million! The long delays arising from unrealistic revenue targets and initiating too many projects is very expensive indeed.
Serious problems in Bangladesh occur when budgeting procedures result in delays in project completion resulting in higher costs and lower benefits.

Forrest Cookson is an economist.
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