As highlighted last week, today we will examine the impact of the increased revenue collections by central government on the macroeconomic framework. For ease of reference, it was reported that revenue collections increased to .2 billion for the half year period ended June 2017 or 13.1 per cent, while central government’s non-interest recurrent expenditure increased by .2 billion or 5.2 per cent to .5 billion. Additionally, .9 billion was expended under other goods and services, representing 6.3 per cent increase over the same period for 2016.
What this means is that the increases in revenue collection are reverted proportionately to funding Government’s day to day activities. Thus, a relatively small fraction is being channelled towards stimulating progressive growth of the economy. In fact, to go a bit further in dissecting the impact of this fiscal outcome, I present hereunder, some empirical evidences of optimal taxation in theory and practice, cited from a working paper produced by Harvard Business School. In doing so, firstly I referenced some of the tax reform policies implemented from Budget 2017. Effective January 2017 – the Government implemented some new measures aimed at reducing inequality and increasing disposable income.
This new policy constitute (i) an increase in the tax threshold from 0,000 per annum to 0,000 per annum and (ii) reduction in personal income tax rate from 30 per cent to 28 per cent for individuals earning less than ,160,000 per annum, together with an increase of 40 per cent to be applied to the incomes of persons earning in excess of ,160,000 per annum. We have also seen in the budget that while the VAT rate was reduced to 14 per cent from 16 per cent, a number of other items, that were previously not subject to VAT, were added, such as key items as electricity and water – these have spurred heated debates during the time of budget presentation. Hence, we can say that we are at a point wherein we are able to deduce how these policies have impacted the economic activities and livelihoods of the people within the economy.
The standard theory of optimal taxation posits that a tax system should be chosen to maximise a social welfare function subject to a set of constraints. This ‘social welfare function’ is based on the utilities of individuals in the society. The social planner’s goal is to choose the tax system that maximises the representative consumer’s welfare knowing that the consumer will respond to whatever incentives the tax system provides. However, policy conclusions drawn from a model with a representative consumer, in some cases can also lead to trouble.
Lesson 4: cited from Harvard Business School working paper – The Optimal Extent of Redistribution Rises with Wage Inequality.
Economic inequality has risen substantially in recent years, especially in the United States. In the context of the theory of optimal taxation, this change can be seen as a widening in the distribution of ability. This fact leads to an obvious question: how, according to the optimal tax theory, should the social planner respond to such a shift in the economic environment?
Theory
Mirrlees (1971) illustrated that greater inequality ability makes the optimal tax policy more redistributive. He suggested that tax rates would generally be higher in less equal societies and that less of the population be required to work. Low-ability individuals would enjoy leisure along with a lump – sum grant to support consumption. However, one has to bear in mind that such an arrangement is non-existent in Guyana’s context – we do not have a system where unemployed persons enjoy any benefits whatsoever from the Government.
In practise and to examine whether policy responds to the level of inequality as the optimal tax models predict, an examination of the data on earnings inequality from the Luxembourg Income Study and data on social expenditure as a share of GDP from the OECD, a commonly used measure of income redistribution, was conducted. It was found that if the optimal tax model is consistent with policymaking priorities, an expectation is therefore developed to see policy react to higher earnings inequality by increasing social expenditure as a share of GDP.
With this empirical ideology in mind, it would be worthwhile to see if in fact the increased revenue from the new tax policy correlates to increases in social expenditure. To this end, while we note that expenditure accounts for increases in other goods and services as highlighted above, the question is, is this being felt or should I say, trickled down to the people? When we talk of social expenditure, to my mind, of importance, the focus should be on things like health and education and so on. But, we have seen, during these periods with the new Administration in place, the abandonment of a project that would have correlated to such an outcome, namely the state-of-the-art hospital project. The public health system needs tremendous improvement which would require substantial capital investment, the same for the education sector. These are two critical pillars characterised as the driving forces for social and economic development.
