Finally, Sri Lanka has the budget for the year 2015. The previously approved budget under the Rajapaksa regime was drastically amended by the new Finance Minister, Ravi Karunanayake. He presented his budget, which is popularly known as a mini-budget, to Parliament on 29 January 2015. However, his mini-budget is a ‘mega-deal’ for the working and low income earners. He offered extensive economic concessions for the majority of the population. People deserve such concessions. No argument about it.

However, this article is not about the economic concessions but about the stability of the economic system. If the economic stability is ensured, the benefits offered will prevail; otherwise they will vanish in no time. I am not trying to caution the new government unnecessarily; instead, my intension is to point out at least the major weakness of the budget and to insist the need of possible corrective measures beforehand.

In fact, Ravi’s mini-budget has violated an important cardinal rule in economics. What is it? It is that you should not finance the continuing expenditure items (benefits) with one-time revenue items. If you do that you put an enormous pressure on the next budget, not on the current one. Ravi did it in big-time in his mini-budget and needs correction immediately in order to preserve the investor confidence. Investor confidence is an enormously important factor in running a market economy. It is the same for the ‘Social-Market Economy,’ which has been envisioned by the UNPto put in place for Sri Lanka. The UNP’s economic vision was previously explained by Dr. Harsha de Silva eloquently.

Investor confidence was shaken after the mini-budget. After the mini-budget was presented the stock market plunged. It recorded the worst plunge after four years. It could be temporary. But the evaporation of Rs 101 billion from market capitalization is not small. Corrective measures could make this trend temporary.

One-time items

Now, let me explain the point I want to make here. There are a few one-time budget items in regard to revenue, expenditure adjustments and transfers. This means that these items, whether they are revenue or expenditure items, are available only in the 2015 Budget. For an example, the government proposes to grant relief for pawning. This is an expenditure item that would be available only in the year 2015; hence, the expenditure incurred for relief for pawning is not continuing and will not appear in the 2016 Budget. But, the cost of increasing Public Sector Salaries will be continuing and would appear in the 2016 Budget as well.

Now, out of these one-time budget items, two items are especially significant; because both items together amount to Rs 88,000 million. One item appears on the expenditure side and it amounts to Rs 38,000 million.

This item is identified as ‘Administrative cost savings due to rationalizing of wasteful expenditures, and reduction of fuel and electricity prices.’ (Summery of Expenditure Measures, presented to Parliament). Any saving made by preventing wasteful expenditure can be treated as revenue because such savings could be used to finance something else which is useful. Hence, the said saving of Rs 38,000 million could be duly considered as ‘revenue item’ but such adjustment would be a one-time adjustment and would be available only in the current budget. So, now, we have Rs 38,000 million as savings to finance the economic concessions granted.

The other important one-time budget item appears on the revenue side. “Finance Minister Ravi Karunanayake imposed a one-time super gain tax of 25% on individuals or companies that earned more than Rs 2 billion in profits in 2013/2014” (Reuters). The expected revenue from Super Gain Tax is Rs 50,000 million. Since, this is one-time tax item it will not be available for 2016 and beyond. However, we now have another Rs 50,000 million in the year 2015 to finance the economic concessions granted.

Both the above items constitute Rs 88,000 million (Rs 38,000 million + Rs 50,000 million). This amount is to be used for financing the cost of economic concessions. The total expenditure for the concessions offered amounts to Rs 133,450 million when you add up all the expenditure items which have been identified. If you refer the Table-11, please ignore the adjustment of Rs 38,000 million made as ‘Administrative savings,’ which figure appears within the brackets in the Table. We have already taken this saving of Rs 38,000 million into account as ‘revenue’ as explained above.
Out of the total expenditure of Rs 133,450 million, at least Rs 123,000 million should be continuing expenditure and hence should appear in the 2016 Budget and beyond.

But the government has proposed to finance approximately 72% of continuing expenditure or Rs 88,000 million from a one-time revenue item and a one-time saving item mentioned above. This means, simply Rs 88,000 million would not be available for the year 2016 to finance the expenditure arising from economic concessions granted. This kind of budgeting has severe down-side risks to the economic and monetary stability of the nation.

Keeping the smiles on

Once I noticed this flaw in the mini-budget, I was reluctant to point it out outright because I did not want to create an uncertainty and destroy the happiness and smiles of the people. Then I realized that if I point it out now, some corrective measures could be taken so as to keep the ‘smiles’ on the faces of the people. I think that is what the new government wants.

When I think of the corrective measures, usually I prefer macroeconomic and monetary policy adjustments and those things can continue. Yet, I do not want this discussion to be an academic one. Hence, I will give you a quick example in order for you to understand what I mean.

The government has now imposed a one-time tax on supper rich companies. Supper rich companies as well as other companies keep some money known as ‘capital reserve.’ In fact, from a macroeconomic point of view part of this money is not capital reserve, instead good part of it must be converted into consumption money. When the money intended ‘to-be-capital-reserve’ is taxed what the government is essentially doing is that it converts the so called ‘capital reserve’ into consumption money.

Also, if the company invests that money in the real economic sector, what the company is essentially doing is that it too converts capital reserve into consumption mode by paying salaries and wages for all workers who participates in the project directly or indirectly. This is the most positive use of capital reserve in the economy. The government can promote this process when they design taxation policy.

For an example, the government can impose continuing taxes on rich companies with a promise or mechanism to allow them to use taxes or part of the taxes paid if they make a loss on new investments made in the real sector. Such policies would encourage the supper rich companies to pay more taxes willingly while being encouraged to increase investments. This is the best way to put the ‘consumption money’ accumulated by the rich companies as ‘capital reserves’ back into the economy. It will be a win-win arrangement. Isn’t it Minister, Ravi Karunanayake?

Perhaps, we might need to dig into economic fundamentals more, in order to be more pragmatic