Financing 2016 budget deficit: Between tax and debt options

Students of public finance are familiar with the debate on whether a budget deficit should be financed by increasing tax or borrowing. A budget deficit, the excess of proposed expenditure over projected revenue, is not out of place for a country like Nigeria battling with myriads of developmental challenges. While presenting the 2016 appropriation bill before a joint session of the National Assembly in December 2015, the president had announced that for the 2016 fiscal year, ‘’the federal government has proposed a budget of N6.08 trillion with a revenue projection of N3.86 trillion resulting in a deficit of N2.22 trillion which will be financed by a combination of domestic borrowing of N984 billion, and foreign borrowing of N900 billion totalling N1.84 trillion’’.

On account of the huge debt component in the 2016 budget proposal, the People’s Democratic Party (PDP) has reportedly described the country’s biggest budget ever as one that is capable of ‘’mortgaging’’ the future of the country. Given that public debt has to be serviced and the principal amount has to be repaid at some point, would increase in tax rates or even printing new commoney offer a better alternative to financing the deficit in view of the country’s current economic challenges? With headline inflation sitting dangerously close to double-digit level at 9.3 percent (according to the National Bureau of Statistics’ October 2015 Consumer Price Index), printing new money would exert more pressure on commodity prices and should therefore not be contemplated.

The option of imposing higher taxes will no doubt reduce the budget deficit. But like spending cuts, it could lead to lower spending by firms in particular and bring about a fall in economic growth thereby rendering unrealistic government’s projection of a real GDP growth rate of 4.37 percent in 2016. As a matter of fact, fiscal tightening via tax raise has the potential of bringing about a higher cyclical deficit ultimately as the government stands to generate lower tax revenue owing to declining economic growth.

There are those who argue that Nigeria has one of the lowest tax rates in the world, especially with respect to Value Added Tax (currently 5 percent) and Company Income Tax (currently 30 percent). As a result, they assert that the government can afford to increase these taxes. However, they must concede that Nigeria also has one of the highest poverty rates and ranks among countries with very high cost of doing business. To buttress this point, the 2015 ranking by the World Bank on the ease of doing business placed Nigeria 170th among 189 countries surveyed. It is important to note that the annual World Bank Group ‘Doing DAYBusiness report’ analyses regulations that apply to an economy’s businesses during their lifecycle, including start-up and operations as well as payment of taxes. A low ease of doing business ranking means the regulatory environment is not conducive for starting and operating small and medium enterprises. An increase in Company Income Tax (CIT) will aggravate the situation as entrepreneurs will be discouraged from undertaking business ventures that could push them into the higher tax bracket. Moreover, in a country experiencing relatively high unemployment rate with many youths unable to find gainful employment, any increase in a consumption tax like the Value Added Tax (VAT) will be a violation of the principle of tolerable tax burden.

Mindful of the adverse consequences of financing the 2016 budget deficit by increasing taxes, is government borrowing equally harmful for the purpose of financing the deficit? The answer really depends on the use to which the proceeds will be applied. In theory, debt finance is advantageous to an economy if it creates new capital assets which increase productive capacity and generate future in stream. On the other hand, it is detrimental to an economy if it is misapplied or consumed as Nigeria’s past records indicate. It is well-documented in literature that the massive external borrowing which took place in the 1980s, largely to offset the collapse in oil prices, was not linked to future growth or exports. Sufficient regard was not given to economic viability of projects coupled with mismatch of loan terms and project profiles as well as leakages associated with governance problems. The cheering news this time around is that there is an assurance by the president in his budget speech that the 2016 borrowings will be principally directed to fund capital projects.

It is important to note that the 2016 budget deficit is equivalent to 2.16 percent of Nigeria’s GDP and is within the 3 percent limit set by the Fiscal Responsibility Act of 2007. Equally worthy of note is the fact that Nigeria is at very low risk of debt distress and by implication has some headroom to borrow. As indicated in the Medium Term Expenditure Framework (MTEF) & Fiscal Strategy Paper (FSP) 2016-2018 recently approved by the National Assembly, “The total public debt stock as at June 2015 was $63.81 billion or about N12.11 trillion. Of this sum, the FGN was responsible for 82.98 percent while the 36 states and the FCT accounted for the balance of 17.02 percent. The total debt stock is comprised of external debt of $10.32 billion (N2.03 trillion) and domestic debt stock of $53.49 billion (N10.09 trillion).” According to the Debt Management Office, Nigeria’s public debt-to-GDP ratio as at June 2015 was about 12 percent. This low debt-to-GDP ratio is well below those of peers such as the ‘MINT countries’ comprising Mexico 42.1 percent, Indonesia 25.9 percent, and Turkey 35 percent. In fact, Nigeria placed 159 out of 174 countries ranked in the CIA World Fact Book with respect to public debt-to-GDP ratio in 2014.

Based on the foregoing, debt finance option with respect to the 2016 budget deficit is a more feasible pathway to stimulating the Nigerian economy. It is therefore laudable that the 2016 budget projections for CIT and VAT are predicated not on any increase in tax rates but on the ‘efficiency factor’ of the Federal Inland Revenue Service (FIRS) in broadening and strengthening the tax net.

In adopting the debt finance option, however, the government should take a number of measures aimed at avoiding the mistakes of the past. These include ensuring that all new borrowings are project-tied and strictly monitored for efficiency. Also, the debt strategy of rebalancing the debt portfolio in favour of relatively less expensive external debt with a view to reducing the overall cost of borrowing should be pursued. Furthermore, the setting up of a sinking fund for the redemption of maturing debt obligations should be sustained. To this end, government should consider increasing the sum of N113 billion to be set aside in the 2016 budget for a sinking fund towards the retirement of maturing loans. By so doing, debt finance will be seen for what it truly is, a leverage, and not a means of mortgaging future generations.

UCHENNA J. UWALEKE
Dr Uwaleke, associate professor of Finance, is head of Banking & Finance Department and deputy director of research, Nasarawa State University, Keffi.