Tax exemptions, huge capital inflow from hydropower and growing public expenditure is a concern

The outlook that fiscal self-reliance would be achieved with increased hydropower generation is an illusion, says a 2016 World Bank paper on public finance.

While higher export revenue, manageable external debt service, faster economic growth, sustained poverty reduction are some positive impacts of hydropower, investments made in this sector is not captured in the official fiscal balance of the government budget.

To elucidate these findings, the World Bank’s chief economist of South Asia region, Martin Rama (Phd) gave a public lecture on Bhutan’s public finance reforms yesterday in Thimphu. The lecture was organised by the Centre for Bhutan Studies and GNH.

He said the country’s fiscal deficit, which is between two and three precent is quite reasonable but if hydropower financing is included, the fiscal balance could hit more than eight percent of GDP.

The combined effect of massive capital inflows from the power sector and an expanding fiscal balance is a large current account deficit, which led to the rupee crisis.

As the deficit stabilised during the last few year, the rupee shortage eased too, but he said that the relief could be temporary only, given that over the next four years the deficit could increase by another 10 percent of GDP.

The fact that once hydropower projects shift to the generation phase, it results into significant export earnings is also true. However, in 2014, about 18 percent of the hydropower export earning was spent on debt servicing and this is projected to reach a maximum of 38 percent over the next 30 years.

Martin Rama (Phd) said this led to a wider gap in achieving fiscal self-reliance because when more than a quarter of revenue generated from hydropower is spent on debt servicing, the country may not meet its expenditure.

In such situations, tax revenue, he said, plays a crucial role.

The World Bank report also highlighted that tax revenue is declining relative to the country’s GDP and that recurrent expenditures could surge in the medium term while actual capital expenditures do not always match government plans.

“In the absence of a clear long-term plan and determined action, Bhutan could be forced to scale down its public investment program,” the report stated.

Martin Rama (Phd) said tax revenue in Bhutan is not enormous. “Lots of revenue are lost in supporting the private sector,” he said.

He said the decline in tax revenue in relation to GDP is not due to a change in tax instruments or in tax rates, but because of policy decisions of tax holidays and exemptions.

Sales Tax exemptions result in 50 percent of foregone revenue. Further around 63 percent of all imported commodities are exempted from Custom Duties.

On the contrary, the pressures on expenditure will mainly come from the social sectors.

For instance, Martin Rama (Phd) said that when the revenue base from hydropower exports increases, there is pressure on the government to expand the civil servant’s payroll.

Providing education to children and youth, while coping with the growing importance of non-communicable diseases among adults will also require more public spending on education and on health.

“The introduction of central school system will add significantly to future public expenditures, as the target is to have 50 percent of students in boarding schools by 2024 and this increases the cost per student by 30 percent,” the World Bank report stated.

Through the reduction of communicable and childhood diseases, Bhutan has increased life expectancy at birth from 59 years in 1990 to 69.5 years in 2010. But longer lives are associated with more years of ill health and a higher prevalence of chronic and non-communicable diseases like cancer, diabetes and heart diseases. The cost of treating these diseases is comparatively high.

The World Bank projected that total expenditures for treating cancer patients will double in this decade (2010-2020). “Bhutan can thus expect to see its public expenditure on health ballooning in the coming years,” he said.

A separate challenge to fiscal self-reliance, in addition to declining tax revenue and rapidly raising public expenditures, is the growing disconnect between planned and actual spending.

Among the recommendations in the report, the chief economist highlighted on the need to have a stabilisation fund to park additional hydropower revenue instead of giving a pay hike. “These rules are difficult to implement when there is weak governance, but Bhutan has a strong governance,” he said.

Instead of losing the tax revenue to exemptions that are not rational, he said efficient management of taxation could also play a vital role in attaining fiscal self-sufficiency.

Tshering Dorji