See all blogs in our public finance and development series.
Challenges of rising debt, climate change and multiple spending pressures are themes that run throughout this month’s round-up. It does feel like we are budgeting in a polycrisis. What then, are reasons for optimism? We can perhaps pick out two: first, digital technologies offer the scope for governments to run more efficiently and reach citizens more cheaply. Second, progress is being made on global corporate tax reform, and recent research suggest that this has potential to deliver some significant additional revenue to all countries across the income spectrum. But we start this month with a look at the budgets of India, soon to be the world’s most populous country, and with two out of Africa’s three largest economies, Nigeria and South Africa.
Big budgets, bigger problems
ODI’s Rathin Roy assessed the state of India’s finances following its budget presentation in February. His verdict is that the budget presented the best macro-fiscal picture since 2016, with the deficit targeted to be 4.5% of GDP or lower by 2025/26 and less than half of borrowing financing consumption. But India remains severely fiscally constrained, hampering efforts to deliver higher growth and improvements in the lives of ordinary Indians. The tax–GDP ratio is forecast to be only 11%, and spending cuts (rather than tax rises) take all the strain of deficit reduction. As a result, increasing capital allocations has required a decrease in allocations to important demand stabilisers like the Mahatma Gandhi National Rural Employment Guarantee scheme.
South Africa also presented its budget in February. It projects that growth will average only 1.4% to 2025, with the Finance Minister levelling much of the blame for this on South Africa’s longest-ever stretch of power cuts due to the crisis at the state-owned utility, Eskom. In the budget speech, it was announced that the government will be taking over two-thirds of Eskom’s debt, providing it with large cash injections worth more than 1% of GDP. But an unexplained change in the way these have been accounted for calls into question the credibility of the budget. Government debt will continue to rise to 74% of GDP in 2025/2026 instead of stabilising. Debt service costs account for just under 20% of total expenditure, more than the allocation to health and education, which received a reduced real allocation.
The continent’s largest economy, Nigeria, held elections at the end of February with Bola Tinubu declared the winner in the closest election since the return to democracy. He will face severe budgetary challenges. The proposed 2023 budget forecast reduced revenues due to challenges in crude oil production and weak revenue mobilisation, falling expenditure on capital investments and increased recurrent expenditures and debt interest. Three potential avenues to tame spending are reducing high personnel costs, duplicated projects and wasteful subsidies.
Budgeting in the polycrisis
If India, South Africa and Nigeria all sound like they have major budgetary challenges, they are not alone. Marc Robinson has a useful survey of the budgeting challenges OECD countries are likely to face in the next few years – and which apply more broadly worldwide. Nearly all governments face both pressures for increasing spending from some combination of responding to the Covid-19 pandemic, ageing populations, climate change, infrastructure and defence spending. At the same time, many need some fiscal consolidation to stabilise, or bring down, debt-to-GDP ratios.
As well as requiring tax increases, this will require strengthening control over aggregate expenditure to ensure deficits are controlled at a time of spending pressures. It will also mean creating or strengthening mechanisms that can identify reallocations to create fiscal space for new spending or to support fiscal consolidation, and ensuring that budgetary processes mitigate the risk of waste in any new spending.
In responding to climate change, the IMF has published guidance on implementing ‘green PFM’, including how to integrate environmental and climate priorities into each stage of the budget cycle and providing examples of where this has already been done. The OECD, meanwhile, has published a framework for governments, particularly those in emerging market and developing economies, on managing the financial implications of the expected increase in frequency and intensity of climate-related extreme events. It discusses how to identify and assess climate-related physical risks and their impacts on public finances, how to transparently report these climate-related fiscal risks, and the financial strategies that can mitigate them by protecting households and businesses.
Back to basics on PFM reform
How can countries undertake the reforms necessary to improve their budgeting systems? Richard Allen has some sage advice on improving the quality of PFM reform plans, and offers four lessons.
The role of leadership is rarely discussed in PFM reform. In ODI’s Public Finance and Service Delivery Working Paper published in January, Daniel Berliner, Martin Haus and Joachim Wehner ask do ministers matter for audit performance? They find that in South Africa, despite strong audit oversight and highly institutionalised PFM practices, good governance depends fundamentally on who is in charge. The analysis highlights the importance of thinking beyond uniform systems, structures and procedures in analysing the performance of PFM and organisational performance more generally.
Digital public finance
The benefits of digital public finance systems were shown during the first year of the Covid-19 pandemic. Among 85 countries, those that were able to leverage digital databases and trusted data-sharing reached on average around half of their populations. More broadly, can a ‘strategic state’ embrace the technological revolution and use data and technology to drive down the cost of public services while improving outcomes, as former UK prime minister Tony Blair advocates?
Many e-procurement projects are not fulfilling their potential to make procurement systems more open, fair and sustainable. A new Open Contracting Partnership report makes eight recommendations and provides guidance on improving the conceptualisation, design, procurement and implementation of e-GP systems.
If you want to further explore how digital improves public spending, do register for our Budgets and Bytes event on 21 March.
Growing out of debt?
Reuters has a useful list of the countries that have defaulted (Ukraine, Sri Lanka, Zambia, Lebanon, Ghana) or are at imminent risk of doing so (Pakistan, Egypt, Tunisia, Malawi, El Salvador). Progress on debt restructuring is being held up by geopolitical tensions linked to where the burden of relief will lie. Lack of agreement is leading to long delays in approval of new IMF financing for countries, which wait for assurances that creditors are ready to negotiate a restructuring in line with the IMF's debt sustainability analysis. A new Global Sovereign Debt Roundtable has been established to address these issues. The first meeting in India was ‘talks about talks’ and the substance will need to wait for the next meeting at the IMF and World Bank Spring Meetings.
Beyond the slow pace of debt restructuring, a further issue is how to ensure that any restructuring deal puts in place conditions for future growth. After all, it can be argued that Africa’s debt problems in the 1990s were mainly the result of slow economic and export growth. Former African Development Bank Chief Economist, Celestin Monga, argues that debt sustainability analysis should take into account the vulnerability of African economies to commodity-price swings, dollar exchange-rate fluctuations, and rising interest rates in major economies by putting issues of external competitiveness and exchange-rate policies at its core. There also needs to be a greater focus on the quality of public investment and whether debt is being used to finance inclusive growth, rather than on arbitrary debt-to-GDP limits.
Similarly, a new paper from a Finance for Development Lab team including Dani Rodrik argues that debt restructuring deals should be evaluated on whether they help to place economies on a green growth path. But future prospects for growth are lower than in the past so deeper debt reduction will be needed over longer time horizons. They argue that IFIs will be the main source of financing, connecting this to the MDB reform agenda, and that conditionality needs to shift from a primary emphasis on meeting macroeconomic targets towards the reforms and investments needed to drive growth.
Gains from a global minimum corporation tax
New research from Gabriel Zucman and Ludvig Wier estimates that corporate profit shifting to tax havens has continued to increase, rising from $616 billion in 2015 to nearly $1 trillion in 2019, suggesting that the 2016 OECD and G20 Base Erosion and Profit Shifting (BEPS) package has had little impact. In 2019, 37% of the overseas profits of the world’s biggest multinationals was shifted to tax havens, up from 20% in 2012, leading to losses of around 10% of total corporate tax revenues in 2019. They argue that a global minimum tax rate would largely eliminate profit-shifting to tax havens.
The OECD has presented its progress report on the two-pillar international tax reform package to the G20. Pillar two is a 15% minimum effective corporation tax rate along the lines advocated by Zucman and Wier (although it has been criticised for the rate being too low and only applying to firms with revenue above €750 million). It reports that a number of countries are moving legislation on the global minimum tax forwards, and the African Tax Administration Forum has developed implementation guidance for its members. It also reports that it is now estimating higher revenue gains from the reforms than previously. The minimum global tax rate is now expected to result in annual global revenue gains of around $220 billion, or 9% of global corporate income tax revenues. It projects that as a proportion of current corporate tax revenues, developing countries will gain more than advanced economies.
This is corroborated in new research from the World Bank: it looks at the distribution of effective corporate tax rates across firm size in 13 countries low- and middle-income countries. It finds an inverse-U shape as small firms have lower effective rates due to reduced statutory tax rates and being more likely to register losses. Tax rates are also lower for the largest firms due to tax incentives, and a third of the top 1% of firms face effective corporate tax rates below the global minimum tax of 15%. The global minimum tax would raise corporate tax revenue by 27% in the median country in the sample.