"... paying down the national debt is beneficial for the economy: It keeps interest rates lower than they otherwise would be and frees savings to finance increases in the capital stock, thereby boosting productivity and real incomes."- Alan Greenspan, former Federal Reserve chairman

Over the past few months, there has been considerable debate about the government's plan to introduce a value-added tax (VAT) regime in The Bahamas by July 1, 2014 and about the likely effects that such a tax will have on the Bahamian economy. In fact, the government has made the introduction of VAT the cornerstone of its efforts to reform the country's taxes.

Last week, we started a series of articles on VAT, with a view to addressing the benefits and costs associated with this new tax system and the challenges that we are likely to face with its introduction and operation. In part one, we reviewed the nation's gross domestic product and government revenue. This week, we will invite our readers to Consider This... just what are the facts on the state of the country's finances relative to government expenditures, and the resulting impact on increasingly challenging deficits, and the national debt and do these components necessitate a quantum shift in our tax system?

Public expenditures

Government expenditures fall into two categories: recurrent expenditures and capital expenditures. The former includes the on-going annual expenditures that are required to run the government and the latter includes expenditures on infrastructural items such as schools, roads, docks and airports, to mention a few.

The major components of recurrent expenditures include the following:

As we can see, the overwhelming majority of the components of public expenditure are generally fixed, with little headroom for discretionary expenditures. Personal emoluments, or government salaries and wages, debt servicing, comprised of interest on and repayment of the national debt, and payments to public corporations represent approximately 74 percent of recurrent expenditures, leaving only 26 percent of total recurrent expenditures to be spent on discretionary items across the entire government. Difficult decisions have to be made on how such limited funds will be expended and the choices are often motivated by commitments that were made during election campaigns.

Average annual capital expenditures for the same period presented above have amounted to $307 million, which, given our country's archipelagic realities, is arguably insufficient to meet the growing demands for infrastructural development.

Notwithstanding the increases in annual expenditures, one of the greatest challenges that any government faces is the enormous pressure to reduce or at best limit the rate of increase in spending public funds.

Fiscal deficits

The other pressing issue relative to the facts about our public finances centers around successive governments' fiscal deficits. Since the turn of the century, we have witnessed an alarming growth in the GFS deficits, ranging from a low of $14 million or one percent of gross domestic product (GDP) in 2001 to a high of $445 million for 2012, 11 percent of GDP, to an even higher projected $532 million or 12 percent of GDP in 2013.

The implications for the economy are immense because these historically high deficits will have to be financed either by increasing taxes or additional borrowings, neither of which is sustainable in the long term. The table below depicts the actual performance of fiscal deficits.

The crux of the fiscal morass that has developed under successive administrations is that, for the first 13 years of this century, recurrent expenditures and the national debt have rapidly expanded at a rate of 185 percent and 226 percent, respectively, while, during the same period, recurrent revenue and GDP have achieved a significantly slower growth rate of only 147 percent and 127 percent, respectively.

The national debt

During this century, the national debt has increased at an alarming rate, from $1.93 billion in 2001 to a high of $4.43 billion in 2013, more than doubling in that period. During the last Ingraham administration, the national debt shot up by almost $1.5 billion, from $3 billion. Another $532 million has been added to the national debt in the past 15 months of the current Christie administration.

The national debt as a percent of GDP has increased from 30 percent in 2001 to 54 percent in 2013. Rising debt-to-GDP and comparatively low revenue-to-GDP have highlighted the critical need for a broadening of the tax base in The Bahamas. A core objective of tax policy must be to raise sufficient tax revenues to finance public expenditure while maintaining sustainable public debt ratios.

If confidence is eroded by lax fiscal policies, we all bear the dire consequences: credit downgrades and higher interest rates for the government and Bahamian businesses and citizens, as well as the potential for further downgrades and higher rates if we fail to act decisively and stop mortgaging our future to support today's spending. Lest we believe these issues are confined to the government, remember that these higher rates of interest brought on by high government borrowings and debt affect the daily lives of all Bahamians through higher monthly payments for consumer loans and mortgages.

According to IMF predictions, if left unchecked, the central government debt is projected to reach 62 percent of GDP by fiscal year 2016/17. Adding the debt owed by non-financial public corporations the total public sector debt is projected to increase to about 76 percent of GDP by then. And, as a consequence, the ever-higher levels of public funds that are being directed towards debt servicing mean that significantly fewer resources will be available to finance critical investments needed for our country's economic growth.

The consequences of failing to act promptly and firmly are evident around the globe. Countries that have allowed their levels of government debt to increase sharply relative to the size of their economies have faced sharply higher interest rates and very real difficulties in obtaining financing to pay for ongoing expenditures. In those circumstances, they have had to resort to borrowing from both the IMF and other external sources, which borrowings have been done only on the condition of the implementation of draconian cuts in public spending and public sector jobs, as well as higher levels of taxation. The Bahamas does not want to go down that road.

Conclusion

Minister of State for Finance Michael Halkitis, at a recent address during Accountants' Week, put it very succinctly: "The Bahamas is at a very important junction in its economic history. We have come to the realization that while the current tax environment has worked to the benefit of our country in the past, if steps are not taken now to make the necessary adjustments to improve the efficiency of revenue collection, our fiscal stance will be significantly worsened in the very near future. We face debt levels cascading to unsustainable levels, credit ratings downgrades, and the need for much severe tax increases and reductions in spending if we do not act now to reverse the trend."

o Next week, we will examine the government's plans to introduce value-added tax and explore some of the challenges that face us in the light of that decision. Philip C. Galanis is the managing partner of HLB Galanis & Co., Chartered Accountants, Forensic & Litigation Support Services. He served 15 years in Parliament. Please send your comments to pgalanis@gmail.com.

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