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Centre for Policy Dialogue (CPD) Centre for Policy Dialogue (CPD)

Exploring Fiscal Legitimacy and Social Contract

in Low Income Economies: Relationship between

Budgetary Allocation and Financing

CENTRE FOR POLICY DIALOGUE (CPD)

B A N G L A D E S H a c i v i l s o c i e t y t h i n k – t a n k

OECD Global Forum on Development

Presentation by

Debapriya Bhattacharya

[email protected]

and

Mustafizur Rahman

[email protected]

Paris: 28 January 2010

Centre for Policy Dialogue (CPD)

Bhattacharya & Rahman: OECD Global Forum on Development 2

FISCAL LEGITIMACY

Fiscal legitimacy: “Negotiations between organized societal and political interests around

substantial, consensual changes on both sides of the fiscal ledger and in the nature of

governance – taxes, patterns of public expenditure, and mechanisms of representation and

rights.” (Schneider, Aaron, Victor Lledo and Mick Moore, 2004)

Two sides of Fiscal Legitimacy

Resource Mobilization

Resource Utilization

“Fiscal contracts secure predictable, bargained tax revenues from organized tax-paying groups in

return for giving those groups formal political representation and substantial influence over fiscal

policy in particular, and public policy generally.” (Schneider, Aaron, Victor Lledo and Mick Moore,

2004)



Fiscal Social Contract

Relationship between taxation, redistribution and the society.

The tax system of a country, which provides a snapshot of the social contract,

binds the government and its citizens. (OECD, 2008)

Forms of Fiscal Social Contract

Fiscal Social contract can be of two forms:

1. Explicit contract (e.g. constitutional rights)

2. Implicit contract (e.g. bargained fiscal policy with organized bodies)

SOCIAL CONTRACT



FISCAL SOCIAL CONTRACT IN BANGLADESH

Major Questions:

In a low income economy-

How transparent and representative the budgetary procedures are ?

Is there a relationship between revenue mobilization and public expenditure?

How important is foreign aid flow?

What determines the revenue mobilization?

How did a government response during the crisis period?

Does political regime influence the public finance framework ?

Bangladesh can be an interesting case study.



TRANSPARENCY AND REPRESENTATIVENESS

Country Rank

OBI

Score

Availability of Key Budget Documents

Pre-

Budget

Statement

Executive's

Budget

Proposal

Citizens

Budget

Enacted

Budget

In-year

Reports

Mid-

Year

Reviews

Year-

End

Report

Audit

Report

United

Kingdom 1 88 89 95 67 100 100 92 77 92

Sri Lanka 13 64 56 75 0 100 46 50 43 84

India 20 60 0 62 67 100 96 25 40 83

Nepal 41 43 0 50 0 100 54 83 7 59

Bangladesh 44 42 0 58 0 33 75 0 0 0

Pakistan 47 38 0 53 0 67 0 0 0 67

Source: Complied from country reports, Open Budget Index, International Budget Partnership, 2008

OBI score (from 0 to 100) indicates that to what extent a given country provides information

in its budget documents –

81-100: extensive

61-80: significant

41-60 limited

21-40: minimal

0-20 little or no information.

Budgetary Process in South Asian Countries



According to the survey, among the 85 countries, South Asian countries

performed poorly.

The scores indicate that information available in the budget documents of low

income economies is rather limited.

Bangladesh is ranked 42nd (among 85).

27 countries (32%) belong to the same category as Bangladesh (limited

information).

In recent years there has been increasing number of pre-budget consultations and

proposals from relevant stakeholders presented to the Finance Minister as well as

post-budget scrutiny– however monitoring at the implementation stage needs to

be improved.

TRANSPARENCY AND REPRESENTATIVENESS



RELATIONSHIP AMONG PUBLIC FINANCE FRAMEWORK

Correlation among different components of public finance in Bangladesh (Time Period: FY1973-FY2009)

As expected, the correlations among the major fiscal variables are very high.

Both revenue mobilisation and foreign aid flow are highly correlated with total budget

and its development related expenditure

The budgetary components are also highly correlated with national income.

GDP Budget Revenue

Budget

Development

Budget

Total

Revenue

Income

Tax

Foreign

Aid

GDP 1.0000

Budget 0.9981 1.0000

Revenue

Budget

0.9893 0.9944 1.0000

Development

Budget

0.9836 0.9764 0.9507 1.0000

Total Revenue 0.9961 0.9986 0.9959 0.9707 1.0000

Income Tax 0.8608 0.8584 0.8601 0.8339 0.8551 1.0000

Foreign Aid 0.9211 0.9033 0.8763 0.9311 0.8955 0.8589 1.0000



• Over the last decade or so, annual change in actual delivery of development

expenditure (ADP) has roughly followed the trend in annual change of revenue

earnings.

• An earlier CPD study indicated that implementation of development expenditure

(ADP) can be mostly explained by revenue collection.

• This reconfirms the interrelation between the revenue mobilisation and

expenditure side of budget.

Trend of Change in Actual Development Expenditure and Change Revenue Collection (FY01-FY09)

RELATIONSHIP AMONG PUBLIC FINANCE FRAMEWORK

Source : MoF, GoB.



DETERMINANTS OF REVENUE MOBILIZATION

TAX-GDP AND REVENUE GDP RATIO OF NEIGHBORING COUNTRIES (FY09*)

• Compared to her South Asian neighbors, revenue mobilization of Bangladesh is

not spectacular.

Source: Budget Documents and Economic Reviews of the respective countries

* Revised budget estimates for FY09 (actual FY09 figure for India)




Determinations of Domestic Resources: (Time Period: FY1981-FY2008)

• Dependent Variable: total tax revenue (log)

• Per capita income has the highest positive influence

• Public sector investment - contributes to revenue generation

• Import - positively significant

• Share of modern sector - positive sign but insignificant

• Dummies for VAT & LTU – positive and significant; implies institutional measures taken

by the governments at different time have also positive impact on revenue generation




• The revenue mobilization in Bangladesh is mainly dependent on indirect taxes.

This is regressive in nature.

• However, during last four years, income tax as share of total revenue is

increasing – implies a positive step towards more equitable society.

• The initiatives of preceding caretaker government are carried over by the

present elected government.

0

5

10

15

20

25

19

91

19

92

19

93

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94

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95

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96

19

97

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98

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99

20

00

20

01

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07

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08

20

09

Pe

rce

nta

ge

Fiscal Year

Income tax as % of total revenue

Source : NBR.



FISCAL LEGITIMACY AND SOCIAL CONTRACT DURING THE CRISIS PERIOD

• Two consecutive fiscal stimulus packages (e.g. cash subsidy for export sector, credit

lines, subsidy at production inputs etc.) were announced to tackle the negative

impact of global recession on Bangladesh economy-

– BDT 3,420 crore ($488.6 million) in April 2009

– BDT 5, 000 crore ($714.3 million) in June 2009

• Other counter cyclical measures include –

– Enhancing public investment programme

– Widening social safety net

– Lower corporate tax rate

– Lower duty on imports of industrial raw materials

– Higher duty on imports of luxury goods

– Provision for legalising undisclosed income



Pattern of Public Expenditure in Bangladesh

Impact of an upcoming election on the government expenditure is limited .

0

100

200

300

400

500

600

700

800

900

1000

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

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05

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06

20

07

20

08

20

09

Bill

ion

TK

Fiscal Year

Election Year Total Budget Revenue Budget Development Budget

Source : MoF, GoB.

POLITICAL INFLUENCE



Pattern of Revenue Collection in Bangladesh

An election does not influence the revenue collection in Bangladesh.

0

100

200

300

400

500

600

700

800

19

91

19

92

19

93

19

94

19

95

19

96

19

97

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98

19

99

20

00

20

01

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02

20

03

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04

20

05

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06

20

07

20

08

20

09

Election Year Total Revenue Tax Revenue Income Tax

Source : Different issues of Bangladesh Economic Review, MoF and Annual Report, NBR.

POLITICAL INFLUENCE



POLITICAL INFLUENCE

Determinants of Public expenditure:(Time Period: FY1991-FY2008)

• Dependant Variable: Log of Total Budgetary Allocation

• Per capita income (Proxy for level of economic development) has significant

positive impact for both cases.

• Other economic variables e.g. import, economic structure of the country,

revenue collection have no significant influence on public expenditure pattern.

• Political cycle (electoral) has no significant influence on public expenditure of

that fiscal or the immediate previous fiscal.



REVISITING THE QUESTIONS

• Bangladesh has to go a long way to establish a transparent and representative

budgetary process.

• The revenue mobilization and public expenditure are highly correlated.

• There exists an interrelated macroeconomic framework ( “Investment-

Growth-Public Finance Cycle” ) in Bangladesh economy.

• Government has been responsive during the crisis period.

• Political cycle (electoral) is not significant for the budgetary outcome.



CONCLUDING REMARKS

• A transparent public expenditure framework at every level of the government has

a leading role to establish of a tighter social contract.

• Promoting demands in civil society for fair and transparent tax services

strengthens the practical relationship between state and society.

• A simple, fair and transparent system that operates with broad social consensus is

important for good governance and compliance.

• Emphasis should be placed on the composition of tax sources for equitable

society.

• Exemptions and leakages in revenue mobilization need to be reduced.

• A broad-based but with low rate tax system is desirable.



CONCLUDING REMARKS

• Improving the quality of public services deliverables should get priority.

• Participation of local governments needs to be ensured in monitoring and

evaluation.

• Monitoring and evaluation institutions need to be strengthened in order to make

public spending more transparent.

• Economic factors (e.g. GDP and its composition), structural weaknesses etc. are

more important compared to legitimacy issues for public finance outcome.

• Development administration has an important role to play along with democratic

administration.

Fiscal legitimacy is crucial; it will still be handicapped if the above issues

remain unnoticed.



Thank You