All over the world, many countries have been faced with an ever increasing gap between public expenditure and revenues collected mostly from taxes on income, consumption, property, and profits. The net result has been the widening of fiscal deficits that in several cases have clearly become unsustainable. Consequently, governments have constantly been in search of strategies to not only reduce the deficits but also to avoid their reoccurrences in the medium to long term.
The accumulation of fiscal deficits over time has two major effects.
First, countries with fiscal deficits have to rely significantly on borrowings to fill the gap between expenditure and revenue which creates outstanding debt that has to be financed in the future.
Secondly, fiscal deficits serve as a drag on economic growth because they limit the extent to which the government can spend on growth-enhancing activities.
Clearly, therefore, going forward, governments have little choice but
to seek ways of reducing fiscal deficits before the said deficits become too difficult to manage. But how exactly should this matter be approached? Have governments demonstrated any real capacity or appetite to resolve the challenges brought about by huge fiscal deficits?
In relation to the first question, two broad approaches have been suggested and attempted by governments around the world. In the first approach, governments rely on stimulus packages which are designed to increase spending particularly on the capital side with the hope that growth and development will take off and hence more revenues can be generated without further increases in taxes. In that way, the fiscal deficit can be lowered not by cutting spending but by growing the economy.
In the second approach, austerity measures have been imposed which essentially entail cuts in spending and increases in taxes in some instances. This approach is clearly more direct in nature. While it has the potential to hurt economic growth and development in the short run, it is clearly likely to result in a reduction in the fiscal deficit since expenditure will fall and revenue should increase.
In relation to the second question, it is quite clear from the evidence in several countries that some governments have demonstrated a capacity to reduce fiscal deficits while others seem more hesitant to do so. Jamaica is a shining example of a country that is trying to deal with its fiscal situation. The same can be said of many countries in Europe that have implemented austerity measures.
The United States on the other hand is yet to convince the world that it is willing to reduce its fiscal deficit anytime soon since Democrats and Republicans continue to fail to reach a compromise on how this goal can be achieved.
Ideology aside, reducing fiscal deficits requires creative measures to bring expenditure down and raise revenues where possible. The measures imposed have to be consistent with treating the root cause of the problem. For example, the Grenadian government recognises that it has both an expenditure and revenue problem. Hence, in its recent budget, the Minister of Finance announced a set of measures intended to lower expenditure and raise revenue simultaneously. The success or failure of this strategy can only be assessed over time.
Nonetheless, since the overall intention is consistent with the fiscal reality facing Grenada, then, the government’s strategy is a step in the right direction. And that is how all countries ought to proceed if they are serious about reducing fiscal deficits!
(Dr. Brian Francis, the former Permanent Secretary in the local Ministry of Finance, is a Lecturer in the Department of Economics at the Cave Hill Campus in Bridgetown, Barbados of the University of the West Indies)