When I check my saving account my first reaction is usually to call the bank or the police. I see the balance and I tell myself ‘my God I have been robbed’. However, the truth is that there is no thief to be blamed other than me. I underestimate deductions, forget to budget realistically for regular expenditures and forget about unplanned expenditures. The result of my overoptimism is that I constantly miss my saving target.
Something similar happens to governments all over the world. Governments budget revenues and expenditures, but midway through the year, there is often a shortfall and adjustments have to be done or targets are missed.
A recent policy brief analyzed this process for Jamaica. Jamaica has been trying for several years to reduce its debt-to-GDP ratio to a sustainable level. Because of limitations in reducing rigid recurrent expenditures—mostly interest and wage salary payments—measures have focused at meeting appropriate revenue targets. In spite of these efforts, the revenue targets have often been missed. (Figure a).
The systematic shortfall has important effects because starting from a required fiscal target, in the Jamaican case one that reduces the debt-to-GDP ratio, the budget defines revenue collection efforts and expenditures simultaneously. As a consequence, these repeated lower-than-expected revenues combined with rigid expenditures led to continuous debt buildup, reaching a level that needs deep, institutional reforms. If Jamaica had stayed on budget over the analyzed period, the debt-to-GDP as of March 2012 would have reached only 114 percent—instead of 129 percent—of GDP. The deviations were especially important between FY2007/08 and FY2009/10 when the weaker-than-expected budget outturns added around 4 percentage points of debt-to-GDP in each year (Figure 2). Infrastructure can also suffer from the weak budget process. Given the rigidity of expenditure in Jamaica budget adjustment often leads to lower capital expenditure. The consistent under-execution of capital expenditure can lead to a deterioration of public goods and infrastructure with adverse consequences for future growth.
The adverse consequences of consistently overestimating revenue projections highlights the importance of the ongoing reform effort in Jamaica. Achieving a sustainable debt trajectory required bold reforms, as it is inadequate to implement incremental tax measures to fund systematic financing gaps. The tax system needs to provide stable revenues while minimizing the need for distorting revenue measures or systematic cuts in capital expenditures. However, the analysis also suggests that limitations to collect sufficient revenues is also associated with unsustainable high expenditures that need to be funded. This is where the Fiscal Rule becomes important as it needs to provide a framework that matches revenues with expenditures based on realistic projections.