public sector financing in jamaica, barbados, and trinidad and tobago 1974–1984

Public Sector Financing in Jamaica, Barbados, and Trinidad and Tobago 1974–1984Author(s): Michael HowardSource: Social and Economic Studies, Vol. 38, No. 3 (SEPTEMBER 1989), pp. 119-148Published by: Sir Arthur Lewis Institute of Social and Economic Studies, University of the WestIndiesStable URL: http://www.jstor.org/stable/27864891 .

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Social and Economic Studies, Volume 38, No. 3,1989

Michael Howard

Public Sector Fin?ncing in Jamaica, Barbados, and Trinidad and Tobago 1974-1984

ABSTRACT

This paper examines the mode of public sector

financing in the Caribbean countries of Jamaica, Barbados and Trinidad and Tobago during the re

cessionary period 1974?1984. The analysis deals

only with central government finances. The paper examines tax structure changes as well as deficit

financing in the three countries. The paper con

cludes that there has been a fundamental shift to

indirect taxation as a method of financing in Jamai ca and Barbados. Further, money creation was em

ployed as the primary method of financing the fiscal deficit in Jamaica during recession, and this had implications for the balance of payments. The

dependence on oil sector revenues in Trinidad and

Tobago is also highlighted.

INTRODUCTION

This paper advances an exploratory analysis of the

policy aspects of public sector financing in Jamaica, Barbados, and Trinidad and Tobago between 1974 and 1984. These years were a period of stress in the world economy marked

by the First Oil Shock of 1973 and the Second Oil Shock of 1981/82. The need to adjust to world recession led the Jamaican and Barbadian governments to modify their tax

structures as well as adopt changes in the mode of deficit



120 SOCIAL AND ECONOMIC STUDIES

financing. The use of indirect taxation and the creation of

money by the central bank were utilized on a larger scale, par

ticularly in Jamaica. The Trinidad and Tobago fiscal system was much more buoyant because of strong tax revenues from

the mining sector after the 1973 Oil Shock. However, the

Trinidad and Tobago public sector came under considerable stress particularly after 1981, as a result of declining oil revenues stemming from the drop in petroleum prices.

The first three sections of the paper examine salient

trends in tax structures, highlighting the most significant policy changes which were implemented. We attempt to

relate these changes to the role of the IMF in Jamaica and the deliberate tax reform strategy of the Barbadian Government.

Discretionary tax increases were not as important in the Trinidad and Tobago case before 1982. The fourth section deals with expansionary expenditure policies of the govern ments which pave the way for a discussion of the mode of deficit financing in the fifth section. In the Trinidad and Tobago case, financing through revenue surpluses was em

ployed for most of the period.

The discussion of the major public sector financing trends is followed by a brief evaluation. We attempt to evalu ate the extent to which Keynesian type expenditure policies placed pressure on the Jamaican and Barbadian balance of

payments. Secondly, we touch on the implication of falling oil prices in Trinidad and Tobago for the fiscal budget after 1981. In this essay, no attempt is made to deal with problems of the public debt, a topic which has been examined else where.1

TAX STRUCTURE CHANGE

This section describes changes in the tax structures in the three countries to set the stage for a discussion of tax

policy. The Trinidad and Tobago economy has the highest



Public Sec tor Financing 121

tax ratio of the three countries varying between 30.0 per cent

in the period 1977/1979, and 35.9 per cent in the period 1980/82. Barbados showed an increase in its overall tax ratio

from 22.7 per cent between 1974 and 1976, to 24.5 per cent

for 1980/82. Jamaica's tax ratio was the lowest of the three

countries rising from 19.9 per cent between 1974 and 1976

to 22.7 per cent for the period 1980/82.2 The high tax ratio for Trinidad and Tobago is primarily

determined by petroleum revenues. Price changes in the

petroleum sector has a direct impact on fiscal revenues.

Table 1 shows that the ratio of income tax to GDP in the non-oil sector has been much lower than the oil sector

except for the period 1983-1984, when the level of corpo ration taxes from the oil sector declined with falling oil

prices. Overall, the analysis reveals a tendency for non-oil

income tax to increase in relation to GDP over time. The

Barbadian income tax/GDP ratio is second to that of Trini

dad up to 1982, but has been falling over time. We explore the reasons for this when we examine discretionary tax changes.

The Jamaican income tax/GDP ratio recorded the lowest levels up to 1982, but averaged 10.1 per cent for the years 1983-1984. The lower ratios in past years do not

suggest a lower incidence of income taxation. Boyd [ 1 ] has shown that in 1984 the Jamaican income tax was burden some because the highest income tax rate of 57.5 per cent

was levied on a low statutory income of J$ 14,000. Perhaps one reason for the low income tax/GDP ratio in Jamaica has been widespread tax evasion, informal labour activity and

unincorporated business activity, which are important factors in reducing the taxable base of the economy. Given these

factors, Boyd suggests that the P.A.Y.E. system is regressive on low incomes.

The indirect tax/GDP ratio is low in Trinidad and Tobago compared with Jamaica and Barbados (see Table 2).




TABLE 1: INCOME TAX/GDP RATIO (PERCENTAGES)

COUNTRY 1974/76 1977/79 1980/82 1983/84

Barbados 12.2 12.5 10.5 9.6

Jamaica 8.6 6.5 8.8 10.1

Trinidad and Tobago

(a) Non-oil Sector 3.8 6.6 9.1 11.7

(b) O? Sector 15.8 15.5 17.8 10.5

Sources; Annual Statistical Digest, Central Bank of Barbados, 1983.

Annual Reports: Central Bank of Trinidad and Tobago.

Economic and Social Surveys of Jamaica, 1981-1984.

TABLE 2: INDIRECT TAX/GDP RATIO (PERCENTAGES)

COUNTRY 1974/76 1977/79 1980/82 1983/84

Barbados 9.4 12.2 12.5 13.6

Jamaica 10.3 10.9 11.3 11.5

Trinidad and Tobago 4.3 5.1 4.4 5.8

Source: Same as Table 1.

This low ratio in Trinidad and Tobago is explained by the dominance of income tax. The Barbados indirect tax/GDP ratio is on average higher than Jamaica's and is increasing

(see Table 2). The high Barbados ratio is a result not only of budgetary policy but is also related to the heavy dependence on service activity in recent years.

The three countries show a number of trends in their

tax structures particularly in relation to the changing empha sis placed on certain categories of indirect taxes.

(1) Between 1974 and 1984, all three countries show an increase in indirect taxation as a ratio of total

taxation.

(2) Jamaica and Barbados show a sharp rise in the

ratio of consumption taxation to total indirect taxation.




TABLE 3: INDIRECT TAX AS A RATIO OF TOTAL TAX REVENUE (PERCENTAGES)

Year Jamaica Barbados Trinidad and Tobago

1974 49.4 41.1 14.4

1975 55.1 39.3 13.4

1976 51.3 44.2 14.8

1977 55.6 45.1 16.3

1978 63.7 43.0 16.3

1979 61.4 47.9 14.1 1980 58.4 50.4 11.7

1981 55.6 57.4 12.2

1982 39.7 49.7 14.4 1983 60.0 53.3 18.4

1984 50.5 57.2 19.6


(3) Jamaica and Barbados reveal a falling ratio of

import duties to total indirect taxation.

We discuss these trends and then examine the major specific discretionary tax changes in the cases of Jamaica and

Barbados.

Gobin's analysis [4] of tax structure development in

Jamaica, Barbados, and Trinidad and Tobago up to the early 1970s provides a useful background for the analysis of tax

structure change after 1974. Indirect taxation in Barbados

and Jamaica was the principal source of revenue during the

1950s and 1960s. In Jamaica, indirect taxes constituted 69

per cent of total tax revenue between 1955 and 1957. This

is not surprising during the early stage of development.

During the colonial period, indirect taxes were mainly in

the form of customs duties. The narrow tax base in staple

exporting economies reduced the yield of income taxation.

By the period 1972/74, the contribution of indirect taxation in Jamaica had fallen to 51 per cent. The comparable figures for Barbados were 58 per cent (1944/57) and 49 per cent




(1972/74). Trinidad and Tobago showed lower rates of indirect taxation of 37 per cent (1956/58) and 27 per cent (1972/74).

This downward trend in indirect taxation was associated

with the increased importance of income taxation as the

economies pursued industrialization strategies to raise income

and employment levels. The expansion of other sectors of

the economies, particularly tourism in Barbados and Jamaica

and the mineral sector in Trinidad and Jamaica helped to

broaden the income tax base. The ratio of income taxation

to total taxes moved from 62 per cent (1956/58) to 72 per cent (1972/74) in Trinidad and Tobago. The income tax/ total tax ratio also rose from 42 per cent (1956/57) to 47 per cent (1972/74) in Barbados, and from 31 per cent (1955/57) to 47 per cent ( 1972/74) in Jamaica.

The period 1974-1984 is characterized by a reversal of

the trend above as the countries relied more heavily on

consumption taxation to finance the fiscal budgets during recession. The relative increases in indirect taxation as a ratio

of total taxes are shown in Table 3*. The increases are sharpest in Jamaica and Barbados with indirect taxes constituting over

50 per cent in Jamaica in most years. In Trinidad and Tobago, indirect taxes became more important in the early 1980s.

The growth of the proportion of consumption taxes as shown

in Table 4 was mainly responsible for the increased contri

bution of indirect taxes to total revenue. These trends were

also associated with a fall in the ratio of import duties. These

tax structure changes were due largely to the re-orientation

of budgetary policy in the three countries studied.

TAX POLICY DURING RECESSION An analysis of discretionary tax changes in Jamaica and

Barbados particularly after 1977 demonstrates the imposition of contractionary indirect tax policy. This policy suppressed

*

demand impulses in order to contain the current account



Public Sector Financing 125

balance of payments, as well as contribute to the financing of the fiscal deficits. Consumption taxes and stamp duties were

the main instruments of contractionary tax policy. In the

TABLE 4: CONSUMPTION TAX AS A RATIO OF INDIRECT TAX REVENUE (PERCENTAGES)

Year Jamaica Barbados Trinidad and Tobago*

1974 21.1 15.8 3.0

1975 25.0 13.6 2.9 1976 45.5 14.0 3.0

1977 50.6 17.0 2.0

1978 60.6 16.3 2.4

1979 53.8 15.0 2.2

1980 60.1 25.5 1.8

1981 . 57.2 26.4 1.8

1982 54.6 37.0 2.2

1983 52.5 37.4 3.5

1984 52.6 33.1 5.3

* Figures are for purchase taxes.


Jamaican case, the trend in discretionary tax financing was

largely related to the institution of the IMF Extended Fund Facility in 1977.3 For example, in 1978 alone, indirect

taxation in Jamaica increased by $251.8m or 96.8 per cent.

A large part of this was due to increases in consumption duties which totalled $ 178.9m. The 1978 budget which was

designed when the economy was in the grip of the IMF4 projected that new consumption duty rates would yield $ 104.3m (see Table 5). Overall consumption duties rose from

21.1 per cent of indirect tax revenue in 1974 to 60.6 per cent

in 1978, thereafter falling to 52.5 per cent in 1983.

The trend in financing the budget through indirect taxation in Jamaica is also evident in the heavy imposition of




TABLE 5; PROJECTED REVENUE IMPACT OF DISCRETIONARY TAX CHANGES; JAMAICA (J$m)

1) Income Tax Adjustments

2) Consumption Duty

3) Retail Sales Tax

4) Stamp Duty 5) Levies

6) Other Indirect Taxes

7) Hotel Accommodation Tax:

Increase in Rates

8) Education Tax

9) Transfer Tax (Adjustments)

Total

1978/79 1983/84 1984/85

10.0 4.0

104.3 24.0 58.0 18.6 12.0

37.3 - 39.5 8.0 10.0

17.5 - 52.6

3.0 - 26.0 15.0

6.0 7.5

180.7 75.0 212.6

Source: Economic and Social Surveys of Jamaica, 1978, 1983,1984.

new stamp duties in 1978 ($37.3m) and 1984 ($39.5m). Other indirect tax rate increases totalled $52.6m. These

included a wide range of licences and fees, excise taxes on

beer and spirits and travel taxes. It is notable that changes in

customs duties were not prominent among the changes. This

is partly a result of the provisions of the CARICOM Treaty which released regional imports from liability to pay duty. The heavy indirect taxation as well as the imposition of the education tax raise questions relating to the incidence of

taxation in Jamaica. Although the measurement of incidence

is outside the scope of this paper, it is arguable that the wide range of taxes imposed fell heavily on lower income groups

during the recession.

Contractionary indirect tax policy was a principal feature of Barbadian budgetary management after 1977. The

budget of 1977 articulated the view that the consumption tax should be a primary defensive measure to protect the balance of payments. There was some ambiguity in the policy




in that contractionary tax policy was combined with expan

sionary money creation policy at that time. This is dealt with

when we discuss deficit financing. The shift to indirect tax was also part of an overall policy to reform the income tax

system to reduce its disincentive effects.

After 1981, the concern with contractionary stabiliza

tion policy led to the heavy increases in stamp duties. Pro

jected discretionary tax rate changes in Barbados are

illustrated in Table 6. The analysis shows the loss to the revenue in terms of income tax concessions. These income

tax concessions totalled a high of $24.Om in 1980. Increases

in indirect taxes were mainly in the form of stamp and con

sumption duties as well as specific levies.

TABLE 6: PROJECTED DISCRETIONARY TAX CHANGES: BARBADOS (BDS$m)

Con

Stamp sumption Year Duties Tax

1981

1982 8.5 11.5

1983 7.0 7.1

1984 19.0 3.0

1985 10.0 -1.3

* Training Levy and reimbursements

Source: Annual Budgets, Barbados, :

Levies and

Other

Indirect Non-Tax Income Tax Tax Revenue Concessions

2.8 0.4 -18.7

2.6 5.2 -2.0

9.8 1.0 -2.7

8.2 - -14.6

19.7* -0.2 8.0

health and transport levy funds.

-1985.

The implications of our analysis is that the governments of Jamaica and Barbados have resorted to increased reliance on indirect taxes under recessionary conditions. In Jamaica,

upward adjustments in taxes were made in 1977 in the




context of declining private sector activity and a slow-down in the rate of income tax collections from companies. The

resort to repeated tax rate changes reflected the lack of

elasticity in the Jamaica tax system under recession, as well as the austerity measures imposed by the IMF which slowed the growth of incomes.

The Barbadian case seemed to have followed the

Jamaican case with respect to indirect taxation. However, the Barbadian case was slightly different in the sense that the government was more committed to reducing the inci dence of income taxes through a system of rebates for lower income groups and adjustment of the income tax bands.

Studies by Worrell [9] and Sackey [7] showed the need for some downward adjustment in income taxes to mitigate the severe impact of the inflation tax after 1973. Therefore, the distributional impact of stabilization policy may have been more severe in Jamaica, where the PAYE was regressive on

low incomes.

Another feature of tax policy during the period in

Barbados and Jamaica has been the tendency to resort to

specific levies to finance the final budget. In 1974, the

Jamaican government imposed a bauxite levy of 7.5 per cent

of the price of aluminium. The levy was intended to increase

the productive capacity of the economy. A large part of the

levy contributed to the consolidated fund and part may have

been used to finance public consumption.5

In Barbados, the implementation of the transport and

health levies introduced a measure of earmarking into the

Barbadian budgetary process. These two levies were in the

form of payroll taxation and were paid into special funds.6

It is argued that despite the income tax concessions, granted

during the period, these levies had the effect of reducing disposable income and offsetting the beneficial impact of income tax reductions.




It is possible to identify some of the reasons govern ments in the region have used heavy indirect taxes and

levies as a first resort in times of recession. In the first place, such taxes are easy to collect and easy to manipulate through the budget. Governments have also been influenced by the

trend in tax reform worldwide which favours taxes based on

consumption rather than income. An important reason, too, is that increased income taxes can have a high political cost

in terms of votes foregone, and in the Caribbean such taxes

have been a heavy burden on the middle classes. However,

heavy indirect taxes levied for the sole purpose of raising revenue are highly regressive and can have a stagflationary

impact. Thus, the stabilization policies pursued by both the

Jamaican and Barbadian governments had some costs in

terms of the deterioration in the income distribution. The

overall incidence due to indirect tax increases is difficult to

measure, since in the Jamaican case frequent devaluations of

the dollar also affected the income distribution. In the Barbadian case, the rate of price inflation remained low

especially in the early 1980s, despite the increase in taxes.

BUOYANCY OF THE TAX SYSTEMS

In the context of heavy discretionary tax changes in Jamaica and Barbados, and the contraction of oil revenue

in Trinidad and Tobago, it is appropriate to examine the

buoyancy of these tax systems. The buoyancy coefficient measures the overall responsiveness of taxes to income

changes, and must be distinguished from the elasticity co

efficient which gives the natural growth or built-in flexi

bility of taxation in the absence of discretionary tax changes. A low buoyancy coefficient usually indicates that tax policy is not very successful in increasing revenue yield. A low

buoyancy may also indicate a low elasticity.




The Jamaican case shows that the buoyancy coefficients for income tax, indirect tax and total taxes are just above

unity (see Table 7). They cannot be considered high, but they indicate that during the recession, large discretionary tax changes have been the main instrument maintaining the buoyancy of the Jamaican tax system, as the authorities

sought to extract revenue from a contracting revenue base.

TABLE 7: BUOYANCY COEFFICIENTS FOR THE TAX SYSTEMS

Indirect Total

Country Income Tax Taxation Taxation

Jamaica 1.14 1.12 1.17

Barbados 0.85 1.3 0.68 Trinidad and Tobago 1.16 1.11 1.3

Note: The buoyancy coefficients were derived from the regression equation log = log a + b log y where is the tax category, b is the buoyancy coefficient

7 and Y the GDP. The T-statistic was significant in all cases and R was generally robust above 95%.

The Barbadian case is different. Indirect taxation is more

buoyant compared to Jamaica and Trinidad, but income

taxes and total taxation have buoyancy coefficients much

less than unity. The analysis indicates that Barbados may have a problem of fiscal revenue insufficiency, in spite of the

changes in the tax system. The authorities need to consider

the revenue productivity of various taxes, with a view to

rationalizing the tax system. Trinidad and Tobago show

moderate buoyancy coefficients for income tax and indirect

tax. The buoyancy coefficient for total taxation is 1.3, which

is somewhat surprising given the slow-down in revenues after

1981.

Structural and administrative factors explain the low

tax buoyancies in these economies. In the first place, the

operation of the Puerto Rican model has produced a 'revenue




deprivation effect' on the public sector. The growth of

import replacement industries as well as exclave export industries was associated with a tax incentive strategy which

exempted a large proportion of capital imports and raw

materials from customs duties. Income tax concessions were

also granted to such industries. The argument is that even

though these industries contributed to output and value

added, governments were deprived of revenue leading to low

tax buoyancy. The other structural argument, which is diffi

cult to support by concrete evidence, is that the growth of an

'underground' economy in Jamaica and to a much lesser extent in Barbados may have reduced significantly the revenue productivity of the tax base.

Administrative factors relate to tax evasion and tax

collection lags. Boyd [ 1 ] has argued that tax evasion may be

significant in the Jamaican case although it is difficult to gauge the extent of evasion. In Barbados and Trinidad and

Tobago, a similar argument is possible. It is also well known that MNCs reduce their tax liability through transfer pricing.

Although it is not possible for us to estimate the magnitude of taxes foregone through transfer pricing, the tax loss to the

State is probably substantial in relation to the value added

produced by these firms. The problems of tax evasion and

transfer pricing are not easy to deal with administratively, and they impact negatively on the buoyancy of the tax system.

EXPENDITURE POLICY

An analysis of the orientation of expenditure policy is essential for understanding deficit financing. In Jamaica, a

contractionary taxation policy was accompanied by expan

sionary expenditure policy. This expansionary policy was a

fundamental reason for persistent budget deficits in Jamaica.

To some extent, these deficits also had structural causes

since they were related to the decline in the major sectors of




the Jamaican economy, particularly Tourism and Bauxite.

This decline led to increased state spending in an attempt to

prop up the Jamaican economy.7

The expansionary expenditure policy was evident in

Jamaica as early as fiscal year 1975/76. Between 1974 and

1976, the ratio of total expenditure to GDP rose from 32.8

per cent to 39.5 per cent. By 1978, this ratio was 49.2 per cent (see Table 8). The data in Table 9 show the level of dis-saving experienced by the Jamaican public sector after

1976. This pattern is to be explained largely, though not ex

clusively, by excessive government consumption expenditures.

In the Barbadian case, fiscal policy was largely contrac

tionary in the years 1974 to 1975 following the First Oil Shock. The ratio of total expenditure to GDP fell from 20.8 per cent in 1974 to 28.6 per cent in 1975. Moreover,

TABLE 8: TOTAL EXPENDITURE AS A PERCENT OF GDP

Year Barbados Jamaica Trinidad and Tobago

1974 30.8 32.8 23.2

1975 28.6 36.1 21.6

1976 34.6 39.5 27.9

1977 37.0 32.7 26.4

1978 34.4 49.2 30.4 1979 33.5 36.5 33.5 1980 34.6 43.7 34.4

1981 36.3 49.1 36.8 1982 34.5 46.3 49.5 1983 32.2 44.2 46.3 1984 33.4 36.9 38.4

Source: Same as for Table 1.




the budgets of November 1974 and May 1976 contributed

$25.1 m to government current revenue.

The movement of the Gs/GDP ratio in Barbados roughly corresponds with periods of economic recession and expan sion. The stagflationary period 1974-1977 led to a slackening in the rate of growth of indirect tax revenue. At the same

time inflation augmented the nominal value of government

consumption expenditures. Government resorted to borrow

ing from the Eurodollar market to compensate for tax

revenue insufficiency. The Gs ratio was at a higher level in

the late 1970s as favourable export trends led to an in crease in the real growth rate which averaged 5.0 per cent

between 1978 and 1980. The Gs/GDP ratio declined in 1981 and 1982 in the context of world economic recession (see Table 9).

TABLE 9: GOVERNMENT SAVING (Gs) AS A RATIO OF GDP (PERCENTAGES)


1974 0.2 0.1 14.4

1975 3.1 0.4 16.8

1976 -0.1 0.8 18.2

1977 0.7 -1.8 20.2

1978 4.3 -0.3 15.3

1979 3.3 -0.4 11.7

1980 3.0 4.3 16.7

1981 1.1 4.4 19.1

1982 1.0 -2.4 4.8

1983 2.8 -10.6 1.0

1984 0.6 -1.5 2.9

Source: Same as for Table 1.




Expansionary fiscal policy on the expenditure side in

Barbados was mainly a phenomenon of the years 1979 to

1981. In 1979, capital expenditures rose on a number of

major projects which were financed largely by foreign borrow

ing. The year 1981 was an election year in which total

expenditure rose to 36.3 per cent of GDP.

The world recession of 1981/82 initiated a contraction

ary fiscal policy which lasted from 1981 to 1985. The stabil ization programme adopted by the Government emphasized austerity measures to curb aggregate demand and reduce

balance of payments pressure. Particular stress was placed on

wage and credit restraints in both the public and private sectors, heavy indirect taxation, cuts in capital expenditures and control of the growth of current expenditures.

The 1971 oil boom led to surplus financing and the pursuit of an expansionary fiscal policy in Trinidad. Capital expenditure increased by over 40 per cent annually between 1971 and 1981. Total expenditure as a ratio of GDP rose from 23.2 per cent in 1974 to a high of 49.5 per cent in 1983 (see Table 8).

Contractionary fiscal policy was pursued after 1982 as oil revenues fell as a result of falling oil prices and the overall

budget moved into deficit. There was an attempt to reduce

capital expenditure between 1981 and 1984. As a proportion of total expenditure, capital expenditure fell from a peak of 47.7 per cent in 1981 to 24.9 per cent in 1984.

In 1982, the massive government savings were con

siderably reduced by a sharp growth in government con

sumption spending and a slowing down in current revenues

consequent upon the fall in the price of oil (see Table 9). More than half the increase in current expenditure was due to a rise in the public sector wage bill, while social service ex

penditure absorbed about 48 per cent of the current budget.




DEFICIT FINANCING: JAMAICA AND BARBADOS

Jamaica relied heavily on money creation to finance

its fiscal deficit as a result of the expansionary expenditure policies discussed above. The ratio of the fiscal deficit to

GDP rose to a high of 20.8 per cent in 1980 in Jamaica, considerably higher than the Barbadian case which was held

to manageable levels below 10 per cent during the period (see Table 10). In contrast to Jamaica and Barbados, expan

sionary expenditure policy in Trinidad was supported by budget surpluses for most years up to 1981. Thereafter, with

the fall in oil prices, the Trinidad budget went into deficit and the ratio of the fiscal deficit to GDP peaked at 13.8 per cent in 1982. Some fiscal restraint was exercised to

reduce this ratio after 1982. The Trinidad case is discussed

in the next section as a special case.

TABLE 10: RATIO OF FISCAL DEFICIT TO GDP (PERCENTAGES)


1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984

-5.3

-2.6

-7.7 9.7

-7.8

-15.4

-14.3

-16.6

-13.4

-20.8

-15.6

-12.6

-18.7

-7.2

8.1

-7.0

-8.3

-2.8

-3.4

-5.2

-8.1

-6.0

-3.4

-5.8

5.8

8.3

2.0

-2.5

5.8

1.0

-13.8

-12.2

-6.9

Surplus (+) Deficit (-)

Sources: Annual Reports, Central Bank of Trinidad and Tobago, 1980-84.

IMF Financial Statistics, 1985.




It is appropriate to examine the financing of the fiscal deficit in Jamaica and Barbados, since the mode of financing has implications for the balance of payments. Also, we look at the mobilization of the budget surpluses in the case of Trinidad and Tobago.

One needs to elucidate the nature of the relationship between government deficits, Central Bank money creation and the balance of payments. This analysis draws heavily on

Howard [5]. We admit that 'real' forces play an important role in creating balance of payments problems. However, the creation of money, especially excessive Central Bank

money creation, is often a significant proximate cause of balance of payments disequilibrium.

The monetary base or 'base money' is defined as cur rency with the non-bank public and commercial bank re serves. This concept can be employed in any economy where commercial bank deposits at the Central Bank are used to settle interbank debt and the conversion of the monetary liabilities of the banks is in the form of currency. Expan sionary monetary policies, especially Central Bank lending to

government in an open economy, expand the monetary base and lead to balance of payments deficits through the reduc

tion of the Central Bank's foreign assets. The effect may be

particularly severe because money creation by the Central Bank does not reduce the resources of the private sector.

Deficit financing by the commercial banks reduces bank reserves and leads to a resource transfer from the private to the public sector. The impact on the balance of payments is of less magnitude than deficit financing by the Central Bank.

Borrowing from the non-bank public by the government results in a direct transfer of resources to the government and

reduces the external leakage by the non-bank public.

Foreign reserve movements also influence the govern ment's borrowing requirements. Foreign exchange receipts




represent inflows into the economy but the creation of

money seriously affects those receipts. The conversion of

foreign exchange into domestic money augments the level of

bank reserves and commercial bank deposit liabilities. How

ever, an initial decline in the inflow of foreign money (for

instance, a sharp decline in tourist receipts) may reduce part of the government's tax take in the form of indirect taxes on

goods and services, and lead to an increase in the public sector borrowing requirement. The above mechanisms are

intended to show briefly how foreign reserve movements are

related to the government's borrowing requirement.

The Annual Reports of the Bank of Jamaica (BOJ) show the extent to which persistent budget deficits were financed

by Central Bank money creation. The Reports advance the

view that money creation was necessary in the absence of

any significant foreign financing in order for the public sector to maintain economic momentum given a sluggish private sector. The annual change in BOJ money creation as a ratio of domestic borrowing was 62.8 per cent in 1975, and 73.5 per cent in 1976.

However, the Jamaican budget of 1977/78 attempted to restrict Central Bank borrowing and to rely on other domestic financial institutions. This was done by means of the issue of special short-term local Registered Stocks and the increase in the Treasury Bill ceiling from J$lQ0m to J$200m. Restrictions were placed on domestic borrowing from the banking system under the Extended Fund Facility Programme in 1978. After 1979, Central Bank money creation was again relied upon as financing from foreign sources failed to materialize. Table 11 shows the large annual increases in BOJ money creation.

By 1984, the Jamaican Government had achieved one of its major objectives in reducing the ratio of the fiscal deficit to GDP, to 7.2 per cent. This was achieved by tight control of public expenditure, as well as the tax package of




TABLE 11: DEFICIT FINANCING: JAMAICA (J$m)

Year

Total

Deficit Borrowing

Net Central Bank

Claims*

1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984

-167.9

-206.0

418.3

428.2

-625.0

?5.8

-986.0

-916.7

-957.1

-1,333.6

-988.7

163.8

97.7

578.7

311.8

480.3

463.3

624.5

-31.5

147.9

207.8

89.8

-5.0

940.1

465.5

263.9

985.9

737.5

*Denotes annual changes in Central Bank credit to Government

Source; IMF International Financial Statistics, 1985.

Economic and Social Survey of Jamaica, 1984 and 1985.

Note: The IMF estimates of the total deficit and net borrowing are for the

calendar years 1974-1980. The estimates for 1981 to 1984 are on a fiscal year basis and are found in the second reference. The estimates are not adjusted for

amortization payments.

J$ 183.6m announced in the 1983 Budget. The reduction of the ratio of the fiscal deficit to GDP was also designed to reduce the rate of growth of the national debt and conform

to the overall economic stabilization package agreed with the

IMF.

The Barbadian Government pursued a more moderate

approach to deficit financing than the Jamaican Government.

This is indicated by the lower ratios of the fiscal deficit to GDP after 1974, as well as the mode of deficit financing. According to Table 12, in 1973 the deficit was financed

mainly from foreign borrowing because of the heavy export

of funds from the banking system stemming from higher




interest rates in the Eurodollar market. For the years 1974, 1976 and 1977, the deficit was financed predominantly from

domestic sources with the Central Bank and commercial

banks contributing large portions of total financing.

The year 1977 was characterized by heavy Central Bank

money creation to the tune of $41.7m. After 1978, the de

ficit was financed by a combination of domestic financing and foreign financing. The Central Bank made a significant contribution to domestic financing in 1979 and contributions

in 1981 and 1982. It can be seen that although Central Bank financing played a significant role in some years in the Bar

badian case, such financing was not utilized to the same ex

tent as in the Jamaican case.

However, in the Barbadian case, the years 1977 and 1981 best illustrate the balance of payments implications of

deficit financing. In 1977, the $41.7m rise in Central Bank credit to government and the $37.Om extension in credit to

a government department, that is, the Sugar Industry Agri cultural Bank, led to a 24.7 per cent injection of base money into the system. This credit expansion was a proximate cause

of the balance of payments deficit of $ 19.5m (see Central Bank Annual Report, 1977).

In 1981, a proximate cause of balance of payments difficulties was a sharp expansion of credit by the Central

Bank to finance an unusually heavy government capital works programme in the first half of 1981. This monetary expansion took place against a background of recessionary conditions in the world economy. Between December 1980

and September 1981, the Central Bank's total financial claims on the government rose by $72.lm with "ways and

means advances" constituting a rise of $32.5m. This money

creation activity was associated with a decline in Central

Bank foreign assets to the tune of $41.2m (see Central Bank Economic and Financial Statistics, October 1981).




Partly as a result of the expansionary monetary policies of 1980 and 1981 and the deepening world recession of 1972, the Barbadian economy became locked into balance of

payments problems. The Barbadian Government went to the

IMF early, not only because of the impact of domestic credit

creation on the balance of payments, but also because a large part of the country's foreign assets were tied up in the

CARICOM Multilateral Clearing Facility (CMCF), a regional institution established to facilitate regional trade. The Barba

dian agreement with the IMF for the period October 1982 to May 1984 required that Barbados make purchases from the Fund in an amount equivalent to SDR 31.875m to be drawn in stages. The arrangements specified quantitative limits on Central Bank net domestic assets to curb the rate of

growth of money creation.

In both the Jamaican and Barbadian cases the fiscal authorities and the IMF adopted a purely monetary approach to the balance of payments. The view can be supported that

money creation was a principal proximate cause of declining reserve levels. Even though heavy taxation reduced private sector absorption, the creation of money enabled the state to

maintain nominal -spending levels much higher than the

capacity of the economies to increase domestic real supply.

The balance of payments problems of Jamaica and

Barbados can be examined further within the context of

political economy. The governments ought to abandon the

dangerous practice of obtaining credit from their Central

Banks to accelerate the production of public goods in small

open systems. The Central Bank in developing countries

cannot be regarded as a truly autonomous institution since

it seems unable to resist the government's request for credit

within the context of the power relationships and political realities attending the nature of the constitutional relation

ship between the two bodies. Central Bank financing should




TABLE 12: DEFICIT FINANCING: BARBADOS (BDS$m)

Total Domestic

Year Deficit Financing

1974 -47.7 60.3

1975 -25.8 -0.9

1976 -53.9 56.2

1977 -89.1 77.1

1978 43.9 -13.4

1979 -55.4 28.7

1980 -51.0 9.1

1981 -181.0 71.4

1982 -99.8 67.3

1983 -87.4 23.4

1984 -95.8 57.8

1985 -119.6 4.2

Central Bank Financing

Foreign as a Percent of

Financing Domestic Financing

-11.2 44.4

1.2 *

6.3 24.2

6.2 58.4

34.0 *

22.9 116.4

51.8 *

94.7 28.2

26.7 39.4

59.4 *

16.8 *

77.7 *

Source: Annual Reports, Central Bank of Barbados.

Note: Domestic and foreign financing do not always add to total deficit because

of a residual.

Indicates net annual reductions in Central Bank Claims on Government. How

ever, the positive annual charges may not always show the full extent of money

creation during the year.

be a short term mechanism of adjustment, but in the Jamai

can case it became entrenched.

THE SPECIAL CASE OF TRINIDAD AND TOBAGO

During the recessionary period a completely different

mechanism was at work in the Trinidad and Tobago case.

The rise in oil prices drove up the level of overall surpluses on the government account as well as internalized a high level of wage increases in the economy. The Government



TABLE 13: DEFICIT AND SURPLUS FINANCING: TRINIDAD AND TOBAGO (TT$m)

1978 1979 1980 1981 1982 1983 1984

to GO O o > > o m

Overall Surplus (+) 167 469 820.1 236.8 -2,652.4 -2,344.1 -1,392.8 O

or

Deficit

(-)

O

External Financing (net) 257 130 149.4 27.0 258.7 228.1 437.5 5

Domestic Financing 424 39

-669.5

-236.8 2,393.7 2,166.0 955.3 3 (a) Borrowing (net) 28 27 24.7 -30.6 129.2 277.4 61.1 o

(b)

Funds for Long-Term co

Development -324 -18

61.7

48.6 554.0 1,153.2 -27.0

(c) Cash Balances (net) -128 30

-1,055.9

-184.6 1,710.5 685.4 921.2

Source: Annual Reports,

Central

Bank of Trinidad and Tobago.




recorded cash surpluses for most years between 1974 and

1981, but after the latter year the budget went into deficit. Large cash receipts made it possible for the Government to

pursue expansionary fiscal policies without resort to Central

Bank accommodation like in the case of Jamaica.

The slow-down in taxes from the oil sector after 1981

and sharp wage increases led to the adoption of a policy of

fiscal restraint. In 1982, the deficit was 13.8 per cent of

GDP. Current expenditure rose sharply in 1981 and 1982 as

a result of wage and salary increases. Wage increases ranged between 30 and 37 per cent in 1981 and from 10 to 11.5 per cent in 1982. As a result, the public sector wage bill rose

from TT$ 1,342.6m in 1981 to TT$2,812.8m in 1982.

The Trinidad and Tobago Government financed its

deficits between 1982 and 1984 by the use of cash balances accumulated after 1974 (see Table 13). Cash balances financed

85 per cent and 78 per cent of the deficits in 1982 and 1983, respectively. Management of the deficits also focused on the

reduction of capital expenditure by 29.1 per cent in 1983

and 23.3 per cent in 1984.

Budgetary management in Trinidad and Tobago had relied heavily on direct subsidization of petroleum products as well as other basic commodities to cope with inflation. By 1984, in order to reduce the ratio of the fiscal deficit to

GDP, Government embarked on a programme of reducing various subsidies in order to finance development expendi ture. This led to increases in the price of petroleum products. Other subsidies were also removed or reduced. In addition, the purchase tax was extended to cover several products and

import duties were introduced on building materials. Where

as in Barbados and Jamaica, the rise in the indirect tax

burden was directly related to recessionary conditions and

the oil shocks, the increase in indirect taxes in Trinidad and

Tobago was related to the impact of falling oil prices on the total budget deficit.




The concept of a budget deficit in an oil-exporting economy has been subject to interpretation. T.W. Farrell [3] has made a distinction between the 'domesticbudget deficit'

and the overall budget surplus in the context of oil-exporting

dependent economies such as Trinidad and Tobago. The

'domestic budget deficit' is the difference between govern ment domestic expenditure and domestic revenue. The differ

ence between foreign expenditure and revenue in the case of

Trinidad and Tobago, represents the budget surplus on

foreign exchange account. Oil revenues accrue in the form

of foreign exchange which is 'surrendered' to the Central

Bank which credits the Central Government with the domestic

currency equivalent in the form of deposits. Although we

have highlighted the overall surplus, Trinidad actually re

corded domestic budget deficits, using the above definition,

between 1973 and 1980. In 1980 the 'domestic budget deficit' was TT$2,140.7m even though the overall surplus was $850.lm. Decreasing oil prices therefore reduced the

surplus on foreign exchange account and created an overall

deficit. However, although Farrell's distinction is useful in an

accounting sense and helps to identify sources of monetary

based expansion, oil production is a domestic activity even

though government revenues accrue in foreign exchange. The

more important budget concept should be the overall budget

surplus or deficit in evaluating the orientation of budgetary

policy.

Our interpretation of the case of Trinidad and Tobago is

that although fiscal restraint was used in the context of

falling reserve levels, that country did not adjust its standard

of living fast enough to accord with its reduced foreign exchange earning capacity. Too high a level of nominal wages

was already internalised in the fabric of the economy. It was

necessary after 1973 to address the issue of international

competitiveness by increasing non-oil productivity. However,

the non-oil sectors had not developed fast enough during the

world recessionary period to supplement oil revenues.




EVALUATION Our brief evaluation hinges primarily on the relation

between the fiscal deficit, money creation and the balance of

payments. In the Jamaican case, Keynesian expenditure

policy, to some extent necessitated by the decline of the

mineral sector and overall recession, was an important factor

augmenting the monetary base through Central Bank money creation. This contributed to the running down of foreign reserves. This is not to say that other factors were unimport ant in the Jamaican foreign reserve problem. Of course the

decline in real sector activity aggravated the problem. How

ever, the Jamaican balance of payments problem cannot be

discussed in isolation from Central Bank money creation.

In the context of the Barbadian economy, the author

has argued that money creation also put pressure on the

Barbadian balance of payments in the context of the decline

of the real sector. In 1981, for example, political expediency led to new money creation because that year was an election

year. The heavy expenditures on projects, which were closely bunched in order to secure an election victory, were made in

the context of stagnating export earnings. Although such

expenditures guaranteed increases in employment, they also led to a deterioration in foreign reserve levels. An expendi ture programme which was more carefully planned and stretched out, would not have produced the same destabil

izing effect on the economy.

In the Trinidad and Tobago case, the decline of the externally oriented mineral sector also had implications for

public sector financing and the devaluation of the Trinidad dollar in 1985. The latter issue is outside the scope of this study. After 1982, Trinidad and Tobago tried to adjust its declining reserves problem by fiscal restraint, consequent upon the sharp public sector wage increases of 1981 and 1982. Trinidad and Tobago should be regarded as a special




case of a small petroleum economy which failed to mobilize

its oil surplus to increase the dynamic of the other sectors of

the economy.

The new orientation of the tax structures to indirect

taxation, apart from the incidence problem, has implications for intra-regional trade. Stamp duties, for example, can dis

tort CARICOM trading patterns. Jamaica has claimed, how

ever, that it is the only country which has not imposed stamp duties on CARICOM products.8 Stamp duties in Barbados in recent years have become a major revenue-raising device.

This brief evaluation has touched on the close inter

relationship between public sector financing and the external

sector. Our analysis has been primarily at the level of theory. It is admitted that a closer empirical investigation of these relationships, particularly based on the monetary approach to

the balance of payments, would necessitate a separate paper. It is hoped that some of the issues raised here would be

investigated in greater detail in later work.




NOTES

See, for example, the study by Zepherin [10].

The data used in this study are derived from International Financial

Statistics 1985; Annual Statistical Digest, Central Bank of Barbados, 1983; Annual Reports, Bank of Jamaica and Central Bank of Trinidad and Tobago, and

Economic and Social Surveys published by the Planning Institute of Jamaica.

3 Public finance in Jamaica is closely bound with that country's relations

with the IMF. Jamaica entered an upper-tranche stabilization programme with the Fund in 1977, which made a total of SDR 64 million available over a two-year

period. The performance criteria dealing with ceilings on net credit to the public sector and ceilings on net domestic assets of the Bank of Jamaica were all part of a contractionary package including heavy indirect taxation. For further analy sis, see Sharp ley [8].

4 Again at the time of the Extended Fund Facility with the Fund, the

1978/79 tax package was designed to produce just over J$ 100,0m of new taxes.

5The Bauxite Levy represented a more aggressive tax policy toward the transnational than in the pre-oil crisis years. For elaboration of the Levy as a

financial device, the reader is referred to C. Davis et al. [2].

6The transport and health levies, before 1986, were not paid into the consolidated fund, but into two extra-budgetary funds, namely, the transport levy and health levy funds. The health levy was designed to finance a "free national health service" which was never brought to fruition.

7 This point is made by a number of writers including C. Davis [2] and

BOJ Annual Reports. The policy of democratic socialism announced by Manley was also designed to increase the role of the State through social service expendi ture (see Sharpley [8]). The policy should, however, be considered as a purely Keynesian response to recession. See Jones-Hendrickson [6].

g This issue was discussed at the Caribbean Heads of Government Confer

ence in Guyana, July 1986.



SOCIAL AND ECONOMIC STUDIES

REFERENCES

[1] BOYD, D.A.C., "Jamaica: Pay as You Earn Taxation", Carib bean Finance and Management, Vol. 1, No. 1,

Summer 1985.

[2] DAVIS, C, W. HUGHES and O. DAVIES, "Financing Impact of Jamaica's Bauxite Production Levy: 1974-1984", Caribbean Finance and Management, Vol. 1, No. 1, Summer 1985.

[3] FARRELL, T.W., "The Government Budget and Money Supply in Open Petroleum Economies: Trinidad and Tobago, 1973-1980", Mimeo, Central Bank of Trinidad and

Tobago, n.d.

[4] GOBIN, R.T., "A Survey and Analysis of the Tax System in the Caribbean Common Market", Bulletin for Inter national Fiscal Documentation, Vol.33, 1979.

[5] HOWARD, M., "An Interpretation of Taxation and Monetary Policy in Barbados", Transition, Issue 8, 1983.

[6] JONES-HENDRICKSON, S., Public Finance and Monetary Policy in Open Economies, Mona: I.S.E.R., 1985.

[7] SACKEY, J., "Inflation and Government Tax Revenue: The Case of Trinidad and Tobago With Comparative Reference to Barbados and Jamaica", Social and Economic Studies, Vol. 30, No. 3, September 1981.

[8] SHARPLEY, J., "Jamaica: 1972-1980", in T. KILLICK (ed.), The IMF and Stabilization, Washington, 1984.

[9] WORRELL, D., "Erosion of Real Disposable Income in Barba dos in the Combined Effects of High Inflation and a

Progressive Tax System", Mimeo, Central Bank of

Barbados, 1975.

[10] ZEPHERIN, M., "The External Debt of Barbados", Quarterly Report, Central Bank of Barbados, Vol. VII, No. 4, December 1980.



public sector financing in jamaica, barbados, and trinidad and tobago 1974–1984

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