Will the Budget Be a Non-event?

"On ne parachute pas au ministère des finances quelqu'un qui ne sait pas calculer la dette publique et qui ne connaît pas l'impact de la fiscalité sur la croissance...."

Rama Sithanen, 2009

Like last year's and most of the budgets since 2006? Well, it doesn't have to. It will essentially depend on a single decision. But first let us understand how we got into a deep mess for ten whole years.

Old Policy Crap in New Bottle

The last part of the quote above – emphasis mine – summarises pretty much the main economic story from Mauritius over the last decade. While tax rates definitely impact growth rates – and both of them drive government revenue – the relationship is far from being linear. And it depends to a great extent on the relative ability of our public and private sectors to create wealth or make things happen. In the 1980s for example, as Paul Krugman reminds us, American top tax rates were cut from 36.5% to 26.7% over nine years but they never got the growth rates that would have financed those cuts. What they did get though is a Federal debt ballooning all the way from less than a trillion dollars to four by 1992. And two decades later US politicians were trying to clinch a deal hours before Uncle Sam was scheduled to go into default. The Economist summed up the situation as essentially the product of two tax-cuts, two wars and one stimulus package.

In a Hurry to Mess Up the Economy

In Mauritius top tax rates were reduced from their sustainable levels by 10 percentage points for corporates, from 25%, and by 7.5 percentage points for individuals, from 22.5%. But the tax-cuts were done a lot faster: a couple of years. With a promise of 8% growth. Year in. Year out. Of course we never got these robust rates and this has caused our economy to end up being a lot smaller. How much smaller? We're looking at a Rs213 billion gap for 2016 alone as illustrated in Chart 1. How big a number is that? Well, it's how big our economy was in 2006. Which gives you a good idea of the size of the multiplier of the FDI that have poured in since then.

Platform Was Not Burning

Lower top taxes were sold as a main policy response to the – fallacious – triple external shocks argument (sugar, textile and oil). The official line a couple of years into the reforms was that if we had not seen the 8% growth rates yet it was because of the Great Recession. And that we would feel the full power of the tax reforms as soon as the global skies would turn sunnier. The recession lasted 18 months but those higher growth rates were still not in sight then or now seven years later. As depicted in Chart 2 we've clocked – by our historical standards – some pretty anaemic growth rates. 2016 is on track to be the 6th consecutive year that growth will be under 4%.

Worst of Both Worlds

It is interesting to note that growth rates over the decade preceding the start of the crappy tax policy – aka trickle-down economics – have been better than those for the ten years following its implementation. This is captured in Chart 3. Combined with reasonable top tax rates they have ensured that public finances were on a more sustainable track between 1996 and 2005. The only year the flat tax was ahead in terms of cumulative growth was in 1999 when inadequate water supplies reduced trend growth by about 60%. The nation is still divided between whether that was the result of a big drought and Mauritius forgetting that she used to be a planning maverick.

Big Poop, Growing Exponentially

So, what has it all meant for Mauritius? Basically a lost decade. Because the flat tax has spun our public finances out of control. Indeed it has caused a huge shortfall in government revenue via its combination with anaemic growth. How big? Well, there are a number of ways of estimating that. An interesting approach is to compare actual government revenue with what it would have been had we kept our remarkable progressive tax structure. And to do that we need to get hold of the government revenue expressed as a percentage of GDP. Between 2000 and 2003 that was about 19%. In 2014 it was 16.3% and a year before that 16.6%. The last two figures need to be adjusted though as they contain the impact of wealth-destroying policies like severing the link between international oil prices and what Mauritians pay to fill up. We also need to adjust for all these levies that have appeared – as part of the Voodoo economics quiver – during the last ten years (telecommunications, bank and message) which have brought in almost Rs5 billion over the five years ending in 2014. Crunching the numbers while assuming that an appropriate number, freed of the effects of unrelenting bean-counting, is 15% yields the results in Chart 4.

The Voodoo Ecolympics Declared Open

The government revenue gap is 8.5 billion rupees in 2006 but grows very fast. It had almost doubled after five years and in 2016 is 3.5 times larger or if you will the size of two overpriced airport terminals. And this explains many of the economic events that have happened because government had had to come up with an unending string of totally stupid policies to manage this gap including: cancel the SC/HSC subsidy, cancel the rice/flour subsidy before it mysteriously reappeared on the books of the STC, cancel the school-feeding program, disconnect pump prices from their international levels and the creation of a galaxy of funds that either didn't spend all of their earmarked budgets or spent it very slowly. For example one Empowerment Fund was created to spend Rs1 billion every year for five years. It actually spent only Rs800 million in its first three years before doing something really ground-breaking: change its name. 

That such frenetic Voodoo economics had been going on for years was confirmed by Xavier-Luc Duval back in 2011 when he stated that the alphabet soup of funds created by his predecessor were set up, as you can imagine, with borrowed money and not on the strength of a faster-growing economy. There were also other blunders like rapidly driving our saving rate – as a percentage of GDP – to levels not seen in 30 years and creating a major structural problem by bestowing a multi-billion rupee gift to a sunset industry. These have dragged down potential growth even further. We shouldn’t also forget the things that didn’t happen like fixing our water distribution system, spending more of our capital budgets and making larger strategic investments. To reduce national frustration levels.

Fixing the Mess

Unsurprisingly, a Minister has recently said that government has no money for capital projects. Lifting the debt ceiling is not an option as the explosive dynamics of the government revenue shortfall will hit whatever new ceiling is set super fast. Government has little choice but to bring back its share of revenue as a percentage of GDP to at least 20%. We may have to go a bit higher to start cleaning the unmitigated mess created by two university buddies under the patronage of an avowed socialist. And we cannot make it go higher in any which way. We need to increase it while re-establishing the link between international energy prices and what Mauritians pay. Taxing inputs of wealth creation is very different from taxing output.

Let’s face it, the flat tax has been Growth Enemy No. 1 and the main reason for a lot of our economic woes. It has also played a big part in driving Navin Ramgoolam out of power. It will gladly do the same with Lepep. Without blinking an eye.