the __earthinc

The consistent fiscal deficit the federal government currently experiences is an issue far removed from everyday life. For many, it is an abstraction without concrete consequences. Hence, it is highly unlikely that the issue will be able to capture public attention and directly become a determinant in any election. This gives the federal government too much free hand in managing its fiscal position.

Despite the lag in effect, the persistent fiscal deficit presents real challenges to the economy and perhaps, more tangibly, to all taxpayers. It is so because the idea of scarcity is not something that is only valid within the theoretical world of economics.

It is because of scarcity that the concept of deficit exists. It is also because of scarcity that any deficit requires financing.

As far as the fiscal deficit of the Malaysian government is concerned, it is being financed through borrowings. The government issues debts in which market participants — be they individuals living within Malaysia or financial firms based abroad — purchase in return for greater payoff in the future.

So far, the federal government is fulfilling its existing debt obligations by issuing more debts. The situation on the ground at the moment allows that to happen but it does not take a leap in imagination to understand how a snowball may cause an avalanche. Argentina in 2001, for instance, defaulted from fulfilling its debt payments; it borrowed to finance its deficit for the longest time until its repayment requirement became too big for it to comply.

Malaysia still has a long way to go before that happens. Nevertheless, eventually, our deficit has to be attended. There are at least three ways to address the deficit: increase revenue, decrease government spending or default.

For any self-respecting government, defaulting is not much of a choice. The Argentine economy was in ruinous state after it defaulted on its payment; capital fled and dried up, bringing the economy to a screeching halt. Regardless of preference, the current local scenario that includes the maintenance of strong foreign reserves by Malaysia makes the likelihood of default very small.

Decreasing government spending is the policy path that libertarians favor because it necessarily reduces the size of government. Unfortunately, this will not occur anytime soon. Even during the Abdullah administration when the fiscal deficit finally saw relaxation, government spending continued to rise. Keynesian thinking meanwhile reigns supreme in the Najib administration; the government has expressed its intention to spend to stimulate the economy. The two factors set the momentum for the federal government’s fiscal position in the near future.

The third way is to increase revenue. This can happen by having enough growth in either non-tax revenue, tax revenue or both. With a healthy economy, those items can help in balancing the fiscal position. Without a sufficiently healthy economy, however, taxes simply have to increase to meet the gap eventually.

A tax increase is the clearest credible solution because it is increasingly clear that the fiscal deficit is structural in nature, and not cyclical. It is structural because it is arguable that we may have seen or are seeing the completion of a business cycle. In that cycle, the federal government has been running on a persistent fiscal deficit. Year 2009 will be the 12th consecutive year that the government has either failed or refused to close the gap and there is no reason to believe why year 2010 will not be registered in red ink.

A tax hike, however, is an unpopular policy, even when it is a potent tool in arresting the runaway fiscal deficit. Under the current political atmosphere where the Barisan Nasional-led federal government faces a considerable number of hostile voters, raising taxes is committing harakiri. The political situation demands spending.

In fact, the pressure is on Barisan Nasional to continue to spend in order to keep the economy going. More importantly, it has to keep voters happy by shoring up the economy in the short term to push its expiry date farther into the future.

Government spending is not necessarily bad or undesirable even in times of deficit. Yet, unless the government spends the money for the purpose of investment, spending for the sake of spending — as the two fiscal stimulus packages are doing — will further widen the difference between revenue and expenditure. For deficit hawks, the situation is gloomy because between investment and spending, the effect of the latter comes quicker than the former. Naturally, political expediency favors quick wins; quick wins mean the deficit will continue to take a hit.

Given the situation of a structural fiscal deficit, weak economic environment and political unpopularity, the only palatable short-term option is to continue to borrow to finance the deficit.

As a result, the present generation will be free from the burden of increased taxes and so too subsequent generations that are lucky enough to live during times when the economic situation allows the government to keep borrowing to finance its deficit. With the problem being out of sight and out of mind among the current generations, regretfully, there is no pressure to address the issue of fiscal deficit.

Somebody, however, eventually will have to pay those debts. By the time that happens, it is likely that the problem will become too big to handle.

First published in The Malaysian Insider on June 15 2009.