Chapter

III. Fiscal Adjustment in the 1980s and Beyond

Author(s):
David Robinson, Ranjit Teja, Yangho Byeon, and Wanda Tseng
Published Date:
September 1991
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A critical element of the adjustment policies that helped set the stage for Thailand’s remarkable economic performance in the late 1980s was the sustained improvement in public sector finances.8 Consolidated public sector deficits averaging 7 percent of GDP at the start of the decade gave way to surpluses of over 4 percent of GDP toward the end of the 1980s (Table 4). Although this turnaround was certainly facilitated by the buoyant revenue growth associated with vigorous economic expansion in the latter half of the 1980s, the shift in public sector finances was more than just cyclical and involved conservative policies plus fundamental changes in expenditure control and in the budgetary process.

Table 4.Accounts of the Central Government, 1980/81–1989/901
1980/811981/821982/831983/841984/851985/861986/871987/881988/891989/90
(In billions of baht)
Total revenue and grants115.5118.8139.4152.2164.3172.1200.1253.8318.5403.3
Revenue111.8116.3136.4148.2160.5166.7193.2248.0312.2396.7
Tax100.7104.7123.4134.6143.0149.4174.6228.0285.3365.1
Nontax11.111.613.013.617.517.318.620.026.931.6
Grants3.72.63.03.93.85.46.95.86.36.6
Total expenditure and net lending140.9167.8177.4189.3218.3223.3227.2243.4261.4306.7
Current expenditure110.2126.7140.5155.9171.4178.5185.3196.9220.6246.4
Capital expenditure32.338.436.034.441.640.137.235.938.655.9
Net lending–1.62.90.8–1.05.34.74.710.62.24.4
Overall balance–25.4–49.0–38.0–37.2–54.0–51.2–27.110.457.196.6
Financing25.449.038.037.254.051.227.1–10.4–57.1–96.6
External5.614.28.24.818.111.44.08.3–3.8–32.3
Domestic19.734.829.832.235.839.923.1–18.7–53.3–64.3
Bank16.629.513.521.82.515.67.1–43.4–49.3–66.8
Other3.25.316.310.533.424.216.024.7–4.02.5
(In percent of GDP)2
Total revenue and grants15.714.815.715.916.416.016.517.618.720.1
Revenue15.214.415.415.516.015.515.917.218.319.8
Tax13.713.013.914.114.213.914.415.816.718.2
Nontax1.51.41.51.41.71.61.51.41.61.6
Grants0.50.30.30.40.40.50.60.40.40.3
Total expenditure and net lending19.220.820.019.821.720.818.716.915.315.3
Current expenditure15.015.715.816.317.116.615.313.612.912.3
Capital expenditure4.44.84.13.64.13.73.12.52.32.8
Net lending–0.20.40.1–0.10.50.40.40.70.10.2
Overall balance–3.5–6.1–4.3–3.9–5.4–4.8–2.20.73.34.8
Financing3.56.14.33.95.44.82.2–0.7–3.3–4.8
External0.81.81.00.51.81.10.30.6–0.2–1.6
Domestic2.74.33.33.43.63.71.9–1.3–3.2–3.2
Bank32.33.71.52.30.21.50.6–3.0–2.9–3.3
Other0.40.61.81.13.32.21.31.7–0.20.1
Memorandum items: Consolidated public sector4–6.9–8.0–6.0–4.6–6.0–4.8–1.61.24.34.8
Of which: All NFPEs–3.6–2.2–1.6–0.7–1.4–0.70.3–0.40.6–0.3
(NFPEs excluding Oil Fund)–3.3–2.1–1.7–1.1–1.0–0.70.3–0.40.7–0.4
Source: International Monetary Fund, Government Finance Statistics (GFS).

Overview of Adjustment Effort

As part of their broader strategy to narrow external current account imbalances, the Thai authorities made a number of attempts in the early 1980s to reduce the size of the public sector deficit. Although many revenue measures were taken,9 these efforts focused mainly on the expenditure side. The principal elements of expenditure reduction included a conservative wage policy (government pay scales were not substantively revised between 1982 and 1989, and cost of living allowances were targeted to the lowest-paid workers); a reduction in capital expenditures in successive budgets totaling about I percent of GDP; and price increases and lower investment by public enterprises that reduced their financing requirements by over 2 percent of GDP between 1980/81 and 1984/85.10 Although these efforts were partly offset by rising interest payments on public debt, they were of critical importance insofar as they set the tone for expenditure policy for the remainder of the decade.

However, these policies proved inadequate for the immediate task of reducing the fiscal deficit during the early 1980s. Thwarting deficit reduction was a fundamental weakness in the budgetary process; a chronic tendency to overestimate revenues (by an average of 1.5 percent of GDP), when combined with the lack of flexibility in scaling back expenditures once they had been budgeted, meant that the overall deficit was persistently larger than targeted. Recognition of this problem brought about a major shift in the budgetary process starting with the 1986/87 budget. Since then, decidedly conservative revenue estimates (now underestimating revenues, on average, by over 2 percent of GDP) have helped check budgeted expenditure and imparted an institutional bias toward the generation of fiscal surpluses.

Total revenue and grants expanded from less than 16 percent of GDP in the first half of the decade to over 20 percent of GDP by 1989/90. The marked growth in central government revenue was entirely due to higher tax receipts, in turn a reflection of the vigorous pace of economic activity during the second half of the decade. The most significant increases were from income and corporate taxes, as well as from the business tax on gross turnover. Indeed, the growth in the underlying base of these taxes was more than sufficient to offset revenue losses that might have arisen from the downward revision in income and corporate tax rates in 1986. Revenues from import tariffs also grew strongly, particularly in the second half of the decade when booming domestic investment induced a rapidly growing volume of imports; however, these receipts were partly offset by the loss of revenues caused by eliminating most export taxes in early 1985. Even so, taken as a whole, average tax buoyancy rose sharply, from just over 1.1 during the first half of the decade to nearly 1.7 during the late 1980s. Among the factors contributing to higher revenue buoyancy was the expansion of activities covered in the tax net (for example, the shift in output from agriculture to manufacturing and the increase in imports as a share of GDP).

The general trend in expenditure has been downward, with its ratio to GDP declining from an average of 20 percent of GDP to about 15 percent of GDP in recent years. The bulk of the adjustment has been in current expenditures, which have fallen more or less across the board (Chart 6). The largest declines were in spending on goods and services and on interest payments (the latter reflecting the reduction in government debt following the successive fiscal surpluses). Also, as noted earlier, government pay scales were not substantively revised between 1982 and 1989—which brought down the total wage bill after 1986 (though not without adverse effects on the ability of the Government to retain and recruit qualified personnel). Central government capital expenditures also fell by over 1.5 percent of GDP during the 1980s. For the most part, this was the outcome of a deliberate effort to avoid large and potentially wasteful capital projects until the need for them was clearly demonstrated. In retrospect, this conservative policy of having capital spending follow demand, rather than anticipate it, was not without its costs, particularly in the late 1980s when infrastructural bottlenecks became increasingly apparent. Despite larger budgetary outlays in response to such needs, capital spending continued to decline as an unintended by-product of capacity constraints in the booming construction sector and because of delays in approving cost increases in such an environment.

Chart 6.Central Government Revenue and Expenditure, 1980/81–1990/91

Source: Data provided by the Thai authorities.

Can fiscal policy in the 1980s be characterized as essentially countercyclical in nature? Table 5 sheds some light on this question by presenting estimates of fiscal stance and impulse. The former, defined as the difference between the actual and cyclically neutral budget, quantifies the extent to which the budget added or withdrew demand relative to an equilibrium potential output level; fiscal impulse, defined as the change in the fiscal stance, measures the extent to which fiscal policy becomes more or less expansionary.11Table 5, which takes 1987/88 as a base year in which output is deemed to be at its potential (noninflationary) level, confirms that the fiscal stance was indeed countercyclical through most of the 1980s.12 Of course, both discretionary policies (specifically, the expenditure restraint evident during the cyclical upswing of the late 1980s) and automatic stabilizers (for example, the responsiveness of revenues to income growth) have played a role in the countercyclical behavior of the budget.

Table 5.Estimation of Fiscal Stance and Impulse, 1980/81–1989/90
1980/811981/821982/831983/841984/851985/861986/871987/881988/891989/90
(In billions of baht)
Neutral revenue and grants1129.2141.5156.0168.4176.5189.0213.4253.8299.9352.0
Neutral expenditure and net lending2121.4136.8151.9164.1176.9194.2217.1246.4269.7306.1
Actual expenditure and net lending140.9167.8177.4189.3218.3223.3227.2243.4261.4306.7
Neutral budget7.84.84.14.3–0.3–5.2–3.67.430.245.9
Actual budget–25.4–49.0–38.0–37.2–54.0–51.2–27.110.457.196.6
Fiscal stance333.253.842.141.453.746.023.5–2.9–26.9–50.7
Fiscal impulse420.6–11.6–0.712.2–7.7–22.5–26.4–24.0–23.8
(In percent of GDP)
Neutral revenue and grants117.617.617.617.617.617.617.617.617.617.6
Actual revenue and grants15.814.815.715.916.416.016.517.618.620.1
Neutral expenditure and net lending216.517.017.117.117.618.117.917.115.815.3
Actual expenditure and net lending19.220.820.019.821.720.818.716.915.315.4
Neutral budget1.10.60.50.4–0.5–0.30.51.82.3
Actual budget–3.5–6.1–4.3–3.9–5.4–4.8–2.20.73.34.8
Fiscal stance34.56.74.74.35.34.31.9–0.2–1.6–2.5
Fiscal impulse42.6–1.3–0.11.2–0.7–1.9–1.8–1.4–1.2
Memorandum items:
Nominal GDP5 (in baht)734.8805.1887.6957.61,004.21,075.11,213.81,443.61,705.92,002.2
Potential GDP5 (in baht)720.0811.1900.8973.01,048.81,151.91,287.11,461.01,599.41,815.2
Real growth5 (percent)5.04.1727.13.54.99.513.212.010.0
Sources: Data provided by the Thai authorities; and IMF staff estimates.

Medium-Term Issues in Public Sector

The agenda for the public sector over the medium term is dominated by three closely related issues. First, investment in infrastructure has to be stepped up if the growth momentum is to be sustained. Second, tax reform, including the replacement of the business tax by a value-added tax, reductions in tariffs, and a realignment of income and corporate taxes, is needed to improve economic efficiency. And third, if the first two objectives work to reduce the public sector surplus, they have to be implemented in a manner that takes into account the imperatives of macroeconomic balance.

Infrastructural Bottlenecks

The rapid growth of output in recent years has placed increasing strains on Thailand’s infrastructure (see Box 5). These have been particularly palpable in the Bangkok metropolitan area, the geographical heart of the economic boom. However, the phenomenon is more than just a problem of excessive strain on urban facilities, as there is some evidence that shortages of skilled labor and infrastructure (notably water and communications) may be raising production costs in other parts of the country as well. Failure to address such shortages would therefore have serious implications for the economy’s cost structure and for the sustainability of its growth momentum.

In responding to these needs, the Government has sought to redefine the roles of the public and private sectors in the development of Thailand’s infrastructure. The new policy, which aims at increasing private sector participation in infrastructure and services, is not geared toward privatization of existing enterprises (an approach partly circumscribed by labor union resistance). Rather, it gives a leading role to the private sector wherever major new initiatives are required. Thus, two of the largest infrastructural projects presently under consideration—-a major expansion in the telephone network and the development of a light rail system to serve the Bangkok area—are to be undertaken and financed by the private sector. The private sector is also expected to take the lead in a telecommunications satellite project and in the construction and operation of an elevated highway. In most of these cases, the Government’s financial participation is expected to be limited to providing land. Where an overlap with public sector entities is unavoidable (for example, in the telephone project where new lines will have to be connected to an existing network operated by a public corporation), the authorities are considering options under which the private sector would undertake the initial construction and afterward lease back the facility, with the public sector getting a share of the revenues.

While the delegation of responsibility for developing infrastructure will certainly moderate the increase in public investment over the medium term, the full macroeconomic implications of large private sector infrastructural projects are as yet unclear, partly because plans have yet to be finalized. In particular, the precise means by which these projects will be financed (domestically or from abroad), and the resulting impact on external debt, the current account, and aggregate demand, are all unresolved issues that will need to be carefully considered.

Tax Reform

Thailand’s revenue/GDP ratio has grown markedly since the first half of the 1980s, increasing by over 4 percentage points to close to 20 percent of GDP in 1989/90. As such, the level of revenue mobilization compares favorably with most other countries in the region (Table 6) and, more important, has been more than sufficient to meet the spending needs of the Government. Accordingly, the emphasis in tax reform is not so much on further increasing revenue mobilization (though this may be needed if public sector investment expands substantially), as on developing a more efficient tax structure. In this regard, three issues dominate the agenda of tax reform in Thailand.

Table 6.Regional Comparison of Revenue Performance and Tax Rates, 19891(In percent)
Revenue/GDPMarginal Income Tax RatesCorporate Tax Rates
Three developing countries
Thailand218.05–5530–35
Malaysia25.45–4535
Indonesia17.515–3525–35
Four NIEs
Korea16.75–5020–33
Singapore330.14–3332
Taiwan Province of China414.222–4015–25
Hong Kong16.83–2516.5
Japan14.310–5026–40
Sources: Price Waterhouse, Worldwide Summary of Individual and Corporate Taxes, 1990; International Monetary Fund, International Financial Statistics, and Fund staff reports; and Taiwan Province of China, Financial Statistics.

Foremost among these is the proposed replacement of the business tax by a value-added tax (VAT). The shift, which has until recently been delayed by a lack of political consensus, has been motivated as much by the desire to increase tax efficiency as to improve tax compliance. The authorities estimate that, after allowing for various exemptions (such as on food and other essential products), a 10 percent tax rate will be required to ensure that revenues from the VAT fully offset the loss of business tax receipts. The administrative machinery required to implement the tax is already in place, and the measure now only awaits legislative approval; full implementation is expected in January 1992.

Box 5.Infrastructural Issues

Thailand’s rapid economic growth has placed increasing strains on the physical infrastructure, particularly in the areas of transportation, telecommunications, power supply, water supply, and port capacity. These bottlenecks are at present concentrated in the Bangkok Metropolitan Region, where much of the recent development has taken place; but substantial infrastructural investment will also be needed in connection with the Eastern Seaboard project, which is already well advanced, and the Southern Seaboard project, still at the planning stage.

Since 1989 public investment in infrastructure has been substantially increased; in the future, however, the private sector is expected to play an increasing role. Projects currently under consideration are

  • Roads, railways, and mass transit. Traffic conditions in Bangkok continue to deteriorate, with the average traffic speed down to 10 kilometers an hour, and chronic traffic jams commonplace; public transportation remains very limited. Thus, a series of projects to improve public transport arc envisaged: the Skytrain (an elevated light rail way); the Hope well community train and urban freeway project; and a light train system in the central business district proposed by the Bangkok Metropolitan Authority. The highway system in Bangkok will also be extended, including a toll road to Don Muang Airport, and the second and third stages of the expressway system. A fourth stage, which will link Bangkok with 19 key provinces, is currently being studied.

  • Seaports and airports. Some 90 percent of Thailand’s external trade passes through the Klong Toey Port, which has become increasingly congested owing to the boom in Thailand’s trade and to the limited space available for further expansion. As part of the Eastern Seaboard project, new ports are being built at Laern Chabong (whose first terminal opened in 1991) and at Mab Ta Phut (where the first phase will be completed by 1992). A second Bangkok international airport, supplementing Don Muang Airport, which is expected to reach capacity by the year 2000, has also recently been approved.

  • Telecommunications. With only 1.3 million telephone lines, and a waiting list of over I million customers (which is increasing at three times the rate new lines are currently being installed), the shortage of telephone lines in Thailand has become an urgent problem. In October 1990. the previous Cabinet approved a B 150 billion project that would increase the number of available lines by 3 million by 1997, to be built and operated under a 25-year lease by the Charoen Pokphand Telecommunications Company. Following a review by the new Government, the number of telephone lines to be installed has been reduced to 2 million only in the Bangkok metropolis. The other I million for rural areas will be open for bidding shortly. The Transport and Communications Ministry has also recently approved a commercial satellite project, to be implemented by the Shinawatra Computer Group, under which two satellites with telecommunications, broadcasting, and mobile phone capabilities will be launched, beginning in the first quarter of 1993.

  • Utilities. Electricity demand has surged over the past five years, with the result that the power reserve (the percentage by which production capacity exceeds demand) has fallen below the standard minimum level of 15 percent. With a substantial increase in investment in new capacity by the Electricity Generating Authority of Thailand (EGAT) in both 1990 and 1991, however, capacity is expected to increase by over 50 percent by 1993, bringing the power reserve well above the minimum level, and thereafter to increase broadly in line with demand. Several projects are also under way to reduce water shortages, particularly in Bangkok, which have led to a series of environmental and health problems (see Box 4).

While improved infrastructure is seen as essential, the authorities view the ultimate solution as decentralizing development away from the Bangkok Metropolitan Region. With the development of the Eastern Seaboard, this has already started to some extent; and growth in the regions should be further stimulated by the proposed Southern Seaboard—-a 180-kilometer “land bridge” of highways, railways, and pipelines linking the Gulf of Thailand to the Andaman Sea. It is also expected that the investment incentives administered by the Board of Investment-—currently under review—will in the future be primarily aimed at boosting regional development.

A second major item on the agenda is a proposed reduction in import tariffs, which are still judged to be somewhat high (see Section V for a full discussion). The authorities also plan to eliminate a number of other indirect taxes, mainly “nuisance taxes” such as the exit tax (a holdover from earlier times when budgetary exigencies necessitated a number of ad hoc measures).

Third, the authorities are considering overhauling income and corporate taxes to bring the tax structure closer in line with other countries in the region (Table 6). Income tax reform is expected to include further reductions in the number of tax brackets and the level of marginal tax rates. Corporate tax rates may also be cut, although the emphasis here is likely to be on reducing and rationalizing the large number of exemptions that distort the incentive structure. The revenue impact of these changes in direct taxes is expected to be modest.

Size of Fiscal Surplus

By themselves, (he requirements for higher capital expenditure (the increase in which will be moderated by private sector participation) and, to some extent, tax reform13 both work to reduce the fiscal surplus. The extent to which a reduction in the fiscal surplus is desirable hinges on the overall macroeconomic situation. In the short term, in the absence of a clear indication that domestic demand growth is slowing to more sustainable levels, a strong case can be made for maintaining a tight stance of fiscal policy. Over the longer term, the appropriate stance of fiscal policy will depend on the needs of macroeconomic balance, particularly taking into account the expected step-up in investment (including the infrastructural projects discussed above), and the extent to which these can be financed by increases in private savings.

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