Innovative models for public finance

By Frank-Jürgen Richter

Public Finance, March 29 2012

There is an urgent need for a complete revamp in the existing models of public finance. Most countries across the world are relying on borrowing as one of the principal means of funding their ever-growing expenses. It has brought the public debts to levels that are completely unsustainable for too long.

Developed countries like Japan, Italy, Greece, Portugal, Ireland and United States have debt levels that are more than 100% of their GDP. The UK, Singapore, France and Canada are not much better either with their public debt of more than 80% of their GDP. This debt is ever increasing. Most countries are struggling to meet their immediate obligations, something which has led to the crisis.

The past few years has seen a slowdown in many large economies. In order to boost GDP, governments resorted to an increase in government spending. It has been a recipe for disaster that has brought significant increases in overall public debt.

Traditionally, taxes have been the mainstay of public finance. Taxes across most European countries have increased significantly to the level that they are impeding growth. Many governments are doling out subsidies, unemployment benefits and welfare schemes, which indirectly promote idleness and inefficiencies.

Vedas, traditional Indian scriptures, say that government should collect taxes like a honeybee collects honey from flowers. The bees take the honey without damaging the flowers and aid in growth and reproduction. Governments of today need to follow a similar tax model to run economies efficiently.

The United Kingdom has individual tax rates ranging from 20-50%, VAT of 20% and Corporation Tax of 20-25%. In order to boost economies, governments should plan to reduce overall tax rates. This will also take away the incentive of wealthy individuals to sink their funds in tax havens.

While individuals and corporations are heavily taxed, charities are enjoying many tax benefits. They are exempt from tax on rental income, tax on capital gains, Stamp Duty, Land Tax and others. Government can gain substantially by rolling back some of these exemptions, particularly on incomes such as on capital gains and rental income. Similarly, it´s time to review tax exemptions on donations to charities.

In the Indian Union Budget released on March 16, the government introduced an innovation which made sale of residential property exempt from capital gains if the amount is invested in a small business. It will pave the way for higher investment in businesses from sale of residential properties. Such an initiative in European economies will promote investment in businesses and reduce burden on banks for mortgage loans.

The benefits system in the UK needs a complete overhaul with tax credits, housing benefit, child benefit, disability living allowance, income support, incapacity benefit, jobseeker´s allowance and council tax benefit costing over $100bn every year. Many of these benefits can be scrapped or reduced without causing grave discomfort to people. This would also help in reducing the budget deficit to manageable levels.

The government should plan public finance like a professional corporation with a focus on corporate social responsibility. It should invest in promoting innovation and building sustainable small businesses. Countries in Europe, and especially the UK, have realised that the solution to current issues lies outside Europe.

In February 2011, the UK Secretary of State for Business, Innovation and Skills, Vince Cable, presented a paper entitled Trade and investment for growth to parliament. The paper laid out the government´s plans to encourage exports from the UK, enhance inward investment and to strengthen international trading systems. With the support of government, over 20,000 SMEs have ventured into new international markets and have secured over £800m of high value opportunities overseas in just one year. These initiatives give much better return on investment on government expenditure.

The UK was always one of the most important foreign direct investment destinations in Europe. Government should make every endeavour to promote investment within the country. The investment of $15 billion by Indian industrial group Tata has made it one of the largest industrial employers in the country with over 45,000 employees. It has also helped British brands like Land Rover and Jaguar expand into fast-growing Asian economies.

In Budget 2012, George Osborne had to announce some bold and potentially unpopular changes to increase government earnings while achieving economic growth and cut borrowing to £126billion. If it eventually achieves what it sets out for, it may be a step in the right direction. Higher income tax for senior citizens and middle class is set to be an unpopular move. Perhaps the government feels that unlike higher taxes on industry, widening the tax base to individuals is not likely to scuttle growth.

Governments need to have a firm resolve to set their house right in managing public finance. Solutions to current and future public finance issues are possible with innovation, strategic thinking and a long-term vision. The road ahead might be bumpy but the only way to go now is forward.

Frank-Jürgen Richter is founder and chairman of Horasis, a global business community