Impacts of government fiscal policies on businesses

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Joshua YEBOAH

Outlook

Ghana’s economy contracted by 3.2 and 1% in the second and third quarters of 2020, respectively, pushing the country into a recession for the first time in 38 years. However, a modest growth of 1.1% is for the full year of 2020, thanks to a strong 4.9% growth in the first quarter of 2020, at the onset of the COVID-19 crisis. The 1.1% GDP growth in 2020 is a steep fall from the pre-COVID-19 levels of 6.5%.

The Government’s attempts to mitigate the pandemics impact on households and businesses by enacting the Coronavirus Alleviation Plan (CAP) and the medium-term COVID-19 Alleviation and Revitalization of Enterprises Support (CARES) program in mid-2020 was a good intervention. But the low growth in 2020, coupled with high population growth, has pushed real per capita incomes 1% lower than in 2019.

The economy showed early signs of recovery in the second half of 2020 as business sentiments improved with the ending of lockdowns as the year-on-year performance in the agriculture; manufacturing and tradable services sectors saw some strong recoveries in the third quarter of 2020.

Government financing needs increased substantially during the pandemic, pushing the Government to resort to central bank financing, resulting in sharp increases in debt and debt service cost. Fiscal pressures arose from costly financial sector reforms in 2018-2020 and the Energy Sector Recovery Program (ESRP), started in 2019. The overall fiscal deficit, including energy and financial sector costs, was therefore already elevated at 7.6% of GDP in 2019 and the debt-to-GDP ratio at 63.9%.

Businesses

The above statistics on the fiscal pressures though was sustained partly by the government’s alleviation programs, businesses are still suffering to recover. This is partly as a result of the fiscal measures that were embarked upon in the 2017 national budget and the almighty Corona Virus Pandemic.

The direct and indirect effects of fiscal policy do influence Corporate and personal spending with regard to transactional or investment decisions. Fiscal policy describes changes to government spending and revenue behavior in an effort to influence economic outcomes. The government can impact the level of economic activity often measured by gross domestic product in the short term by changing its level of spending and tax revenue.

Thus, fiscal policy is a government’s way to influence the economy and it has had two opposing forms:  contractionary fiscal policy and expansionary fiscal policy. Hence, Fiscal policy is considered to be a demand side policy used by the government to achieve macroeconomic objectives.

Under the expansionary fiscal policy, in a more simplified form, if taxes decrease, consumption will increase, investment will increase and finally aggregate demand will increase. Alternatively, we can increase government spending be it current expenditure or capital expenditure.

This will also cause the aggregate demand to increase. However, these expansionary fiscal policies do have severe effect on the economy and sometimes forces government to revitalize the economy through the imposition of taxes and reduction of government spending in order to achieve it macroeconomic targets by using contractionary fiscal policies which sometimes do not go well with businesses.

For instance, the government’s overarching fiscal policy objective in 2018 was to further consolidate its public finances relative to the 2017 position. Consequently, the fiscal balance and primary balance were set as primary anchors. In the case of the fiscal balance, the target was to reduce the recorded deficit of 4.8 percent of GDP in 2017 to 3.7 percent in 2018. For the primary balance, the target was a surplus of 1.4 percent of GDP in 2018, an improvement over the surplus outturn of 0.8 percent in 2017.

To achieve these targets, Government set out a strategy to improve domestic revenue mobilization through improved tax compliance, as well as the introduction of new revenue measures announced during presentation of the Mid-Year Review of 2020 Fiscal Strategy Document 10 the Budget to Parliament.

The new revenue measures included: imposition of a Luxury Vehicle Levy on motor vehicles with engine capacity of 2950cc and above; introduction of an additional Personal Income Tax band of 35 percent on monthly incomes in excess of GH¢10,000; and a restructuring of the VAT by separating the GET Fund and NHIL levies from the Input-Output mechanism of the VAT and converting them into straight levies at rates of 2.5 percent, while maintaining the VAT rate at 12.5 percent.

Also, the NFSL is a 5% tax on the accounting profit before tax levied on selected entities. These entities include some financial institutions, breweries, mining support companies, telecommunication companies. This levy was introduced in 2009 as a short-term measure to raise revenue to stabilize the economy for the years 2009 and 2010; this was subsequently extended to 2011. The Government in 2013, re-introduced the levy for the initial periods of 2013 and 2014, but the levy has witnessed several extensions with the previous extension initially expected to end in 2019. The 2020 Budget proposed a 5-year extension of the levy to the end of December 2024. The extension was operationalized by the passage of the NFSL Amendment Act, 2019 (Act 1011).

I hold the view that, since the levy is not tax-deductible, it increases the effective income tax rate of the affected entities reduces the rate of return to investors as well as restrains its investment decisions among the affected entities. Perhaps the NFSL has outlived its short-term purpose as the proposed 2024 expiration brings its existence to a total of 14 calendar years. It is my hope that this will be the last extension to improve the certainty of that tax handle in order to help the affected entities capitalized on this levy for it growth.

These contractionary fiscal policies affected and still affecting the related business parties and decreased aggregate demand from 2017 to 2020.

Business Cycle

Businesses go through cycles of expansion, recession and recovery. Fiscal policies can affect the timing and length of these cycles. In the expansion phase, the economy grows; businesses add jobs and consumer spending increases. At some point, known as the peak, the economy overheats and the BOG increases interest rates to stave off inflation. Factories shut down, job losses rise and business sales fall. Prime rate cuts and government spending, or both, are often necessary to recharge the economy. Eventually, the economy hits rock bottom, known as the trough, and gradually starts to recover.

The business cycle then resumes with a new expansion phase. A business cycle is the rise and fall of business activities within an industry that include periods of profitability and periods of loss. Business cycles do not occur at regular intervals. These cycles occur irregularly but repetitively. Typical business cycles include expansion, a peak, contraction and recovery. When dramatic business cycles occur in different industries, it often affects the national economy as a whole and not just the industry experiencing the fluctuation.

Expansion

During the expansion phase, businesses are growing and creating more jobs. This causes an increase in employment and decrease in the unemployment rate. If the economy is growing at a relatively fast pace, it puts upward pressure on the general prices of goods and services, resulting in inflation. Inflation is also an indicator of too much currency circulating in the economy. To help slow the rate of inflation and stabilize currency value, the government might use fiscal policies and interest rates to mop out the excesses and discourage borrowing. This helps to decrease the economic money supply and prevent further depreciation of the cedi. This might seem to be the right step, however unless these interventions are used on a moderate basis, businesses are likely to be affected in the long term.

Peak

A peak occurs when the expansionary phase of the business cycle is about to end. Certain economic indicators such as drop in the number of new jobs added to the economy and a rise in the unemployment rate can signify the peak of an expansion cycle. During an economic peak, the economy is no longer growing, retail sales are declining and economic output is decreasing. Economic output is the total value of all goods and services produced in an economy.

Contraction

The contraction phase of the business cycle is when the economy begins to shrink. Economists also refer to this period as a recession or trough in the business cycle. During this period, economic output decreases. This results in job losses and an increase in the unemployment rate. During periods of economic contraction, there is not enough currency circulating in the economy because consumer spending is down. To encourage borrowing and increase consumer spending, the government might use expansionary fiscal policies in order increase aggregate demand.

Recovery

When economic outputs increase and businesses begin to expand, it indicates that the business cycle is in the recovery phase. During this phase, the employment rate is rising while the unemployment rate is falling. The economic recovery period of a business cycle can be difficult to forecast because other factors might cause a short-term stimulation in the economy but does not necessarily indicate a permanent recovery. An example of a short-term stimulation is the holiday shopping season. During this period, retail sales and employment might increase but only temporarily. Contractionary fiscal policies at this level can have the negative impact for businesses: higher and new taxes lower future investment undertakings in order to sustain it recovery and lower profits.

Analysis

A major way in which businesses are affected by fiscal policy is in tax rates. Over time, the government of Ghana constantly establishes tax policies that raise or lower business taxes. If policies reduce businesses rate of taxes, their earnings after taxes grow. This increased profit allows greater opportunities to reinvest into business growth or to pay out dividends to company owners.

Hence, the positive sides of fiscal policy holds when Government embarked on expansionary fiscal policy, either by decreasing taxation which might be a decrease in income tax or expenditure tax. This will cause consumption to increase since one’s disposable income increases when income tax falls. In addition, if corporate profit taxes fall, this will make the firms have more profit which can be reinvested into the business, hence, resulting in an increase in investment, all other things remaining unchanged. These fiscal policy strategies help businesses save cost on it input and output taxes at the various four stages of the business cycle.

Moreover, the success of an economy is commonly measured by a few factors including GDP. Another factor is aggregate demand, which is the sum of goods and services produced by a nation purchased at a certain price point. The aggregate demand curve dictates that at lower price levels, more goods and services are demanded, while there is less demand at higher price points. Fiscal policy affects these measurements, with the goal to increase GDP and aggregate demand in a sustainable manner.

Thus, spending by consumers is a major driving force behind businesses success. Government fiscal policy is often used to encourage or stabilize consumer spending for a healthy economy. If the government sets out it expansionary fiscal policies, this can ultimately result in consumer confidence and spending. In general, if the economy is growing and consumers have money, businesses of all sizes benefit. If your business sells non-essential luxury goods, you especially benefit from increased consumer buying power.

In addition, Businesses can see investment opportunities from government spending as well as private investment. This commonly happens during an expansionary policy, when more money is flowing into the economy from the government and from other sources since taxation is also low. When a balance between price and demand are met, then businesses can expect to thrive and grow.

On the other hand

While on the surface expansionary fiscal policy efforts may seem to lead to only positive effects by stimulating the economy, there is a domino effect that is much broader reaching. When the government is spending at a pace faster than tax revenues can be collected, the government can accumulate excess debt as it issues interest-bearing bonds to finance the spending, thus leading to an increase in the national debt. For instance, Ghana’s public debt stock increased to 57.9 percent of GDP at the end of 2018, from 55.6 percent of GDP in 2017. Though, the increase in the debt-to-GDP ratio partly reflects the financial sector bailout fiscal cost of GH¢9.8 billion, much was as a results of the government’s taxes reduction mechanism when it took office in 2017.

In nominal terms, the gross public debt stock at the end of 2018 was GH¢173,068.7 million (US$35,888.5 million), up from GH¢142.6 billion (US$32,292.5 million) in 2017. The stock of public debt further increased by GH¢24.9 billion over the end-December 2018 to GH¢198.0 billion (57.5 2020 Fiscal Strategy Document 2 percent of GDP) at the end of March 2019, partly reflecting the depreciation of the cedi against the US dollar earlier in the year.

What happens is, when the government increases the amount of debt it issues during an expansionary fiscal policy in order to revitalize the economy or boost aggregate demand by issuing bonds in the open market, this end up competing with the private sector that may also need to issue bonds at the same time. This crowding out effect can raise interest rates indirectly because of the increased competition for borrowed funds. Even if the stimulus created by the increased government spending has some initial short-term positive effects, a portion of this economic expansion could be mitigated by the drag caused by higher interest expenses for borrowers, including the government. The latest Debt Sustainability Analysis shows that Ghana is at high risk of debt distress. Apart from the solvency ratios that improved on the back of the rebased GDP, all liquidity ratios breached the thresholds.

Conclusion

Ghana is in the midst of a severe but not unprecedented macroeconomic crisis. First of all since, these policy measures are needed, it decisions and implementations shouldn’t be based on political agenda.

Even though economic studies of specific taxing and spending programs can help to inform decisions about whether taxes or spending should be changed, and in what ways. Ultimately, decisions about whether to use contractionary or expansionary mechanisms to implement macroeconomic policy are, in part, a political decision rather than a purely economic one. Hence, governments could do better on grounds of economic adviser’s intervening in major economic decisions.

Also, when the government decides to give fiscal stimulations, it needs to make straight statement that the action will depend from the conditions in the economy. This is important from the aspect of financial markets, since they seek opportunities to question the medium term sustainability, which in return will have negative effects on the interest rates and consumer spending.

Lastly, government needs to improve its revenue mobilization to help finance its expenditure in undertaking infrastructural development instead of introducing new taxes. This can be done by improving

efficiency in tax administration and also strengthening and modernizing customs administration

and the streamlining of tax exemptions. This will resolve the crowding out issue arising from excessive government borrowing to finance its expenditure. Also, to achieve higher and sustainable economic growth, government should embark more on expansionary fiscal policies in the form of an increase in government spending through the central bank on domestic transactions in the key sectors of the economy such as the infrastructural, manufacturing and services sectors to increase output. In addition, as a way of expansionary fiscal policy, the government should reduce taxes on imported items intended for production.

This will encourage the private sectors to come on board in complementing government’s effort to achieving economic growth.  Further, with respect to financial market, though through the effort of Mr. Ernest Addison – Current Governor of Bank of Ghana had the rate reduced to 13.5%. I suggest the Central Bank should still consider reducing the lending rates further in the future so that the financial institution can borrow to firms and business sector at low rates to enhance growth and development of the economy.

The writer is the CEO of Josh Academic and Professional Research Consult Associate and a member of the Institute of Chartered Accountant, Ghana. 

TEL 0548332922

Email: Joshua.[email protected] /10093422upsamail.edu.gh

 

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