Financing Social Protections: Fiscal Space Analysis Somchai Jitsuchon Thailand Development Research Institute

Content Fiscal Space Analysis Adaptation of macroeconomic theory Making the model – Sources – Analysis tools Examples of analysis: Thailand case study – Using the model – Reporting results – Analyzing results

Fiscal Space Definition “Room in a government’s budget that allows it to provide resources for a desired purpose without jeopardizing the sustainability of its financial position or the stability of the economy” (Peter Heller, 2005) Why/When? – Analyze Fiscal Space when the government needs to increase necessary and permanent expenses Invest in basic structure Invest in social welfare system

Fiscal Space How? – Generally looking at both government's income and expenses – Income Tax Not tax – expenses Regular expenses (Difficult to change) Expenses on investment (Can be changed) Expenses on debt administration such as interest, capital (Can be managed)

Thailand’s Finance

Thailand's finance has structure problem, especially finding income 6 Source: Sucharit and committee (2010), picture 1 Income tax revenues and GDP per capita in Thailand from World Bank research indicates the potential for paying tax of the Thai economy's GDP at 21 percent.

A high risk of fiscal sustainability 7 Source: Sucharit and committee (2010), Estimates the public debt to GDP Growth = 4.5% per year (base case) and 3.5 years (lower case) without including the long-term investments 3.5% of GDP and expenses of the welfare system

Analysis of the Government revenue Typically, the government revenue depends on:  National income both in Nominal GDP and / or Real GDP.  Income distribution. (Effect the size of the tax base).  The size of the formal sector (Effect the size of the tax base).  Tax policies (the extension of tax base, Enforcement of tax laws, Collection of new types of taxes, Modification of tax rate).  Other variables

Thailand's Tax Structure Proportion of national income tax in Thailand is still relatively low, even when compared with developing countries in Asia. Rely on indirect taxes than direct taxes. Although the ratio of indirect tax decreases, direct tax increases but not much. Corporate tax has a high proportion of direct taxes. (More than about 2 times of the normal income tax). Proportion of value added tax (in indirect taxes) increases rapidly in recent years. 9

Overall picture of tax structure(% GDP) 10

Direct Tax structure (% GDP) 11

Indirect Tax Structure (% GDP) 12

Tax base is the value of the activity or economic value as the basis for taxation. Generally consists of: 1. Income Base 2. Consumption Base 3. Trade Base 4. Wealth Base 5. Other Tax Bases 13 Tax Base Analysis

Comparison of the size of tax bases

Government Revenue Forecasting (3) Tax Reform Scenario Tax Reform StringentModerateMinimal VAT (12.5%)  VAT (10%)  PIT Tax Base Expansion  CIT (educed tax rate, to 20%)  BOI (priviledge reduction)  Land and Infrastructure Tax  Capital Gain Tax (stock)  Windfall Tax  More/Higher Excise Tax  ภาษีมรดก 

Government expenditure The expenditure in the long run will depend on.  The size of government. (Number of officials / public employees), both central and local.  The mission (may interact with the fiscal space).  Constitutional (The basic policy of the state).  Population structure. Irregular expenditure. (Investor / populist).  Fiscal Space  Politic

5/24/12 Examples of guideline in building financial sustainability under tax reform and social welfare system Sustainability Benchmark “If the economy grew 4.5%, inflation 2.5% and the average deficit of government is 3% of nominal GDP, public debt will not exceed 50% of GDP Example of guidelines 1. Analysis budget under the current tax structure to reduce the structural deficit remains from -4% to less than -2% of GDP 2.Reform Tax Structure to have more income - 3% of GDP within 10 years 3. establish additional social welfare (welfare set 3) will spend 2.5% of GDP 4. Reduce unnecessary expenditure to 1% of GDP 5. Government invest in basic economic structure - 2.5% of GDP and let the private sector invest through PPP – 1% of GDP 6. Implement policies which support growth to expand economy no less than 4.5% 7. The result of imparity will be = -3% GDP the public debt is at maximum 50% of GDP 8. If there is a rapid implementation of PPP, will easily achieve sustainability

5/24/12 Macroeconomic

5/24/12 Macroeconomic Projections Study Timeline: forecast of 20 years ( ) – Link with the idea to develop economy in the long run Have 3 scenarios 1. Past-Path ‘Potential Output’ Approach (this is ‘business-as-usual’ projection), or Base Case (PO) 2. Structural Changes to overcome Middle-Income Country Trap, or High Case (MIT) 3. Suffered from ‘Institutional Weakness’, or Low Case (SW)

5/24/12 Past-Path Potential Output Review literature on potential output which set the income level of Thailand in the future using the past structure Pro – based on research that have theory, sound methodology Cpn – depending too much on the past events while Thailand is at the turning point either up or down Is the application of existing research, not the new one (no time) Could do consistency check: there are many research done in this area and could do simple extrapolation for the future.

5/24/12 Overcome Middle Income Trap Is the case of Thailand which overcome middle income trap by reformation of: – education – innovation – Reducing inequality – etc.  Led to continuation of high economic growth in the next 20 years, and approach the high-income countries

5/24/12 Overcome Middle Income Trap (2) Study Method – Use Growth Pattern of countries who never were in the middle income trap such as Japan, South Korea, Taiwan and Singapore – Use context matching so that we can establish time period at the level of development of those countries for Thailand – Context Matching will use these variations: GDP/NI level and per capita Education level (general and some specific aspects) ของ labor/population Level of innovation R&D Foreign trade (to match the result of globalization). Basic structure Quality of main institutions in the country (public / private sectors/ politics / etc. Others

Middle-Income Trap (MIT) Source: China 2030, World Bank

5/24/12 Institutional Weakness Thailand is stuck in the mud of the weakness in economic management because of the weakness of national institutions such as Government is not strong. Lack of qualified personnel and foresight. Political turmoil is in conflict with the ideals and character. Lack of political vision. Some even tried to enter the private sector in developing countries. However, the level of participation remains very low The Thai economy may grow very slowly in the next 10 years, and then (hopefully) be improved.

5/24/12 Projection of other macro variations Inflation Rate - In general, depending on the level of economic growth. - However, should be within the framework of the inflation target set by the Bank of Thailand (0.5 to 3.0%) - will use the parameters in the model of BOT to link with economic growth in this study with inflation rate

5/24/12 Projection of other macro variations Wages – Build equation of average wage which depends on relevant variations such as : Average minimum wage or proxy of minimum wage Average education level of Labor Force Urbanisation rate GDP

Model Structure Macro Projections Government Revenue Projections Education Innovation Institutional Quality Etc. Potential Output Structural Reforms Education 3 GDP Projections 3 Revenue Projections Tax Reforms, Formal/ Informal Inequality

5/24/12 Summary Financial Sustainability can be analysed in 2 dimensions – Societal (financial) Sustainability: overall society can take the burden or not? – Fiscal Sustainability: government can take the burden or not Societal Financial Sustainability – Overall, depending on GNP – But need to match financing appropriately Fiscal Sustainability/Fiscal Space depends on – Government overall income(depends on GDP/Tax Reform) – Regular Expenditure (including social welfare expenditure) – Expenditure on economic investment such as physical infrastructures – Expenditure to tackle crisis such as flooding

Model

5/24/12 Model: Government Revenue Forecasting Study Method: build equation which explains government revenue 3 Scenarios same as Macro Projections – High Revenue (high GDP, stringent tax reform) – Medium Revenue (medium GDP, moderate tax reform) – Low Revenue (low GDP, minimal tax reform) May consider cross case between GDP and other Tax Reform such as – High GDP but moderate tax reform – Medium GDP with stringent tax reform

5/24/12 Sources  Office of the National Economics and Social Development Board - National income, government revenue. Ministry of Commerce – CPI/inflation rate National Statistic Office – Average wage, (Labor Force Surveys) – Urban Rates (Socio-Economic Surveys) World Development Indicators – World CPI  Crude oil prices in global market (Dubai,WTI)

Estimation Result

Estimation Results Dependent Variable: LOG(GOV_REVENUE) Method: Least Squares Date: 02/28/12 Time: 00:56 Sample (adjusted): Included observations: 31 after adjustments VariableCoefficientStd. Errort-StatisticProb. C LOG(GDP_NO) D_CRISIS URBAN_HH LOG(GOV_REVENUE(-1)) R-squared Mean dependent var Adjusted R-squared S.D. dependent var S.E. of regression Akaike info criterion Sum squared resid Schwarz criterion Log likelihood F-statistic Durbin-Watson stat Prob(F-statistic)

Government Revenue (Base Case)

Government Revenue/GDP (%)

Next Steps 1. Increase MIT/SW case 2. Increase Tax Reforms 3. Expenditure analysis of different scenarios 4. Summary of Fiscal Space of different scenarios 5. Assess possibility of different scenarios – Macro/Tax reform/Expenditure

Comparison of Long-term Growth between Thailand and Countries not trapped to MIT

Growth Comparison - average of 50 years. ( ) Thailand grew more slowly at 0.5 to 1.5% per year.

Relationship between GDP and Tax Reform Tax/GDP GDP per capita Thailand