PNG's 2017 budget cuts government expenditures, introduces tax changes

Getting the books to balance will be a significant challenge for Papua New Guinea going forward. Although the country has made some deep cuts in expenditures, it will be years before the government takes in as much as it needs to operate. The authorities have few options in the short term other than carefully balancing interests. As it works to reduce outlays, the government has to focus on ensuring the cuts do not cause long-term damage to the economy.

Revenue VS Expenditure 

To stay ahead of the deteriorating fiscal environment, the government has had to make rapid and sometimes radical adjustments. In the “2016 Final Budget Outcome” document, revenues were significantly lower than projected, while expenses were higher. The original budget and the supplementary budget had both called for a PGK2.1bn ($666m) shortfall, but the actual figure came in at PGK3bn ($951m). Revenue and grants totalled PGK10.5bn ($3.3bn) against PGK12.7bn ($4bn) in the original budget and PGK11.7bn ($3.7bn) in the supplementary. Expenditure and net lending was PGK13.6bn ($4.3bn) against PGK14.8bn ($4.7bn) in the original and PGK13.8bn ($4.4bn) in the supplementary budget. The supplementary budget was issued in the third quarter of 2016 as it became apparent that the first budget was unrealistic in the face of rapidly falling revenues.

Revenue from almost all tax lines came in below the original and revised levels. Personal income tax totalled PGK2.8bn ($888m) in 2016, less than the original PGK3.5bn ($1.1bn) expected and the revised PGK3bn ($950m). Corporate taxes reached PGK2bn ($634m) compared with the budgets of PGK2.8bn ($888m) and PGK2.2bn ($697m). Goods and services tax collection came in at PGK1.4bn ($444m), compared with the original budget’s PGK1.76bn ($558m) but about the same as forecast in the supplementary budget.

According to the “2016 Final Budget Outcome”, mining and petroleum taxes totalled PGK92m ($29.2m), slightly above the revised budget estimate of PGK88.8m ($28.2m), while royalties and management tax collection came in at PGK44.3m ($14m), compared with the PGK40.4m ($12.8m) in the supplementary budget. The interest withholding tax was PGK78.7m ($24.9m), higher than the original budgeted amount of PGK52.7m ($17m) and the supplementary figure of PGK69.2m ($22m). Total revenue has increased slightly in recent years, going from PGK9.4bn ($3bn) in 2012 to PGK10.8bn ($3.4bn) in 2016, according to the IMF’s January 2017 Article IV consultation. Tax revenue was also up in that period, from PGK8.2bn ($2.6bn) to PGK8.8bn ($2.8bn). However, resources revenue fell from PGK1.1bn ($349m) to PGK478m ($151.5m).

On a relative basis, performance has been poor. As a percentage of GDP, revenues and grants fell from 21.3% in 2012 to 17.4% in 2015, and are forecast by the IMF to decline to 16.7% in 2017. Expenditure, on the other hand, rose significantly, from PGK9.9bn ($3.1bn) to PGK13.5bn ($4.3bn). As a percentage of GDP, expenditure fell, but only slightly, from 22.4% to 21.8%. The IMF sees government revenues falling to 16.7% in 2017 and then rising back to 17.3% in 2021, while expenditure is seen falling to 18.1% of GDP by 2021. While the 2016 budget forecast the country would return to a budget surplus by 2020, the 2017 budget expects a deficit through to at least 2021.

Tightening The Purse Strings 

Certain sectors are being hit hard. In the 2017 budget, health expenditure, at PGK1.2bn ($380m), was down 20.5% on the 2016 supplementary budget, and health expenditure is set to fall each year until 2021. Meanwhile, the amount allocated for education, PGK1bn ($317m), declined by 14% from the 2016 supplementary budget and will also drop over the forecast period. Major cuts have also been planned for teacher education funding and physical investment in colleges and universities. At the same time, capital expenditure on infrastructure is budgeted to fall to PGK836m ($265m) in 2017, compared with PGK1.4bn ($444m) in the original 2016 budget.

Observations 

Critics contend that the cuts are too severe. Local media reported in May 2017 that Sir Mekere Morauta, the former prime minister, said the government’s plan to reduce health expenditure would cause severe problems. He noted that in 2021 the government would be spending PGK77 ($24.41) per person on health care, down from PGK220 ($69.74) in 2015. Hospitals are already facing financial difficulties and have been forced to cut back on services, he said.

For its part, the IMF has praised the 2017 budget as being prudent, but added that more work is needed on the revenue side. The Asian Development Bank, meanwhile, is advising PNG to get more from its expenditures. For example, spending on health care was equivalent to around 4% of GDP in 2013 – much higher that the 1.6% average in lower-middle-income economies – but it is not generating the results that would be expected from that level of spending. The bank also suggests an improvement in revenue collection.

Some analysts say that the budget is a reasonable document, as it seems to demonstrate that the government understands the position it is in. Others are not so certain, noting that it sets unrealistic expectations for the revenue that can be raised from increased compliance. They doubt the assumption that for every PGK1 ($0.32) invested in tax collection, PGK25 ($7.93) of revenue will be generated, and contend that the 2017 revenue numbers may be overly optimistic.

The general elections were a challenge in terms of expenditure throughout 2017, making it more difficult to cut spending and implement new revenue-generating measures. A total of PGK400m ($126.8m) was budgeted for the 2017 election, with another PGK250m ($79.3m) earmarked for the 2018 APEC meeting.

The government is making cuts on many fronts, but it remains committed to holding the APEC meeting. The sense is that the cost is justified, as the event will bring in thousands of international investors and showcase the country as a possible target for their activities.

Longer Term

In its “2017 Budget Review” report published in November 2016, KPMG PNG sees the trends on spending continuing for some time. Based on its analysis of the 2017 budget, the accountancy forecasts health care outlays will fall from 12% of spending in 2016 to 9% in 2017 and then down to 8%. Education spending, meanwhile, is projected to decline from 9% in 2016-18 to 8% in the 2019-21 period. Administration costs will rise from 17% in 2016 to 20% in 2017-21, while funds disbursed to the provinces are set to increase from 27% to 30%. According to Deloitte’s “PNG Budget 2017 – Budget Alert”, PNG can close the budget gap by reducing spending, building new industries and increasing state enterprise dividends. But each is problematic. Cutting too much could damage the economy, new industries will take time to develop, and the government is already extracting significant dividends from its enterprises.

Over the next five years, KPMG anticipates more revenue coming from taxes and less from “other revenue”, which includes dividends from state-owned companies. Increases in tax revenue will be the result not only of economic recovery and stronger commodity prices, but also of improved compliance and tax collection.

Tax Reform 

Tax reform will be essential. Higher rates can result in a bigger take for the government, while lower rates can increase compliance, as can more equitable rules. It was difficult to achieve major code changes ahead of the 2017 elections, but some tax measures were implemented in the new budget effective from January 1, 2017. A standardised corporate tax rate of 30% was introduced for all companies resident in the country. Prior to the law change, some companies paid rates as high as 50%. A 15% dividend withholding tax will cover all sectors, taking the amount paid by petroleum companies from 0% to 15%, the amount paid by mining companies from 10% to 15%, and the amount paid by all other enterprises from 17% to 15%.

Allowances for company-provided housing have been significantly reduced, the additional profits tax extended to all companies, including mining, a tax exemption for non-resident lending to resident resources companies repealed and a double deduction for exploration expenses ended. The taxation of foreign contractors has also been changed, while stricter reporting rules were implemented to address transfer pricing issues. Taxes on logs were reverted to a progressive system from the flat system that was introduced in 2007, while excises taxes on alcohol, cigarettes and diesel were increased.

These moves are largely in line with the National Tax Review of 2015, which called for reducing the corporate and personal rates, trimming the number of exemptions and increasing the consumption tax.

In addition, it recommended lower government equity ownership in state companies, higher taxes on the resources sector, improved administration, a reduction in incentives – and centralised management of those incentives – a capital gains tax that is to be limited initially, simplified paperwork and a general shift from income taxes and towards consumption taxes.