UGANDA DEBT NETWORK. Review and Analysis of the 2009/10 National Budget Taxation Proposals

Transcription

1 UGANDA DEBT NETWORK Review and Analysis of the 2009/10 National Budget Taxation Proposals

2 Table of contents 1.0 Introduction The 2009/10 National Budget Analysis Performance of the 2008/9 budget and focus for the 2009/10 budget Resource envelope for financial year 2009/ Tax revenue Composition of Government Spending Roads Education Health Energy infrastructure Agricultural sector Water and environment Decentralization of Spending Other measures to improve the business climate Conclusion and policy recommendations Policy recommendations References... 37

3 List of figures Figure 1: Investment composition, 1986/ / Figure 2: Sector GDP growth rates... 8 Figure 3: Trend of Public Finance; 1987/ / Figure 4: Comparison of sectoral budget allocation 2008/09 and 2009/ Figure 5: Breakdown of education sector allocation, 2009/

4 List of Abbreviations ADB AG BTVET DRC GDP HIPC ICT IDA IMF MDG MDRI NAADS PAYE PETS PPPs QEI R&D SSA UPE URA USE VAT - African Development Bank - Auditor General - Business Technical and Vocational Education and Training - Democratic Republic of Congo - Gross Domestic Product - Highly Indebted Poor Countries Initiative - Information, Communication and Technology - International Development Association - International Monetary Fund - Millennium Development Goal - Multilateral Debt Relief Initiative - National Agricultural Advisory Services - Pay As You Earn - Public Expenditure Tracking Survey - Public Private Partnerships - Quality Enhancement Initiative - Research and Development - Sub Saharan Africa - Universal Primary Education - Uganda Revenue Authority - Universal Secondary Education - Value Added Tax

5 1.0 Introduction Economic growth is the key to the prosperity of nations. Countries that have sustained strong economic growth have been able to reduce poverty, strengthen their democratic principles and political stability, improve the quality of their environment, and reduce - conflict, crime and violence (Barro, 1996 and 2002); Easterly, 1999; Dollar and Kraay, 2002). Understanding the sources of past growth, removing the constraints to present growth, and maximizing the prospects for future growth for a country must therefore be a central aim for a good budget that is pro-growth. Uganda has continued to register growth in 2009 despite the current global economic downturn. However, like the rest of the world economies, Uganda s economy has been affected by the global financial crisis. The real GDP is projected to have grown by 7% in the financial year 2008/09, which is lower than the 8.1% for the financial year 2007/08. The effects of the financial crisis will continue in financial year 2009/2010, consequently, the economy is projected to grow by between 5% and 6%. However, an estimate of 7% real GDP growth rate for Uganda is above the average Sub-Saharan Africa GDP growth which is estimated at 2.4% (International Monetary Fund, April 2009). There is clear evidence to show that economic growth is an essential requirement and, frequently, the main contributing factor in reducing income poverty. Evidence shows that poverty was reduced from 56% in 1992/3 to about 31% in 2005/6 due to economic growth. Short episodes of growth, either rapid or modest are not sufficient to provide the opportunities that poor people need to escape economic poverty. The key to reducing economic poverty lies in ensuring that a rapid rate of growth is sustained over the long term. Sustaining growth requires deepening the incentive to invest and increasing the use and productivity of capital and labour across the economy as a whole, through appropriate policies and institutions. The government challenge is to ensure that growth accelerates to levels required to achieve MDG and is sustained by appropriate policies and institutions. Factors that contribute to sustaining growth include macroeconomic stability; institutions that provide clear rules that are enforced predictably, good governance that will reduce corruption and rent seeking; a favourable investment climate which includes secure property rights and efficient markets that allow the productive assets of land, labour and capital to flow to areas where the returns are highest and increases access to these resources, including the poor. The theme for this year s budget is Enhancing Strategic Interventions to Improve Business Climate and Revitalize Production to Achieve Prosperity for All. Accordingly, the government intends to scale up investments in physical infrastructure including transport and communications, and intends to enhance access and availability of reliable and affordable energy. In accordance with the theme, the allocation of resources in the budget was focused on those areas that will facilitate the private sector to do business more efficiently and therefore stimulate production and economic growth. It is envisaged that the incremental accumulation of physical capital on an annual basis transforms both current and future potential for economic growth and development. Consequently, government intends to consolidate the strategic areas that were embarked

6 on in the last fiscal year that prioritized the following areas, which have a big potential for stimulating economic growth and development. The priority areas in financial year 2009/10 budget are therefore the following: a) Agricultural Production and Value Addition; b) Transport Infrastructure; c) Energy Infrastructure; d) Human Development; and e) Peace, Security and Good Governance With expenditure estimate of about Shs. 7.3 trillion (equivalent to about US$ 3.5 billion), what can be achieved to have a meaningful impact on growth? Can these areas be covered adequately to have meaningful impact? Is there likelihood that the areas that may get the appropriate funding could be the areas that are not particularly significant for economic growth and that produce low economic returns? Moreover, this expenditure will result in a fiscal deficit excluding aid of about 7.5% of GDP or about 3.9% of GDP including aid. Starting from what can be regarded as the single most important symptom of low growth: inadequate levels of investment especially private investment. Low returns to education over time, high rates of underemployment amongst the limited number of secondary and college graduates, and high returns to private capital in formal business seem to signal that Uganda is physical capital-constrained, and that - although still low - human capital is relatively abundant compared with equipment. Congestion on main roads around Kampala and power shortages are symptomatic that growth is outstripping road and energy infrastructure. Moreover, there is international evidence of public-private complementarily. Countries which maintain high public investment attract more private investment. Countries that think less about tomorrow in their determination to balance fiscal books and reduce debt, eventually stagnate. Figure 1 shows investments trend. There is no doubt investment has risen substantially since Gross capital formation has averaged 21% of GDP for the period , of which 15% was construction and 6% machinery and equipment. The share of construction in total gross investment averaged 73% in the same period, suggesting that construction is the driver of investment. Private investment averaged 16% of GDP in the same period. However, total investment in Uganda remains low by international standards, and its composition may no longer be as productive as it was in the recovery period. Within capital formation, the shares of machinery and equipment and public infrastructure need to expand. The factors keeping private investment low can be traced to three possible proximate sources. Investible funds may be too scarce and the cost of capital too high. The social returns to private investment may be too low. The social returns may be high, but private investors may be unable to appropriate these returns. The first task is to figure out which is of these is the binding constraint to economic growth. According to the World Bank (2007), investment is constrained by low social returns due to a relative shortage of complementary factors of production (skilled workers), poor infrastructure, and geographical or other advantages that depress the overall productivity of the economy. In this case, government spending proposal has been geared to remove

7 these constraints. Overall, the physical capital stock needs to improve in size and composition. Figure 1: Investment composition, 1986/ /08 Source: Statistical Abstracts and Background to the Budgets The degree of poverty reduction following growth is at times less evident. It is therefore important to classify growth patterns into those that lead to poverty reduction and those that do not, which is the notion of pro-poor growth. Growth on its own is a necessary condition for poverty reduction. In that sense, growth is good for the poor, and the empirical literature supports this proposition. Pro-poor growth, however, is about how good growth is for the poor. If it is appropriately defined, pro-poor growth can be considered a sufficient condition for poverty reduction. What poverty eradication strategy requires is growth that enables the poor to actively participate in and significantly benefit from economic activity. Along these lines, there are two possible ways to achieve propoor growth. The direct way implies that growth is pro-poor if it immediately raises the incomes of the poor, or, in other words, if growth occurs in those sectors and/or regions where the poor are employed and uses the factors of production they possess. It is widely accepted that growth has to be strong in agriculture and non-farm rural and informal sector activities in order to be pro-poor. It must be labour-intensive and land-intensive, and it must be concentrated in localities with high poverty rates. The indirect way suggests that growth is pro-poor if the gains from overall economic growth are redistributed to the poor via progressive taxation and targeted government spending. Pro-poor growth requires the sectoral pattern of growth to be biased in favour of the poor. In Uganda, the majority of the poor population live in rural areas and are engaged in agricultural activities, as urbanisation has occurred only slowly. Therefore, growth obviously has to be strong in agriculture to reduce poverty effectively. In fact, agricultural growth in the 1990s was strong enough to achieve the magnitude of poverty reduction. Yet, other sectors have grown by much higher rates. The agricultural sector accounted for about 20% in 2008, down from 38% of GDP in 2002/3, 48% in 1992/3. Consequently, the recent performance of the agricultural sector has been less than hoped for. From 1982 to 1999, agriculture grew at 3.13% per annum and between 2000/01 and 2008/09 by an average of 2.8% per annum as shown in Figure 2, much lower than the

8 overall economic growth of 5.2% and 7.7% respectively. Such modest rates of agricultural growth definitely hinder reductions in rural poverty. The incidence of poverty declined from 56% in 1992 to 36% in 1999 and to 31% in 2005, but nearly half of this reduction occurred after In five years from 1992 to 1997, Uganda reduced its poverty by 11.5 percentage points but between 2000 and 2005 by only 5%. Figure 2: Sector GDP growth rates Uganda has a comparative advantage in food production and has the potential of becoming the food basket of the region. It is also well placed as a trading hub. While demand for Ugandan exports might reduce among industrialized countries due to global recession, Uganda has the potential of expanding regional exports, especially food-related exports, provided the constraints to agricultural sector output are removed and right incentives are given. The government budget proposal intends to address constraints to accessing regional markets and supply constraints in the domestic economy. It intends to increase production and promote regional trade based on the following policy initiatives: i. increasing agricultural productivity and production, ii. increasing agro-processing and value addition, iii. increasing investment in infrastructure and human resource development to facilitate regional trade and economic growth. These intentions clearly reflect pro-poor growth strategy. If these intentions are implemented effectively, this would be the government s stimulus that would lead to increased production, and stimulate regional trade while making the private sector more competitive to take advantage of regional demand. 1. Summary of key policy issues The budget is the key instrument for the execution of government economic policies. The government budget may promote or retard economic growth in certain areas of the economy, and views about priorities in government spending differ widely. Thus, the government budget is the focus of competing political interests. Because the budget should be the mirror of society s choices, the expenditure management mechanism

9 should include strong links between the policies that are decided by government and the budget that is intended to implement them. In addition, participation, in appropriate ways, can improve the quality of budgetary decisions and provide an essential reality check for their implementation. Predictability, transparency, and participation, in turn, are the essential ingredients of accountability, which is the key to good budgeting. Accountability entails both the obligation to render accounts of how the budgetary resources have been used and the possibility of significant consequences for satisfactory or unsatisfactory performance. Uganda s government expenditures rose from about 8% of GDP in 1988 to about 22% of GDP in 2008 and is projected at 22.4% of GDP in Compared with the moredeveloped countries and neighbouring African countries, this percentage is small. Average share of government in GDP in SSA is about 32% and for Developed countries it is about 45%. There is contemporary debate on whether government expansion helps or hinders economic growth. Advocates of bigger government argue that government programmes provide valuable public goods such as education and infrastructure. They also claim that increases in government spending can bolster economic growth by putting money into people s pockets. Proponents of smaller government have the opposite view. They explain that government is too big and that higher spending undermines economic growth by transferring additional resources from the productive sector of the economy to government, which uses them less efficiently. They also warn that an expanding public sector complicates efforts to implement pro-growth policies such as fundamental tax reform because critics can use the existence of budget deficits as a reason to oppose policies that would strengthen the economy. Which side is right? What is clear however that is public expenditures offer significant opportunities for promoting growth and the equitable distribution of its fruits. Investments in basic social services -- primary education, primary health care, safe drinking water, sanitation, nutrition, and family planning -- yield high payoffs for individuals as well as for society. Investments in rural infrastructure and new agricultural technologies are essential for raising the productivity of farmers. The government budget allocation for the financial year 2009/10 focuses on infrastructure and human development. The government spending on education, health, physical infrastructure, and research and development can increase long-term productivity rates but only if government spending does not crowd out similar private spending, and only if government spends the money more competently than other economic agents. More specifically, government must secure a higher long-term return on its investment than taxpayers' (or investors lending the government) requirements with the same funds. Thus, the government has to institute measures to ensure that the budgeted resources are either not wasted or spent ineffectively. This requires long-term and sustained capacity building measures. Overall, the budget for financial year 2009/10 seems to be pro-growth and pro-poor. But this will depend on how it is implemented. To the extent that government spending is on activities that could be more productively undertaken in the private sector, or is financed

10 from taxing the private sector with inefficient taxes, or by borrowing from the private sector (whether directly or indirectly through crowding out), the beneficial impact of the spending may be offset by the costs of financing it. Deficits which are domestically financed are generally growth debilitating. Similarly, if beneficial public spending leads to macro instability, it may have a cost in terms of growth. Conversely if spending cuts result in lower inflation and income growth, this could limit revenue collections and compromise the initial fiscal contraction. What is uncontroversial is that reducing unproductive spending, reducing inefficient taxes, and increasing productive spending are most likely to be growth enhancing. This would be especially true when spending is on outputs which remove growth constraints. The level of public spending seems to be less important for growth than its composition, how it is governed, and how it is financed. Uganda has had macroeconomic stability since 1992 with growth, in such instance, the level of public spending is probably in the right range if growth constraints from public service gaps are not emerging. The composition of spending is therefore more important than the level in determining whether growth can be further accelerated. The government can contribute most to economic and social progress by focusing on the things it can do best. Sustained improvement in living standard through growth, human capital development, and safety nets requires a strong partnership between the government and the private sector. The government needs to provide goods and services - - law and order, national security, and an environment conducive to business and the smooth functioning of civil society -- which only the state can provide. And even where activities fall in the domain of private economic agents, the government should correct market failures, but without creating vast and costly administrative and bureaucratic structures. In sum, the government appreciates the role of the private sector in development as reflected in the market-oriented economic reforms. However, there are areas where neither the government nor the private sector can carry the entire responsibility. In such areas -- health, education, infrastructure and agricultural research and extension -- a judicious blend of government and private effort is needed. Public expenditure has accounted for an average of about 20% of GDP in the last decade. Although this is low even by Sub-Saharan Africa standards, the efficient management of these resources is critical to economic growth, human capital formation, and the welfare of the poor. That management in turn requires a cadre of professionals who can formulate and implement government programmes. This is part of the reason why public administration is often weak, as manifested in poorly managed public expenditure, poor law enforcement and haphazard justice. Because poorly functioning bureaucracies give conflicting signals to the private sector, they also damage long-term investment. Building institutional capacity thus needs to figure prominently in any strategy to reduce poverty. Need to ensure that government spending does not create opportunities for rent-seekers to waste resources to curry political favour. Rent-seeking distorts economic markets, reduces economic growth, and destroys the free market ethic. While there is broad consensus that economic growth is a necessary condition for meeting development objectives such as the MDGs, it is also widely accepted that growth alone is insufficient. In order for growth to become a sufficient condition, more direct public action is required, especially in the form of more agriculture-intensive

11 investments. However, it is not just the scale of government spending that matters; when, where, and how the government intervenes is also crucial. The poor are often poor because they are disproportionately affected by market failures. This leads to win-win possibilities because government intervention, if designed properly, can lead to both a more efficient and a more equitable allocation of resources. Roads, electricity, telecommunications, and other infrastructure services are also important for stimulating growth in agriculture and in rural areas, as well as enhancing food security and reducing poverty. The government through its budgets in recent years has shown commitment to increasing expenditure on health care (its share in the total expenditure for the 2009/10 budget is estimated at 10.5%). Indeed, the lack of quality healthcare is particularly a problem for poor households without access to affordable private provision. Thus, there is a need to find ways to deliver quality services to poor populations, first by recognizing the capacity-intensive nature of such services and then by finding cost-effective solutions. Improving the distributional impact of health expenditures requires both reallocating resources toward primary healthcare and increasing the access of the poor to quality health services. This may be done partly through enhanced resource allocation and mobilization. While there may be some role for the introduction of fees for some services and income groups, such an approach may not be consistent with improving the health status of poor households. The government should consider an integrated approach that addresses access, information, quality, and poverty. But the design of these programmes needs to reflect the health and administrative realities. There has been gradual increase on expenditure on education, particularly primary education (share of education in the total expenditure is estimated at 15.3% for the financial year 2009/10). This has been reflected in increased classroom construction. However, extensive expansion of schools is worthwhile only if basic quality is maintained (such as ensuring access to basic infrastructure and instructional resources, including teachers or instructors who show up and are motivated to teach). Although building more schools and facilities is likely to be more progressive on the margin, when initial enrolment levels are relatively high, it is unlikely to be a cost-effective way of improving the equality of access, relative to better-targeted expenditures. Further increase of enrolments from already high levels tends to be extremely difficult and often costly, partly reflecting the preferences and constraints facing extremely poor households. In such circumstances, targeted education subsidies can be a very cost-effective way of making education more accessible to children from the poorest households. Once a basic level of quality is attained, intensive expansion is more likely to have an effect on improving student performance than on increasing enrolment; and is thus likely to be only slightly progressive even if confined to primary education. A major challenge for rural Ugandans is their extremely low access to electricity. Only 12% of all villages and only 2.1% of all rural households have electricity connections in Uganda. These rates are among the lowest in the world. The Ministry of Energy and Mineral Development is planning to increase the rate of rural household electricity access to 10% by Access to electricity poses a great challenge for development of rural areas in Uganda. However, the biggest challenge is generating sufficient and affordable electricity first and controlling electricity loss which is estimated at between 35-40% of

12 electricity that is generated. Government investment in improved water infrastructure is also important for economic growth and poverty reduction. Following the Multilateral Debt Relief Initiative and HIPC relief, Uganda is at a low risk of debt distress. Several rounds of debt relief have removed the bulk of Uganda s public sector debt. As a result, the government s ability to meet its debt obligation when they arise is not at risk. Following the latest round of debt forgiveness - the Multilateral Debt Relief Initiative (MDRI) - which forgave debt owed to IDA, other multilateral donors, and the IMF - the central government s foreign debt stood at approximately $1.7bn (or 12% of GDP) in 2007/8. Although debt levels are currently low, this will most likely be a temporary phenomenon. The public sector accumulated debt in the past because of persistently large fiscal deficits which are typical of a low-income country with a small tax base and large development needs. Irrespective of the debt relief, Uganda remains a poor country with demands on the government vastly exceeding its ability to finance domestically through taxation and domestic debt. Even under extremely optimistic economic growth scenarios, this situation will persist for the foreseeable future. Partly, foreign grants (which are not debt-creating) finance the shortfall in revenues but, on average over the past decade, foreign loans have financed a third of the fiscal deficit and this is likely to continue. Nevertheless, if new borrowing is on concessional terms, Uganda should not face a fiscal debt service problem. Barring reckless fiscal management or cataclysmic events, new borrowing on concessional terms is unlikely to pose any fiscal sustainability risks. Most of Uganda s loans are and most likely will continue to be given on concessional terms, implying long grace periods and interest rates less than 2%. As a result, for most of the next two decades, the government will be able to finance large fiscal deficits with loans, without experiencing the stress of having to put aside funds for annual interest payments and loan repayment. A major challenge for rural Ugandans is their extremely low access to electricity. Only 12 percent of all villages and only 2.1 percent of all rural households have electricity connections in Uganda. These rates are among the lowest in the world. The Ministry of Energy and Mineral Development is planning to increase the rate of rural household electricity access to 10 percent by Access to electricity poses a great challenge for development of rural areas in Uganda. However, the biggest challenge is generating sufficient and affordable electricity first and controlling electricity loss which is estimated at between 35-40% of the electricity generated. Government investment in improved water infrastructure is also important for economic growth and poverty reduction. Following the Multilateral Debt Relief Initiative and HIPC relief, Uganda is at a low risk of debt distress. Several rounds of debt relief have removed the bulk of Uganda s public sector debt. As a result, the government s ability to meet its debt obligations when they arise is not at risk. Following the latest round of debt forgiveness - the Multilateral Debt Relief Initiative (MDRI) - which forgave debt owed to IDA, other multilateral donors, and the IMF - the central government s foreign debt stood at approximately $1.7bn (or 12 percent of GDP) in 2007/8. Although debt levels are currently low, this will most likely be a temporary phenomenon. The public sector accumulated debt in the past because of

13 persistently large fiscal deficits which are typical of a low-income country with a small tax base and large development needs. Irrespective of the debt relief, Uganda remains a poor country with demands on the government vastly exceeding its ability to finance domestically through taxation and domestic debt. Even under extremely optimistic economic growth scenarios, this situation will persist for the foreseeable future. Partly, foreign grants (which are not debt-creating) finance the shortfall in revenues but, on average over the past decade, foreign loans have financed a third of the fiscal deficit and this is likely to continue. Nevertheless, if new borrowing is on concessional terms, Uganda should not face a fiscal debt service problem. Barring reckless fiscal management or cataclysmic events, new borrowing on concessional terms is unlikely to pose any fiscal sustainability risks. Most of Uganda s loans are, and most likely will, continue to be given on concessional terms, implying long grace periods and interest rates less than 2 percent. As a result, for most of the next two decades, the government will be able to finance large fiscal deficits with loans, without experiencing the stress of having to put aside funds for annual interest payments and loan repayment. 2.0 The 2009/10 National Budget Analysis 2.1 Performance of the 2008/9 budget and focus for the 2009/10 budget The financial year 2008/09 budget was Shs trillion, which was financed by domestic revenue amounting to Shs trillion and external support of Shs trillion. The budget expenditures performed at 99.8 percent. The performance of resources that financed the budget was attributed to higher than programmed donor inflows. Grants were above programmed level by Ushs 55.4 billion, resulting in a combined shortfall of Ushs 76.8 billion. This shortfall, however, was fully compensated for by more than programmed loan disbursements amounting to Ushs 430 billion of which project loan disbursements were Ushs billion over and above planned levels. As a result the share of the budget financed by donor resources, both grants and loans, increased from 27.6% in fiscal year 2007/08 to 42.4% in fiscal year 2008/09. Tax revenue and grants as a percentage of GDP is estimated to have increased during fiscal year 2008/09 to 17.1% compared to 15.8% in the previous year. Domestic revenue to GDP also declined from 12.8% to 12.4% in the same period. Domestic Revenue performed well, even though at a lower level than targeted recording a shortfall of Shs. 151 billion against a target of Shs trillion. This was attributed mainly to the underperformance of indirect taxes and VAT on local goods and services. The projected revenue from Domestic Direct Taxes for financial year 2008/09 was Ushs 1,051 billion against a budget estimate of Ushs 1,020 billion, registering a surplus of Ushs 31 billion. Non-tax revenues showed significant improvement compared to the previous year by 42 percent. Although there was a deficit of 12% and 0.7% in respect of corporate tax and other domestic direct taxes respectively, this was compensated for by the surplus from PAYE and withholding tax. The underperformance of corporate tax may be attributed to the global financial crisis which may have had a negative impact on sales and subsequently tax. The 3.1% surplus in respect of domestic direct taxes for financial year 2008/09 is attributed to the good performance of PAYE and withholding tax by

14 9.8% and 11% respectively. The PAYE surplus may be attributed to increased compliance by employers as well as salary increments. The good performance of this tax head is unlikely to result in a review of the PAYE threshold, which review has been time and again presented to government. Total expenditure during the financial year 2008/9 was estimated at Ushs billion, less than the programmed level by Ushs 18.5 billion, but nonetheless representing an annual growth of 37% over the previous year. Total expenditure increased from 17.7% of GDP in fiscal year 2007/08 to 20.6% of GDP estimated for fiscal year 2008/09. The increase in expenditure during the year under review reversed the sharp decline over a five-year period from fiscal year 2003/04 when expenditure was 21.6% of GDP. The significant reduction in expenditure during fiscal year 2007/08 was due to significant delays in donor disbursements of particularly budget support loans. The phenomenon underlines the importance of donor resource predictability in the execution of the national budget, and the need to strengthen mutual accountability in the politics of donor assistance. Table 1: Tax revenue breakdown (billions of shs) 2006/ / /09 Budgeted 2008/09 Projected Domestic Direct taxes Indirect taxes International trade taxes Tax revenue/gdp % Resource envelope for financial year 2009/10 The strategic objective of the financial year 2009/10 budget is enhancing growth, development and social transformation, in an environment of macro-economic stability. Although the economy is currently experiencing the spillover effects of global recession and global financial recession, the government views the global economic challenges as an opportunity for Uganda. This requires government intervention based on identifying where Uganda s competitive advantage lies and developing innovative ways of harnessing these opportunities by applying the most effective interventions to achieve those aspirations. This will involve concerted effort at removing the constraints to growth and socio-economic development at all levels through effective budgeting and implementation of the budget. According to the 2009/10 budget speech, Uganda s immediate comparative advantage lies in developing agriculture into a modern, efficient and highly productive sector. The budget speech underscored modernization of agriculture as crucial for structural transformation of the economy due to its contribution to employment, food security, foreign exchange earnings, agro-processing and tax revenue. The 2009/10 budget therefore rightly recognized development of efficient infrastructure including all-weather feeder roads, national trunk roads, rail and waterways, together with the provision of

15 reliable and affordable energy, and a skilled and healthy workforce as interventions required for productive agricultural sector. During the financial year 2008/9, the government held a mid-term budget review with the objective of assessing the linkage between resources availed to spending agencies and the targeted outputs. This review established some of the problems related to the implementation of government programmes. To address these challenges, in the financial year 2009/10, the government is proposing to put emphasis on having in place work plans, including procurement and recruitment plans, which will form the basis for the disbursement of funds. The government is not a cow fed in heaven and milked on earth: expenditure must be financed by taxes, borrowing, and aid. Each of these has associated distortions. In a developing country like Uganda, there is an urgent and obvious need for more revenue to enable the government to provide and maintain the most basic public services. However, the reality is that those with economic ability are few and do not want to pay tax, moreover they could have the political leverage to evade taxes. Those without political power are many but have almost nothing to tax, and do also resist paying taxes. This is amplified by the fact that aid flows, which presently constitute more than one-third of the government budget are subject to possible policy cessation, hence making tax revenues even more important for government incomes. In addition, globalization and Uganda s membership to regional trade blocks has increasingly resulted in economic integration and pressure to adhere to international trade agreements, and hence imposing severe constraints on the ability of the government to choose its own tax policy directions. There are essentially four sources to support government spending, viz. internal borrowing including borrowing from the central bank, running down foreign reserves, external borrowing, and tax revenue. The former three sources can be used to finance unexpected shortfalls in revenue, but in the long run a healthy tax system must be centre stage. Taxation is thus a critical element in the financing of fundamental economic and social programmes necessary for economic transformation of the country. Much of the growth in revenues in the past has been on account of increases in duty and tax rates. However, in financial year 2009/10 there will be no increases in duty and tax rates, as a measure to stimulate the economy. Therefore, raising revenue/gdp ratio in the financial year 2009/10 will require big improvements in Uganda Revenue Authority (URA) administration. Reforms at the URA are continuing with emphasis on strengthening management, developing better internal controls and introducing more integrated information systems. The resource envelope for financial year 2009/10 amounts to Shs 7,333.7 billion of which Shs. 4,800.2 billion (about 65%) is financing from domestic revenues comprising tax revenues of Shs. 4,474 billion, non-tax revenues of Shs billion and loan repayments from government parastatals of Shs. 39 billion; Shs billion (about 2.9%) from domestic bank borrowing; and Shs. 2,533.5 billion (about 34.5%) from external sources including both budget support and project aid.

16 2.3 Tax revenue One of the victims of the numerous economic crises that have plagued Uganda since 1966 has been the tax system, i.e. inadequate tax base and a limited ability to collect taxes. Tax effort has been dominated by indirect taxes, which often has had exemptions both within and outside of the tax law, resulting in significant dispersion in the rate of effective marginal tax rates, thereby leading to distortions in economic incentives. Uganda s dependence on trade taxes and in particular taxes on fuel is harmful to growth. Moreover, administrative constraints on the ability of tax authority to collect revenue have often led to the imposition of high rates on a narrow tax base resulting in a high rate of tax evasion and subsequent growth in the informal economy. In addition, tax administration has had excessive numbers of poorly trained staff, often recruited on patronage criteria rather than on merit, political meddling in administration, unethical management practices, and discretion in the application of the tax law partly owing to weak legal structures. These have often created opportunities for corruption and tax fraud. In particular, despite the rosy economic performance depicted in the national statistics, Uganda has failed to generate sufficient tax revenue to meet even the recurrent needs of government services. As shown in Figure 3, the tax effort, measured by the ratio of tax to GDP is about 12.4% compared to the Sub-Saharan Africa average of about 18%, and the OECD average of about 40 percent. With government expenditure of about 22% of GDP, this apparent failure of the tax system to generate sufficient revenue has led to the government running chronic primary deficits. Consequently, the government has been far too dependent on donors to provide a minimum level of essential services and its ability and fiscal discretion is very much curtailed. Moreover, Uganda s taxation system, especially income taxation, is heavily punitive to the formal sector. This form of taxation distorts individual behaviour and could deter growth in formal sector. Figure 3: Trend of Public Finance; 1987/ /10

17 2.3.1 Composition of Government Spending The composition of government expenditures reflects government priorities. The relative spending priorities in Uganda have changed much since the 1990s. In fact, the top three expenditures for Uganda in the 1990s were defence, general public management, and public administration. In recent years as shown in Table 2, there has been a trend to increase expenditure on infrastructure, education and health as a share of government expenditure. The ranking in terms of the shares of total expenditure for the financial year 2009/10 is: works and transport, education, health, energy, public management, security, accountability, interest payment, justice and order, agriculture, public administration, water and environment, legislature, and tourism, trade and industry. Indeed, time trend in key health and education indicators points to general improvements for some indicators such as school enrolment, child mortality, immunization and literacy. But while the generally improving trends are a corollary to the increasing access to social services, it is not evident that such access can be primarily attributed to more generous social spending policies by the government. This heightens concern of enhancing public social expenditure and monitoring social spending. Table 2: Sectoral budget allocation 2006/ / / / /9 Share in total expenditure 2009/10 Share in total expenditure Security Works and transport Agriculture Education Health Water and Environment Justice and Order Accountability Energy and mineral development Tourism, Trade and Industry Lands, housing and urban development Social development Information and communication Public sector management Public administration Legislature Interest payment Unallocated Total

18 Development of rural infrastructure is key to rural social and economic life. Rural populations tend to define poverty in terms of access to infrastructure, most often roads, education, and health centres, rather than just services. Four aspects of access to infrastructure have especially far-reaching implications for development in general and agricultural production in particular, namely (1) schools, (2) medical care, (3) markets, and (4) credit facilities. The plight of the rural poor emphasizes the need for access to health care in emergencies, but health facilities are usually hard to find in remote locations. Moreover, the poor in remote areas are often the most in need of medical assistance, since water and sanitation facilities are frequently inadequate and poverty levels are above regional averages. Moreover, the costs of medicine further exacerbate existing high costs of transporting the sick to a health facility. Roads are crucial for effective rural transport systems. The poorest communities are often the most isolated ones. The roads programme, which was the earliest focus of government poverty reduction efforts, had some impact but more investment is still required in this sub-sector to uplift the quality of rural transportation infrastructure. Figure 4: Comparison of sectoral budget allocation 2008/09 and 2009/ Roads Public capital is a major source of long-term economic growth and poverty reduction. It contributes not only to growth in agricultural production, providing an adequate food supply for an increasing population, but also to the development of the rural non-farm sector, which has become increasingly important for further poverty reduction in rural areas. It also helps to connect poor people to the growth process by improving their access and mobility. One mechanism is by connecting remote areas to growth poles and, in this way, correcting regional imbalances and helping poor people break out of poverty traps. The government has increased its infrastructure expenditure (road and other transport services) in absolute terms from Shs billion in 2006/7 to Shs.1134 billion in 2009/10. This is about 3.6% of GDP.

19 In the financial year 2008/09, the government embarked on an ambitious programme to scale up interventions in the road sector. US$ 600 million was earmarked over three financial years to develop the Northern Transport Corridor from the Malaba/Busia border post to Katuna. The government proposes to maintain this programme in the medium term in order to remove the constraints to transportation, thereby lowering the costs of doing business and generating higher economic growth. In the process, it proposes to upgrade to tarmac a total of 322 kilometres of the national road network. These include Soroti-Dokolo-Lira, Kabale-Kisoro-Kyanika and Kampala-Gayaza-Zirobwe, Fort-Portal- Bundibugyo-Lamia, Kapchorwa-Suam, Muyembe-Namalu-Moroto, Kafu-Karuma-Gulu, Jinja-Kamuli, Tororo-Mbale-Soroti and Gulu-Atiak-Bibia highways. It also proposes to rehabilitate a total of 395 kilometres of national roads network, which include Mbarara- Ntungamo-Kabale-Katuna, Kampala-Mukono and Lira-Kamdini highways. The design for upgrading to tarmac, of a further 2,050 kilometres of the national road network will also be undertaken in financial year 2009/10. These roads include Mbale-Magale- Lwakhakha, Olwiyo-Gulu-Kitgum, Hoima-Kaiso-Tonya, Musita-Lumino-Busia, and Moroto-Kotido roads. Substantial resources will also be committed to road maintenance through the operationalization of the Road Fund, whose Board has recently been inaugurated. A total of Shs. 268 billion will be allocated to the Fund from which districts, urban authorities and the Uganda National Road Authority (UNRA) will seek funding, to undertake road maintenance, upon presentation of acceptable work plans to the Secretariat. Overall, the share of roads is estimated at 16.4% of total expenditure in the financial year 2009/10. The government s commitment to the development of the road infrastructure is commendable. However, it is important that plans to develop the road network are implemented on a timely basis now that funding levels have significantly increased and in view of the constraints to economic growth and development arising from poor roads. The road sub-sector is projected to get equivalent to about US$ 550 million, but the focus is on more than 22 roads. The estimates are that to construct one kilometre of a good road requires about US$ 0.8 million, which suggests that US$550 would give Uganda about 540 km of paved roads. This clearly points to the need for medium to long-term plans on infrastructure development. Moreover, Uganda being a landlocked country requires the development of an efficient railway system. This will not only ensure cheaper access to the sea but also relieve the pressure on the existing road network. In conclusion, road infrastructure contributes to both growth rates and growth patterns and to both income and non-income dimensions of poverty. Improving the management of road infrastructure by prioritizing maintenance and rehabilitation, building management capacity, reducing corruption will have a substantial impact on growth and poverty reduction Education In the education sector, the financial year 2009/10 budget will consolidate the achievements so far gained under Universal Primary and Secondary Education programmes. Implementation of UPE and USE programmes to achieve the target of universal primary education and universal secondary schooling by 2015 remains

20 government s key priority for the education sector. The sector targets for access remain to increase enrolment ratios in primary to 95%; and to increase the transition rates from primary to secondary from 50% to 80% in the medium term. In the 2009/10 budget, Shs.59 billion has been provided to the education sector to support UPE, USE, and Business Technical and Vocational Education and Training (BTVET). In addition, Shs.2.5 billion has been provided to strengthen school inspection. The major government focus is improving the quality of schooling through the construction, provision of instructional materials and improving inspection. Sanitation in primary schools has been identified as one of the most urgent needs that require replacement of latrines. Over 90 percent of the Shs billion School Facilities Grant allocation will be spent on latrine construction next financial year in needy primary schools and the balance on teachers houses. Government will also intensify school inspection to check on teacher absenteeism and school fires, and continue monitoring the number of children in schools, among others. To consolidate the gains of UPE, the government focuses on enforcing the Education Act 2008 which makes primary education compulsory. As part of monitoring the implementation of these programmes, the government proposes to carry out a census of children under these programmes. The government will also roll-out the USE programme to cover senior four and complete the cycle for lower secondary education. In addition, construction of seed secondary schools and construction of additional classrooms in over-enrolled schools will be undertaken. To increase access and enhance the quality of secondary education, government secured US$ 230 million, US$ 80 million from the Africa Development Bank and US$ 150 million from the World Bank, for continuation of the school construction programme and the provision of instructional materials, over the medium term. It is envisaged that the above funding will support the construction of 6,200 new classrooms in over 500 schools which are over-enrolled; 2,300 five stance latrines; 405 multi-purpose science rooms and 144 libraries. The projects will also support completion of 1,900 half-built classrooms in another 400 schools, and purchase1.7 million textbooks and 6,300 science kits for both Government and private schools. The funding from the African Development Bank will also be used for the expansion of 12 schools, construction of 15 new ones and rehabilitation of 42 traditional secondary schools and two Business Technical Vocational Education Training (BTVET) institutions, turning them into centres of excellence. According to the Background to the 2009/10 Budget, the USE enrolment indicates that a total of 452,137 students were benefitting from the programme, of whom 255,324 students (56%) were male. Government schools accounted for 314,819 students (70%) while private schools accounted for 137,318 students (30%) of USE enrolment. The number of schools participating in the USE programme increased from 1,231 (800 government and 431 private) in 2008 to 1,347 (802 government and 545 private) in To increase access to USE, construction of 24 seed schools with funding from the African Development Bank (ADB) was completed. Each of the 24 seed schools received an administration block, laboratory block (with 2 laboratories: chemistry/physics and biology/agriculture), 2 blocks of classrooms with 2 classes each, and toilet stances (3