ELEMENTS OF TAXATION: BBA 2104

PUBLIC DEBT

Meaning of Public debt:

 Public debt, sometimes also referred to as government debt,

 It represents the total outstanding debt (domestic and external debt) such as (bonds and
other securities) of a country's central government.

 Public debt as a percentage of GDP is usually used as an indicator of the ability of a

government to meet its future obligations.

DIFFERENCES BETWEEN PUBLIC DEBT AND NATIONAL DEBT

1. Public debt/ Government debt: This involves raising capital finance from the public by
issuing debt instruments like bonds.

 A greater share of Uganda’s country's outstanding debt is obtained or sourced from

multilateral creditors like World Bank, African Development Bank and the Islamic
Development Bank as well as bilateral creditors, such as Japan, France, etc.

2. National debt: It is the total amount of money which a country's government has
borrowed (individuals, businesses, and even other governments.)

TERMS USED IN PUBLIC DEBT:

Internal debt: When a government borrows money from its own citizens by selling bonds or
long-term credit instruments an internal debt is created. It is owed by a nation to its own citizens.
So, it may apparently seem that an internal debt does not impose any burden on society because
we owe it all to ourselves.
External debt: When a country borrows money from other countries (or foreigners) an external
debt is created. It owes it all to others. When a country borrows money from others it has to pay
interest on such debt along with the principal amount. This payment is to be made in foreign
currencies (or in gold).
Short-term debt: In short-term borrowing, treasury bills and treasury guaranteed bond are used
(1 year)
Some common examples of short-term debt include:
  Short-term bank loans. These loans often arise when a company sees an immediate
need for operating cash. ...
 Accounts payable. This refers to money owed to suppliers or providers of services. ...
 Wages. These are payments due to employees.
 Lease payments.
 Income taxes payable.

Long-term debt: Long-term public debts refer to debts more than 5 years. The instrument of
long-term borrowing is the government debt, mortgages, and bonds or debentures.

Medium-term debt: Medium-term public debts refer to debts ranging from 1 to 5 years. Higher
interest rate than shorter term debt.

Funded debt: Funds raised through issuance of securities such a bond. Sometimes long-term
(but not short-term) loans are also called funded debt.
Dead weight debt: – these are debts which are not covered by purchase of any real assets.
These debts are mainly borrowed to finance current consumption with no real asset acquired.
E.g., debts acquired to finance war. This is characteristic of national debts.
Reproductive debt: When a debt has assets to balance it, it is called reproductive debt. For
instance, if a state barrows money for spending it on the construction of canals, railways,
factories, etc., it is then able to repay the loan from these self-liquidating projects.

WHY DOES A COUNTRY INCUR PUBLIC DEBT?

The State generally borrows from the people to meet three kinds of expenditure:

(a) Public Debt to Meet Budget Deficit:

 It is not always proper to effect a change in the tax system whenever the public
expenditure exceeds the public revenue.
 It is to be seen whether the transaction is unplanned/casual or regular.
 If the budget deficit is unplanned/casual, then it is proper to raise loans to meet the deficit.
 But if the deficit happens to be a regular feature every year, then the proper course for the
Government would be to raise further revenue by taxation or reduce its expenditure.

(b) Public Debt to Meet Emergencies like War:

  In many countries, the existing public debt is, to a great extent, on account of war
expenses.
 Especially after LRA in Northern Uganda, a large portion of public debt has been incurred
to cover the expenses of the last war.

(c)To finance political activities- voting process

(d) Public Debt for Development Purposes:

 The largest beneficiaries of debt financing in Uganda by sector includes; energy, works,
agriculture. This is consistent with the government strategy to reduce the cost of doing
business, develop infrastructure to boost growth, energy for support industrial
development.

PUBLIC DEBT MANAGEMENT

Objectives of public debt management

Public debt management is the process of establishing and executing a strategy for managing
the government's debt in order to raise the required amount of funding, achieve its risk and cost
objectives, and to meet any other sovereign debt management goals the government may have
set, such as developing and maintaining an efficient market for government securities.

Objectives

The main objective of public debt management is to ensure that the government's financing
needs and its payment obligations are met at the lowest possible cost over the medium to long
term while taking a careful degree of risk.

THE BURDEN OF PUBLIC DEBT IN DEVELOPING COUNTRY

 External debt (borrowed from foreign lenders, including commercial banks, governments,
or international financial institutions) reduces society’s consumption opportunities GDP
since the monetary payments flow out of the country. Consequently, external debt
payments reduce the amount available to invest in improving public services, which can
help economic development

 Internal debt creates the following problems:

 a. Extra tax burden has distorting effects on incentives

b. Diverts society’s limited capital from the productive private sector to unproductive
capital sector, and

c. Slows the rate of economic growth.

WAYS IN WHICH PUBLIC DEBT MANAGEMENT IS CARRIED OUT

Debt Management Strategy

 The risks inherent in the structure of the government's debt should be carefully monitored
and evaluated.
 Mitigation of risks by modifying the debt structure, taking into account the cost of doing so.
 In order to help guide borrowing decisions and reduce the government's risk, debt
managers should consider the financial and other risk characteristics of the government's
cash flows. Debt managers should carefully assess and manage the risks associated with
foreign-currency and short-term or floating rate debt.
 Cost-effective cash management policies- to enable the authorities to meet with a high
degree of certainty their financial obligations as they fall due.

DEBT FINANCING AND TAXATION FINANCING

Debt Financing

Definition: A method of financing in which an organization receives a loan and gives its promise
to repay the loan.

Debt financing includes both secured and unsecured loans. Security involves a form of collateral
as an assurance the loan will be repaid. If the debtor defaults on the loan, that collateral is
forfeited to satisfy payment of the debt. Most lenders will ask for some sort of security on a loan.
Few, if any, will lend you money based on your name or idea alone.

Here are some types of security you can offer a lender:

 Guarantors sign an agreement stating they’ll guarantee the payment of the loan.
 Endorsers are the same as guarantors except for being required, in some cases, to post
some sort of collateral.
 Co-makers are in effect principals, who are responsible for payment of the loan.
  Accounts receivable allow the bank to advance 65 to 80 percent of the receivables’ value
just as soon as the goods are shipped.
 Equipment provides 60 to 65 percent of its value as collateral for a loan.
 Securities allow publicly held companies to offer stocks and bonds as collateral for
repaying a loan.
 Real estate, either commercial or private, can be counted on for up to 90 percent of its
assessed value.
 Savings accounts or certificate of deposit can also be used to secure a loan.
 Chattel mortgage applies when equipment is used as collateral—the lender makes a loan
based on something less than the equipment’s present value and holds a mortgage on it
until the loan’s repaid.
 Insurance policies can be considered collateral for up to 95 percent of the policy’s cash
value.
 Warehouse inventory typically secures up to only 50 percent of the loan.
 Display merchandise such as furniture, cars and home electronic equipment can be used
to secure loans through a method known as “floor planning.”
 Lease payments can be assigned to the lender, if the lender you’re approaching for a
loan holds the mortgage on property you’re trying to lease.

Unsecured loan:

 Your credit reputation is the only security the lender will accept -if you have a good
relationship with the bank.
 these are usually short-term loans with very high rates of interest.

Most outside lenders are very conservative and are unlikely to provide an unsecured loan unless
you’ve done a tremendous amount of business with them in the past and have performed above
expectations. Even if you do have this type of relationship with a lender, you may still be asked to
post collateral on a loan due to economic conditions or your present financial condition.

In addition to secured or unsecured loans, most debt will be subject to a repayment period. There
are three types of repayment terms:

1. Short-term loans are typically paid back within six to 18 months.

2. Intermediate-term loans are paid back within three years.
3. Long-term loans are paid back from the cash flow of the business in five years or less.
  Loan from family and friends: The most common source of debt financing for start-ups
often isn’t a commercial lending institution, but family and friends. When borrowing money
from your relatives or friends, have your lawyer draw up legal papers dictating the terms of
the loan. Why? Because too many entrepreneurs borrow money from family and friends
on an informal basis. The terms of the loan have been verbalized but not written down in a
contract.

Lending money can be tricky for people who can’t view the transaction at arm’s length; if they
don’t feel you’re running your business correctly, they might step in and interfere with your
operations. In some cases, you can’t prevent this, even with a written contract, because many
state laws guarantee voting rights to an individual who has invested money in a business. This
can, and has, created a lot of hard feelings. Make sure to check with your attorney before
accepting any loans from friends or family.

 Start-up capital using Credit card: Even though most charge high interest rates, credit
cards provide a way to get several thousand dollars quickly without the disturbance of
paperwork, as long as you don’t over extend your ability to pay back the money in a timely
fashion. Interest payments on credit-card debt adds up quickly.

Banks tend to shy away from small businesses experiencing rapid sales growth, a temporary
decline or a seasonal collapse. In addition, firms that are already highly leveraged (a high debt-
to-equity ratio) will usually have a hard time getting more bank funding.

Every financial year, the Minister of Finance, Planning and Economic Development is
mandated to prepare the Public Debt, Guarantees, other Financial Liabilities and Grants
Report. This report is published in accordance with the sections of the Public Finance
Management Act, (Act No.3 2015), namely:

i. Section 39 (4), which states that “The Minister shall every financial year, table before
Parliament, with the annual budget, a report of the existing guarantees which shall
include an analysis of the risk associated with those guarantees”,
ii. Section 42 (2), which states that “The Minister shall, by 1st April, prepare and submit to
Parliament a detailed report of the preceding financial year, on the management of the
public debt, guarantees and the other financial liabilities of Government”,
iii. Section 42 (3), which states that “The report shall indicate the management of the public
debt, guarantees, and the other financial liabilities of Government against the National
 Development Plan, the objectives of the Charter for Fiscal Responsibility, and the
medium-term debt management strategy”; and,
iv. Section 44 (5), which states that “The Minister shall, every financial year table before
Parliament a report of the grants received by Government or by a Vote”.
External financing
External financing can be obtained through the following sources;

i. Budget Support: This is where funds/resources, either loans or grants, from a

Development Partner (DP) are transferred directly to the consolidated fund of the
recipient Country following the fulfilment of agreed conditions for disbursement.
Budget support is normally in two forms namely:
a) General Budget Support; and,
b) Sector Budget Support (earmarked/targeted towards a specific sector for
example, the ADB-HEST Project that supported construction of infrastructure in
institutions of higher learning).
The financial resources thus received are part of the national resources of the
government and allocated to respective government strategic areas of
 intervention in the National Budget and thereafter appropriated by Parliament.
ii. Project Support: Both Government of Uganda (GoU) and the DP(s) enter into a
financing agreement which stipulates a set of inputs, activities and outputs to reach
specific outcomes within a defined area, budget and timeframe. This financing can be in
form or loan, grant or blended.
iii. Export Credit financing: This is where the borrower (GoU) and a DP Export Credit
Agency (ECA) pre-identify a contractor to implement a project largely in the
borrower’s jurisdiction. The financing is to support international export operations of
the lending country by removing any potential uncertainty of exporting to other
countries, underwrite political risks and commercial risks of overseas investments,
encouraging exports and international trade. Uganda has been a recipient country,
through this arrangement.
The financing terms for such arrangements are generally semi concessional.
iv. Technical Assistance: This entails the transfer of ideas, knowledge, practices,
technologies or skills from either development partner identified experts or procured
experts under respective projects. This knowledge transfer is mainly for policy
development, institutional development, capacity building, and project or programme
support.
v. Off Budget Support: This covers all Official Development Assistance (ODA) not
channelled through Government systems and structures both in form of disbursement
and management; hence not appropriated by Parliament.
The related project activities and finances are mainly channelled through Non-
Governmental Organisations (NGOs), Civil Society Organisation (CSOs) or directly
implemented by DPs.
vi. On-lent: This is where Government contracts a loan from DPs and lends it to a third
party implementing the project. This is mainly done for State Owned Enterprises
(SoEs).

Domestic Debt
Prior to FY 2012/13, government issued domestic debt (government securities) for monetary
purposes only. Since then, government securities have been issued on the domestic market to
finance government budget deficit. The borrowings have been
within the limits given in the annual macroeconomic framework and consistent with the
thresholds stipulated in the respective Public Debt Management Frameworks.

The two types of domestic debt instruments issued include;

i. Treasury Bills, and

ii. Treasury Bonds
Other financial liabilities

Other financial liabilities include the following;

i. Loan Guarantees: this refers to when government agrees to assume a debt

obligation in the event that the borrower defaults on repayment. This debt obligation
is usually to private companies or institution.
ii. Contingent liabilities: An obligation arising from past events whose existence will only
be confirmed by the occurrence or outcome of one or more uncertain future events
and, if confirmed, will result in expenditure being incurred to settle the confirmed
obligation by government. Contingent liabilities can be either implicit or explicit.
Implicit contingent liabilities represent moral obligations or burdens that, although not
legally binding, are likely to be borne by governments because of public expectations
or political pressures. Explicit liabilities are legal obligations there the government
are legally required to make payments only if particular events occur.
iii. Domestic arrears: This refers to unpaid bills that remain outstanding beyond the fiscal
year in which they were incurred.
BBA YR2 SEM1-Elements of Taxation by Sharon Apio Lira University