Title: A Revenue diffusion fund for the Caribbean
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Title: A Revenue diffusion fund for the Caribbean
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Language: English
Creator: Jones-Hendrickson, S. B.
English ( Contributor )
Jones-Hendrickson, S.B. (Simon B.) ( Contributor )
Publisher: Caribbean Studies Association
Publication Date: 1982
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Subject: Caribbean   ( lcsh )
Spatial Coverage: North America -- Caribbean
Caribbean
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Volume ID: VID00001
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A REVENUE DIFFUSION FUND FOR THE.CARIBBEAN*


S. B. Jones-Hendrickson**


















Paper prepared for presentation at the Seventh Annual Conference

of the Caribbean Studies Association, May 25 29, 1982, Kingston,

Jamaica.










**Caribbean Research Institute
College of the Virgin Islands
St. Croix, USVI 00840








A REVENUE DIFFUSION FUND FOR THE CARIBBEAN


Introduction

In 1975-1976, the British Government literally gave Dominica

a check to maintain its economy. Subsequently, the Anguillian

government received one quarter million dollars to assist it in

its budgetary inadequacies. More recently, in April, 1982, the

Guyana Government publicly noted that it was bankrupt. From recent

reports, it is alleged that the government of St. Kitts-Nevis will

be bankrupt by June, this year. These illustrative examples are

sympotmatic of the fiscal problems that nearly all of the Caribbean

countries have been facing over the years. In an effort to come to

grips with this problem, we suggest that the Caribbean countries

should implement a plan which we call a Revenue Diffusion Fund (RDF).







1
The idea for this Revenue Diffusion Fund was first developed
in a 1976 monograph (Tones-Hendrickson, 1976). Another version of
the idea was incorporated in a1979 book prepared for the Regional
Monetary Studies Program; see Jones-Hendrickson (1979). This third
version of the Revenue Diffusion Fund incorporates the substantive
features of the early discussion and expands on the model.












-2-


In this paper we will cover three areas: in section one we will

outline the RDF in terms of the nature and need for the RDF; in

section two the development and administration of the RDF is dis-

cussed, and in section three a model is presented as an illustra-

tion of one approach to testing and implementing the RDF over time.

In the conclusion we present a politico-economic rationale for the

need to have an RDF in the Caribbean.

I. OUTLINES OF THE REVENUE DIFFUSION (RDF)

A. Nature and Need:

We view the Revenue Diffusion Fund (RDF) as a pool of money

from which Caribbean countries can draw when they have budgetary

problems, and a fund to replace external borrowing, in the long-

run. One way of understanding the nature of the Fund is to see

it as a "partner-hand," in terms of the Caribbean connotation,

or a revenue-sharing arrangement in terms of fiscal federalism.

The RDF is best understood in the context of a fiscal system

wherein there are a central system and a local system. In the

case of the Caribbean, the RDF will work best in a situation

where fiscal responsibilities rest both at the overall coordinat-

ing body, called it the Caribbean-Nation State (CNS), and at the

local level, the Island-Nation State (INS).











-3-


There is a strong political and economic rationale for

structuring the nature of the RDF on a Caribbean-Nation State

and Island-Nation State system. The rationale stems from our

evaluation of the fiscal structures of the various Caribbean

governments, and our analysis of the skewed resource bases of

the countries, principally the Microstate Economies versus the

Macrostate Economies. Given this skewness in the distribution

of resources, among the countries, and given the political need

for a Caribbean-Nation State (CNS), we believe that a fiscal

mechanism, such as the RDF, which seeks to minimize the region's

fiscal inadequacies, ought to be tried.

Apart from the general need for the RDF to be a multi-govern-

mental operation, there are some specific needs attached to its

necessity. If we examine the public sector estimates of any Carib-

bean country, we are sure to discover some instances of fiscal mis-

management. Part of the mismanagement is due to inherent problems

in the system of fiscal affairs; however, some of the problems are

due to the low effort of technocrats/bureaucrats in their manage-

ment of the affairs of the states. But there are also external

forces imported inflation, for example which coalese with the

internal factors which impose severe constrains on the fiscal

systems of the governments.












-4-


At any point in time, therefore, there will be some surplus

country, for example Trinidad today, but invariably there will

be many deficit countries. Objectively, the RDF is aimed at

establishing a pool of funds which could be diffused from surplus

countries to deficit countries. While Trinidad is a surplus coun-

try today, there is no guarantee that it will be a surplus country

forever. Given the nature of economic reality in the region, and

given the need for socioeconomic transformation of the economies,

we see the RDF as providing a partial solution to minimizing the

budgetary problems of the region.

II. THE ESTABLISHMENT OF THE RDF

A. Development:

The Revenue Diffusion Fund (RDF) should be operated such

that money is collected from the various Island-Nation States

(INS) and placed in the pool of funds. Some fraction of the

INS's local revenue will be set aside each fiscal year for the

fund (one percent is desirable fraction). The fraction is

negotiable but should reflect the arrangement that presently

obtains in the case of the countries' contribution to regional

bodies.2





2
We are aware of the problems that the countries have in
making payments to regional agencies. In the case of the RDF
their ability will be closely related to their benefits.












-5-


Ability to pay would be an integral part of the RDF in

the first five years. It is possible, therefore, that some fis-

cally strong countries may have to make an above average (for the

group) contribution to the RDF in the initial five year phase-in

period, all things being equal. Such contributions could be

viewed as assistance to the fiscally weak countries, and self-

sufficiency to contributing countries (when the time comes that

they have to draw from the RDF).

B. Administration:

1. Running the RDF

We suggest that a regional committee, comprised of individuals

from the Ministries of Finance and the Central Banks, serve as

the agency to administer or run the operations of the RDF. Each

fiscal year the Island-Nation States would be expected to make

their contributions to the RDF. The Regional committee (Revenue

Diffusion Fund Committee, (RDFC)) will review the fiscal status

of each country both for the required contribution and for possi-

ble assistance from the RDF. The day-to-day running of the RDF

should be the function of an oversight select committee from the

Central Bankers of the RDFC.

The RDF will differ from the social "partner-hand" arrange-

ment in that:












-6-


(a) a surplus country will not have the automatic

right to get assistance from the fund;

(b) surplus funds, that is, funds minus assistance

to deficit countries and administrative costs,

will be actively invested in the region.

The term structure of the fund should be skewed more to short-iterm

than long-term. This would make funds easily available for all.

The RDFC should have the option of investing the surplus funds in

financial instruments of those regional governments which are fis-

cally strong.

2. Using the RDF:

Island-Nation States will be permitted to borrow money from

the RDF based on their population, "tax effort" and "need". For

our purposes, we define tax effort as the ratio of inland tax

revenue to Gross Domestic Product; "need" is defined as export

to import ratio.

The money which an Island-Nation State receives from the

RDF will not be earmarked. There should be no time constraint

on the number of years a country may receive assistance from the

RDF. When a country, an INS, receives assistance from the RDF

it would be subject to quarterly review by the RDFC. The country

would have to adhere to certain rules of fiscal management.

These rules should be jointly agreed upon by all members of the












-7-


Caribbean-Nation State's Ministers of Finance and Central Bank

Governors.

3. Penalties for Misuse of RDF:

Penalties should be impose on INS for excessive use of the

RDF. Loans should be refinanced, but these loans should be made

to the INS on a "variable finance rate (VFR)." The VFR may or

may not benefit the borrower of funds from the RDF. Composite

Caribbean-Nation State rate of interest, and not the London

Interbank Bank Rate, should be the guideline for determining

the VFR for the borrowers from the RDF.

The RDF should differ from the present financial arrange-

ments in that no intrastate arrangements should be permitted in

effectuating borrowing from the fund. For example, a surplus

country should not be permitted to be the sole decision-maker

in deciding to lend to a deficit country. The RDF should be

carefully structured. Individual-Nation States may borrow from

the RDF, outside of their normal assistance. However, the INS

which request funds should get permission from the RFDC. An

INS which borrow outside of the normal assistance program will

be charged at a higher rate than that applicable in the normal

case. Such an INS must also subject its fiscal policies and

programs to scrutiny of the Revenue Diffusion Fund Committe

through quarterly evaluations.












-8-


It would be strongly discouraged for any INS to lend funds

to another INS at rates which are in competition with the RDF

lending rates. Any INS which violates this regulation should

be suspended from borrowing privileges, and or should be

penalized monetarily. The penalty should be the equivalent of

the difference between the normal RDF lending rate and the lend-

ing rate of the lender to the borrower state (a rate differen-

tial principle). Let us expand on this penalty. If state A

makes a loan to state B, outside of the RDF arrangements, state

A would be denied access to the RDF for some time or a penalty

should be imposed whereby state A pays into the RDF an amount

that is equivalent to the difference between the amount at RDF

rate and the amount negotiated at the states A B rate. For

example, if Antigua borrows $60,000 from St. Kitts at six per-

cent per annum and the RDF lending rate is two percent per

annum, St. Kitts would be required to pay the amount of $2,400

into the RDF ($60,000 x 4%). If, on the other hand, the

St. Kitts-Antigua negotiated rate is one percent per annum,

St. Kitts would be charged $600 ($60,00 x 1%). How could this

concept of the RDF be put into operation? In section three we

present a model which is illustrative of one approach to the

implementation of the RDF.











- 9 -


III. THE REVENUE DIFFUSION FUND: A MODEL

A. Revenue to be Diffused:3

Operationally, the RDF is best viewed as a system of col-

lective states, which we call the Caribbean-Nation State, pass-

ing (diffusing) funds to Individual-Nation States. Let us assume

that the revenue to be diffused falls between to and tl, where

to is the minimum revenue and is strictly positive. Let r(t)

represent the number of islands with revenue of t. Assume that

t is continuous and strictly positive between t and tl. In a

continuous case, we can show the Caribbean Nation State with

revenue to be diffused of t or lower. This will be:


R(t) = t1 r(t) dt (1.0)
t

and in the discrete case, it is:
E r(ti)
R(t) = ti t (1.1)

The average amount of the revenue to be diffused from the

Caribbean-Nation State where the t is the minimum revenue for

the continuous case is:

R (t) = tl t r(t) dt (2.0)
to
R(t)



3
The development of "need" is similar to the development
of Revenue to be diffused.












- 10 -


and for the discrete case, it is:

E(t) R*(t) = t r(t ) (2.1)
i i

B. Formula For Diffusion of FundsfromCNS to INS

Formally, one formula which may be used as the basis for

the diffusion of funds from the Caribbean-Nation State (CNS)

to the Island-Nation State (INS) is the following (using the

discrete case):

R(t) = G {pj ( T ) }Nj

Q.
3.0
Pi ( Ti ) Ni

Qi

where R = the funds to be diffused from the Caribbean-Nation
State to the Island-Nation State

G = the amount of revenue collected by the Revenue
Diffusion Fund Committe (one percent of local
revenue).





4
Our model expands on the revenue-sharing model of Musgrave
and Polinsky (1970). Here we have incorporated a "Need factor"
which is a function of the export nature of Caribbean Countries.
For discussions and amplifications of revenue-sharing models
similar to Musgrave and Polinsky (1970) see Goetz (1967) and
Pechman (1967).















- 11 -


P the population in the Island-Nation State j.
j

T = inland revenue of Island-Nation State j.
j

Q = the Gross Domestic Product of Island-Nation

State j.

N = export to import ratio for Island-Nation

State j.

Let us rewrite equation (3.0) as follows:


R(t) = G [P (Qj*)] N.

P (Q (3.0)
P" (Qi ) N.
1 i 1


where Q = T/Q.












- 12 -


A given Island-Nation State has several options opened to

it in terms of what it could do to maximize the receipt of its

funds from the RDF. Let us consider three options:

(1) the receipt of money from the RDF relative

to the amount of money collected by the RDF;

(2) the receipt of money from the RDF relative

to the inland revenue of the INS; and

(3) the receipt of money from the RDF relative

to the Gross Domestic Product.

One interpretation of the three options could be a deriva-

tion of three short-run "multipliers" from equation (3.0). Thus,

for the three options, the three "multipliers" will be:

(1) the change in the funds to be diffused to

the INS relative to the amount of money

collected by the Revenue Diffusion Fund

Committee;

(2) the change in the funds to be diffused

relative to the inland revenue; and

(3) the change in the funds to be diffused

relative to the Gross Domestic Product.




5
We did not derive a multiplier for the need factor since
its performance could be best understood in the Gross Domestic
Product expression.











- 13 -


The mathematical expressions of these three options are:

(1) d R(t) = Pj(Q*)Nj

dG ZPi(Qj)Nj

-1
(2) d R(t) = G P Qj Nj

d Tj tPi(Q*)Nj

-2
(3) d R(t) = G PjT Qj Nj


d(Qj) EPi(Q*)Ni

In the case of (1), the amount of money that diffuses

to a given state, relative to the quantum in the fund, depends

on the size of the population, the tax revenue to Gross Domestic

Product and the export to import ratio. From this option, a

given state has five policy decisions. It has control over

population; inland taxes; GDP; exports and imports. All, except

population, are manageable in the short run.

The second case, namely the amount of money to be diffused

to a state relative to its inland revenue, is a useful one. It

indicates, graphically, that any state may improve the level of

its receipts by improving the level of its tax revenues. But,

specifically, this case suggests that fiscally strong economies

are critical to the tax effort. Here, the buoyancy of component

G and the size of Nj are crucial short-run indicators.











- 14 -


Turning to the revenues to be diffused relative to the

Gross Domestic Product, we note that there is an Inverse rela-

tionship between the two variables. Here, the values of money

collected, the population, the tax revenues and the need factor

are all a composite relative to the square of the Gross Domestic

Product. In this case there are short-run and long-run variables

to be manipulated.

C. A Numerical Illustration of the Model:

Using data for 1975 and for St. Kitts, we can illustrate

how much money St. Kitts would have gotten from the RDF were it

in operation then. From (3.0) we know that:



R(t) = G Pj(T.)N
(3.0)
Qj

ZPi Ti Ni

Qi

The following data are from the East Caribbean Common

Market Digest of Statistics (1975) and the Annual Statistical

Digest, St. Kitts-Nevis-Anguilla (1978), all data are in thousands,

except the ratios.

G = $1452.79 [1% of local revenue]
P. = 46
P. = 528.8
1
T. = 15,437
J










- 15 -


Ti = 145,279
Q. = 74,146
J
Qi = 507,400
N. = .912
N. = .451
1

The value of R(t) = $185,857. This means that St. Kitts

gained $31,489 ($185,859-$154,370) by joining the RDF and

exercising its option to draw from the RDF. The $154,370 is

the one percent local revenue contribution that St. Kitts would

have been required to make in 1975. If St. Kitts exercises poor

economic planning in a given year and if this planning results

in a lower exports to import ratio (our need factor)as well as

a lower tax effort, the amount that St. Kitts will get will be

lower. It is to be remembered that the RDF is not a surrogate

for poor fiscal planning. It is a reward for prudent fiscal

management.

The values of the "multipliers" given the numerical

values for the St. Kitts data above are:

d R(t) = Pj(Q*) Nj .013

d G Pi(Q*) Ni

-1
d R(t) = G. P.Q. Nj
d T = .1 2 1
d Tj
4 EPi(Q*) Ni









- 16 -


-2
d R(t) = -G. Pj Tj Qj Nj = .003

d Q
EPi(Qi*) Ni

The multipliers may be interpreted as follows: In the case

of R(t) relative to G, a state will get 1.3 cents for every addition-

al dollar of funds to be diffused to the state. Or put it another

way, a one percent increase in G brings about 1.3 percent increase

in R(t). Likewise a one percent increase in Tj brings about a 1.21

percent increase in R(t). And, in the case of Qj, a one percent

increase in Qj brings about a .3 percent decrease in R(t).










- 17 -


IV. CONCLUSION


The Revenue Diffusion Fund is a mechanism which seeks to

minimize the fiscal instabilities from which many Caribbean

governmentssuffer. The RDF is a pool of funds. From it funds

are diffused from surplus countries to deficit countries. In

our estimation, the RDF is only a necessary condition. It

should be seen as important, nonetheless, because it could be

a mechanism of the region's own selection with the sole purpose

of using the region's own funds towards self-sufficiency. It is

necessary because, we believe, it could serve as a further incen-

tive for coordination in regional fiscal planning at the level of

the Caribbean-Nation State. The RDF is necessary, also, because

it may minimize the likelihood of Island-Nation States entering

the conditionality trap of the IMF or other lending agencies

(Odle, 1978).

What guarantees exist that:

(a) the RDF is workable?

(b) the Island-Nation States would adhere

to the rules? and

(c) it would not be dominated by the larger

countries in the Caribbean-Nation State?











- 18 -


There are no guarantees. However, we believe that it is workable

given:

(1) the politico-economic necessary and

sufficient conditions for the integration

of monetary and fiscal policies at the

Caribbean-Nation State level; and

(2) the need to have collaborative economic

planning, since the fiscal inadequacies

of an individual state tends to have

negative spill-over effects on other

states in the region.

Any guarantee of a workable RDF, therefore, rests on the collec-

tive interests of the regional states and the individual states.

The states' perception at the Island-Nation States' level and at

the Caribbean-Nation State will, in the long-run, determine if

this money cooperative effort or any such effort will work.

In the final analysis, then, a State's adherence or non-

adherence to the rules and regulations of the RDF would depend

on the collective interests of the Caribbean-Nation State and the

Island-Nation States. Implicitly, this collective view is a type

of "moral" obligation of the regional political directorate.

Since morality alone cannot run a country, we suggest there










- 19 -


should be further negative sanctions, in addition to those

mentioned before under the penalty section.

If an individual state violates the rules and regulations

of the RDF, such a state should be barred from obtaining loans

from the RDF for a specified period of time. Those states which

engage in transactions with the debarred state should also be

penalized if the debarred state benefits from the transaction at

the expense of the RDF. What do we mean?

Suppose St. Kitts violates the rules of the RDF. If

Trinidad lends St. Kitts money at rates more favorable than the

RDF rates, then Trinidad should be penalized according to the

"rate differential principle" established under the penalty

section. Funds, in the RDF, which belong to a debarred country

should be frozen from its use for the time of debarrment. The

debarred state should not have an automatic right to withdraw

its funds from the RDF. However, when the period of debarrment

ends, the debarred state should getthe benefits of its contribution

and all interests that its contribution accrued that is if the
6
state needs the money.

We wish to make it abundantly clear that the Revenue Diffusion

Fund is merely one attempt at minimizing the constraining and con-




6
A state need not take back its money from the RDF immediate-
ly after it renters the RDF system. See Appendix for an indica-
tion of the procedure it may adopt.











- 20 -


stricting forces of the Caribbean regional states in their borrow-

ing from external sources. There are many inherent problems in

the mechanism of the RDF. Nevertheless, it could be a starting point

to cut down on the dependency on foreign borrowing. The RDF, how-

ever, should not replace all foreign borrowing in one massive dis-

placement. We suggest that there should be a phase-in period,

from high external borrowing to the RDF, over a ten-year period.

The phase-in of the RDF and the phase-out of foreign borrow-

ing suggests that, initially, the quantum of funds in the RDF

should be very small. The large states may wish to draw on the

RDF at some period when the percentage rate of growth of their

contributions to the RDF equals the alternative earnings of their

contribution as measured by the rate of interest.7

The phase-in/phase-out period of the RDF and foreign borrow-

ing should be a period for evaluating the merits/demerits of both

the RDF and foreign borrowing. Normatively, we believe that the

RDF could be superior to foreign borrowing. However, the political

directorate of the individual states has to decide on the options

opened to bringing the Caribbean-Nation State together. The

political directorate will also have to decide what is the best

solution for the fiscal crises of the states for all of the states





See the Appendix for an illustration of this concept.










- 21 -


and not some of the states.

In the end, whether a mechanism such as the RDF is adopted,

or not, depends on the long-run feasibility of the plan as well

as the practical alternatives that are available to states. If

those alternatives have a strong substitution effect, then the

RDF will not be considered. If alternatives to foreign support,

foreign aid and dependency diminish, over time, then mechanisms

of self-sufficiency, such as the RDF, will attain priority in

the matrix of decision-making of the regional political directo-

rate. The present conjuncture of forces, events and conditionali-

ties in the external lending market,suggest that self-sufficiency

has to be accorded greater priority. It is in this spirit that

the RDF is offered.











- 22 -


APPENDIX



A state need not take its money from the RDF immediately

after it returns to the RDF. In addition, a large state which

may have the capacity to get external funds at better rates

than from the RDF may want to leave its contribution in the

RDF for a period of time. How would this benefit the RDF and

the state? In the case of the RDF, more funds will be avail-

able for investment and also disbursement to deficit states.

In the case of a state which opts not to "take its partner-

hand" when its turn comes up, let us consider the following

Fisherian Investment decision (Fisher, 1930; Silberberg, 1978).

Assume that the contribution to the RDF enters at time

t = 0 and grows in value to R(t) at time t. Assume that we have

a smooth differential function and that the function increases at

a decreasing rate. In other words, the first derivative of R(t)

is positive and the second derivative is negative:

R'(t) >0 (A.I)
R"(t) <0 (A.2)

At what time should a state take its "partner-hand" from the

Revenue Diffusion Fund such that it would get the maximum value?

To find the value, we derive the present value of the amount.

Assume continuous discounting. The present value will be:

Rs = R(t)e-it (A.3)
5 A3










- 23 -


According to the maximization rule, we need to set the change

in the present value for the state (Rs) equal to zero:
-it -it
d Rs = R(t)(-ie )+R'(t)e = 0 (A.4)
dt


Dividing through by e-it we get

R'(t) = i R(t)

or i = R'(t) (A.5)
R(t)

We may interpret (A.5) as the percentage rate of growth. In

essence, what the above suggests is the following: A state could

maximize the amount it will get from the RDF if it takes its money

at the time when the percentage rate of growth of the value of the

contribution equals the alternative earnings (of the contribution)

as measured by the interest rate. If R(t) is known, the contribu-

tion-maximizing time, tl,is easily derived.










- 24 -


REFERENCES



(1) East Caribbean Common Market, Annual Digest of Statistics,
The Secretariat, St. John's, Antigua, 1975.

(2) Fisher, Irving, The Theory of Interest, New York:
Augustus M. Kelly, 1930 [First Edition].

(3) Goetz, Charles J., "Federal Block Grants and the Reactivity
Problem," The Southern Economic Journal, July, 1967.

(4) Jones-Hendrickson, S.B.., "The Role of the Public Sector:
A Caribbean Perspective," Department of Economics,
University of the West Indies, Jamaica, April, 1986.
[mimeo].

(5) Jones-Hendrickson, S.B., Public Finance and Monetary Policy
in Open Economies: A Caribbean Perspective, Caribbean
Research Institute, College of the Virgin Islands,
St. Thomas, USVI, October, 1979.

(6) Musgrave, Richard A. and A. Mitchell Polinsky, "Revenue
Sharing A Critical View" in Financing State and
Local Government, Federal Reserve Bank of Boston,
Conference Series No. 3, Boston, Massachusetts, 1970.

(7) Odle, Maurice A.,"Guyana Caught in an IMF Trap" Caribbean
Contact, Vol. 6, No. 6, October, 1978.

(8) Pechman, Joseph A., "Revenue Sharing Revisited" in Financing
State and Local Governments, Federal Reserve Bank of
Boston, Conference Series No. 3, Boston, Massachusetts,
1970.

(9) Silberberg, Eugene, The Structure of Economics: A Mathematical
Analysis, New York: Mc-Graw Hill Book Company, 1978.

(10) State of St. Kitts-Nevis-Anguilla, Annual Digest of Statistics
for 1977, Basseterre, St. Kitts, 1978.




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