If India has to grow faster, States have to grow faster: Bibek Debroy

Half the States are growing at less than 6%, says the Chairman of the Economic Advisory Council to the PM

December 17, 2019 12:15 am | Updated 12:48 pm IST

To present the economic slowdown as a binary of structural versus cyclical or demand side-driven versus supply-side driven factors is completely unwarranted, says Bibek Debroy, Chairman of the Economic Advisory Council to Prime Minister Narendra Modi. In this interview, Mr. Debroy hints at expenditure cuts and reduction in personal income rate to 15% for some income brackets provided taxpayers agree to give up exemptions they enjoy currently. He also says a simplification of the Goods and Services Tax (GST) to fewer number of rates is likely to be taken up by the GST Council.

Is the economy in a slowdown or, as many well-regarded economists are saying, in a growth recession?

There’s no point of getting into the semantics of it because this year we are going to end with a growth rate of 5% or thereabouts. Next year it is going to be a growth rate of about 6%. That has implications for what can be done to raise the rates, the fiscal consolidation exercise, tax revenue and all of that.

There is no clarity or consensus both in and outside government on the reasons for the slowdown.

To present it as a binary of structural versus cyclical or demand versus supply-side driven factors is completely unwarranted. Let’s step back. For four successive years GDP growth was about 9%. During those four successive years, the exports-GDP ratio was about 20%. Exports grew 15% plus in dollar terms. Sometimes 19%. Sometimes even 20%. Back-of-the-envelope that means that at least 3 percentage points of the GDP growth were because of exports. If I take that away from 9%, I am at 6%. If exports are not doing well then [GDP growth would be 6%].

If you remove the railways and defence and stuff like that, 90-95% of national income is generated in the States. The data on the States’ GSDP [Gross State Domestic Product] is slightly dated but half the States are growing at less than 6%. You can’t expect India to grow faster than that.

If I look at the list of structural reforms — land, natural resources, labour, privatisation — all of those have been pending since 1991. If India has to grow faster the States have to grow faster. I am not for a minute denying the importance of the structural reforms. All that I am pointing at is that there are obstacles in the way of structural reforms. Sometimes the 7th Schedule [of the Constitution], sometimes legislation, sometimes the judiciary, sometimes the environment clearances. The tardy progress of the reforms in the past indicates that they are not that easy.

A large part of the growth in the last 15 years was driven by the financial sector. The heretical view is that the financial sector grew disproportionately high compared to the real sector. The financial sector is now slowing down to what the real sector warrants.

The GDP estimates for the latest quarter show that financial sector growth is holding up at about 6%. The manufacturing sector is the drag on the economy, having slipped into negative growth.

That’s why I said this is by no means a binary. If I look at the trend or make a general assertion, [I would] much rather get annual trends, than quarterly figures. Quarterly figures are never firm figures. They are all sorts of estimates. If I am to respond to the quarterly figures, large part of the growth has come from government expenditure. But there are limits to government expenditure. I am not even talking about a temporary deviation from the FRBM [Fiscal Responsibility and Budget Management Act], which is always possible in the current circumstances. But there are limits to [even that]. A large part of government expenditure is committed – salaries, pensions, interest payments, centrally sponsored schemes, schemes that are legislation-mandated… Government expenditure does not just mean Union government.

There isn’t much leeway with the Central government? The growth multiplier of expenditure by State governments is in fact twice that of expenditure by the Central government.

Precisely. So, we should be much more concerned with what the State governments are spending on.

Not much of a fiscal stimulus should be expected from the central government?

Depends on what we mean by fiscal stimulus. Traditionally, it means either taxes or expenditure. If I don’t slash expenditure, just because the denominator, i.e. the GDP, has declined, the deficit will be higher [because fiscal deficit is expressed as a percentage of GDP].

On the tax side, what items can be brought under GST is a decision of the GST Council. That leaves the direct taxes. The Finance Minister has said there is going to be a relook at the direct tax rates because the corporate tax rate has come down but the MSME [medium, small and micro enterprises] don’t pay the corporate tax rate, they pay the personal income tax rate.

However, as with the corporate tax rates, you cannot have reduced personal income tax rates and exemptions at the same time. Everyone who wants a fiscal stimulus says give me a concession for my sector — both on the GST and also on the direct taxes side. But if you do that you will never clean up the system that is discretionary and completely ad hoc.

So sensible fiscal stimulus can only be a reduction in tax rates. Direct taxes by their very nature have to have an element of progressivity. So, it cannot be 15% for everyone and you cannot have 15% and also have exemptions. You can have the cleaning up only if you let go of the exemptions.

So, exemptions on home loans, investments in provident fund and tax savers will be withdrawn?

All I am saying is that if you begin to have exemption A, there will be an argument for exemption B. Better to get rid of all. And I am giving you a choice: either you avail of the exemptions or you avail of the lower rate.

Isn’t it a contradiction to give a boost to consumption by reducing direct tax rates and at the same time raise rates of GST, which, being an indirect tax, is non-progressive?

The trouble is, we want GST to be simplified. [To] how many rates the GST Council will decide. Let’s say three rates. Let’s say [those will be] 6%, 8% and 12%. When Arvind Subramanian was the CEA [Chief Economic Adviser] he did some exercise that showed the average GST rate ought to be 16% to make it revenue neutral. Today, the average GST rate is 11.6% because a large number of items are at 0%.

To make the GST a simpler tax, the 28% [highest bracket GST rate] has to come to 18%, which everyone wants. But the 0% must also go up, which no one wants. I don’t think the GST Council has yet arrived at a decision. Newspaper reports suggest some items from the 12% GST rate bracket may move to the 18% bracket. And some items that are in the 5% GST rate bracket may move to the 12% bracket. In the midst of a growth slowdown, that’s a bad idea.

What do you recommend?

It’s the prerogative of the GST Council. A perverse incentive has been created by the compensation guarantee. We are stuck with it. If I were to recommend, I would say as an economist: to avoid complications, I recommend one single rate. If you want to address items for the poor, it is best not to do it through indirect tax policy but other means. But let us recognise that no country in the world has a single indirect tax rate. So, the best you can probably get is three rates — a standard rate, a higher rate for ‘luxury items’ and a lower one for merit goods.

Economists and technocrats speaking in responsible, measured tones are expressing concern and flagging the retreat of the optimism of 1991-2011.

One should not get swayed by the negative sentiments which are, in my view, disproportionately high compared to the macro. There macro story is still a very good one. It’s not a gloom and doom macro story. It’s a macro story where even 5 or 6% [GDP growth] may not be good enough for employment. That’s a legitimate point to make. Give the negative thing another two quarters, it will become fine.

There is an impression that the Central government has not fully comprehended the gravity of the economic challenges. And that it has little patience with technical economic analyses.

Sometimes what people really mean is, ‘I am not being consulted, therefore the government is not consulting’.

You just spoke of Arvind Subramanian’s GST recommendations being the right approach and yet they failed to guide decisions. The Finance Ministry could have persuaded the GST Council to see merit in his report.

The GST Council is a phenomenal success as a decision-making body. We are one of two and half other countries that have implemented GST of this nature. Others are all unitary GST. There are a whole lot of people out there in the world who think the Union government should behave like a dictator and ram it down throats.

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