A fine balance on the Budget

Given the pressing need for financial prudence and the equally pressing need for increasing public investment, the Finance Minister needs to raise additional resources and rationalise and target subsidies.

It is Budget time again, and a lot of things have been written and spoken about what the Finance Minister should and can do. Indeed, every section of the community has expectations. No one wants to pay more in taxes and everyone wants more and better public services. While everyone wants to bequeath considerable wealth to their progeny, myopia sets in while it comes to government borrowing even as it involves a burden on the future generations.

Even in the best of times, Budget-making is a very difficult exercise in India. Given the depressing global environment, marked slowdown in domestic manufacturing and increasing expenditure demands, the challenges this year look formidable.

The spend-or-save dilemma

The revival of investment climate requires structural reforms besides substantially increasing public investment since private sector investment is stagnant. At the same time, the government will have to leave enough savings for the private sector to borrow at a reasonable rate of interest which requires it to contain its claim on the household sector’s financial savings.

In India, aggregate tax-to-gross domestic product (GDP) ratio is just about 17 per cent. Gross tax collection at the Union level is just a little over 10 per cent and after devolution, the Union government gets just about 6.5 per cent. With the non-tax revenue collections amounting to about 2.5 per cent, the total revenue available to the Union government is less than 10 per cent of GDP. This year, in addition to meeting competing demands from various departments, the Finance Minister is saddled with the problem of recapitalising the public sector banks which are saddled with huge non-performing assets, provisioning for pay revision and meeting additional requirements for “ > One Rank One Pension (OROP) ”.

It is therefore not surprising that the discussion has veered around the need to increase government expenditure even if this requires violating the fiscal deficit target. While the Chief Economic Adviser in his mid-year review and subsequently in various fora has strongly argued for increasing public investment by pausing once more on the fiscal deficit target, the Reserve Bank of India (RBI) Governor as well as the vice-chairman of NITI Aayog have emphasised the need to conform to the targets. The stance the Finance Minister will take in the Budget will be keenly watched.

Indeed, this is a major dilemma, but breaching the deficit target to increase expenditure is only an easy route riddled with serious repercussions. The problem is that at a time when the financial saving of the household sector is just about 7.6 per cent of GDP, even if the government conforms to the fiscal deficit target of 3.5 per cent, with the total deficit of the States at 2.5 per cent, the consolidated deficit will be about 6 per cent; the States have to take the additional burden of over 1 per cent of GDP under UDAY (Ujwal DISCOM Assurance Yojana). Additional borrowing will leave very little room for the RBI to reduce the interest rates, and even if it is forced to, the banks will find it difficult to transmit it to the borrowers simply because they will not have enough money to lend.

Furthermore, interest payments at the Union level are estimated at about 50 per cent of the net tax revenue and 40 per cent of its net revenues. With nominal GDP growing at lower than the real GDP, further addition to debt will increase debt-GDP ratio at a much faster rate. More importantly, there is the question of credibility. The government has paused four times since the Fiscal Responsibility and Budget Management Act was passed in 2003; it has redefined the targets and more often than not, it has observed the targets by breaching it. Credit rating agencies will be keenly watching the stance.

Raising additional resources Surely it is important to increase public investment to revive the investment climate, particularly when the global environment is fragile and exports are declining. Injection of additional expenditures through pay increases and the OROP provision will increase consumption demand. The way to increase public investment is to find other resources.

First, there is no strategic objective served by the government continuing to hold the stocks of blue chip companies under SUUTI (Specified Undertaking of the Unit Trust of India). Offloading this could yield about Rs.60,000 crore.

Second, the volume of taxes held stuck in disputes is Rs.5.8 lakh crore, and over 60 per cent of it has been in the last five years. Creating a mechanism to resolve the disputes, even if only 20 per cent of this is recovered, could fetch the government over Rs.1 lakh crore and, more importantly, it will create a more favourable investment climate. The Kelkar committee has provided useful guidance for reviving the public-private partnership projects, including the ways to deal with legacy issues and immediate implementation could untangle significant investments. As it is, the road sector has shown a good performance and the implementation of the Kelkar committee’s report can give it a further fillip.

Tax and expenditure reforms On the taxes front, > the Finance Minister in the last Budget has indicated that he will phase out tax preferences for the corporate sector and reduce the rate of tax to 25 per cent in the next three years, and his actions on these will be keenly watched. More importantly, the government will have to show its seriousness in introducing the > Goods and Services Tax by rationalising the excise duty and service tax structures. This requires, in the case of excise duty, pruning of the exemption list, reducing the threshold from the prevailing Rs.1.5 crore, limiting the list of items taxed at low rates to essential commodities and reclassifying them into general rate category, and unifying the rates of tax to two. In the case of service tax, the exemption list will have to be increased from the prevailing Rs.10 lakh and items in the negative list and exemptions will have to be pruned further. It would also be useful to merge the cesses and surcharges with the basic levy and make the general rates of excise duty and service tax uniform. I do not see much change in the personal income taxation though there may be marginal increase in exemptions and savings incentive.

On the expenditure side, the government will have to expand the > JAM (Jan Dhan-Aadhaar-Mobile) initiative and move over to cash transfers wherever feasible, particularly on items like gas and kerosene subsidy. The subsidies in 2015-16 are budgeted at Rs.2.43 lakh crore and actual outgo will be lower on account of low oil prices. Food and fertilizer subsidies continue to proliferate, and it is important to rationalise and target them. Increasing the price of urea is important not only to contain the subsidy but also to promote balanced nutrient intake. Unfortunately, the Union government has continued to expand centrally sponsored schemes rather than limiting them to a few meritorious services where the minimum standards of services must be ensured across the country. Perhaps, the Finance Minister should discontinue the less important schemes and fund those that are important adequately.

(M. Govinda Rao is Emeritus Professor, National Institute of Public Finance and Policy, and Non-resident Senior Fellow of the National Council of Applied Economic Research.)