The Hindu Business Line : Mini-Budget, and maxi impact

The Finance Minister's latest measures endorse his recognition of the strikingly strong economic link between personal consumption spend and fiscal robustness, and of the fact that the former has to outpace government consumption spend if the country's fiscal condition is to improve, says G. Ramachandran.

Consumer is key: Consumption, jobs, incomes and taxes constitute a virtuous cycle where a spur to private consumption is the surest way to achieve an array of social, economic and fiscal objectives.

WITHOUT a spur to private consumption there would be no spur to the production of goods and services. Where the prospects of growth in consumption of goods and services are dim, there would be little enthusiasm for increasing employment and investments.

And, without the spur to employment, there will be fewer `new jobs'. New jobs, `more jobs' and `more new jobs' are prerequisites for economic equity, and a surge in incomes, savings, investments and taxes. They are also prerequisites for new consumption.

If private consumption is the cause, then income is the effect. If income is the cause, then consumption is the effect. Consumption, jobs, incomes and taxes constitute a virtuous cycle where a spur to private consumption is the surest way to achieve an array of social, economic and fiscal objectives.

The mini-Budget, from such a perspective, signals an epochal change in the government's mindset in the context of economic management and making `economic growth' happen for the sake of people. It is not surprising that the mini-Budget has been described as a consumption-friendly initiative that is aimed at `wooing consumers'.

But the mini-Budget is certainly not a pre-poll ploy that is aimed at wooing consumers.

To understand why, we need to understand where taxes come from and how dependent the government is on private consumption. We need a change in our mindsets to reject the view that wooing consumers is good for winning elections and that private consumption is bad for fiscal soundness, stability and robustness.

We need a new mindset that allows an honest examination of how fiscal soundness, stability and robustness are logically and empirically dependent on private consumption.

Old mindset

We have lived amidst policy and propaganda for more than 40 years that subordinated private consumption to government consumption.

We have lived amidst policy and propaganda that regarded private consumption as the cause of fiscal infirmity and monetary turbulence. We have lived with the highest rates of excise duties, Customs tariffs and income taxes that were imposed with the assumption that public spending and government consumption funded from high tax inflows would lead to enhanced prosperity. But the result has been awful.

We live amidst significant private poverty and public prosperity. The per capita annual income of India's 194 million households is about $475, higher than that of 41 countries. However, there are more poor households in India than in all of Africa, Asia and Central America. The modal or most frequently observed income is about $100.

Where households derive incomes from the public sector, their per capita income is over $1,280. More importantly, their modal per capita income is over $510. But the public sector provides incomes to only about 10 per cent of the households. The private sector provides incomes to about 90 per cent of Indian households.

Where households derive incomes from the private sector, their per capita income is about $400, below the national mean. More importantly, their modal per capita income is about $100. Households that derive incomes from the private sector are awfully poor: they are at least five times worse off than other households.

Inescapable result

Despite the high rates of income tax, excise duties and Customs duties, fiscal soundness, stability and robustness have quite clearly eluded India.

Revenues to government are about 18 per cent of gross domestic product (GDP) and spending by government is about 27 per cent of GDP. The Central and the State governments earn about two-thirds of their expenditure. They accumulate a deficit of about a tenth of GDP each year!

But India is not a welfare state. It is an elitist state. Households in the public sector — about 10 per cent India's households — account for 26 per cent of total private final consumption expenditure (PFCE). Households in the private sector — about 90 per cent India's households — account for about 75 per cent of PFCE.

But the private sector is the net-net source of an awesome 97 per cent of savings and taxes that support government spending, consumption and investments in public infrastructure.

The high rates of income-tax, excise duties and Customs duties have not led to fiscal soundness, stability and robustness because they are derived from a low level of PFCE and low per capita PFCE. At the same time, high rates of income-tax, excise duties and Customs duties have constrained the growth of PFCE because government spending has merely been government spending. There has been little investment in public infrastructure.

Woo, woo, woo

Empirical evidence shows that economic reforms, in general, and lower rates of income-tax, excise duties and Customs duties, in particular, improve tax flows to government. "India Inc: World's `reforms' playmaker" (Business Line, January 2) provided evidence of the attractive benefits that government could derive from tax reform.

Corporate tax to capital employed by India's 250 biggest companies surged by 425 per cent between 1990 and 2003. Corporate tax to net sales surged by 230 per cent.

Low rates of income tax, excise duties and customs duties have the potential to cause fiscal soundness, stability and robustness. Their potential can be enhanced if aggregate taxes and duties can be derived from a higher level of PFCE and higher per capita PFCE. Since the private sector is the net-net source of an awesome 97 per cent of savings and taxes, it makes economic sense to expand PFCE.

It is reasonable to argue that policies aimed at boosting GDP and per capita incomes do not have finite starts and stops. If the mini-Budget can expand PFCE and lead to a higher per capita PFCE, an array of social, economic and fiscal objectives would be served.

From such a perspective, it would be absurd to assess the mini-Budget as a dubious tool and deceptive gimmick to win an election — now, in the near future or in the distant future.

It makes economic sense to boost private consumption and PFCE since PFCE is the most significant determinant of economic growth in India. The rank correlation between growth in PFCE and GDP growth at factor costs is 0.94 with a significance level above 0.002.

The chances that the Finance Minister, Mr Jaswant Singh, would have gone wrong by reaffirming his faith in private consumption to spur GDP growth are less than two in thousand.

New mindset

By contrast, the rank correlation between growth in government final consumption expenditure (GFCE) and GDP growth at factor costs is 0.22 with a significance level below 0.20.

The chances that India would err by betting on government spending to spur GDP growth are more than 800 in 1000.

Governments in the past have enhanced public expenditure with the hope that such spending would lead to a rise in private well-being and societal well-being around the time of elections.

GFCE in constant prices (1993-94) has grown from 5.82 per cent of GDP in 1960-61 to 12.68 per cent in 2000-01. In 1960-61, PFCE was 85.2 per cent of GDP. PFCE had declined sharply to 61.68 per cent of GDP in 2000-01.

The economic data over the last four decades show that the government's consumption interests have comprehensively prevailed over the citizens' private consumption interests.

Relative to the aggregate economy, GFCE has grown annually by 1.96 per cent over the last four decades. But PFCE has declined annually by 0.8 per cent. In absolute terms, GFCE has grown annually by 6.62 per cent over the last four decades. But PFCE has grown by 3.72 per cent annually.

The cumulative debt of government and the annual accretion to the fiscal imbalance show clearly that India has an unsustainable economic matrix comprising PFCE, GFCE, taxes and duties. PFCE growth has to overtake GFCE growth, and sooner the better.

Moreover, we have to come to terms with the empirical evidence that the private sector and PFCE are the net-net source of nearly all savings and taxes in the economy.

Therefore, it makes economic sense to push PFCE growth because government's income and India's fiscal robustness depend on private consumption.

If PFCE shrinks, inflows to government will shrink. India's fiscal condition would be aggravated. If PFCE were expanded, inflows to government will rise.

India's fiscal condition would be ameliorated. The Finance Minister has signalled his appreciation of the strikingly strong economic association between PFCE growth and GDP growth, and between PFCE growth and fiscal robustness.

(The author is a financial analyst. Feedback may be sent to indiagrow@sify.com)