How to grow out of deficits and debt

The country is preparing for a pre-election year Union Budget, and much is expected of the experienced Finance Minister. Would the rich be taxed further to narrow the deficits and woo the aam aadmi ? On fiscal prudence, an enlightening argument is presented by Evsey Domar, accomplished academician and central banker. To quote: “If all the people and organisations who work and study, write articles and make speeches, worry and spend sleepless nights — all for fear of debt — could forget about it for a while and spend even half their efforts trying to find ways of achieving a growing national income, their contribution to the benefit and welfare of humanity and to the solution of the debt problem would be far greater (Page 823, American Economic Review , 1944).”

INDIA AND THE REST

In 1992, the Maastricht Treaty sanctified the two ratios of fiscal deficit and debt to GDP at 3 per cent and 60 per cent, respectively.

There was, and still is, no theoretical literature to justify these ratios; fiscal pundits simply claim that these were based on select empirical literature.

The performance of India on various fiscal indicators has been mixed. The fiscal balance between 2006 and 2012, vis-a-vis other major countries, was not among the highest. And, the debt to GDP ratio has certainly been improving.

Contextually, in 2003, when The Fiscal Responsibility and Budget Management Bill was adopted by the Government of India, the combined GFD of the Centre and States was nearly 10 per cent and debt was 85 per cent of GDP. In 2012-13, the combined deficit is estimated to be about 7 per cent and debt-GDP ratio around 71 per cent. The improvement in the ratios has been mainly due to high growth recorded by the economy over the years (Table 2) .

The recently announced measures on prices of cooking gas, diesel and petrol would allow a further reduction in subsidies in the current year and beyond.

On raising taxes on the rich, the number of income tax payers in India, estimated at around 3.5 crore or about three per cent of the population, is less than the owners of cars, two-wheelers and expensive cell-phones, many of which are arguably provided by employers/firms.

TAXING THE RICH

Therefore, identifying the rich for higher taxation may not be easy. An easier way to raise revenue could be to tax those services which are generally availed of by the rich.

However, it is difficult to contain the spillover of such indirect taxes on to the aam aadmi ; these get built in the price spiral, because a lot of such conspicuous expenditure is incurred in the name of firms and companies.

However, it also needs to be conceded that most of the ‘rich’ are entrepreneurial in nature and instrumental in creating jobs.

Therefore, taxing them excessively could be counter-productive to growth. Rather, given the technological advancements, availability of Aadhaar cards, and in-principle acceptance of GM crops which raises income levels manifold, widening the tax base should be a priority.

GROWTH MEASURES

A still better alternative could be to make efforts to kick start the sagging economy. The government needs to think innovatively and out-of-the-box to spearhead growth, translating into higher employment, higher revenue, and lower ratios of debt and deficits. In view of the continuous slowdown in the global economy, export markets are not expected to be encouraging.

Therefore, the government should be looking inward at the domestic economy. Infrastructure and construction could be an area of continued interest. There is the example of China which has built an extensive infrastructure, boosting economic growth in the process.

On tourism, given that India is considered a low-cost destination, renewed international efforts through the Indian embassies could be explored, especially with respect to medical tourism. India can also attract international students to study in elite educational institutions, bringing in financial resources, giving a boost to educational tourism.

An important area to explore is the housing sector, which has inter-sectoral linkages with many other industries. There is a housing shortage for economically weaker sections of the society. In an election year, this could be a trump card.

A pre-election year Budget could be an opportune instrument to launch some of the schemes.

(The author is RBI Chair Professor, IIM Bangalore. Views are personal.)

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