Ashima Goyal

Budget wedded to short-termism

ASHIMA GOYAL | Updated on March 11, 2013

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The problem arises when tax concessions are used to placate FIIs, while burdening domestic businesses. The latter, in fact, are as mobile, even if over the longer run.

The focus of the latest fire-fighting Budget was on establishing credibility through meeting of fiscal deficit (FD) targets by the Government.

That, in itself, was no mean feat, especially when national elections are due in a year and given the current Government’s own past record at fiscal consolidation.

But much of what the Budget has resorted to are short-term measures that do not really provide a lasting solution to the current economic problems. As a result, it has left even foreign institutional investors (FII) unimpressed, despite the Government actually managing to achieve the fiscal targets they were themselves closely tracking.

This shouldn’t surprise; for, FIIs ultimately are looking at growth.

GOVERNMENT SPENDING

The last row of the table shows how even services sector growth has fallen in the last October-December (Q3) quarter, which has directly to do with a slowdown in government final consumption expenditure (GFCE).

During the third and fourth quarter of 2008-09 and the first two quarters of 2009-10 — the period coinciding with the global economic crisis triggered by the collapse of Lehman Brothers in September 2008 — the Government consciously resorted to a fiscal stimulus, manifested in high GFCE growth rates.

This stimulus was wasteful, in that it was larger than the increase in growth it induced. Even so, the profligacy kept growth going, by insulating the country’s economy from the global demand shock of that period.

To that extent, the current fiscal austerity, reaffirmed by the Budget, is likely to hurt India’s growth in the short-term, just as it is doing in Europe.

At the same time, the earlier GFCE growth largely involved an increase in transfer spending levels that led to a boost in demand for food items. However, institutional bottlenecks, especially in marketing of agricultural produce, meant that the supply response through induced rise in private investments was not commensurate with the new pattern of demand, even though farm output did rise.

As a result, a significant part of the fiscal stimulus got frittered away by inflation. A similar danger awaits the proposed Food Security Bill: Without reforms in delivery mechanisms, the legislation, which aims at covering 70 per cent of the population, would only maintain, if not worsen, the distortions that vitiate supply response.

The current official calculation appears to be that the reduction in GFCE and the fiscal deficit would create space for the Reserve Bank of India to cut interest rates, which will then induce a rise in private investment. But as interest rates fall, there is simultaneous need for other measures to boost financial savings. Otherwise, the already dangerously high current account deficit (CAD) in the country’s balance of payments may further widen, with the investment-savings gap, although an investment led rise in output does itself raise savings.

The inducements for savings in the Budget, however, stop short of offering schemes exempting tax at least at the points of investment and interest accrual. Such an exempt-exempt-tax regime (along with exempt-exempt-exempt for special categories such as provident funds, where even withdrawal is not subject to taxation) would have helped compensate for the attack that inflation has made on financial savings of households.

Instead, the focus has been largely on inviting short-term capital flows through tax and other inducements.

EXPENDITURE CREDIBILITY

The sharp brakes applied in the past few months may have hurt growth, but there are some hopeful auguries from the Budget. Even lower aggregate expenditures can deliver better growth if accompanied by appropriate restructuring of government spending.

The growth in aggregate (22.3 per cent) and sectoral Plan outlay targets for 2013-14 are high, when compared with the revised estimates for the previous year. But the latter, in turn, turned out much below the budgeted expenditure, so much so that a promised rise of 16.7 per cent ends up as a negative (-0.4 per cent) growth. At the same time, there was expenditure growth in areas such as health and education that build human resource capacities. The respective ministries here increased their spending by 7.5 and 11 per cent in 2012-13 and have, therefore, been awarded large increases of 31.5 and 17.2 per cent for the coming fiscal.

Ministries always tend to delay and bunch their spending during the new last quarter. So, the rules that now put restrictions on expenditure in the last quarter have good incentive properties. Only those who spend are eligible for getting supplementary grants: The few departments that actually managed to spend their allocations have even found mention in the Budget speech.

Ultimately, spending the promised amounts is just as important for credibility as is reducing deficits. Ex-post accidental expenditure control, as opposed to proper ex-ante planning, assumes the analyst has limited rationality that does look beyond deficits. That is not at all the case.

TAXES

A dangerous element of short-termism comes in, when tax concessions are used to placate FIIs, while burdening domestic businesses. The latter, in fact, is also as mobile, even if over the longer run. FII inflows, on the other hand, may come in and finance CADs. But they, too, will depart, if growth and exports are seen not as reviving.

The Budget has missed the opportunity to really aim for a high growth-based expansion of the tax base, by aligning rates with that of other high-growing Asian economies. Without that happening, Indian exporters may, over time, well choose to export from more business-friendly locations.

The 15 per cent tax deduction allowance for investments of above Rs 100 crore made in the next two years and the proposed setting up of a Tax Administration Reforms Commission are, no doubt, good initiatives.

The latter should work towards removing the discretionary powers and incentives that have been built in to over-collect and then give tax refunds. Rather than terrorising law-abiding tax payers, it is time the lens turns on to high incomes that evade taxes.

(The author is Professor of Economics. IGIDR, Mumbai.)

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Published on March 11, 2013
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