The ‘golden mean’ for this Budget

All eyes are on the Union Budget of February 29, 2016. There is a strong school of thought that the Finance Minister (FM) should focus on the need to accelerate the real GDP growth rate. There is a not so popular school of thought that the FM should stick to the path of fiscal consolidation. There is also a school of thought, which has inadequate support, that the Budget should give overriding importance to distributive justice. In dealing with this ‘Impossible Trinity’ the FM needs Aristotle’s Golden Mean.

As global economic growth is in the doldrums, India’s growth rate, projected at 7.5 per cent in 2015-16, is the highest in the world. The FM has expressed the aspiration of attaining a 9 per cent growth rate. India, however, faces falling savings, declining exports and hesitant corporate investment.

Since, private investment is languishing, it is advocated that public investment should be stepped up. It is felt that if the government pushes up public investment, private investment sentiment will change and a virtuous cycle of high growth will be unleashed. Historical evidence points to the need for 3.5-4.0 per cent investment for growth of 1.0 per cent. Thus, to step up the growth rate by 1.5 per cent the investment rate would need to grow by 5.25-6.0 per cent, which is clearly outside the realms of reality.

What renders such a high growth unattainable is that there is strong support across the political spectrum to keep lowering interest rates which adversely affects savings. With global financial instability there are signs of turbulence in international portfolio capital outflows from the Emerging Market Economies (EMEs). China has experienced very large capital outflows. We in India need to recognise that sooner or later there will be large portfolio capital outflows from India.

India would be well advised to hold the growth rate at around 7.5 per cent in 2016-17--what trade cycle theorists call ‘creeping along the ceiling of growth’.

For the past twenty years India has been considering fiscal consolidation. This was enshrined as an objective for the Centre’s gross fiscal deficit of 3 per cent of GDP under the Fiscal Responsibility and Budget Management Act 2003.The record since 2003 has been that each time the government has been on track to achieve this target, the government has been overtaken by events and the deficit has increased.

The present projected path of fiscal consolidation is a deficit of 3.5per cent of GDP for 2016-17 and 3.0 per cent for 2017-18.The corporate sector viewpoint is that if a growth rate 9 per cent increases the fiscal deficit in 2016-17, so be it.

The underlying fear is that with the new GDP series, the nominal GDP in 2015-16 will be close to the real GDP, implying a GDP deflator of zero. With the absolute GDP number being very large, small changes in the GDP numbers can affect the ratio of the gross fiscal deficit to GDP. In the column of October 30, 2015, it was suggested that a better indicator would be the Gross Fiscal Deficit to Total Expenditure ratio which, for 2015-16, was budgeted at 31.2 per cent. It is this ratio which should be monitored and brought down.

The dilemma before the authorities is that the pressure groups which are powerful want the government to step up public investment without a commensurate increase in taxation. It is in this context that unhealthy measures are resorted to like forcing public sector units to transfer higher profits to the government and other skillful fiscal jugglery to show a lower deficit.

There are strong pressures for a phased reduction of the corporation tax from 30 per cent to 25 per cent. While the government has, in principle, agreed to the phased reduction, with the proviso that exemptions would be phased out, in practice there would be stiff resistance to phasing out exemptions.

The lower petroleum prices and the move to Direct Benefit Transfer (DBT) will result in very large savings on subsidy. Likewise, the move to DBT for the food subsidy will result in very large reduction in subsidy payments. The powerful elements would lobby to channel these savings into public investment to revive corporate investment.

In this context there is a need for a serious review of distributive justice. It is articulated that if the general exemption for individual income tax is raised from ₹2.5 lakh to ₹5.0 lakh the loss of revenue would be ₹15,000 crore which the government would not be willing to lose. Furthermore, it is argued that such an increase in the general exemption limit would put 90 per cent of the present income tax payers out of the tax net. It is further argued that these tax payers pay only 10 per cent of the total income tax collected. The flip side of this argument is that there would be very large reduction in administrative costs.

Distributive justice calls for Aristotle’s Golden Mean. As a minimum, the general income tax exemption limit could be raised from ₹2.5 lakh to ₹3.0 lakh, with a commensurate increase for senior citizens. Again, a part of the savings in subsidy should be used to provide a large subsidy for pulses which is an overriding priority. There have been demands for increasing the 80C concession, which is ₹1.5 lakh now. As a minimum the National Pension Scheme (NPS) should be given a separate ₹50,000 exemption in addition to the 80C exemption. Further, the NPS should be moved from the Exempt- Exempt- Tax regime to an Exempt- Exempt- Exempt regime. To sum up the weaker segments of society should not be forgotten.

The writer is a Mumbai-based economist

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