Tuesday, February 10, 2015

Budget 2015-16: Some Suggestions


    This note makes suggestions on issues that either come directly under the purview of the Ministry of Finance or are closely related to it.  These include Fiscal Deficits, Taxation, Expenditures and Subsidies and Financial Sector.  Though “Big Bang budgets”  have sometimes had policy announcements outside these areas, this is only successful if there is a great deal of confidence that the policy announcements will reach fruition & implementation. Otherwise they can do more harm than good.

Fiscal Deficit & Revenue Deficit

    The budget needs to stick to the Fiscal deficit targets (glide path for reducing FD) outlined by FM Arun Jaitly in his maiden budget, or risk losing credibility. It is equally, if not more, important however to achieve the original FRBM target of zero Revenue Deficit by 2016-7. These two together imply an improvement in the quality of central government expenditures with a shift from subsidies and current expenditures to investment-capital expenditures: In other words the reduction in revenue expenditures can provide room to increase investment in infrastructure while meeting the old fiscal deficit targets.[1]
    This will also create the confidence in the RBI to move aggressively on Repo rate reductions an easing of monetary policy to complete the “Macro Pivot” that the Indian economy desperately needs to stimulate demand for consumer durables (like automobiles, housing & home goods).[2]
   As a reduction in the revenue deficit represents an increase in public savings, this will help increase national savings and thus help slow down the rapid accumulation of foreign liabilities [increasingly negative Net international Asset (NIA) position of India] that has occurred since 2010 and minimize the probability of sudden stops in capital inflows.

New FRBM & Credit Rating

  India’s high fiscal deficit has been the major reason for its marginal credit rating (lowest investment grade: Moodys Baa3/S&P’s BBB-). Government may consider targeting a further reduction in the Fiscal deficit to zero by 2019-20 with the objective of raising India’s global credit rating. FM could announce his objective of raising India’s global rating by three notches to upper medium investment grade [Moodys A3 or S&P’s A-] over the next five years or so.  This would also need to be supported by a new FRBM with new FRBM targets to establish credibility and ensure a credit rating upgrade of this magnitude.

Tax reform

Administration, Appeal & Settlement

       What has been called “Tax Terrorism” by some and “harassment” by others, has been one of the contributors to the collapse of economic growth from 2011 to 2014. There is an urgent necessity for a dramatic overhaul of the entire system of tax administration, tax procedures and tax rules and of the review, appeal and rectification mechanisms. Based on the recommendations of previous committees on tax administration reform and the Government’s  E-Governance ideas, the FM’s budget speech could outline a credible road map for reform of the revenue administration and speeding up of the appeallate system. For instance recording of every decision of each tax officer, including those relating to tax demands, success of legal cases and years spent, would help analysis of outcomes of these decisions with a view to continuous improvement.  It is important to demonstrate quick, fair & effective tax justice for all actual & potential tax payers.

Goods & Services Tax

  The FM can spell out a road map for GST and set in motion any changes in administrative structures/systems that will be required for the GST. He could also start modifying Central Excise/ VAT/ Service tax rates to close the gap with rates that will be required under GST.

Customs Tariffs & Duties

     Inverted duty structures arise whenever selected products are allowed below the average/median rate which is currently close to the general peak tariff rate of 10%. The IT zero agreement reduced tariffs on many electronics final goods to 0% and therefore created an inverted structure in electronics. To the extent it is legally possible an effort must be made in the budget to move to a uniform 10% tariff rate by raising import tariffs that are below this rate and lowering those which are higher than this rate. This is the best structure for the “Make in India objective”
    Textiles and Agriculture are two major sectors of the economy, for which customs duty reforms lagged far behind the others. Textiles still has a complex mix of Specific and Ad valorem import tariffs that is a source of enormous corruption. This undermines/defeats any objectives that such a complex structure was designed to achieve. It would be far better to drastically simplify these rates. The ideal solution would be to eliminate specific duties and unify Ad velorem rates at 10% (which is the general peak rate). The second best solution would be a uniform rate of 15% to be reduced to 10% in a few years. The third best would be to reduce the specific rates to 2-3 at most and eliminate them in next few years.
Agriculture is the only sector subject to Ad hoc bans on import and exports. I know from experience that these bans and their removal always come too late to benefit the farmer. These Ad Hoc changes usually benefit some favored intermediary. The consumer is usually saved from the worst excesses. The farmer can only benefit if there is a stable regime of import tariffs and export duties on the basis of which he can plan future crop patterns and investments for productivity improvement. The FM could announce his intention to eschew import-export bans (in future) and announce a committee to work out a structure of import tariffs & export duties that would balance the interests of farmers and consumers. If some reports/studies exist in the Ministry he could even announce some rationalization of tariffs & duties, for instance a move to reduce tariffs on all agricultural inputs (cotton, wool, silk etc) into manufacturing to 10%.

Income Taxes

   The Income tax law and rules are a ramshackle structure built over decades with new extensions added every year.  The original version of the new Direct Taxes Code, which I saw in 2009 as CEA, came fairly close to a simplified structure based on sound economic principles. There were a few minor items which could have easily been corrected. I understand it has lost some of its economic soundness and simplicity as it went through Parliament. However, the need for a new Income Tax law and simplified rules remains.  Some effort needs to be made to simplify the income tax on the basis of the principle of reducing ‘exemptions and deductions” and reducing marginal rates to produce revenue neutral change. 
The complexity and harassment is even greater with respect to business and corporate taxation, and a good budget must show some effort at simplification, particularly with respect to cross border entities and transactions.
One uniquely Indian anti-entrepreneur tax rule introduced in the last 3 years needs to be eliminated: That is to treat issue of shares of Start-ups to funders at a price above the face value (at which they are held by the start up entrepreneur) as short term capital gains on which a tax must be paid at time of issue.

Non-Tax Revenues

  Finance Ministry must continue to pursue the change in system for leasing national assets like spectrum, minerals, and land is done through transparent, competitive auctions. In the case of spectrum, this requires removal of artificial stipulations of minimum price (price of rural spectrum in many states is zero), freedom to trade or sub-let the spectrum to other qualified bidders and to ensure open access in areas where spectrum is surplus (e.g. many rural areas)


    With the abolition of National Planning and the Finance Commission recommended transfer of higher share of gross taxes, the Central Government should increasingly focus on subjects in the Central list and on public goods(& service) aspects of those in the Concurrent list. The division of expenditure into Plan & non-Plan should be re-classified into the economic categories of “consumption” and “investment”. These overlap broadly with the budgetary categories of “current” & “capital” with the major exception of expenditure on maintenance and repair of capital assets(which is a form of capital formation).  A serious effort must be made in this budget to change the expenditure mix from current to capital and thus reduce the revenue deficit.

Investment Expenditures

    The Central Government must focus its limited resources on classic “Public goods infrastructure”. These are parts of infrastructure in which social benefits far exceed private benefits or from which it is difficult or impossible to collect user or service charges on a sustained basis. Highways and roads, carefully selected rail lines & related signaling equipment and critical bottlenecks in Ports and waterways are already identified focus areas on which greater budgetary emphasis is needed. However, to successfully bring in complementary or supplementary private investment in “private goods infrastructure” the policy & regulatory environment must simultaneously be made more transparent and free of policy and regulatory risks.

Consumption Expenditures

        On the consumption side the focus has to be on the subsidy and other reforms already identified by the government should be pushed along by this budget: Drastic reform of Food Corporation of India and the entire procurement-PDS system can reduce wastage & corruption and make more funds available for investment. Initial steps could also be taken for shifting all metros/urban areas (given competitive supply of food grains) from physical supply to cash subsidies for food grain purchase.  Similarly, NREGA reforms to increase capital component and pay wages directly through Aadhar linked accounts could also change the mix.
        In Education and Health, Central Government should focus on preparing and propagating E-education and E-health systems and platforms that can be used in any/every State, it should focus on educating the educators, teaching the teachers, training the trainers and managers of (public & private) education and health systems across the country. It should focus much more on “Public health” & eradication of Communicable diseases and on “Public Education,” than on personal health & education. The “Swach Bharat” and “Beti Padhao, Beti Bacha” campaigns are good examples of this approach. The Skill Development Mission, including the need for Standardization and Certification of the thousands of certifiable skills, is another initiative that requires a much greater urgency and thrust to be imparted to it.


   The decision of the Govt. to increasingly transfer subsidies directly to intended recipients (without distorting prices of products and services) by linking them to the UID/Aadhar number is a very good one. Government has also accepted the advice to make the (cash) transfer payments through bank accounts.  If all subsidies including kerosene to the poor & fertilizer/Urea subsidies to farmers can be given directly, it will be a signal achievement of the government. The funds saved through reduced administrative costs and elimination of corruption can be used for job creating, productivity enhancing, infrastructure development.
The Aadhar authority needs to start analyzing all its records to eliminate duplicates and identify incomplete coverage. For the latter, one way is to compare with the digitized electoral roles with Election Commission. Second way is to aggregate UID Nos issued, by blocks and compare with population records from the last census, to identify areas that need special effort.
There are two non-conventional ideas that are worth considering & adopting. First is the use of cell phone based subsidy/transfer payment systems for reaching the poorest of the poor, given that 80-90% of the population has cell phones. In fact it would probably be cheaper to give all the ultra-poor a free cell phone than to ensure that they have usable bank accounts.[3]
Second, adopt a UID linked multi-application smart card (MASC) as a single unified platform for all subsidies, welfare and social schemes. Such a card can easily have slots for the poor’s entitlement to public education and government healthcare facilities or Govt. funded credit/debit limits for use in private facilities.[4]

Financial Sector

          The rise of NPAs in Public sector Banks (due to forced lending for infrastructure projects subject to Govt policy & regulatory risk) and the imminent necessity of introducing Basel III capital adequacy norms, makes capitalization of PSBs an urgent problem. The funding required has to be raised from the market. One possible solution is to set a dual limit: 51% for SBI and a few of the strongest & most profitable PSBs and 26% for the rest. Then sell shares in the latter to capatilise all PSBs to required levels (Many years ago a committee headed by Dr. Bimal Jalan had recommended lowering the limit for Govt. shareholding in PSBs to 26%).


    In his speech to the ET Global summit, the PM has laid out the elements of a New Development Paradigm, of Employment Generation and Empowerment of the Poor and Middle Classes.  The forthcoming budget should flesh this out and give it a more concrete shape.[5]


[1] During 2005-2008  an argument was made that subsidies for health & education should be classified as “capital expenditures” (as “human capital”) contrary to the accepted budgetary practice all over the World. The result of this exercise was not better health & education but a large increase in consumption expenditures that helped create the 2010-11 bubble and subsequent bust in economic growth.
[5] A New Development Paradigm: Employment, Entitlement and Empowerment, Economic and Political Weekly, Vol. XXXVII No. 22, June 1-7, 2002, pp. 2145-2154. https://docs.google.com/viewer?a=v&pid=sites&srcid=ZGVmYXVsdGRvbWFpbnxkcmFydmluZHZpcm1hbml8Z3g6MjQ4ODc3YWI2ZDcxZmE5NQ

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