The forthcoming budget is expected by some to be ‘make or break’ or ‘path breaking’ , by others to provide a legislative or economic road map for the remaining term of the Govt. Most likely it will focus on issues under the purview of finance ministry, namely macro management, taxation, expenditure, financial sector and Balance of Payments.
The abolition of the Planning Commission and Finance Commission recommendations on tax devolution, together makes it possible for this budget to initiate a structural movement back to the principles of Federalism embedded in the constitution and its Central, State and concurrent lists. Though the Concurrent list gives overall policy responsibility to the Central government for many sectors, the administrative responsibilities have been fairly well defined. Thus the States are responsible for the basic Health, Education, Social Welfare (poverty) and Security (police) of the general population.
The Finance Commission recommendations to increase non-discretionary tax devolution by 10% points to 42% from 32%. This calculation accounts for the actual & potential revenue receipts and expenditures of the States on all sectors that are the administrative & financial responsibility of the States. This effectively means that instead of an extra 10% being channeled through the Central Govt and the (erstwhile) Planning commission into Centrally Sponsored Schemes (CSS) on Health, Education, Social Welfare, these funds will go as untied funds to States to allocate in the manner that they feel is most appropriate for their State. The budget will inform us how quickly the old schemes in these sectors are to be phased out or abolished. This is the essence of Federalism: Financial funds, allocation rights and administrative responsibilities must be located in the same level of Govt., whether it is the Center, State or Local Govt..
The fiscal recommendations of the Finance Commission, a constitutional body, has removed some of the uncertainty about government’s fiscal stance. The government now has clear backing to ignore demands for a fiscal stimulus beyond earlier targets of 3.6% in 2015-16 and 3% in 2016-17. It can also focus more strongly on reducing the Revenue deficit (RD), something I have argued for years. The RD mirrors the net dis-saving of the Central Govt. A reduction in the RD is therefore critical to raising the National saving rate. This in turn is linked to India’s net international asset position (NIA), stability of capital flows and the international credit rating of the country. The budget is expected to spell out its approach to Fiscal responsibility legislation and possibly to raising India’s credit rating over a decade.
The Growth rate of the Indian economy has accelerated by about 0.9% point in 20014-15 (compared to 2013-4). This is accompanied by (or partly due to) an acceleration in growth rate of private consumption growth and gross fixed capital formation. However, available indicators also show that the growth of demand for the corporate sector is weak. In the case of Automobiles, housing & other consumer durables, high real interest are an important contributor. A clear and credible fiscal consolidation path will make it imperative for the Central Bank to reduce high nominal policy rates that are partly responsible for choking consumer demand.
The budget is also expected to lay out a clearer approach to and road map of the Government’s new flagship programs, namely Jan Dhan Yojna, Sagar Mala, 100 cities, Digital India/e governance, e-health/education, Make in India, Skilling India, Swach Bharat(S) and Beti Bachao-Beti Padhao. The move from price distorting subsidies to direct transfers to deserving poor will gather steam and help reduce corruption & admin costs. The consequent fiscal space will be used to increase spending on public goods infrastructure that can attract complimentary job creating private investment.
Eliminating Tax Terrorism
Tax administration and appellate procedures, their speed and effectiveness, are known to be an important focus of the Govt., since the BJP manifesto used the word “tax terrorism”. Both domestic and foreign tax payers are looking for more concrete measures to further these objectives and end the anti-deluvian practices of the tax administration and their replacement by a more modern, accounts based customer focused approach. Business is also looking forward to Initial steps towards GST implementation, a clear statement on the simplification of Income taxes and the Direct taxes code. I am also hopeful the interrupted journey to a simple, uniform customs duty structure will resume. For instance the elimination of dozens of specific duties on textile products is overdue. Some steps towards rationalization of Agricultural import & export duties would also be welcome.
Minor Tax Sops vs Simplification
An interesting question is the extent to which, government will go back to the pre-1990s practice of using deductions & exemptions to stimulate demand for or investment in, certain sectors like defense, electronics, real estate and automobiles. I expect it to follow a middle path of some simplification coupled with modest incentives, which many budgets since 1991 have done. An increase in the housing (interest) deduction in the personal income tax can probably be justified on grounds of inflation adjustment and is likely to occur. Electronics suffers from an inverted customs duty structure because we bound ourselves to an IT0 agreement that eliminated tariffs on many final goods, but not on imported inputs. Tax incentive may be used for incentivizing job creation and employment opportunities in labor intensive sectors like tourism
As financial and external sectors come directly within the purview of the Finance ministry, I would expect the budget to address the legacy problems of the Public Sector Banks, such as the NPA’s incurred by them due to Govt. forced lending by PSBs to unviable infrastructure projects. These projects were recognized by private banks to have excessive policy and regulatory risks to be viable for debt financing. On the positive side one expects new policy and institutional reform initiatives relating to the financial and external sectors. For instance the stalled proposal for creating a global financial center in India, is likely to be revived in a new form. Similarly, some reduction of controls on the external/BOP account can also be expected.
Overall I expect the budget to give us a sense of the Govt’s approach to fiscal and financial policy and to give an indication of economic reforms to accelerate and sustain the growth of the economy, jobs and employment opportunities.
A version of this article appeared on the Op Ed page of the Indian Express on August 28, 2015 under the banner, “No Clean Slate.” http://indianexpress.com/article/opinion/columns/no-clean-slate-2/