Introduction
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.
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).
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)
Expenditures
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.
Subsidies
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.
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.
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%).
Conclusion
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.
