Thanks to the IMF, rating agencies and incessant commentary by economic and other experts, public focus today is on the fiscal deficit, when it comes to the Budget. This is a welcome shift from cooking gas prices, which television had made people believe to be the touchstone for deciding the quality of a Budget. But that is not good enough. The size of the Budget matters.
Fret Not Over Fiscal Deficit
Before economic reforms began, the Union Budget used to be as large as 17% of GDP. Over time, it has shrunk to less than 13% of GDP. Only Pranab Mukherjee presented Budgets that were 14-15% of GDP, and that was because he ran up large fiscal deficits. The overall size of government spending matters, when it comes to giving a boost to the torpid economy. So, the first goal should be to make it big, say, 14% of GDP.
Wouldn’t that push up the fiscal deficit? Should Arun Jaitley walk the path trodden by Pranab Mukherjee? A larger Budget need not push up the fiscal deficit. A full percentage point of GDP rise in direct tax revenue can easily be expected in the next fiscal year, as a result of the goods and services tax (GST).
Right now, attention is focused on collections from GST, and how these have disappointed. But the tax will stabilise, as the GST Council irons out yet more wrinkles. But what is as significant is the multiplicity of audit trails that GST would generate, which taxmen could follow to hitherto hidden sources of direct tax.
Gross value added is the sum of gross profits and wages and salaries. This identity holds good at the level of the nation and at the level of the firm. What this means is that there are limits to how much a firm that pays GST can fudge its books to hide its profits, on which it has to pay tax. In addition, GST makes a firm yield pointers not just to its own scale of activities, but to the activities of those who buy from it and those who supply inputs to it.
Further, GST makes a slew of small companies that had evaded tax to start paying tax, both direct and indirect. Some would not be able to survive after giving up their erstwhile competitive edge, namely, tax evasion. This slack would be picked up by the organised sector, which does pay tax.
All told, the country is poised to make a big jump in direct tax collections, provided the direct and indirect tax departments talk to each other and deploy good information technology to analyse GST data.
Jaitley can use this realistic expectation to budget larger expenditure. But this apart, this is not the time to worry too much about the fiscal deficit.
Think Out of the Box
The fiscal deficit matters because it is a claim on the savings of the non-government sector. If this claim exceeds the spare savings the non-government sector has after meeting its own investment plans, there would be excess demand, pushing up prices and widening the current account deficit. But right now, the non-government sector is not investing much. Gross fixed capital formation is below 27% of GDP (both in current prices), 11 percentage points below the peak of 2007-08.
There is little risk of added government borrowings depriving the private sector of the savings to meet its investment plans. On the contrary, stepped up capital formation out of public outlays could crowd in private sector investment.
In an election year, it would be surprising if the government did not prioritise schemes that put money directly in the hands of the voter. Affordable housing is one area that can directly woo the voter with funds and, at the same time, create new demand for steel, cement and construction, boosting growth. Expect that to get a boost.
The lesson from Saurashtra is that rural distress is hurting the BJP. It is not surprising that the finance minister said recently that economic growth is not justified if it does not improve the lot of the rural poor.
So, the Budget would have lots of things to alleviate rural distress, apart from higher tax thresholds and a higher ceiling for tax-exempt savings, for the middle class.
Making good the difference between the minimum support price for crops and the market price is far superior to state procurement. The Centre could co-finance such a scheme with the states.
Get the Employees’ Provident Fund (EPF) and the National Pension System (NPS) to compete to generate higher returns on the retirement savings. Let them set up special situation funds to take advantage of one-off events. The sale of distressed assets that flow from resolving the banks’ huge burden of bad debt offers scope for windfall gains. Why should only foreign private equity gain from this? Why not the EPF and the NPS?
The tobacco industry has been complaining for long about smuggled cigarettes eating up their market. The government loses an estimated Rs 13,000 crore because people smoke duty-evaded cigarettes. Set aside Rs 1,000 crore as incentives for helping confiscate smuggled cigarettes. The lumpen unemployed would chase down smuggled tobacco and Revenue would get a boost.