August 01, 2020
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That Fine Balance

The economics of political credibility is the tone of the budget

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That Fine Balance
The intense pre- and post-budget debate is an indicator of the vibrant Indian democracy. Taxes and expenditure are the primary means by which the government takes from some and gives to others. It's a delicate task, as few want to give and most want to get. The elected government is supposed to implement the will of the people and the people have every incentive to oversee and influence the process. Since the FM has used the tax bonanza in handouts that target different groups of voters, it's a common reaction to call the budget 'populist'. But inclusion is a valid task of government. And people have an intrinsic sense of fairness—a thriving sector is willing to help one that is not doing so well. It only expects the help to be in sustainable and effective ways. Killing the goose that lays golden eggs or wasting its largesse leads to scarcity.

Fiscal policy has to make growth inclusive yet sustain it to reverse the threatened cyclical slowdown in industrial growth, while improving longer-run or structural growth prospects. How well has the budget tackled these tasks?

There has been a fine balancing act. The saving grace is that much of the expenditure for target groups is in health and education, which can give them and the economy long-term benefits. Relief to taxpayers will put more money in their hands to spend, thus boosting industry and smoothing the cycle. The cut in excise duty benefits industry. The reduction in production cost reduces inflationary pressures, a major objective of the government.

For this year, longer-term structural FRBM targets are on track, but the FM has noted that to accommodate all the social sector schemes and the Sixth Pay Commission, it may need one more year to meet the revenue deficit target. After the pay commission award, he will ask the 13th Finance Commission to suggest a new roadmap for fiscal adjustment. More government spending and some relaxation in deficits are acceptable to stimulate the economy during a slowdown. But given the cost-push inflationary factors, the spending must also expand supply. Thus, investment in infrastructure, health and education are valid targets for expenditure. But benefits will accrue only to the extent delivery improves. Here the budget takes some useful initiatives combining the carrot and the stick. States are to be given supplementary funding for schemes depending on achieving their quantitative and qualitative targets. A monitoring mechanism is to be set up to include better accounting, management information systems and independent evaluations by research institutions. This is to be completed by the mid-term review of the 11th Plan. The attempt will be to measure outputs instead of the past focus on inputs. Since state governments have to deliver on most schemes, it is necessary to motivate them. The improvements following such conditionalities in the 12th Finance Commission award and in the Urban Renewal Mission show that measuring and rewarding performance does help. But effective implementation is the key.

Other good initiatives are pilot smart cards project in two states and shifting to specific from ad valorem duties on petrol and diesel. Direct cash transfers can circumvent leaking delivery systems, specific duties will not cause a rise in taxes when oil prices rise. The movement towards lower, uniform, broad-based taxes, which improve compliance, continues. There is some tinkering with sectoral taxes, but these are minor except for boosts to pharmaceuticals, small cars and textiles. The first has a logic given the emphasis on health, the last is an employment-intensive sector hit by rupee appreciation.

The FM has given some relief to exporters, but correctly notes that the net expenditure on accumulating reserves and sterilisation through the monetary stabilisation bonds is also an implicit subsidy to exporters. In its absence, the rupee would have appreciated even more. There is some restructuring of taxes for the financial sector and positive initiatives for development of derivative markets. Higher short-term capital gains tax will encourage longer-term investments.

The loan waiver to farmers amounts to about one per cent of gdp and is affordable when the tax/GDP ratio has risen to a buoyant 12.5 per cent. It's not clear how the burden is to be shared between the taxpayer and banks, but banks will probably be subsidised above non-paying loans they had already written off, thus strengthening their balance-sheets. But the waiver is disappointing in the absence of attempts to link it to improving the structural conditions that create indebtedness. Thereby hangs a tale of two committees whose recommendations have been selectively implemented—an example of poor economics that can destroy political credibility.

(The author is a professor at IGIDR.)
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