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June 18, 2014

Indian Economy|Public Finance

Budget Imperatives

By Nitin Desai


The first budget of the new Government is eagerly awaited by stock market punters and corporate managers who have been greatly enthused by the electoral outcome. Middle class income earners will also expect some sign of fiscal benevolence.  However the Prime Minister's recent speech warning of tough measures is a good corrective to this expectation of a budget bonanza. What are the more specific signals that Arun Jaitley's first budget should convey and what are the temptations that he needs to avoid?

First, he must avoid the temptation to please middle class supporters with some big give away in the income tax. The BJP has won the election and  does not need to do this now. Save the  give aways for some later pre election year.

There has been some talk of raising the income tax exemption limit to as much Rs. 5 lakhs and the 80C exemption to Rs. 1.5 lakhs. There is no justification for such a largesse. If one looks at the IT exemption limit and the level at which the peak IT rate applies, the increases since 2004 have been way higher than what the inflation numbers could justify. Between 2004-05 and 2013-14 the exemption limit rose fourfold and the peak rate level rose sixfold while the CPI rose twofold. An increase in the exemption limit may not cost much in immediate revenue loss. But the reduction in the numbers in the tax net would go against the long term fiscal goal of widening the tax base.

The 80C exemption is an expensive concession and it's actual impact on the level of personal savings is questionable and needs to be studied carefully.  In fact the FM should signal his intention to examine the impact and the cost benefit ratio of all of the exemptions in direct  taxes, that, according to budget documents implied a loss of  Rs. 113 thousand crores against the direct tax collection of Rs. 564 thousand crores in the budget estimates for 2012-13. Expenditures or revenue loss of this order of magnitude require a justification that goes beyond casual empiricism and requires a more rigorous with and without analysis of impact on the target variable. Another matter which requires attention is the regressive nature of the present arrangements for dividend taxation.

The FM must signal a serious intention to contain fiscal profligacy by announcing a three year set of targets for tax-GDP, expenditure-GDP and the deficit-GDP ratios based on a realistic assessment of the pressures from the need to restore defence preparedness, improved policing and the forthcoming Pay Commission award. The best signal of a serious intention to control the deficit would be measures to cap open ended subsidies and tax sops. He must also give a clear timeline for the introduction of the GST and the Direct Taxes Code

The budget will have to show a beginning towards the goals that the PM mentioned in his maiden speech in Parliament about Swaccha Bharat by 2019 and a pucca home with electricity, piped water and sanitation for all by 2022. Hopefully this will be done without compromising on the need to contain the deficit.

A budget to put the fisc back on a sustainable track is not one for radical proposals. But the FM can signal his commitment to equity by starting a debate on the role of an inheritance tax in reducing inherited inequalities and encouraging philanthropy.

The signal that is eagerly awaited is what the FM will do to restart stalled projects and the investment growth engine. His Government has promised us job oriented growth and that too needs a budgetary signal. One is reluctant to suggest tax concessions in the present fiscal environment but some tweaking of regulatory provisions to expedite clearances, encourage venture funding, agro  processing and marketing and skill development would be welcome.  A liberalised system of bank loans to young persons for skill training or higher education would go down well with the youngsters who want opportunities not doles.

A major theme of the vision laid out by the Prime Minister is cooperative federalism. The budget must include some bold steps in this direction. At present responsibilities for Centre State finance are split between Finance Ministry, Planning Commission, sectoral ministries with large centrally sponsored programmes and RBI. These could be  consolidated in a Division or Department for Federal Finance in the Finance ministry which would provide a single stop contact for State finance officials on all Centre-State transfers and market borrowing programmes.  He may also indicate the Governments intention rationalise Centrally Sponsored Schemes and set up NDC Committee for this.

The FM is also the Minister for Corporate Affairs and in both capacities he must convey the message that crony capitalism is out and his Government is market-friendly rather than business-friendly. The difference arises because being market friendly involves doing things like enforcing disclosure norms, prosecuting wrong doers, opening up entry options and promoting competition which corporate owners and managers may not like. Ensuring competition involves more than the Competition Act and the Competition Commission. Many other policy areas affect the state of competition. For instance fiscal and trade policies may be discriminatory and favour some and discretionary allotments of natural resource rights may be distorted by favouritism or worse. A draft of a national competition policy is ready, one understands. The FM must announce the acceptance and release of this in his budget speech and establish arrangements to subject all policies to the test of fair and open competition. Nowhere is this more important than in the process the Government intends to follow in the allocation of rights to publicly controlled resources.

The election of this Government with a decisive mandate has generated a huge sense of hope, not just in the corporate board rooms which have been waiting for this for some time, but in millions of young persons who expect new opportunities to open up for them. They are not looking for doles and handouts but for a chance to acquire a skill, to educate themselves, to get a decent job or start some enterprise of their own.  The FM has the difficult job of responding to this spirit of hope and yet getting the country back on a more sustainable fiscal path. Good luck to him!

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