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February 18, 2015

Indian Economy|Public Finance

A Budget for the Aam Aadmi

By Nitin Desai


The Aam Aadmi  has delivered a clear message to the political class - we are the boss not you. Perform or perish. And as your boss we want a government free of corruption that delivers what we need - skill training and jobs, quality education and health care, clean water and sanitation, affordable housing, energy services at reasonable cost, safety and security in our streets and a climate of religious tolerance.

What should be the implications of this clear message on the tone and orientation of the forthcoming budget? How should the Finance Minister ensure that the messages his budget conveys are in sync with what his boss, the electorate wants?

Budget priorities are communicated to the 97 percent of Indians who do not pay income tax mainly through the expenditure proposals. The FM should protect public spending on health, education, skill development, water and sanitation and urban infrastructure. These are not areas amenable to the public-private partnership cop out that has been promoted so extensively. They require both public spending and institutional reforms to give the users far greater control over the public service providers. Fiscal conservatives can be placated with subsidy reform and direct benefit transfer.

Second, he cannot present a budget that focuses only on liberalisation for the corporate sector.  The overall message of the budget should be the freeing up of opportunities, not just for the corporate sector, but for small scale industries, public sector enterprises, State Administrations and Municipalities.

Third, it should have a convincing set of proposals for raising the rate of job creation.  The broader political context requires not just growth but growth that delivers new jobs and business opportunities quickly. The budget must show clear evidence of a shift in taxation and public spending towards employment and skills generation.

In doing all this the Finance Minister is caught between the fiscal prudence enjoined by the FRBM Act and by rating agencies and the demand for more public spending to fulfil poll promises and to boost growth.

The domestic macroeconomic environment  is more favourable than at any time since 2008. Investor sentiment has improved, the fall in crude oil and other commodity prices is hugely beneficial for the balance of payments and the budget and inflationary pressures have clearly abated.  It is time to take a few macroeconomic risks to kick start the growth process so that we can get back to 8-9 % growth in a couple of years.

The main adverse factor is a slow down in global growth and reduced spending capacity in the Middle East oil exporting countries which can affect our exports and remittances. Given this risk the central thrust of economic strategy at this point must be to boost domestic demand through public investments in infrastructure and fiscal measures to promote domestic manufacturing.

Tax concessions are a powerful way of conveying the Governments message on the orientation of growth. The present orientation is reflected in the budget estimates of revenue foregone. In the last budget the revenue foregone from concessions in corporate tax in FY 2013-14 amounted to Rs. 103 thousand crores or Rs.76 thousand crores after taking into account receipts under the Minimum Alternate Tax (MAT). The major items of revenue loss are accelerated depreciation (Rs.42 thousand crores), concessions to infrastructure, telecommunication power and oil exploration companies (Rs.24 thousand crores), concessions on export profits (Rs.16 thousand crores), backward area incentives (Rs. 8 thousand crores) and weighted deduction for R &D expenditure (Rs. 7 thousand crores).

The Government can convey its intentions by reorienting corporate tax concessions away from capital subsidies and linking them to current priorities viz. new job creation, investments to reach infrastructure to small producers and households and green growth.  This may be difficult to work out for the next budget and the Government can signal its intention to do so by the next budget.

Since this shift away from capital subsidies would also probably lead to a substantial reduction in the volume of tax concessions, the Government could also signal their intention to lower the corporate tax rate so that the effective incidence remains at the present level of  22-23%.

The budget generally includes specific changes in indirect tax rates to take into account various industry submissions. These changes are so diverse and itsy-bitsy that they do not convey a clear message. In order to strengthen the "Make in India" message the budget could lay down a policy framework calibrating import duties by stage of manufacture.  The higher duties on raw material imports may be accepted in the present environment of falling commodity prices. As for excise duties, the budget should avoid industry specific changes so that the prospect of a national GST is made more credible.

The case for change in income tax rates is weak as over the past decade the exemption limit has gone up five-fold and the rate at which the maximum rate applies has gone up more than six-fold, which is well beyond what could be justified by the rate of inflation.

The tax treatment of dividends received by individuals is quite regressive as the incidence of the corporate tax and dividend distribution tax is the same percentage of income received as dividend, for a pensioner getting a few thousand rupees and a billionaire getting crores. This needs to be corrected by eliminating the dividend distribution tax, adding dividends received beyond some threshold level to an assesses income and taxing it at the marginal rate.

This budget may also be path breaking in Centre-State financial relations with  the shift of responsibilities for plan grants and the recommendations of the Finance Commission. The theme of cooperative federalism must be reinforced by a decisive shift from scheme-wise conditional transfers to block grants.  The message on urbanisation should be made loud and clear through policy changes to promote municipal bonds. In order to provide the States with a one window contact, the budget could announce the formation of a Department of Federal Finance in the Finance Ministry. This will reinforce the  message of effective federalism that came out of the recent NITI Ayog meeting.

The FM has to present a reform budget - but it must be reform from the perspective of the Aam Aadmi and not just that of the corporate leaders and foreign investors.

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