Budget-making needs to be disaggregated

It is time to rethink the need for an omnibus mechanism for the three distinct tasks that budgets encompass, and unbundle them so that we can do justice to each of the three tasks

It will soon be time for the Union and state Budgets, the principal rituals of the Indian fiscal system. The Budgets receive extensive media coverage and are given critical attention by experts and the laity alike.

Budgets, as presented in India, broadly encompass three distinct tasks. The first is a constitutional obligation of the Union or the state government under Articles 112 and 202, to present to Parliament or the state Legislatures — as the case may be — a statement of estimated receipts and expenditure for every financial year, called the annual financial statement. The second task is the delineation of taxation policy for that financial year — such as, for example, income tax or customs duty changes. The third is to review economic policy in general and make major policy announcements — disinvestment policy, for example.

These three tasks differ in terms of their optimal timing and frequency. The annual financial statement is a constitutional obligation, embodying the principle of legislative control over the public purse, which must be scheduled annually. However, the same cannot be said of the other two tasks.

As far as the delineation of taxation policy is concerned, there is no sound legal or economic rationale for tinkering with taxation policies or rates on an annual basis. It is a universally accepted dictum of public finance that a stable taxation policy with fixed tax rates over the medium term helps the actors in the economy — producers and consumers — to plan their actions (investment, consumption and saving) without worrying about the unforeseen impact of changes in taxation policy. This helps to optimise their decisions on investment and consumption, thus maximising the collective benefit for the whole economy.

The possibility of annual changes in taxation policy creates costly uncertainties in the calculations for prospective investment/consumption decisions, leading to sub-optimal results. Around the world, most developed economies have stable taxation policies and rates over the medium term. The United States would be a good example. US tax rates are, typically, coterminous with presidential terms. Annual tax changes may be the result of the government’s genuine concern for vulnerable sections (budget announcements of tax concessions), or they may be nimble-footed responses to changing economic conditions (changes in growth rates, inflation, natural calamities and so on), but they have their own attendant costs, as explained above.

Moreover, there is no logical reason why such exigencies must be addressed only at the time of the “annual budget”. If the proposed tax changes are really unavoidable and must be made in spite of the attendant costs, they should be made immediately, without waiting for the annual ritual.

Another point to be noted is that government expenditure as embodied in the annual financial statement is an instrument available to the government to directly intervene in certain selected domains of the economy that are impacted by such expenditure, whereas taxation policy is an instrument available to the government to indirectly intervene in every domain of the economy. The two have a very different nature as well as  extent of incidence, and hence, deserve separate legislative treatment.

Finally, the third task pertains to a broad review of general economic policy and the related major policy pronouncements. In general, policy should ideally respond to changing economic conditions on an ongoing basis. Clubbing various policy announcements to make them newsworthy for a “Budget speech” leads to two problems. First, such clubbing delays or advances the timing of such policy announcements and prevents optimally timed policy responses to economic realities from taking shape. Second, the clubbing of policy announcements in the “Budget speech” leads to a cumulative impact, which in turn creates a problem of policy discontinuity, or policy surprises.

Again, it is generally accepted that economic actors dislike policy surprises, because they throw their plans and strategies off track, requiring costly mid-course adjustments. For example, there is no good reason why policy changes relating to capital account controls should not be made immediately in response to diminishing or burgeoning foreign exchange reserves, but be made to wait for the next Budget. Similarly, new disinvestment policy need not wait for the “Budget speech”.

Last but not least, there is the problem of limited time in which the Budget proposals have to be discussed and approved by the legislature concerned, to provide funding for the government in the upcoming financial year. Due to the clubbing of three distinct tasks, with each requiring time for careful consideration, most of the expenditure demands (the first task) are “guillotined” — in other words, passed without any discussion. Further, economic and taxation policy proposals do not get the patient legislative deliberation that they require.

Our budgetary process has a lot of political glamour, with the briefcase-wielding finance minister and the halwa ceremony providing remarkable photo-ops. However, these come at a sizeable cost to the economy. It is about time that we rethink the necessity of such an omnibus mechanism for the three distinct tasks, and unbundle them so that we can do justice to each of the three tasks.

The writer is Deputy Secretary, Cabinet Secretariat. These views are personal