 "Development strategy & Budget")
On February 1, 2019, the finance minister will present the final Budget of this administration. It should be an interim Budget as this is an election year and the regular Budget for the 2019-20 should be presented after the general election. However, Arun Jaitley will use this occasion to present a report card on the management of fiscal policy over the past five years. Judging by recent pronouncements, in a departure from established practice for pre-election budgets, he will also use the occasion to make some announcements of expenditure proposals and policies designed to win electoral support.
The report card on fiscal policy will focus on the goals announced in the two key policy statements on medium-term fiscal policy and on fiscal policy strategy that form part of the Budget documents. Looking at the text of these statements over the past several years it would appear that the primary goals of fiscal policy are a steady reduction in the fiscal deficit as a proportion of GDP, a rise in the tax/GDP ratio, simplification of the tax structure and improved compliance. The Budget this year will undoubtedly present suitably calculated numbers to show that the finance minister's five budgets have delivered on these goals. The question that needs to be asked is whether these goals are enough.
The tax/GDP ratio is a crucial component of grand development strategy. But there is little discussion on the pace at which this ratio needs to rise. Pressures for public spending on social security, health, education, and urban infrastructure will increase as the economy industrialises and urbanises and as rising prosperity raises people’s expectations of the quality of public services they expect. Hence a medium- and long-term assessment of desirable levels of public spending should be part of the publicly articulated fiscal strategy. These public spending responsibilities devolve on the Centre, the states and local authorities. Hence the long-term vision for fiscal devolution must also be part of the strategy.
A long-term vision for public spending can also help in a constructive use of short-term fiscal compulsions. A fiscal stimulus required for macroeconomic reasons can be an opportunity for supporting long-term development strategy. For instance, when a fiscal stimulus was required after the 2008 global crisis China raised spending by 3 per cent of GDP and South Korea by 5 per cent of GDP to accelerate research and development of industries based on technologies such as artificial intelligence, smartphones, solar panels, electric cars and wind turbines. This is now providing them with a strong capacity to challenge Western technological dominance. We, on the other hand, used the post 2008 fiscal stimulus to simply scale up spending on established welfare-oriented programmes.
Development strategy does seek to narrow income inequalities. Fiscal policy affects income distribution mainly through the direct tax rate structure and the concessions and subsidies in the Budget. The stated policy of the government on direct taxes is “to broaden and deepen the tax base while maintaining a moderate tax rate and gradually phasing out exemptions.” The basic 10-20-30 per cent rate structure of the income tax has been around for over two decades now and has replaced the more progressive tax structure that prevailed before the liberalisation of the nineties. Over this period personal income tax collections as a percentage of non-agricultural GDP rose from around 2 per cent in 2003-04 to 3 per cent into 2013-14 and further to around 3.5 per cent during the tenure of the present administration.
This does not suggest any dramatic improvement in compliance because of demonetisation as has been claimed by some. Moreover, the impact on income redistribution would be minimal even if all of the income tax collection were available for transfers to the poor. The fiscal concessions given to the taxpayers, the generous treatment of dividends and capital gains and the total absence of an inheritance tax suggest that neither this nor previous administrations have used the tax system for redistribution. The only instruments they have sought to use for this purpose are price subsidies and welfare programmes.
The report card on fiscal policy will focus on the goals announced in the two key policy statements on medium-term fiscal policy and on fiscal policy strategy that form part of the Budget documents. Looking at the text of these statements over the past several years it would appear that the primary goals of fiscal policy are a steady reduction in the fiscal deficit as a proportion of GDP, a rise in the tax/GDP ratio, simplification of the tax structure and improved compliance. The Budget this year will undoubtedly present suitably calculated numbers to show that the finance minister's five budgets have delivered on these goals. The question that needs to be asked is whether these goals are enough.
The tax/GDP ratio is a crucial component of grand development strategy. But there is little discussion on the pace at which this ratio needs to rise. Pressures for public spending on social security, health, education, and urban infrastructure will increase as the economy industrialises and urbanises and as rising prosperity raises people’s expectations of the quality of public services they expect. Hence a medium- and long-term assessment of desirable levels of public spending should be part of the publicly articulated fiscal strategy. These public spending responsibilities devolve on the Centre, the states and local authorities. Hence the long-term vision for fiscal devolution must also be part of the strategy.
A long-term vision for public spending can also help in a constructive use of short-term fiscal compulsions. A fiscal stimulus required for macroeconomic reasons can be an opportunity for supporting long-term development strategy. For instance, when a fiscal stimulus was required after the 2008 global crisis China raised spending by 3 per cent of GDP and South Korea by 5 per cent of GDP to accelerate research and development of industries based on technologies such as artificial intelligence, smartphones, solar panels, electric cars and wind turbines. This is now providing them with a strong capacity to challenge Western technological dominance. We, on the other hand, used the post 2008 fiscal stimulus to simply scale up spending on established welfare-oriented programmes.
Development strategy does seek to narrow income inequalities. Fiscal policy affects income distribution mainly through the direct tax rate structure and the concessions and subsidies in the Budget. The stated policy of the government on direct taxes is “to broaden and deepen the tax base while maintaining a moderate tax rate and gradually phasing out exemptions.” The basic 10-20-30 per cent rate structure of the income tax has been around for over two decades now and has replaced the more progressive tax structure that prevailed before the liberalisation of the nineties. Over this period personal income tax collections as a percentage of non-agricultural GDP rose from around 2 per cent in 2003-04 to 3 per cent into 2013-14 and further to around 3.5 per cent during the tenure of the present administration.
This does not suggest any dramatic improvement in compliance because of demonetisation as has been claimed by some. Moreover, the impact on income redistribution would be minimal even if all of the income tax collection were available for transfers to the poor. The fiscal concessions given to the taxpayers, the generous treatment of dividends and capital gains and the total absence of an inheritance tax suggest that neither this nor previous administrations have used the tax system for redistribution. The only instruments they have sought to use for this purpose are price subsidies and welfare programmes.
Illustration by Ajaya Kumar Mohanty
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