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M Govinda Rao: Balancing growth and stability

The FM has done a fine balancing act of giving a thrust to growth while trying to contain fiscal imbalance

M Govinda Rao 

The Union Budget for 2009-10 presented by the finance minister is on predictable lines. Surely, the finance minister has done a fine balancing act of giving a thrust to growth while trying to contain fiscal imbalance. The fiscal deficit relative to GDP is estimated at 6.8 per cent and the revenue deficit at 4.8 per cent. Despite constraints on resources, the Budget has attempted to increase capital expenditure by 26.8 per cent over the 2008-09 revised estimates, and plan expenditure is proposed to be increased by 14.9 per cent. There is an attempt to augment infrastructure spending through PPP with IIFCL enabled to refinance 60 per cent of commercial bank loans to infrastructure projects. As expected, a higher allocation has been made for various flagship schemes. There is a promise of moving over to the nutrient-based fertiliser subsidy regime and of reviewing the pricing policy on petroleum products. The commitment to switch over to GST in April 2010 is important. The attempt to achieve a measure of convergence in tax rates is a move in the right direction. As expected, the Fringe Benefit Tax and Commodities Transaction Tax have been abolished, though the Securities Transaction Tax continues. There is a commitment to move over to a simpler and broad-based tax regime in the next five years. Most of all, there is a measure of realism in the Budget and that will go a long way to reassure the international community.

Despite the positives, high fiscal deficit is a matter for worry. The fiscal deficit of the Centre alone is estimated at 6.8 per cent and with the states enabled to borrow about 3.5 per cent of GDP (4 per cent of GSDP), the consolidated deficit will be 10.3 per cent. Thus, for the second year in succession, we have a deficit of over 10 per cent. When the household sector’s financial savings is just about 11 per cent of GDP, borrowing of this magnitude leaves very little savings available for the corporate sector and this will exert significant pressure on interest rates, unless the Reserve Bank creates additional space through Open Market Operations and reduction in the CRR. The revenue deficit at 4.8 per cent comes on the back of 4.4 per cent last year and this adds to the concern.

The finance minister’s assurance to initiate a process by which tax collectors will work like honeybees collecting nectar from flowers without hurting them, but spreading their pollen to help them to bear fruit, is reassuring. An efficient tax policy is one which minimises the cost of collection, compliance cost and cost in terms of distortions. Indeed, the attempt to unify the excise rates at 8 per cent is a measure in the right direction. However, selectively reducing customs and excise duties does not further this cause. Surely, it is necessary to reduce customs duties generally, but selective reduction on LSD panels and set top boxes does not make sense. Similarly, the list of exceptions for having a lower excise duty rate will only complicate the tax system. The objective of the tax system is to raise revenue and loading it with many other objectives will complicate the system.

One important measure the finance minister could have initiated is to move from selective taxation to general taxation of services. That would have helped in making a smooth transition to GST. Introducing a service tax on railway freight is a major step in the right direction, but it still is a selective tax. General taxation of services would have helped to minimise the administrative problems, helped to provide general input tax credit for all services and helped in the evolution of GST at the manufacturing stage by the central government by April 2010, even if the states do not get ready.

This brings us to the preparedness to levy GST in April 2010. As mentioned above, the commitment to move over to the GST regime is important and hopefully, both the central and state governments will make earnest efforts at preparing for the same. However, experience shows that we do not act until it is absolutely imperative. For this reason alone, a reiteration of the commitment is important. However, the introduction of GST requires constitutional, policy and institutional reforms and it would be too optimistic to expect them to be completed within the next nine months. The Constitutional amendment to enable the Centre to tax beyond the manufacturing stage and empower the states to levy taxes on services; an agreement to share revenue among the states on taxes on services with inter-state scope; determining the revenue-neutral rates and compensation formula; training tax officials and educating taxpayers; and, above all, instituting the information system for tracing inter-state transactions are too much of an agenda to be completed within the time frame. Hopefully, the reiteration of the commitment will galvanise both the Centre and states to gear up to undertake such a landmark reform and help to move over to the new tax regime sooner than later.

On the whole, the finance minister has done his best within the short time period that was available to him. What is important is, unlike the 2008-09 Budget, the current Budget seems to be much more realistic. Over time, hopefully we will move over to a simpler and more transparent fiscal regime.

Govinda Rao, Director, National Institute of Public Finance and Policy

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First Published: Tue, July 07 2009. 02:10 IST