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Parthasarathi Shome: The evolving fiscal stance

Fiscal consolidation based on curbing expenditure is a sensible move, but direct tax collection efforts also need to be strengthened

Parthasarathi Shome 

The 2010-11 Economic Survey and 2011-12 Union Budget have come and gone. The immediate reactions sought by media have dissipated. Now is the moment to deconstruct and thus view the overall fiscal stance that is emerging over the last few years through, and post, global financial crisis.

First, India’s fiscal developments reveal a relaxation in tax and expenditure efforts during the crisis followed by relative tightening after the crisis from 2010-11. Thus, consolidation is taking place during the current up-cycle. Overall, therefore, the stance has been counter-cyclical as it should be. And any overall fiscal strategy behind this has to be commended.

However, the total consolidation picture appears to be dependent somewhat on serendipity as non-tax revenue growth flip-flopped due to temporary gains from spectrum sales (Table 1, Row 2) and disinvestment receipts. On the expenditure side too, though efforts towards counter-cyclical policy in non-Plan current expenditure have been successful, (Row 5), Plan expenditure maintenance has been unstable over recent years. Of course, the finance minister expressed satisfaction in his Budget Speech that last year Plan expenditure was met.

The second good aspect is that post-crisis, in 2010-11 and 2011-12, fiscal consolidation is coming mainly from the expenditure side rather than from revenue (excluding the spectrum windfall) (Table 1, Rows 4 and 7). Academic research has shown that consolidation based on expenditure tightening is less recessionary than that based on tax revenue increases.

However, further scrutiny of the effort to reduce the fiscal deficit (Row 8) as well as the primary deficit (Row 9) indicates that, while fiscal deficit tightening, or reduction, turned out to be 1.3 per cent of GDP in 2010-11, it is budgeted to be only 0.5 per cent of GDP for 2011-12. One explanation for this tepid course of action is that there were no underlying discretionary tax effort or net revenue yielding tax measures in the Union Budget. Going deeper, since no net tax measures were taken, post-crisis, the tax revenue buoyancy is coming from economic growth rather than from tax effort. During the up-cycle, the lack of tax effort appears to be somewhat pro-cyclical and remains a challenge to be corrected in the 2012-13 Budget. A positive, and higher tax effort would enable a faster reduction in the deficit, and getting back on, and recharting the course of, FRBM quickly.

Further, whatever tax effort has been made in increasing indirect tax revenue has been given away through decreases in direct tax revenue. This is especially curious in an economy that should have been continuing to reduce its dependence on narrow production taxes while expanding the direct tax base even while reducing the headline income tax rates. And this would not have been a new direction since revenue reform had already made a solid start in this direction from 2005, tilting the revenue balance in favour of direct over indirect tax.

Indeed, the components of tax effort or buoyancy are widely different year by year (Table 2). Whatever the underlying explanations, overall it appears that varying tax policies have been employed through time, for example corporate income tax (Row 1) in 2011-12 and customs duty (Row 3) in 2010-11. The overall stance in the mix and sources of tax revenue change should ideally reflect a well-rounded strategy rather than a mere bottom-line. This should occur even if the DTC or GST is awaited since neither of them would represent an immediate solution to the right revenue balance between direct and indirect taxes. Indeed, no such calculation is known to have been conducted. Thus, the revenue mix and balance between direct and indirect taxes should be independently addressed and treated as another challenge for the 2012-13 Budget.

The third nice aspect in the 2011-12 Budget was the tightening of subsidies. This has been the case in all major subsidies and has taken place over recent years as revealed in the numbers (Table 3) for subsidies on fertiliser, food, and petroleum. This too is commendable.

However, the Budget might have been cautious on its allocation of petroleum subsidy in the prevailing global environment of escalating oil prices that might not abate for some time. Instead, it has shown a tightening of 0.22 per cent of GDP in petroleum subsidy even after experiencing a loosening of 0.26 per cent of GDP in 2010-11 (Row 3). It is this hue of optimism rather than judicious caution that is a bit worrisome in the Budget. It does detract from successfully garnering the confidence of analysts.

To sum up, India has been following counter-cyclical fiscal policy outcomes through, and post, crisis. This is a welcome overall policy stance. However, analysis reveals that some of it is chance. Also, discretionary tax effort is nil. It should be revived, and in such a way that direct tax revenue effort overcompensates indirect tax loss rather than the opposite way around as in the just introduced Budget. Subsidy policy is on the right track though realistic projections for petroleum subsidy are lacking in light of last year’s experience and in anticipation of the international petroleum environment that is emerging. It would help if the derivation of important Budget numbers are presented to Parliament as in mature and many emerging economies. This indeed remains another challenge for the 2012-13 Budget.

Parthasarathi Shome is Director and CEO, ICRIER. The views and opinions are exclusively those of the author

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First Published: Sat, March 12 2011. 00:32 IST