Shankar Acharya: Budget 2016 - Stick to basics

By now, the finance minister has been inundated by advice, from within the government and outside. The counsel ranges from spending more to stimulate the economy to announcing major economic reforms. In truth, he should bear in mind four over-arching considerations.

First, the Budget is only one component of economic policy at his command; most of economic policy is conducted throughout the year and outside the Budget. For example, the successful legislative and administrative implementation of the Goods and Services Tax (GST) is likely to be much more important than anything in this Budget. Second, there is much merit in delivering on past Budget initiatives, such as the bankruptcy bill or the promise of corporate tax reform. Third, a Budget is more likely to be good for the economy if it sticks to basics: Moderate fiscal consolidation, sensible tax proposals and judicious expenditure programming. Finally, and perhaps most importantly, in a fragile global economic context, the Budget should err on the side of prudence. That said, here is a suggested list of "do's" and "don'ts".
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Some 'do's'

• It's best to take the finger off the "pause button" on fiscal consolidation and target 3.5 per cent of GDP (gross domestic product) for the fiscal deficit for financial year 2017. Well-known reasons include: Sustaining domestic and international policy credibility, the continuing (and enabling) windfall of low oil prices, the still high rates on benchmark 10-year government bonds, the expectation of larger state fiscal deficits from the UDAY (Ujwal Discom Assurance Yojana) programme and low nominal GDP growth complicating debt dynamics.
   
• Provided this moderate fiscal consolidation (of 0.4 per cent of GDP) is targeted, the finance ministry should negotiate a 0.25 per cent reduction in the repo rate with the Reserve Bank of India, to be implemented concurrently with the Budget. This will visibly improve the fiscal-monetary mix and boost investor confidence through demonstrated coordination between the government and central bank.
  

 

Deliver on the previous Budget's promise of reducing the company tax rate while making matching cuts in tax exemptions. A one or two percentage point reduction in the corporate tax rate could be done, but if and only if the matching exemption withdrawals can be executed.
 

In preparation for the long-sought GST, increase the services tax rate by one or two per cent, since the general GST rate will have to take account of the current non-taxation of services by states.
 

Announce a phased launch of a direct cash transfer (to farmers) approach to fertiliser subsidies. The current plant-based system suffers from major leakages (including smuggling to neighbouring countries) and has discouraged any fresh domestic fertiliser capacity creation for nearly 30 years.

 

Announce implementation of some of the recommendations of the Parthasarathi Shome Committee report on tax administration and the more recent Easwar Committee report on income taxes.

Some 'don'ts'

• The government has recently succumbed to steel industry lobbies and announced a set of "temporary" minimum import prices for some basic steel products, which were being "dumped" by Chinese producers. While this will undoubtedly be beneficial for domestic producers, it will inevitably raise costs for a range of domestic steel-using industries and render them less competitive for both exporting and import-substitution. Quite likely, they in turn, will seek protection ….and so on. This is the slippery slope back to the protection-ridden, high-cost economy of the 1970s and 1980s, not the highway to 'Make in India'. It is imperative that the Budget (and off-Budget government policies) resist further pressures for tariff and non-tariff measures to protect specific industries from import competition.
  

 

While several of the Easwar Committee recommendations merit support, the one suggesting a halving of the tax-deducted at source (TDS) rate for individuals to five per cent does not. The current 10 per cent rate (the entry rate for income tax slabs) is low enough. Further reduction will simply disrupt the smooth inflow of tax revenues throughout the year and complicate the management of government finances.
 

Every Budget announces some fresh excise tax exemptions and concessions. Surely, with the transition to a full-fledged GST likely within the year, the time is ripe to reverse the tide and severely prune the existing range of product and end-use specific exemptions and concessional rates.

 

Rumours are rife that the current system of dividend taxation (at the level of the company rather than in the hands of shareholders) may be tinkered with once again. In the past 20 years, we have flipped and flopped on this at least twice, but not, fortunately, in the last dozen years. Purely on the grounds of stability, predictability and massive administrative ease, it would be best to resist another flip…lest it become a flop.
 

As with every Budget there will be hopes and expectations for an increase in the income tax exemption limit from the current Rs 2.5 lakh. In a year of low inflation and serious fiscal pressure (from the Seventh Pay Commission award) there is little justification for such an increase.

 

Above all, the Budget should eschew adventurism in taxation. The retrospective tax amendments of 2012 are still taking their toll on business confidence in India. Nor did the earlier experimentation with financial transactions taxes (such as on cash withdrawals) and fringe benefit tax lead to anything but complexity, confusion and avoidable economic pain (with little revenue gain).

All this sounds pretty mundane and perhaps even boring. Where is the clash of cymbals, which might energise the party faithful and rekindle animal spirits? Well, sticking to basics does tend to leave out the drama. But, it might just make for a better Budget at this point in India's economic and political trajectory. Put another way, just as the Hippocratic Oath enjoins medical practitioners to "do no harm", so with budget-making. A finance minister who pays due heed to that principle, may also end up doing a power of good!

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The writer is Honorary Professor at ICRIER and former Chief Economic Adviser to the Government of India.
These views are his own.