MUMBAI: Finance Minister Arun Jaitley is an unlucky man having to prepare the Budget amid a slowing economy, falling revenue and rising debt. Lower crude oil prices and better-than expected revenue helped the government adhere to the fiscal consolidation path in FY17, but this year’s target is constipated due to demonetisation, GST, weak private consumption and investments.In the current context, Jaitley should work like a fiscal hawk, donning a fiscal straitjacket, but considering the election year, his government expects him to be bold, yet within the parameters of public spending. In other words, the biggest signal he needs to show is he can do things differently, perhaps beginning with taxes.
Cut, Cut, Cut Tax?
The ideal tax structure includes a broad tax base, low rate, minimum rate differentiation, simplicity and transparency. But despite efforts, our tax system doesn’t generate the revenue we need. The tax-GDP ratio was 15.8 per cent in 1992 when economic reforms were initiated, but fell to 13.4 per cent in 2002 and is now struggling to cross past 11 per cent, which was last seen in 2008.
According to M Govinda Rao, former member of Prime Minister’s Economic Advisory Council, the predicted value of tax-GDP ratio using per capita GDP at dollar exchange rate in place of PPP value for 2010 is 18.6 per cent. The low tax ratio is due to multiple reasons. All agricultural income is exempted, we have a narrow tax base, large amounts are held in tax disputes, there’s tax abuse by MNCs and of course poor enforcement.
Besides raising revenues, it is required to incentivise savings, promote exports, achieve balanced regional development, promote investments in infrastructure, expand employment, promote scientific research and development. Such vast objectives, which our tax system pursues is also its main drawback paving way for tax evasion and avoidance.In FY15, revenue foregone was a staggering `5,89,285 crore, while tax arrears accounted for over 5.1 per cent of GDP in FY14. Sadly, 86 per cent of this was held up in disputes. Rao believes, scrutinising tax preferences may enhance tax-GDP ratio by at least one per cent.
When tax revenue is less than desired, public spending is financed by debt, assuming it leads to additional economic activity. The prevailing low tax and non-tax revenue, weak capital receipts, slack in private investments and consumption compels us to borrow more, but at over 75 per cent of GDP, India’s debt is already higher than middle income countries (58 per cent).
There’s no fixed number on the level of deficit and debt, and countries borrow as long as the borrowed funds generate employment and income. That said, all debt has to be repaid through higher taxes or lower expenditure. Else, it leads to balance of payment crisis, forcing credit rating agencies to attach high risk perception tag that leads to higher borrowing costs. The continued spotlight on fiscal discipline is to reduce the government’s share in the economy and free resources for private investment, but economists say it will take another year for corporates to return to the investment binge.
One of the defining factors of the fiscal policy framework in FY17 was to increase investments to promote growth and increase expenditure on three broad sectors: infrastructure, agriculture and rural sectors. Thanks to buoyant tax revenues, achievement of estimated non-farm revenue (despite a shortfall in spectrum auction receipts), the government stuck to the fiscal deficit target of 3.5 per cent of GDP in FY17, while increasing allocations for expenditure.
Though the overall fiscal policy continued to promote growth and stability, amid sluggish private investments, FY18’s fiscal policy was guided by the need to revive growth, yet sticking to fiscal consolidation via increased tax collections. Last year’s budget thus focused on redirecting expenditure to promote growth and employment, with investments in infrastructure, social and rural development. But facts and fortune didn’t favour him, with indirect tax collections going upside down (due to GST), while non-tax revenue collections are falling by the wayside.
Curtailing expenditure isn’t the preferred fiscal path. The NDA government shifted focus from curtailing expenditure, but instead generate higher revenue to lower deficit. As such, the forthcoming budget may see Jaitley orienting broadly in favour of minimising exemptions and broadening the tax base.Also, a section of the economists believe, the tax-GDP ratio in the Indian context isn’t a good metric as GDP includes economic activities of unorganized/informal sectors, which may not be covered under the tax net.
Non-taxation of agricultural and allied sectors, relatively higher threshold for small scale industries and fiscal concessions in the form of exemptions for socio-economic are collectively dragging down tax revenue.The concept of a fiscal straitjacket constraining expenditure and borrowing to reduce deficit may not be advisable in a country that has excess unutilised capacity.