Finance minister Pranab Mukherjee will need to do some tightrope walking when he presents Budget 2010 on the 26th. On one hand, he has to ensure that the country returns to the path of fiscal consolidation and, on the other, that economic recovery is not stymied. On the whole, macroeconomic data and corporate results make a compelling case for a gradual rollback of some of the tax cuts announced starting December 2008 amid global recession, and the exercise could begin partial restoration of the across-the-board excise duty cuts.
The estimates of the Central Statistical Organisation (CSO) that the economy may expand by 7.2% in the current fiscal year further strengthens the case for withdrawal of the tax cuts. But complicating the decision-making is the lack of hard evidence that growth can be sustained even after the withdrawal of tax cuts.
While many economists are convinced that it is time to begin gradual withdrawal of the stimulus package in the process to return to fiscal consolidation, some others, including the countrys chief statistician Pronab Sen, have sounded a note of caution.
Dr Sen feels that the government should wait until May-end before deciding to withdraw some of the tax cuts, as a clearer picture on demand side would be known only by then. The revised numbers of GDP growth for the current fiscal year would be released May-end . Most data, such as the index for industrial production, currently available pertain to the supply side.
If indeed, demand was driven primarily by the stimulus, then its withdrawal would without doubt have consequences . Demand for many goods, particularly those that are price sensitive, may contract quickly if taxes on them rise.
That would not help either industry or the government. Also, the impact of disappointing monsoon on demand may be experienced with a lag, perhaps in the demand in the current quarter and the next.
Yet, there are several other sectors where demand would not be affected with a small increase in duties or prices. That should then make a convincing case for selectively increasing rate of duties on some goods.
The trouble with that approach is that it would seem like reversal of years of tax reforms reducing the number of slabs of tax rates. The finance minister would need to take a considered view, especially now that the Centre seems inclined towards a single rate for the goods and services tax (GST).
But the government must increase its tax revenues if it wants to keep up spending on social sector programmes as well as in creating infrastructure, while keeping the fiscal deficit under check. Disinvestment proceeds would help bring in more revenues, and so would auction of 3G spectrum , thereby reducing the need to borrow for spending on these projects.
Increasing tax revenues is important if the Centre intends to accept the recommendation of the Thirteenth Finance Commission (TFC) for transferring higher share of taxes to states from its collections. Devolution of taxes to the states deteriorated in the current fiscal year as Centres own collection of taxes remained below target.
There was a small impact in the last fiscal too as indirect tax collections plunged following the cut in tax rates.With states heavily dependent on central transfers to run their budgets, the Centre has to ensure states do not suffer for the third consecutive year and that they do not stray from the path of fiscal consolidation.
It is argued that the fisc will anyway look better next year, even if the government were to adopt a standstill approach on fiscal stimulus. This is because one-time expenditure such as the Pay Commission arrears will not recur next year.
Perhaps programmes such as National Rural Employment Guarantee Scheme may not need the support that it did this year if the monsoons are good and activities such as construction continue to improve. Improvement in the economic environment would anyway improve tax buoyancy. And thats something the TFC too has bet on, even though it is understood to have been fairly conservative in its estimates of nominal growth a difficult first year (2010-11 ) but growth gaining momentum by the fourth year (2013-14 ).
However, a standstill policy would raise doubts about the Centres seriousness to rein in fiscal profligacy. So act it must, to keep fiscal deficit at moderate level of less than 5%.