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Will taxes match Budget hopes?
July, 13th 2009

The Finance Ministers Budget speech kindled a great deal of interest among analysts and economists. The discussions range from whether the Budget has been too timid in respect of reforms to whether it has been too ambitious in undertaking several expenditure programmes without providing for resources raised by taxes or disinvestments.

One of the criticisms levelled by experienced economists is that in spite of the projected high fiscal deficit, the Budget statement assumes fiscal correction will return within the next two years. The fiscal policy framework in the Budget contains a medium-term fiscal policy statement, as per the requirements of the FRBM, which indicates the following:

A question has been raised whether these estimates present a too optimistic picture of correction for improvement in fiscal deficit as a result of revenue, mainly tax performance, over the next two years. A legitimate question is raised whether this improvement will be sustainable.

An expert says his analysis shows this improvement may not occur as during the past two years, in spite of high GDP growth, the fiscal deficit improved by only a smaller percentage than what was projected in the medium-term fiscal policy framework. The estimates in the Budgets medium-term fiscal policy are, in this light, unsustainable. In response, I would make bold to remark that the estimate for 2009-10 proceeds on the assumption that the economy is in the throes of a sharp slowdown. Going into the next two years, an increase in GDP and tax revenue from the low base of a slowdown is perhaps more likely than a rise in the similar period in a boom, which was characteristic of the previous 4-5 years. This is perhaps the base effect, which economists are familiar with.

Borrowings estimates

However, it is relevant to stress the critics point that the estimates of borrowings are, indeed, on the high side.

Borrowing by the Government of India can be from three sources the local market, namely domestic banks and insurance companies; RBI; and foreign sources. In any event, the extent of borrowings visualised in the current Budget is far too high to be met from the market.

Suggestions of monetisation have been criticised by monetary purists on the basis that it would lead to inflationary consequences. This may not be quite justified in view of the present negative inflation. The other source of borrowings is external.

It is surely not possible for the Government of India to borrow such large amounts externally, given the market conditions abroad and the fiscal indicators, which will definitely lower our rating.

Recourse to divestment

There seems to be no alternative to reconsidering the Budgets basic assumptions on disinvestment. Whether full-scale disinvestment can be taken up in the current political situation is obviously doubtful.

There is also the argument that if domestic investors are expected to take up the principal private share of disinvestment, there will inevitably be a pressure on local private-sector resources.

Therefore, disinvestment through foreign investors may be a preferable option. This will, of course, require careful packaging of the disinvestment proposal. There will likely be a great deal of political opposition from the radical elements of the Congress Party and its allies to such a proposal. This also underlines the need to proceed with the auction of spectrum, which was expected to fetch the exchequer non-tax resources of nearly Rs 50,000 crore.

Time for tax code?

The assumptions of Mr Pranab Mukherjees Budget that fiscal stimuli can lead to growth and, thereby, increased tax receipts are vulnerable to criticism.

These assumptions have to be realised through more effective tax administration, and care taken to see that tax revenues do not stagnate as a result of litigation and/or evasion.

In this context, Mr Mukherjees suggestions for a new Direct Tax Code seem to me a bit inappropriately timed. A revised tax code could mean extended litigation and loss of many tax assessments and revenues in the judicial process. The Finance Minister may like to consider the tax code proposal after a while, at least after the fiscal numbers stabilise and the economy is on the revival track.

There is also the fact that the proposed fiscal stimuli based on expenditures such as NREGS and urban renewal programmes cannot be easily turned off or revised. Fiscal stimuli should last for some time, until the economy revives. Once established, programmes such as food security and NREGS are difficult to roll back. The result may be mounting revenue deficit with increased borrowings unsupported by any asset build-up.

Aid of exports

Some critics have pointed out that the Budget does not adequately address the problem of balance of payments. The fact that the export sector has received very little attention in Budget 2009-10 is obvious.

While it is true that exports of both goods and services are dependent on international economic situation and the Government of India cannot do much to help, this however does not free the Government of its responsibility to introduce and sustain a policy framework tuned export revival.

One has the right to expect greater attention to ensure favourable conditions for our export industries, particularly textiles, leather and information technology. These challenges require specific attention from the Finance Ministry in the coming months.

The whole debate calls for a return to issues of fiscal as well as BoP sustainability. Some of the questions may well be referred to the Finance Commission, which is presided over by a renowned economist, Dr Vijay Kelkar, who is credited with the decision to bring in the FRBM Act.

He can also be entrusted with the task of reviewing the situation and indicating to what extent the Budget targets are sustainable in the present environment of global slowdown and accompanying domestic economic contraction.

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