Modi takes charge of the budget

In the run up to the annual budget it is said the Prime Minister is engaged in reviewing the working of departments in eleven hour long meetings. The PMs brand managers possibly think this nugget will comfort the nation that all is well, now that the man at the helm has his hand on the wheel.

Sadly, the last time the Finance Ministry and the RBI stood aside in favor of political management of monetary affairs, in late 2016, it lead to demonetization which became the last straw on the camel’s back for an economy already undermined by a subterranean, loan fueled realty bust.

The annual budget, in the Indian context, is very much like what every middle class salaried household does towards the end of every month – prioritize what to spend in the last week and push low priority expenditure to the next month because revenue is generally inelastic.

Tax revenue and growth

Tax revenue is related to GDP growth. Significant changes in the tax regime or structural change in the economy can however disrupt the relationship if the two reforms are not aligned. For example switching to a universal tax regime across all goods with no exemptions can increase the tax share in GDP. Conversely, large exemptions from tax can reduce the tax share. Neither is intrinsically better than the other. Each context requires a unique set of tax policies to optimize sustainable tax revenue.

The gross tax revenue (including the states shares) to GDP ratio (GTR) for India remained between 8 to 9 per cent from FY 1999 to 2005. From FY 2006 onwards it shifted up to between 10 to 11 per cent. FY 2008 was a high point. Chidambaram’s daring “dream budget” which sought to increase revenues by lowering tax rates boosted GTR to 11.9 per cent.

Sadly, this was not sustained. It slid to a low of 9.6 per cent in FY 2010 but recovered to the 10 to 11 per cent range over the next decade reaching a high point of 11.9 per cent again in FY2019 – the last year that the late Arun Jaitley helmed the Finance Ministry. It seems the torch of a high GTR can only be handed over from one lawyer Finance Minister to another.

Elections and tax revenues do not mix well

Another characteristic of the GTR is a dip in the year after elections – as happened in FY 2000, 2005, 2010 and 2015. Maybe the tax people need to relax or possibly it is a learning curve effect as the new FinMin team settles in. Bottom-line, don’t expect a good outcome in FY 2020 – the current year. The likely ratio is 11.5 per cent.

Budget an instrument of political economy

But GTR and fiscal deficits are just technical jargon. The essence of a budget is political. In FY2021 politics shall dominate. State elections loom in Delhi and Bihar in 2020 and West Bengal and Assam the next year. The BJP is sensitive to election routs in the context of the recent reversals in Maharashtra and Jharkhand.

In political economy timing is everything. Today, India needs a strong dose of economic revivalism. Here are four initiatives Mr. Modi could consider.

Give the middle class a break

First, following the corporation tax breaks in this fiscal the Prime Minister must similarly reduce the effective income tax rate for the middle class in the next fiscal by ending the 4 per cent education and health cess. The revenue lost will be Rs 0.3 trillion. But the state governments will be relieved that their tax share of tax revenue is intact since cess accrues only to the Union government. Think of this as an equity and consumption enhancing initiative.

Encourage one time tax inflows

Second, the revenue loss of Rs 2 trillion due to a stagnating economy, lower corporation tax receipts and contracted household budgets for consumption can partially be made up by expediting one-time settlements of tax disputes on terms favourable to the assessee. Tax amnesties do the same periodically, so why not shore up the revenue receipts through negotiated settlements when we need them?

Revive MSME business revenues

Third, much of the economic recession is in the medium and small sector where business has had to rejig its business model to operate through banks rather than in cash. Reducing the GST tax hurdle they face, can help them transition to the formal economy. Currently 7 per cent of items are exempt from GST whilst 14 per cent of items are charged at 5 per cent GST. The 5 per cent slab should become the default rate for all items without exception. 43 per cent of items are charged at 18 per cent tax. These should be migrated to the 12 per cent tax slab which is currently applicable to 17 per cent of the items. The Sin Goods comprising 19 per cent of all items can continue to languish in the 28 per cent tax slab for the moment.

A medium or small industrial unit which shuts down and is not replaced by another supplier, means a triple loss from direct tax on profits and salaries in the entire supply chain and the loss of indirect tax revenues from reduced down-stream consumption by employees. Assess the sweet spot for gross tax buoyancy not “bean count” the accounting revenue lost.

Put cash in the pockets of the bottom one fourth

Finally, the allocations for the two primary direct transfer schemes – PM Kisan Samman (but only for farmers up to 2 hectares) and NREGA for landless workers must be doubled and speedily disbursed. In both, the objective should be to transfer at least Rs 50,000 per family annually to around 60 million discrete families – these are the bottom one fourth families by income.

Trade-off fertiliser and food subsidy with direct transfers; free agriculture from  export controls

The required enhanced allocation of Rs 2 trillion (Rs 1 trillion allocation already exists in FY 2020) can be adjusted against the existing budget outlays for petroleum – mostly for household gas and CNG used by taxis and fertilizer subsidy (together Rs 1 trillion) and by halving the food subsidy (Rs 1.84 trillion).

To pacify outraged “kulak” – large farmer interests, all export controls on agricultural products should be axed. Farmers should be free to export their produce and earn profits at any time. Domestic price line management for urban consumers can be done by the government, as was done recently for onions in a timely manner, by imported supply or by domestic purchase at the landed price of imported substitutes.

The priority during budget preparation for the top political leadership is primarily to be watchful on the growth, poverty and inflation metrics. Do nothing to kill growth. Keep poverty and inflation at bearable levels. Doing the plumbing correctly to achieve these objectives should be left to the specialist ministries.

Had we followed this approach from 2014, there might have been no need to burn the midnight oil in the dark of the hole we have dug for ourselves, whilst looking up at the distant, blue sky.