The Union government has done well to resist being dragged into “bhed-chaal” (following the herd) by blowing up its fiscal balance beyond repair in the hope of a steep economic recovery.
The case for continued fiscal rectitude
The fiscal deficit (FD) is on track to increase to Rs 12.5 trillion this year. The expected GDP (current terms) is around Rs 189 trillion, just 7% lower than last year, on the back of higher than targeted inflation. The FD will consequently remain within the 6.6% of GDP, the limit of profligacy, set by the UPA in 2009-10. Report cards matter.
Common sense dictates fiscal rectitude – but that is a rare commodity in our world of international templates. Reversing an economic recession, caused by supply-side disruptions from Covid, remains strongly dependent on the path that the pandemic follows and not the amount of cash thrown at the problem. Yes – cash helps to dull the human cost of disruption. But you must have it, to spend it.
Our past fiscal profligacy – running fiscal deficits routinely higher than target cannot be wished away until the accumulated debt is paid off. We have a poor track record of reversing fiscal deficits spikes quickly. Despite the competing fiscal requirements, our debt levels must be kept well below the red flag of 90% of a smaller GDP.
So, extreme care was advisable, and the Union government should be congratulated for having trodden the path most desirable from the public interest point of view. The first lesson is the government must stand tall and strong against the outcry of “market agents” looking for instant relief.
Diversified revenues build fiscal resilience
The second lesson in fiscal management is that, like Billionaires, the government must diversify its sources of revenue. Billionaires use multiple sources of income cleverly – profits (surplus in governments case); dividends; interest (RBI manages governments portfolio and our reserves); capital gains (selling the public sector or surplus land is a source); rent (revenue from use of spectrum) and royalty (extraction of mineral resources or monetization of other physical assets).
Against these six pillars of diversified income, consider how limited is the revenue basket of the government. Around three-fourths of its revenue come from tax. User charges account for another 17% and the sale of assets (disinvestment) another 10%.
In 2014 when the new Modi government opened its “Bahi-khatta” (accounts), there were high expectations that the sources of revenue would be diversified, and non-tax sources deepened. This is not yet reality.
Instead, the sale of assets has become an easy fallback as a proxy for diversification. Sadly, this line item is used as a budget-balancing device, rather than a source of sustainable revenue. This fiscal, receipts under the head “other receipts” remain minimal versus the overblown, never-before, target of Rs 2.1 trillion.
The virtues of revenue diversification are also visible in the contracyclical revenue from Union excise duties (High sin taxes imposed on alcohol, liquor and petroleum products). it is the only buoyant source of revenue this year performing 26% above last years’ receipts – a good example of a revenue source linked to an external benchmark (the price of oil for petroleum products) which allows the government to partly make up shortfalls in revenue linked to domestic factors.
Broadening the tax base can build fiscal resilience
Third, consider another factoid. By end September this fiscal (end of H1) GST collection was 24% lower than last year even though the economy (current terms) was just 13.3% lower. This speaks to the narrow base of GST, which excludes some goods; levies marginal rates of tax on most others, whilst gouging a few products like white goods and consumer durables.
If India had a better designed GST, with a uniform but low rate on all products, without exception, the revenue would have been resilient to downturns. Look to behavioral economics for the answer.
When people are tight for money, they postpone consumption of all those products and services where the tax paid is a significant portion of the cost to the customer and go for cheaper and lower tax substitutes. Consider the boom in low power scooters versus the slump in cars. This example illustrates that “tax gouging” works only in the near term with strong negative impacts on both sustainability and the resilience of tax revenues in a downturn.
Similar lessons should be drawn from the performance of the Income and Corporate Taxes, which are lower this year by 19% and 40% respectively than last year. (Note- Corporate tax revenue is also low because of a reduction of 5 percentage points in the basic rate this year). Lower rates and a broader coverage could have diversified the impact to sectors which have not suffered from pandemic dislocations to the same extent- like agriculture.
Needed a National Commission for cooperative fiscal federalism
India needs to reorder its tax architecture to make it simpler and more uniform. The best option is to legislate a national, political Fiscal Commission, empowered to determine all tax rates across the three schedules of the Constitution, subsuming thereby both the GST Council and the inter-governmental grants work of the constitutionally mandated, Finance Commission – a non-political, intermittent entity – out of sync with the spirit of “direct federal cooperation” as embodied by the new GST Council.
Equal voice and participation for all three levels of government in fiscal matters – via a Fiscal Council- can end the prevailing politics of “competitive immiseration” and generate the resources required to meet our aspirations -albeit in a fair, resilient and sustainable manner.
Also available at TOI Blogs November 29, 2020 https://timesofindia.indiatimes.com/blogs/opinion-india/making-revenue-resilient-lessons-from-half-yearly-fiscal-outcomes/