Ideas for a convention-breaking Budget
This should be an opportune time for investors to look carefully at how revenue collected by the government will be spent
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The Union Budget is expected to break many conventions, even down to the date on which it is to be presented. This should be an opportune time for investors to look carefully at how revenue collected by the government will be spent. We expect much analysis to be focused on tax laws and administration. But up to now, there has not been much debate on the expenditure side. After all, a rupee well spent is more important than an extra rupee earned.
First, we need to define what is the government’s objective? One way to consider this is to look at the government primarily as a service organization, i.e., the government needs to ensure the social and economic well-being of its citizens. Though these objectives are well defined, the means to achieve them need to be debated. Should the government own enterprises? Should it invest in infrastructure? Should the government favour one form of capital over another?
It is well established that the government should intervene only in areas where other mechanisms, such as markets, fail. Yet, we find the government spending a lot of money on economic activities. Although some sectors such as power generation, telecom and airlines don’t require any government funding, others such as railways and roads do. The expenditure on the latter sectors leads to a large drain on the government’s resources.
Let’s examine this further by looking at one such expenditure: viability gap funding, which encourages economic investments in areas such as road construction. Why fund this if it’s not viable? Why not charge the road user instead of making the whole tax base pay? Instead, the government should invest in beefing up regulatory mechanisms to provide clear and transparent rules so that private capital can be attracted to such projects.
A large amount of government capital is also invested in public sector undertakings (PSUs), which usually provide a poor return on capital as well as distort the industries in which they operate—discouraging private-sector investments. The government, in its ability to tax income of all corporations, is by default a one-third owner of all enterprises. Hence, the rationale for investing more in some of these corporations does not seem prudent.
These PSUs do fulfil social objectives such as employment generation and undertaking activities that are not economically remunerative. I would argue that employment generation should be an important objective of the government but that this goal can be achieved more effectively by means other than owning corporations. First, the government should increase its own employee base—direct or indirect—to deliver better service to its citizens. This could occur in areas of internal or external security, health care, education, regulatory infrastructure, or others. A good model of a service-led organization is the issuance of passports, where the government capacity has increased manifold by partnering with a private enterprise. For a country the size of India, there is no doubt that the number of ‘government service professionals’ can be increased to provide a better quality of life.
Second, by withdrawing from certain industries, the government will allow the private sector to compete without markets being distorted, thus providing significant employment opportunities. One can see this in sectors such as telecom, where the number of people employed today is substantially more than in 1990s.
Regarding the fact that the PSUs need to undertake social tasks such as providing railway services, which are not always economically remunerative, the government can apply surcharges. We see this in the case of telecom, airlines, and other sectors.
By privatizing PSUs, a large sum of capital could be released, which would improve budgetary finances and provide resources for improving social infrastructure.
Another area where India has suffered is from poor investment growth especially in the private sector. The two hurdles to overcome this seem obvious to me. First, the structure of the Minimum Alternate Tax (MAT) and second, the subsidization of debt capital. When a company undertakes large investments, it is often subject to MAT. Under MAT, the company’s reported profits are taxed where the depreciation rates are not as high as those used in its calculations. Thus, MAT acts as a major dampener on corporate willingness to invest.
Next, the subsidization of debt capital, by which interest is tax deductible while dividends are not, skews the capital structures of companies. They become more leveraged and are unable to take risks that are essential for investments to grow. By subsidizing debt capital, the government loses a significant chunk of tax revenue too.
To ensure the social and economic well being of citizens, the government should focus solely on areas such as health, education, security and regulatory infrastructure. It should aim to become a high quality service organization that employs a large number of people to ensure world-class public services for its citizens. Instead of allocating capital to economic projects or enterprises, it should lower the tax burden on the common citizen. This will increase their earnings and provide greater legitimacy for taxation. The increased earnings by households would then provide capital to private enterprises. These private enterprises would be answerable to their capital providers, while delivering economic services that are valuable for the country.
Huzaifa Husain, head-equities, PineBridge Investments, India.