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How to cut the fiscal deficit

How to cut the fiscal deficit
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First Published: Mon, Feb 22 2010. 10 13 PM IST

Illustration: Jayachandran / Mint
Illustration: Jayachandran / Mint
Updated: Mon, Feb 22 2010. 10 13 PM IST
There is now a clear consensus that the government will have to start getting its finances back in order in the Union Budget to be announced on Friday. Economic growth has already picked up and should soon be back to the levels we saw in the boom years. Sustaining this growth and maintaining economic stability will not be easy if the total government deficit stays above 10% of the gross domestic product (GDP) and public debt hovers around 76% of GDP.
The report of the 13th Finance Commission that is to be released on Thursday will chalk out a medium-term plan of fiscal correction, but finance minister Pranab Mukherjee will have to take the first steps in the new Budget.
Illustration: Jayachandran / Mint
That still leaves the debate open on how the fiscal deficit should be cut. Much of the discussion is focused on taxes. Around this time last year, the government had cut excise duties and service tax to prevent a collapse in growth. It is likely that the finance minister will begin raising them closer to their old levels.
However, that alone will not do. One myth about contemporary Indian economic policy is that these tax cuts were the main reason why the government deficit widened in recent years. This hides the more uncomfortable truth that the deficit—when measured correctly—had begun growing much before the global economic storm hit Indian shores.
The United Progressive Alliance had funded a huge farm loan waiver, increased salaries of government staff, poured money into the National Rural Employment Guarantee Scheme and added to the subsidy bill by holding down domestic fuel prices.
In other words, the increase in the government deficit was because of a hike in spending and not just because of a cut in taxes. In fact, this newspaper has consistently argued that the first Manmohan Singh government myopically let the fiscal problem fester in the boom years and hence it had little fiscal space to stimulate demand when the actual downturn came. What’s worse, much of the extra spending was to build political goodwill rather than the infrastructure needed to sustain future economic growth.
So we agree with the Prime Minister’s economic advisory council when it says that fiscal consolidation should include not just tax hikes, but also reductions in spending—hopefully revenue spending rather than capital spending.
However, the record of the ruling alliance since 2004 on spending discipline is not at all encouraging.
How should the deficit be reduced? Tell us at views@livemint.com
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First Published: Mon, Feb 22 2010. 10 13 PM IST