Union budget and the need for structural reforms

The budget has done some things right but there is a limit to what can be achieved through stroke-of-the-pen reforms

Structural reform is about the correction of government as it functions at the ground level, a process which calls for deep immersion and follow-through. Photo: Abhijit Bhatlekar/Mint
Structural reform is about the correction of government as it functions at the ground level, a process which calls for deep immersion and follow-through. Photo: Abhijit Bhatlekar/Mint

The immediate audience for the Union budget presentation on 1 February was Parliament, but the targeted audience was rating agencies—and of course, the electorate in the five state elections looming up. The first audience ensured that the fiscal consolidation path was broadly adhered to, with the message that India has the kind of responsible government deserving of a reward through a ratings upgrade. For the electorate in the large and important states going to the polls, details were provided of non-compliance in the upper income-tax brackets, with a promise of follow-up action. The message here was that demonetisation was somehow a needed starting point for elimination of kala dhan (black money), although, of course, it was not. The tax base could and should have been expanded 25 years ago, or last year, or the year before.

The link made by the finance minister between tax-base expansion and demonetisation was the promise that data from the pattern of cash deposits in bank accounts between 8 November and 31 December 2016 would be mined for information on individuals outside the tax net. He reported that deposits of an average size of Rs3.31 crore were made in 148,000 bank accounts.

As information, it is startlingly revelatory of the mammoth size of cash that was being held outside the banking system, and of the scale of tax evasion in past years, but it does not necessarily map on to an easy expansion of the tax base. Those large deposits most likely came from charitable organizations and religious trusts, and if stories are to be believed, folded in contributions from individuals who did not want to be tracked through their individual bank accounts. Whatever the case, the finance minister has certainly marked a date from which his own performance can be tracked, in terms of adding to the number of taxpayers, particularly at the high end, and he is to be commended for having designed his own report card.

The most promising tax-revenue enhancement measure is the limit on deductibles from taxable income in the form of cash expenditure—a maximum of Rs10,000. This will not raise the number of people in the tax net, but will curtail the most commonly used avenue for reducing tax liability by business and trader assessees. An even more important curtailment is the reduced limit on cash donations to charitable trusts, from Rs10,000 to Rs2,000, although I see no way this can be enforced.

The Income-Tax Act is proposed to be amended to rule out cash settlement of any transaction over the value of Rs3 lakh. In the normal course, the goods and services tax (GST) would have eliminated cash payment even for much lower-value transactions—in product markets, that is. But how such a ruling is to be enforced in the urban house rental market, or in contractual payments in the informal sector, is not clear at all. In urban real estate sale transactions, where cash plays (or has hitherto played) a major supplementary role to a formal component routed through banks, it cannot be enforced at all. These are the more intractable segments of the black economy where reform can be achieved only at a measured and carefully sequenced pace over a long period of time.

Another measure that will defy enforcement is the Rs2,000 limit on the cash donation any single individual can make to a political party (is that per year?). Larger amounts have to be made through formal cashless channels. There is no explicit reference to corporate contributions, but by implication they are denied the option of donations in cash. There is no mention of how this can be enforced.

I found the idea of electoral bonds bought by a donor, redeemable in the account of a registered political party, very innovative, perhaps the most interesting budget idea in a long time. This could, however, lead to a further proliferation of fake political parties, an issue the Election Commission is already grappling with. Also, unless electoral bonds are given an income-tax deduction of the kind currently available for political contributions under sections 80GGB and 80GGC of the Income-Tax Act, they might not prove very popular. As for political parties having to file income-tax returns, this will actually happen only if it is made a legal precondition for a political party to contest an election at any level.

Meanwhile, cashless India is party time for foreign manufacturers of point-of-sale (POS) card readers and fingerprint and iris readers/scanners, especially after the elimination in the budget of basic and additional customs duty on such machines. Why did no domestic entrepreneur see this market coming when Aadhaar kicked off as long ago as 2009. What was the department of industrial policy and promotion (Dipp) doing?

Dipp’s failure to project the market for POS gadgetry is only a small instance of the larger failure of the government in its growth-enabling and regulatory roles. Government disabling of economic activity through delays and misuse of its role as regulator is the principal cause of stalled private sector investment in the Indian economy.

A whole section of the finance minister’s speech was indeed devoted to measures by which to improve the ease of doing business in India, but the proposals merely nibble at the fringes of what is a much larger problem. They include raising the threshold beyond which compliance with audit or bookkeeping requirements apply, relaxing income-tax monitoring of domestic transfer pricing between related parties, and reducing the time taken by income-tax authorities for scrutiny and refund claims.

All very welcome, of course, but by definition applicable to ongoing businesses. What of aspiring businesses which have achieved financial closure, and cannot commence commercial operations because of a hold-up in one or the other government clearance?

The prospect of these indefinite delays is what retards private investment, and makes potential entrepreneurs shift their sights to overseas locations. For investors who despite everything want to persist with projects in India, delayed government permissions add hugely to the stress on banks.

The state of the Indian banking system is a major reason why rating agencies are unwilling to grant an upgrade. In terms just of that limited objective, if no other, structural reform of the functioning of government is no longer just a preferable option. It is an imperative. Structural reform, in turn, is about the recognition and correction of government as it functions at the ground level, a process which calls for deep immersion and follow-through. There is a limit to what can be achieved through stroke-of-the-pen reforms, although there was enough opportunity even there that the budget has very usefully exploited.

These were listed by the finance minister right at the beginning of his speech. The most major was the advancement of the date of the budget announcement to the start rather than the end of February. It gives enough time for the Finance Bill to be actually passed before the start of the next fiscal year, and therefore prevents the kind of delayed start to implementation that is a major cause of poor outcomes. The merger of Plan and non-Plan expenditure, another welcome departure from the past, became naturally possible at this juncture since March marks the end of the 12th (and last) Plan. It gets us on to a new platform where the expenditure under a budget head gets unified, instead of being splintered by source of funding. It will be a great relief for those who have to prepare and oversee the printing of budget documents in finance departments all over the country.

Finally, the merger of the railway budget with the overall budget is another welcome change, enabling as it does integrated transport planning across modes. If, as announced, the railways will design integrated end-to-end transportation solutions specific to commodities and destinations, with a particular focus on perishable agricultural commodities, we might begin to see a reduction in the post-harvest losses that are such a notorious feature of the agricultural supply chain in India.

But the neglect of any mention of the horrendous rail accidents that have happened over the last year was an egregious omission. What we needed was a listing of these, the cause as ascertained through the inquiry into each, and what is proposed to be done in respect of each cause in the rail segment where it happened. What we have instead is a generalized Rashtriya Rail Sanraksha Kosh, which will develop a corpus of Rs1 trillion over five years, and will harness “expert international assistance” to improve rail safety. My sense is that several reviews of railway safety have already identified the courses of action needed. This is a problem too immediate and too damaging in its past and future consequences to be fobbed off with a corpus.

As for cleanliness, the SMS-based “Clean My Coach” service is very welcome, provided the service is equipped to catch mice. Bio toilets are most welcome too, but more immediately, there is a need to ensure water supply in the toilets of every train for the full duration of its run. Here again. there is that futile sense the citizen gets, of grand talk about cleanliness way up there in the stratosphere, while the most elementary basics are lost sight of.

Finally, to end on a positive note, the performance since 2014 on road construction, both highways and the Pradhan Mantri Gram Sadak Yojana for village connectivity, has been most impressive. It could have been even better had the problems with public-private partnership contracts been sorted out, along the lines suggested in the report of the Kelkar committee. Road construction on the scale required cannot possibly rely on public funds alone.

Indira Rajaraman is an economist.

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