Economics or politics? That is the difficult choice that finance minister P. Chidambaram will have to make today, when he announces the new Budget, most probably his last before the next general election.
There is little doubt that the Indian economy is on a higher growth arc. The latest Economic Survey rightly points out that the “new challenge is to maintain growth at these levels”. Only a dozen or so major countries have maintained average economic growth of above 9% for more than a decade. Half of them lost steam soon after. Very few of these could grow at above 9% for yet another decade.
India needs to join this exclusive club if it has to abolish poverty and hunger. That means that current rates of growth will have to be maintained—if not increased—for at least another 15 years. What needs to be done?
Countries can sustain high growth if they have open markets, low taxes, human development and macroeconomic stability. Chidambaram should focus on stability right now, especially given the turbulence in world economy. But there are two immediate pressures on the finance minister. Companies want taxes to be cut. Politicians want more money to be spent on various welfare schemes. Both will hurt India’s fiscal fitness.
We already have one of the world’s highest fiscal deficits, if the budget gap is properly defined to include the state government imbalances and the off-budget bonds that the Union government has issued to meet subsidy-related losses of the oil companies and the Food Corporation of India. As the Economic Survey notes, “most South-East Asian economies had a fiscal surplus during a large part of their high growth phase”. High growth with huge deficits is a recipe for economic trouble.
So, what about tax cuts? There are two reasons why taxes are usually cut—to maintain an economy’s long-term competitiveness and to deal with a short-term slowdown. Neither problem— structural and cyclical—is big enough right now to justify tax cuts. The finance minister could, however, throw a few well-aimed incentives at the middle class to signal his intentions. And he should do away with levies such as the senseless fringe benefit tax. (Our second edit below looks at the spending issue.)
Low fiscal deficits and government borrowing will help bring down interest rates and keep the economy on its current growth tax. Tax cuts and spending splurges can wait.
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