FRBM report is out. This is why it matters to you5 min read . Updated: 25 Jan 2017, 07:56 AM IST
We seldom worry about the macro part of the budgetabout terms such as fiscal deficit and tax-to-gross domestic product (GDP) ratio
The Fiscal Responsibility and Budget Management (FRBM) Committee submitted its report on 23 January 2016, a bit over seven months after it was set up. Read more on the origin of FRBM here: bit.ly/2klLFki. Though the report is not public, news reports say that the panel has recommended fiscal consolidation, but not at the expense of growth. Reports say that it tells the government not to worry if the fiscal deficit stays at, or just above, 3%. If your eyes are glazing over, unglaze them, because we’ll find out what this means and how it affects our lives.
What is the fiscal deficit and why should we worry about it, especially at budget time? As households, we usually worry about individual tax rates and prices of goods as they change in response to taxes that the government levies. We seldom worry about the macro part of the budget—about terms such as fiscal deficit and tax-to-gross domestic product (GDP) ratio. It may be a good idea for us to understand what these mean and how changes in these two numbers finally do affect us, though in a roundabout way. But affect us, they do. A government runs what is called a fiscal deficit when it spends more than what it collects as revenue. Revenue is the sum total of taxes (personal income, corporate, excise, customs to name a few) the government collects. If revenue is equal to the expenditure, the government’s budget is balanced, but most governments run on a ‘deficit’ or spend more than they collect. How does it finance this deficit? It borrows. Market loans in Budget 2016 were Rs4.25 trillion or 21% of the budget of Rs19.78 trillion. Fiscal deficit for 2015-16 was at 3.9% of GDP, with a target of 3.5% for 2016-17. FRBM targets are 3% fiscal deficit and a zero revenue deficit. Very quickly: look at a revenue deficit as your credit card debt that finances current consumption—it is a bad loan—and look at fiscal deficit as your home loan that leverages future income to build an appreciating asset. A fiscal deficit of 3%, when revenue deficit is zero has been seen as the magic formula for the government to borrow responsibly.
Why does the government need to borrow so much? Fiscal deficit was 6.6% in 2009-10 and the government’s borrowing programme zoomed. One reason that the government borrows so much is the poor tax-to-GDP ratio of 16.6 in India, as compared to the emerging market economy average of 21% and OECD average of 34%. Tax on income (what you and I pay as income tax) in Budget 2016-17 was ₹ 3.53 trillion, or just 18% of the budget. The numbers of taxpayers tells a story. Just 1% of the Indian population pays income tax and the number of people who say they earn ₹ crore or more is around 48,000. Looking around at the luxury houses and luxury sports utility vehicles (SUV) purchases around, the numbers tell their own story of tax evasion.
We know that people don’t pay taxes, why should it matter to me? Large government borrowing programmes usually lead to financial repression (other than in countries like the US, where the appetite for US Treasuries is global). Financial repression is the ability of the government to attract cheap household saving to itself by fixing the rules of the game. Ever wondered why you get just 4% on your saving bank deposit and why the rate of fixed deposits is usually below that of inflation? Look deeper into the return from your traditional life insurance policy and be horrified to see a return of about 3% a year over a period of 15-20 years. In order to finance the deficit, the government needs to borrow. By fixing the investment rules of banks and insurance firms, it can have a steady pipeline of funds that are forced into G-Secs.
Did you know that at least 24% of total bank deposits are invested in government bonds due to the way rules are framed? Did you know that investment rules of life insurance companies ensure that a large part of your premium is invested in government securities? According to the Insurance Regulatory and Development Authority of India (Irdai) annual report for 2015-16, life insurance companies had an investment of Rs8.3 trillion as of 31 March 2016 in central government securities. This is only for traditional products, and not including unit-linked insurance plans.
This is why reforms in the capital market have been much easier than in banking or insurance. There are no fixed investment rules that suck household money through mutual funds or other market-related products. The government worries when bank deposit rates slow down. It worries when premiums of life insurance companies begin to fall. At stake is the sale of government bonds. A higher tax-to-GDP ratio will usually mean lower reliance on borrowed funds for a sensible government not in election mode. Remember that the 2008-09 United Progressive Alliance budget squandered away a rare moment of fiscal consolidation through its farm loan waiver programme. Read this column from that year: bit.ly/2iYI63c
A high fiscal deficit that goes to service current government consumption or pre-election freebies needs to worry us, as should a low tax-to-GDP ratio. Because the final bill is paid by us – the taxpaper, the investor and the inflation-hit consumer. What will work? A government that commits to the FRBM targets, no matter if it is a pre- election year or not. The setting up of the public debt management authority (PDMA) that takes the conflict of managing the government borrowing programme out of an inflation-targeting central bank. Better tax compliance that lifts the tax-to-GDP ratio. The presence of the FRBM limit stops a government from spending away the advantage. Once this is in place the ground is ready to end financial repression that is today carried out through banks than insurance companies. We need to worry if the government spends too much of its tax revenue on itself. We must worry when too many people evade the tax net and buy fancy SUVs out of undeclared incomes. We must understand that macro numbers relate to our micro lives.
Monika Halan works in the area of consumer protection in finance. She is consulting editor Mint, consultant NIPFP, and on the board of FPSB India. She can be reached at firstname.lastname@example.org