Budget 2014: The fiscal mess and the way forward
Jaitley should overhaul the direct tax system and push for more disinvestment in order to raise tax revenues
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In his interim budget former finance minister P. Chidambaram had claimed that the fiscal deficit for fiscal year (FY) 2013-14 had been narrowed to an impressive 4.5% of gross domestic product (GDP). With fiscal deficit officially reported to be 5.3% for the eleven months until February, the entire fiscal improvement was apparently achieved in the single month of March. If true, this was miraculous because the fiscal compression was achieved despite sharply lower tax revenue, weak disinvestment receipts and higher subsidy payments.
The miracle was unfortunately a result of clever accounting that included, bringing forward revenue receipts by asking public sector undertakings (PSUs) to pay special dividends; shelving some expenditures from the last quarter to the next fiscal; and making unsustainable cuts of around ₹ 1 trillion in Plan expenditure. Conservatively, around ₹ 50,000 crore of expenditure seems to have been pushed back from FY14 to 2014-15.
Finance minister Arun Jaitley should come clean and use the option of the modified cash accounting to present the true fiscal picture. This will show the FY14 deficit to be 4.8-5% of GDP. This will not only help the new government to start with a clean slate but more importantly restore the new government’s credibility. The markets and rating agencies may well appreciate the transparency and not be spooked if the budget also includes a set of bold, and feasible measures to restore fiscal discipline.
The second step is to junk the unrealistic fiscal target of 4.1% for FY15, announced in the interim budget. This target was based on an optimistic assumption of 6% GDP growth in 2014-15; revenue growth of 20% and income tax revenue growth of 30%. GDP growth is likely to be around 5%. Given that tax revenue elasticity to GDP growth has averaged around 1-1.2% over the last five years, tax revenues are more likely to increase by 13-14%. Moreover, oil subsidies will certainly be larger than budgeted due to the carryover from FY14 and the hardening of global oil prices in the wake of the unfolding Iraq crisis. Food subsidy will also be higher given the spill-over and the prospect of a poor harvest that might require higher release of subsidised food grains. Therefore, Jaitley should announce a more credible fiscal deficit target of 4.4% of GDP for FY15. Even achieving this will require bold reforms. These can include the following measures:
Overhauling the direct tax administration: This reform is long overdue. Successive finance ministers have talked of making the income tax department more taxpayer friendly, less corrupt and not used as an instrument for harassing political opponents. But none has walked the talk. Jaitley should do so. It will help widen the tax net, improve compliance and generate additional revenue. Isn’t it absurd that in a country that boasts of more than 1 million multi-millionaires, only 43,000 persons declare their income to be above ₹ 1 crore and a measly 1.5 million have incomes above ₹ 10 lakh. India cannot remain the country with the third lowest tax-to-GDP ratio among G-20 countries and also hope to finance its massive infrastructure needs.
• Strapped for resources, Jaitley should, at this time, resist the pressure to even marginally raise the personal income tax exemption limit. He should also continue with the surcharge on the super rich brought in by his predecessor and ensure that it covers at least 100,000 Indian multimillionaires.
• Tax reform measures should include recovery of taxes stuck in litigation. And the first step would be stop the pernicious practice of making extraordinary tax demands to meet annual targets and repaying a part of the sums subsequently. Reportedly, more than ₹ 1 trillion in indirect taxes and a whopping ₹ 4.72 trillion in direct taxes are locked up in litigation and arrears. Given his limited options, the finance minister should go after these at this time.
•The temptation to re-introduce the universally hated and hugely misused wealth tax should be resisted. Instead, some initial steps should be taken to bring back the estate duty, which is a feature of all capitalist societies. It encourages wealth creation and punishes rentiers.
Increasing disinvestment receipts: It is possible to raise disinvestment receipts by another ₹ 20,000 crore to about ₹ 80, 000 crore, as markets are close to record high sentiment is likely to improve further. Recently the Reserve Bank of India (RBI) committee has recommended sale of government’s shareholding in public sector banks to below 50%. A 5% reduction in government’s holding in the State Bank of India and Punjab National Bank, the two largest banks, can alone bring in around ₹ 11,000 crore.
The finance minister has inherited a challenging fiscal situation. He could convert this into an opportunity to thoroughly overhaul and reform the direct tax system and in the process also raise much-needed tax revenue.
Using the budget speech to lay down a road map for structural reforms and announcing some liberalization of foreign direct investment in insurance and defence will help ignite investment sentiments and bring the economy back to high growth trajectory.
Rajiv Kumar is senior fellow at the Centre for Policy Research, New Delhi.
Geetima Das Krishna is senior researcher at the Centre for Policy Research, New Delhi.
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