Bae, look how I shrank the Budget

"Okay boomer”, said a friend’s 22-year-old daughter who believed her parents’ generation has made things worse for millennials like her on too many fronts.

“Yes Ma’am”, I promptly replied, not taking offence to what she had just said.

“What’s this budget thing that you and Ma keep talking about?”

“Why don’t you ask your mother?”

“Oh, she is an economist; and ends up confusing me even more,” she replied. “You tell me.”

“When you get the pocket money at the beginning of the month, do you plan what to spend it on over the month?” I asked.

“Plan? Eh?”

“Hah, I forgot I was talking to a millennial. Anyway, before the beginning of a fiscal year in April, the government has to plan what it wants to spend money on during the year. The budget for the next fiscal year 2020-21 will be presented by the finance minister Nirmala Sitharaman on 1 February.”

The expenses

I continued to drone on: “The government spends money on the salaries and the pensions of its current and former employees. It spends money on running different schemes in the areas of education, health, agriculture, etc. The government also sells rice and wheat at fairly cheap prices through the public distribution system to maintain food security in the country. Money is also needed to maintain and run an army, and more to defend the nation.”

“That’s a whole lot of things,” she exclaimed.

“Yes. Now, tell me something. Where does the money you get as pocket money every month come from?”

“Ma gives it to me.”

“Of course, young lady. But where does Ma get it from?”

“Well, she earns it. This is the least she can do,” she said, clearly implying that monthly pocket money was her birthright.

“Like your mother, the government also has to earn that money,” I replied.

“Through taxes you mean?”

“Taxes are one way. But there are other ways as well. Here’s where the most important part of the budget comes in— making the right assumptions. Your mother gets a monthly salary from the think tank she works for and more or less knows what she is going to earn over the year. The government does not know how much money it is going to earn through taxes during the course of any year.”

“So, it has to assume?”

“Yes. And assumptions often go wrong.”

“Oh yes. As Ma keeps repeating, assumptions are the mother of all mess ups,” she said.

“Take the current fiscal year, 2019-20. When the budget for this was presented, the government hoped to earn ₹24.6 trillion through different taxes. This was 18.3% more than what it had earned in 2018-19. Well, between April and November, the first eight months of the current fiscal year, the total taxes collected by the government stood at just ₹11.7 trillion, around 0.8% more than what was collected last year.”

“So, the tax collection has gone up by just 0.8%, when it should have grown by more than 18%?” she asked, immediately understanding what I was trying to say. “Why so?”

“Oh, for the simple reason that economic growth has slowed down. The economic growth in nominal terms (not adjusted for inflation) this year is expected to be at 7.5%. It’s the slowest since 1975-76, when the economy had grown at 7.4%. So, when the economic growth is at 7.5%, taxes can’t grow by 18.3%. Ultimately, taxes are paid on income and consumption. The economic growth is slowing down because income and consumption are slowing down as well.”

“That I understand.”

“Good. The government doesn’t.”

“Really?” she asked.

“There are multiple repercussions because of this,” I said, adding, “In 2019-20, the government had budgeted to spend ₹27.9 trillion over the year. When tax collections slow down, it becomes difficult for the government to spend what it had originally planned for.”

“It can cut down on its expenditure then?” she interrupted.

The trade-offs

Well, yes. But in an environment when economic growth is slowing down, if the government also cuts down on expenditure, economic growth will slow down further. This will mean even lower tax collections for the government,” I replied. “Economics is all about understanding trade-offs. A government budget is no different. For instance, what do you do when you run out of pocket money before the end of the month?”

“I borrow from S. He is my best friend.”

“Well, all over the world, governments don’t earn every rupee that they spend. Like you, they borrow.”

“And who lends to them?” she asked, getting extremely curious about the entire thing.

“The governments borrow by selling bonds, which pay a certain rate of interest. These bonds are bought by banks, insurance companies, mutual funds, pension funds and even directly by individuals. These monies are basically the savings of people that are invested with financial institutions hoping to earn a certain rate of return.”

“Sure.”

“Now, if the government earns less through taxes, it has to borrow more money to meet its expenditure. When the government borrows more, it leaves a lesser amount for everyone else to borrow, given that there are only so much savings going around,” I explained. “And that leads to a situation where interest rates can go up or continue to remain at high levels. So, if interest rates continue to remain high, millennials like you will have to pay higher EMIs (equated monthly instalment) when you borrow.”

“Millennials don’t like to take loans, remember?” she quickly responded. “We like to use Ola and Uber instead of taking loans and buying cars. And houses are anyway so expensive, we may never move out of our parents’ homes.”

“Ha. On a more serious note, when the government expects tax collections to grow at a very high rate, there is pressure on tax officials to play ball and help increase collections. Beyond a point, when there is an economic slowdown, this can only happen through putting pressure on taxpayers. And that’s not good for the economy over the short or the long term.”

“That makes sense. When the economy is slowing down, more and not less money should be available in the hands of people to spend,” she said, trying to summarize my point.

“Also, Indian economy’s growth has slowed over the years. In 2010-11, India had grown by 19.9% in nominal terms. This year, the growth is expected to be 7.5%. The nominal economic growth has fallen dramatically over the years. In this scenario, the government’s assumptions on increase in tax collections also need to be scaled down. The drafters of the budget also need to realize that the times they are a changin.’’

“Hey, isn’t this a song written by this guy who won the Nobel Prize in Literature a few years back?” she asked, suddenly changing track.

“Yes, Bob Dylan”, I replied, wondering how someone could not know Dylan’s name. But then, every generation has their musical heroes. Until a couple of years ago, I had no idea who Ed Sheeran was.

“Ma listens to Dylan every time she has a fight with my father about his visitation rights. Dylan is Ma’s bae.”

“Dylan?” I asked. “I thought she was more into Pink Floyd.”

“Pink who?”

“Never mind. Let’s get back to what we were talking about.”

The family silver

She continued: “Now, you had said that the government earns money through ways other than taxes.”

“Yes. One such way is disinvestment or selling stakes in companies that the government owns. Like in 2019-20, the government had planned to earn ₹1.05 trillion. Between April and November, it has only been able to earn ₹18,099 crore through this route.”

“Oh, that’s too low.”

“Yes. Also, given how much time remains during the year, it looks difficult for the government to meet the disinvestment target it has set for itself. The problem is that during most years, the government starts concentrating on disinvestment only in the second half of the year,” I explained.

“Makes sense.”

“Also, over the years, the disinvestment route has been abused by getting one government company to buy another and paying the government for it.”

“Really? Isn’t that just moving money around different arms of the government?”

“Yes. So, ONGC (Oil and Natural Gas Corp. Ltd) bought HPCL (Hindustan Petroleum Corp. Ltd) a few years back. ONGC did not have enough money to carry out the transaction. Hence, it had to borrow money. This money was paid to the government. The government showed this as an earning. If ONGC hadn’t borrowed money to buy HPCL, the government would have to borrow money to meet its planned expenditure or cut down on its planned expenditure. In a way, money that government should have borrowed, ONGC ended up borrowing.”

“Ah, accounting tricks everywhere,” she said. “So, if tax collections haven’t grown as expected and disinvestment receipts aren’t anywhere as expected, where does that leave the government?”

“This year, the government got itself a huge dividend by dipping into the reserves of the Reserve Bank of India (RBI). In late August 2019, RBI paid over ₹1.7 trillion to the government. It is important to understand that RBI is not a bottomless pit. God forbid, if tax collections continue to remain slow next year, where will the government get money from then?”

The unknown

I continued: “Oh and in July 2017, the government introduced the goods and services tax (GST). The GST system was an amalgamation of a large number of indirect taxes that the state governments and the central government used to earn. In order to get state governments around to the idea of GST, they were promised a 14% increase in GST proceeds year-on-year. If that did not happen, the central government, or what I have referred to just as the government up until now, has to compensate them.”

“Hmmm. So what’s the problem?”

“As we discussed, if the economy grows at 7.5%, the GST collections cannot grow at 14%. So, there has to be some rethinking on this. Of course, the problem is that the states will not like any talk of such a thing happening.”

“Basically, I now know why Ma keeps saying assumptions are the mother of all mess ups.”

“Her context is different.”

“Well, I gotta bounce!”

“Where to?”

“Meeting S. My OTP.”

Vivek Kaul is an economist and the author of the Easy Money trilogy.