Stim­u­lus in a time of ris­ing fis­cal deficit

With farm loan waivers and UDAY shut­ting out the space for an ex­pen­di­ture-side stim­u­lus, tax cuts are the best bet

The Hindu Business Line - - THINK - HARDAYAL SINGH BLOOMBERG

Till re­cently, the one bright spot on In­dia’s eco­nomic land­scape was the Cen­tre’s grip over the fis­cal deficit. Of­ten mea­sured as a per­cent­age of GDP, this statis­tic rep­re­sents the to­tal bor­row­ing that the Gov­ern­ment has to re­sort to meet its an­nual ex­pen­di­ture. The 14th Fi­nance Com­mis­sion has stip­u­lated a limit of 3 per cent sep­a­rately for the Cen­tre and States — and 6 per cent for the econ­omy as a whole. Judged by this yard­stick, be­cause its fis­cal deficit has con­sol­i­dated from 3.9 per cent in FY 15 to 3.5 per cent FY16 and FY17; and was fur­ther planned to be re­duced to 3.2 per cent in FY 18, the Cen­tre has so far per­formed cred­itably.

Cer­tain wor­ry­ing devel­op­ments, how­ever, have taken place re­cently. While the fis­cal deficit of the Cen­tre has been de­clin­ing, that of State gov­ern­ments has tended to slip of con­trol. The deficit — which was as low as 2.4 per cent in FY 09 — touched 3.6 per cent in FY16, breach­ing the 3-per cent limit after nearly a decade.

This was largely be­cause of Ujwal DISCOM As­sur­ance Yo­jna (UDAY), a fi­nan­cial and re­vival pack­age for State-owned elec­tric­ity dis­tri­bu­tion com­pa­nies, to help them out of the fi­nan­cial mess which they were fac­ing. For im­ple­ment­ing this scheme, State gov­ern­ments had to bor­row money from the mar­ket.

Widen­ing gap

Now, on top of this mea­sure come an­nounce­ments of waiver of farm loans by UP (₹36,000 crore), Ma­ha­ras­tra (₹30,000 crore ), Kar­nataka (₹8,165 crore) and Pun­jab (₹10,000 crore). As a con­se­quence, fis­cal deficits of these States may over­take that of the Cen­tre. But the lat­ter too may be at the be­gin­ning of an­other round of sub­si­dies to woo the elec­torate or tackle the eco­nomic slow­down. If so, it is likely that the Cen­tre’s own deficit may now fur­ther in­crease, hav­ing al­ready touched 96 per cent of the bud­geted fig­ure at the end of Au­gust. The Cen­tre and States to­gether may well end up se­ri­ously breach­ing the limit of 6 per cent un­der the Fis­cal Re­spon­si­bil­ity and Bud­get Man­age­ment (FRBM) Act.

Such a de­vel­op­ment does not au­gur well for the coun­try. An un­ac­cept­ably high fis­cal deficit, with­out any at­ten­u­at­ing fea­tures, may even­tu­ally com­pletely ruin the chances of an up­grade by rat­ings agen­cies who have even cur­rently placed In­dia in the low­est in­vest­ment class of BBB-.

This is just above the junk sta­tus. Al­ter­na­tively, an out of con­trol fis­cal deficit might re­duce the sov­er­eign credit rat­ing to junk. This is bound to ad­versely af­fect the in­ter­ests of both the Gov­ern­ment as well as Indian busi­ness, who will find it much more dif­fi­cult to raise funds abroad and at­tract in­vest­ments to In­dia. Do­mes­ti­cally too, a high fis­cal deficit will crowd out pri­vate in­vest­ment and pos­si­bly lead to the re­turn of in­fla­tion in the econ­omy.

It is no­body’s case that the Gov­ern­ment should not deal with the cur­rent slow­down, help the poor or al­le­vi­ate agrar­ian dis­tress. The ques­tion is whether in­cur­ring ex­pen­di­ture through un­af­ford­able sub­si­dies is the only op­tion.

Wrong tar­gets

A farm loan waiver is noth­ing but a poorly tar­geted sub­sidy to farm­ers that trans­fers li­a­bil­i­ties from pri­vate books to that of the State. It leaves out about two thirds of small and mar­ginal farm­ers who had to bor­row from pri­vate in­for­mal chan­nels. It also pe­nalises those farm­ers who dili­gently paid their debts. The ₹52,000 crores waiver granted to farm­ers in 2008 hardly ad­dressed the is­sue be­cause farmer sui­cides con­tin­ued un­abated. In the 1980s, the Cen­tre co­erced public sec­tor banks to run loan melas. A few years later, The best way to re­vive econ­omy

be­cause the farm­ers could not pay their debts, VP Singh’s gov­ern­ment an­nounced a debt re­lief pack­age of ₹10,000 crore; it took public sec­tor banks a decade to re­cover from that hit.

States should also con­sider the op­por­tu­nity cost of this fast spread­ing con­ta­gion. If more States are pres­surised to im­ple­ment sim­i­lar schemes the to­tal cost to the ex­che­quer, es­ti­mates the Eco­nomic Sur­vey (FY 17), would be about ₹2.7 lakh crore ( about 1.8 per cent of the cur­rent GDP).

The same ex­pen­di­ture on build­ing ir­ri­ga­tion fa­cil­i­ties, roads, ware­houses and other in­fra­struc­ture would help farm­ers earn higher in­comes on a much more durable ba­sis. Even if a sub­sidy is re­quired to be given, it would be much more eq­ui­table and ef­fi­cient to dis­trib­ute it as an out­right grant or a univer­sal ba­sic in­come to all equally placed cit­i­zens after tak­ing into ac­count the fis­cal space avail­able and after sub­sum­ing all other sub­si­dies which the ben­e­fi­cia­ries re­ceive from the Gov­ern­ment.

The Cen­tre too should re­con­sider any stim­u­lus pack­age it may cur­rently be con­sid­er­ing to deal

with the re­cent slow­down in the econ­omy, if this en­hances its fis­cal deficit. An al­ter­na­tive to such a pack­age would be a re­duc­tion in the rates of in­ter­est, but that would fall within the do­main of the RBI, who would be gov­erned by its own pa­ram­e­ters while con­sid­er­ing such a move.

Make the cut

This would leave only dis­in­vest­ment and re­duc­tion in the rates GST and in­come-tax within the con­trol of the Gov­ern­ment. Both are good ideas, but re­duc­tion in rates would be eas­ier to im­ple­ment. This mea­sure would put more money into the hands of the peo­ple.

The econ­omy would as a re­sult ben­e­fit from the in­crease in both pri­vate con­sump­tion as well as sav­ings. To meet the new de­mand, firms would bring into use their ex­cess ca­pac­i­ties, and ul­ti­mately in­cur the much needed cap­i­tal ex­pen­di­ture needed to cre­ate new ca­pac­i­ties for in­creas­ing pro­duc­tion and gen­er­at­ing em­ploy­ment.

In­deed, the re­cent re­duc­tion of GST rates an­nounced by the FM is a step in the right di­rec­tion, even though the tax it­self con­tin­ues to suf­fer from mul­ti­ple rates and com­plex pro­vi­sions. Indian fis­cal his­tory teaches us one im­por­tant les­son: con­trary to tax­payer be­hav­iour in the de­vel­oped world, in In­dia, when­ever in­come-tax rates have been re­duced, rev­enues have in­creased.

This is be­cause peo­ple re­port higher in­comes: when Indira Gandhi, for ex­am­ple, de­creased the max­i­mum mar­ginal rate of in­come tax from 97.75 per cent in 1974-75 to 77 per cent in 1975-76 and 66 per cent in 1977-78, per­sonal in­come- tax rev­enues grew from ₹362 crores in 1974-75 to ₹480 in 1975-76 and ₹542 crores in 1976-77.

Be­tween 1985-86 to1987-88, VP Singh low­ered the max­i­mum tax rate from 67.5 per cent to 50 per cent and brought down the num­ber of slabs to four.

Roughly cor­re­spond­ing to the pe­riod of this re­form (be­tween 1984-85 and 1988-89) col­lec­tions in­creased from ₹697 crores to ₹1492 crores. There is hardly any rea­son tax­pay­ers should be­have dif­fer­ently this time.

The writer is for­mer chief com­mis­sioner of in­come-tax and om­buds­man to the in­come-tax depart­ment, Mum­bai

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