Episode 9: Reviewing Modi 2.0’s First Budget

AP: You’re listening to the “Transforming India” podcast, jointly brought to you by the Deepak and Neera Raj Center on Indian Economic Policies at Columbia University and the Times of India. I am Arvind Panagariya, Director of the Raj Center and Professor of Economics at Columbia. My co-host on this podcast is Professor Pravin Krishna. He is a professor of International Economics and Business at Johns Hopkins University. Welcome, Pravin.

PK: Hi Arvind. Delighted to join you. We’re now in the ninth episode of this podcast. In the previous episode, which was ahead of the announcement of the Budget for 2020-21, we discussed the nuances of India’s budget exercise and offered our suggestions to the Finance Minister on what could be included in the first budget of this decade. Now that the Finance Minister has presented the budget, it’s time for us to dissect it for our listeners.

Episode 9: Reviewing Modi 2.0’s First Budget

AP: Pravin, for the benefit of our listeners, let’s start off with some important positive take-aways from this year’s budget. First and foremost, consistent with our suggestion to hold the line on the fiscal deficit, the Finance Minister has reiterated her commitment to fiscal discipline despite revenue challenges faced by the economy. With GDP growth having declined sharply during the year 2019-20, tax revenues fell well below the target. But the government managed to keep fiscal deficit at 3.8%, just half percentage point above the original plan, which is permitted by the Fiscal Responsibility and Budget Management or FRBM Act under exceptional circumstances. This is significant since revenues had fallen short of the target by the much larger figure of about 1.5% of the GDP. The government cut its own expenditures as well as transfers to the states. For the next year, the FM has pegged the target at 3.5%. Once again, half a percentage point above the original target, also permitted by the FRBM Act. Revised fiscal targets for subsequent years are 3.3% for 2021-22 and 3.1% for 2022-23. Contrary to the demands by many for higher fiscal deficit to combat slowdown, the FM has chosen to keep the fiscal consolidation train on track with slight course correction forced by the slowdown.

PK: And I think this has been a wise decision, Arvind, for two reasons. The first reason is that once we take account of the fiscal deficits of states and of the off-budget borrowing, public sector borrowing at 9% or more is already quite high. So it’s a bit of an illusion to argue that the government is shying away from stimulating the economy. To the contrary, its large borrowing poses a threat to the availability of financial resources for the highly productive private sector. The second reason to avoid yet more spending to stimulate the economy is that the effect of such spending will take place with a lag of six months or longer. And the past actions of the fruit it appears by most indicators, the economy is already turning up. So, it is best not to go overboard by pushing already high level of public sector deficit even higher.

AP: Those are excellent arguments in favor of the approach taken by the government, Pravin. Let me next turn to the second important positive in the budget: initiation of a major reform of personal income tax system. For taxpayers willing to forgo most, even if not all exemptions, the government has lowered the tax rate by 5 to 10 percentage points depending on their tax brackets. Immediately, the effect of this reform will be limited because many taxpayers would continue to find it more advantageous to take exemptions that are currently available and pay the higher tax on the remaining taxable income. But in the longer run, if the government accepts the suggestions we had made in our previous podcast, honest taxpayers will get a huge relief and the government will also be able to raise more revenue than under the old, exemption ridden system. Recall that we had suggested that the long-run goal of the reform should be to align the top personal income tax rate to the 22% rate now applicable to corporate profit tax. Additionally, we should compress the middle tax rate in the old system proportionately.

PK: This reform is much needed, Arvind. Today, we are kind of in a strange situation in on the one hand, as the Prime Minister himself said this at the recent Times Now conclave that the government feels that not enough people pay taxes. And at the same time, numerous taxpayers bitterly complain that they are subject to harassment by tax authorities even though they’re among the highest taxpayers in the world. Going by the low tax-to-GDP ratio in India relative to comparator countries, the Prime Minister certainly has a point. But the complaints of harassment by taxpayers are also widespread and they cannot be dismissed. The only conclusion from all of this is that there is something very wrong with the tax system, which leaves both tax collectors and taxpayers hugely dissatisfied. This is partially supported by data: Annex 7 of the Receipts Budget this year lists 27 different exemptions and deductions that are applicable to personal income taxes. The elimination of these exemptions while bringing the tax rates down will simplify the tax system, end the vast numbers of tax disputes, expand the tax base and, I think, above all, eliminate what economists call horizontal inequity in taxation. Horizontal inequity means that individuals with the same income today pay very different taxes depending on how they spend that income. This type of taxation distorts spending behavior and also leads to tax disputes.

AP: Moving to the next important positive, consistent with our recommendation in the previous episode, the budget proposes a large-scale program of disinvestment including outright privatization of many Public Sector Enterprises. GDP growth and therefore growth in tax revenue is going to be tepid in the coming year. This makes tapping other sources of revenue a matter of urgency. The budget recognizes this fact and doubles the disinvestment target for the next fiscal year to 2.1 Lakh Crore rupees. For the first time, it is a realistic prospect that we will see many public sector enterprises passing into private hands. By all indications, the process for privatization is now in place and promises to produce concrete results.

PK: Yes, Arvind, from newspaper reports, I’ve gathered the impression that unlike the previous half-hearted attempt, this time around the government is making a genuine effort to privatize Air India. Its committed to divest 100% of its equity and also reduced the debt to be assumed by the buyer to a little over $3 Billion. There are reports that buyers including the Tata Group, which had of course owned the airline before the Government of India nationalized it in 1953, are now seriously interested in buying it. In parallel, the government has also committed to sell all of its equity in BPCL, which will introduce a major private sector operator in the oil sector in India. Also significant is the decision by the government to list the Life Insurance Company, popularly known as LIC, on the stock exchange. Such a listing will finally bring genuine pressure on those managing it to perform. For the first time, policyholders of LIC will have an indication of how their moneys are being managed. These are all excellent proposals and I hope that the government will bring them to their logical conclusion.

AP: There is one small item in the budget that I want to mention. I have long felt that arguably India has the richest heritage of all countries in the world and we do not do enough to preserve and nurture it. In part, this is understandable. Scarce resources must first be used to assist the poor. At the same time, we do need to begin investing at least minimal resources in preservation of our heritage. From this perspective, I was very pleased that this budget has provided for the development of five archeological sites with on-site museums, including the Harappan site of Rakhigarhi in Haryana and Dholavira in Gujarat, which testify to the highest degree of advancement of Indian civilization. Other three sites are in Assam, UP and Tamil Nadu. I think this is a very positive step by the government.

PK: Now Arvind, in addition to the positives that we’ve discussed so far, I wanted to come to one important area in which the budget takes a step back, which is international trade. As we have discussed in the past episodes, reversing the long-standing policy of outward orientation, this government, more than two years ago, began to raise tariffs with the view to replace imports by domestic production, a process that economists call import substitution. This is a very unfortunate development on the part of a government that is otherwise reformist and appears to believe in competition. Outward-oriented policies have played a pivotal role in sustaining high growth in India. In fact, the highest growth period in India’s recent history has also been the period of highest growth in its international trade, both of exports and of imports. In contrast, during the decades of 1950 and 1990 when we pursued unconstrained import substitution, the economy performed badly and India remained poor. The current budget has unfortunately taken the step of rolling back international trade.

AP: No doubt, Pravin, this budget has given import substitution an extra edge. For one thing, most of the goods on which tariffs have been raised significantly are labor intensive. A good example is toys, on which the tariff has risen from 20% to massive 60%. Other items include household goods and appliances, electrical appliances, footwear, furniture and stationary. These are all products that we should be exporting in vast volumes as a country with a large supply of labor. These are the products that China built its own growth process on in the 1980s and 1990s. Stamping out competition in these products by raising tariffs will only work to promote the low quality and high cost of manufacturing these products. The question we need to ask is why are we unable to compete in products in which we have the natural comparative advantage by virtue of having a vast labor force. Only then, Pravin, we will begin to take the right policy actions. I must say, that this clear trend towards rising protectionism has made me revise my growth expectation for India. I had been of the view that in 2 to 4 years, we will be able to touch double-digit growth. But with protection having returned, 8% is the best we will do I fear.

PK: Unfortunately, the government has also amended the Customs Act of 1962 to empower itself to prohibit the exports and imports of any goods. And yet another amendment, applied to the Customs Tariff Act of 1975, enhances the government’s power to impose safeguard duties and tariff quotas on imports. We have also seen the return of the license-permit raj era vocabulary of disallowing imports of “non-essential” and “domestically available” products. I would have thought that we had buried that vocabulary for good in the wake of the 1991 reforms and its really unfortunate that we haven’t done so.

AP: To end the episode on an optimistic note, Pravin, let me say that the Prime Minister is reformist. We can hope that he will see the folly of our turn to protectionism and take corrective action in not too distant future. One way to proceed will be to engage with large countries in Free Trade Agreements. We must return to negotiations with our Asian trade partners in the Regional Comprehensive Economic Partnership or RCEP agreement and separately we should also engage the countries in the European Union in a free trade agreement negotiation.

PK: Well, Arvind, that’s certainly a topic for another day. And our time for today’s episode is up. So, let me summarize. On the positive side, the Finance Minister has done the right thing by reiterating her commitment to fiscal consolidation and disregarding the calls for greater spending to stimulate the economy. The launch of reforms to simplify personal income taxes is also a very important step. The decision to set a very ambitious target for disinvestment, including the outright privatization of many public sector enterprises, will contribute handsomely to raising economic efficiency while also helping the government balance its books. Continued movement towards raising protection in pursuit of import substitution is, however, a step back. And it’s almost certain to prevent India from realizing its ambition of double-digit growth.

That’s all we have today for our listeners. Signing off until our next episode, this is Pravin Krishna.

AP: And this is Arvind Panagariya, on the “Transforming India” podcast, produced by Atisha Kumar, Research Scholar at Columbia University and edited by Rebecca McGilveray at INCITE at Columbia University. Thank you for listening.

DISCLAIMER : Views expressed above are the author’s own.

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