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LATEST NEWS UPDATES | Why this will be a reform budget-Surjit S Bhalla

Why this will be a reform budget-Surjit S Bhalla

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published Published on Mar 15, 2012   modified Modified on Mar 15, 2012

Most of us don’t even get a single shot at making history — Manmohan Singh has a second chance

The fiscal deficit is an outcome, not a policy. It is the net resolution of the policies pertaining to taxes and expenditure. It is worth analysing separately the two components of the deficit. The table reports the results of relating the tax and expenditure share of GDP to per capita income for 16 developing countries. Data are from the IMF for the year before the crisis, 2007, and the tax and expenditure figures are inclusive of centre, state and local taxes/expenditure. For most countries, data are only available till 2008 or 2009, so choosing a non-crisis year is appropriate.

The table reports the shares of taxes and expenditure to GDP, as well as excess shares relative to the per capita GDP level of the country. This normalisation is done via a cross-country regression, which relates the share to the log of per capita income, the latter expressed in current US dollars (use of PPP dollars makes little difference to the results). The results are surprising for those who argue, often on misguided analysis or evidence, that Indian tax collection is too low. Indeed, among these countries, excess Indian tax/GDP ratio is among the highest as is the excess expenditure/GDP ratio! What this squarely points to, and this is no surprise, is the inherently populist nature of the UPA government.

Compare India with China. China’s tax ratio is 18.1 per cent, some 1.7 percentage points (ppt) above the “normal” level. India’s ratio, at 18.5 per cent, is above that of China even though the latter’s per capita income is 2.5 times that of India. India’s excess at 3.9 per cent is one of the highest in the developing world, exceeded only by a few African economies.

The story on expenditures is the same. China’s ratio is only 18.7 per cent, reflecting its low fiscal deficit (not strictly — non tax receipts also enter the revenue side), and some 2.1 ppt less than normal. India’s expenditure, at 27.7 per cent of GDP (yes, no typo there), some 9 ppts above China and 9 ppts above trend or normality. These figures suggest that those who argue that Indians are taxed too little are just not looking at the data — more ideology or misguided analysis, but not hard facts.

So how does India solve its deficit problem? Budget 2012 will tell but here are some pointers. The structural populist problems cannot be solved in one budget, but a beginning can be made. Indirect taxes — excise, custom, and service — can be raised to their 2007 levels, that is, to a 12 per cent rate from the present level of 10 per cent. On the personal income tax front, the government can adopt the recommendations of the standing committee on the direct tax code. The recommendations imply a reduction in the effective tax rate, expansion of the base, and should increase compliance.

The major story of the budget, however, has to be on the expenditure side. There is a considerable amount of accumulated evidence — from reports of the government itself, and the continuous rejection of the UPA by the voters — that populist subsidies are inefficient, do not reach the poor, and do not yield any political dividends. So why should the UPA continue with them? If they do, there are two possible explanations. First, that despite huge political losses, the Congress party leaders are slavishly hewing to the socialist beliefs and ideals of its leader, Sonia Gandhi. There is nothing wrong with such ideals per se, but they should not communicate the vision of being caught in a time warp. Perhaps, such ideals were okay when Indians were dirt-poor, as in 1960. At that time, India’s per capita income was around 82 dollars a year; today, the per capita income is more than 20 times that amount. In the 1960s, Indians were worried about hunger; today, they aspire to a good education for their boys and girls. That is how much India has changed. The Congress may not believe me — but it should believe the results of Census 2011, as well as the vote in 2012.

The second reason that the Congress would continue with its populist policies is that it has a death wish. It is not only satisfied with the beginning of the end of the Nehru-Gandhi political dynasty, but it would also like to extinguish any memories that the party was responsible for ushering in major economic reforms in 1991 (oops, but that was the one and only time when the dynasty was not in control). Stated differently, the second reason is that the Congress leadership is stupid beyond belief or comprehension.

I do not subscribe to this view. I think (and certainly hope!) that Budget 2012 will be a non-populist and reform budget. That government expenditures will begin to be brought under control. These reforms can mean one or several of the following easy-to-implement policies. Reduction in subsidies for diesel and elimination altogether over a stated, pre-announced, time frame. Elimination of special status for urea. Reduction in subsidies for food via both an increase in subsidised food prices, and announcement of cash transfers on a pilot basis as a substitute for the PDS. A quiet burial of the stated food security bill along the lines of “it is under consideration by a standing committee”. And announcing plans for reform of the entire agricultural sector, including a vision of India without the PDS. A reduction in expenditures on giveaway corrupt schemes like MNREGA. This should be easy since the government in any case could not spend the Rs 40,000 crore allocated to the scheme.

These policies should yield huge dividends to the poor and to the economy. A reduction in RBI interest rates, around 200-plus basis points in 2012, can start in earnest. And India can be reset on its path towards 8 to 9 per cent GDP growth, and likely the deserved status of the fastest growing economy in the world. So place your bets — will the Congress be stupid, or realistic? Will Manmohan Singh be responsible for both the first-generation reforms, and the second-generation reforms? I think so.

The writer is chairman of Oxus Investments, an emerging market advisory firm

The Indian Express, 15 March, 2012, http://www.indianexpress.com/news/why-this-will-be-a-reform-budget/923756/0


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