Business Daily from THE HINDU group of publications
Wednesday, Oct 04, 2006
Industry & Economy - Economy
Budget that deceived to impress
Many reform-centric economists expected big-ticket reforms in the Union Budget 2006. They expected vigorous statements, bold moves in disinvestments and large outlays on infrastructure. They found none of the three. They described the Budget a dull exercise. They did not hide their disappointment. They saw in it a trade-off between growth and fiscal robustness.
But data on the economy and advance tax collections between April and September show little evidence of any trade-off between the two. Data pertinent to the first half (H1) of 2006-07 show that gross domestic product (GDP) may be growing at an annualised 8 per cent.
Collections of advance taxes and indirect taxes have grown by a cumulative 32 per cent in H1. Therefore, the ratio of tax growth to GDP growth is a whopping four. This ratio is extraordinary.
So, if there has been a trade-off at all, it is not between the revenue side of the fiscal equation and GDP growth. Revenue inflows have increased by four times GDP growth. In such circumstances, if fiscal discipline is not achieved, the problems are not with the Budget. They lie elsewhere. And resolving them requires managerial thinking .
The Finance Minister, Mr P. Chidambaram, is an expert at exploiting the power of the managerial approach to balance the books. He presented a managerial Budget based on the principles of breakeven analysis (Business Line, March 10 and 17).
It was neither loud nor flashy. It was quite staid. This explains why reform enthusiasts were unimpressed. The results after six months, however, are very impressive. The results are proof that managerial Budgets based on breakeven analysis and profit planning will deliver growth and fiscal discipline.
The principal objective
The managerial Budget was aimed at overwhelming the stubbornly high costs of governance. Fixed costs of governance in India are among the highest in the world relative to GDP; it is unlikely they will decline in a hurry.
Therefore, the managerial plan was focussed on raising activity and output in numerous product and services markets and thereby on raising the aggregate contribution to the exchequer. Higher contribution to the exchequer is a non-negotiable necessity for meeting the high fixed costs of governance.
Towards this, the Budget had to sustain the good times of ordinary people by not ruffling their consumption patterns. Second, it had to expand the market for goods that trigger economic proliferation and earn higher indirect taxes. Third, it had to give a big push to the consumption of low-end branded goods that trigger economic penetration and thereby higher employment. Fourth, it had to impact favourably the profitability of past investments made by the private sector, making future investments more attractive and sustainable.
The principal logic
Mr Chidambaram's managerial Budget was seemingly unimpressive because it acknowledged the centrality of consumption to fiscal robustness.
It did not say too many things about savings and investments. It did not say how important it is to invest in infrastructure. It did not contain a lecture and a set of sops aimed at funding infrastructure.
Instead, it gave a big push to the consumption of low-end branded goods that trigger economic penetration. It brought about deep cuts in the context of many visible Customs tariffs and excise duties. In particular, it exploited the positive externalities of ownership of the small car by cutting the excise duty. These components together were aimed at plucking the low-hanging fruits.
The impact of the managerial Budget is positive. Corporate tax collection has grown by 67 per cent. Income-tax collection has grown by 33 per cent. Together, they account for 50 per cent of the rise in tax collection in 2006-07.
The tax buoyancy is the result of the enhanced robustness of the private sector. This points to the necessity for government to govern so as to sustain demand, create jobs and income and the profitability of corporate enterprise. One insensitive move move by government can negate all four in one quick stroke (Table 1).
The rise to prominence of corporate and income taxes is an important economic development. This has fiscal and governance implications.
The government is now a partner of the private sector even if it does not see itself playing that role in the creation of jobs and incomes. It has an obvious role in making enterprise in India more rewarding. It has to play this role in its self-interest. Why?
The relative importance of indirect taxes has fallen from 67.86 per cent to 63.71 per cent of total taxes. The relative importance of direct taxes has risen from 32.14 per cent to 36.29 per cent of total taxes (Table 2).
It is customary for highway operators to post the `drive carefully, dangerous curves ahead' sign when a straight road is set to become curvy. The rise to prominence of corporate and income taxes requires a similar signposting. Excise duties and Customs tariffs rise linearly when the economy does well and fall almost linearly when the economy trips and dips. But corporate tax and income tax do not rise or fall linearly.
When the economy does well, the profitability of companies rises smartly because companies cover their fixed costs first and then they have to cover only their variable costs.
Therefore, corporate tax rises higher and faster than corporate sales. But the danger is obvious. When the economy loses momentum, corporate sales become inadequate to cover both variable and fixed costs. Corporate tax falls lower and faster than corporate sales when the economy trips and dips.
The same can be said of income taxes. Taxable incomes and the number of taxpayers rise handsomely when the economy does well. The rise is not linear. Taxable incomes and the number of taxpayers fall quite depressingly when the economy turns bad. The fall too is not linear.
Therefore, the present signs of fiscal comfort arising from smart collections of direct taxes may be short-lived. The risk that such collections may drop in some other year is considerable.
The only way in which India can bullet-proof itself from the fiscal stress that may follow a tripping of the economy is to ensure that Parliament, citizens and the private sector do not accept revenue deficits. Legalised revenue deficits will surely undermine fiscal robustness.
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