Budget 2019: Nirmala Sitharaman’s fiscal dilemma

Avinash M Tripathi

Budgets in India serve a number of functions. First, they seek legislative sanction for levying taxes and incurring public expenditure under specific heads. Second, they ensure the legislative scrutiny of the estimated, revised and actual receipts and expenditure pertaining to different years. Besides these original functions, budget speech has also become an occasion to articulate economic policies and programmes of the government and outline a fiscal roadmap for the future.

Due to these reasons, the budget speech of finance minister Nirmala Sitharaman is one of the most anticipated in recent times. Despite dealing with the expenditure for merely three quarters of the year, it is expected to lay down the economic roadmap of a government backed by a robust parliamentary majority. Observers will take note. Every word uttered by the finance minister will be interpreted indefinitely.

Besides laying the roadmap, the finance minister’s real challenge will be a tightrope walk between containing the fiscal slippage and handling growth slowdown. The latter — due to slowdown in consumption, exports and gross domestic capital formation — calls for an economic stimulus package which is at odds with the objective of fiscal consolidation.

Some numbers may give a sense of the challenge. According to the medium-term fiscal policy statement, fiscal deficit and revenue deficit for the fiscal year 2020 is estimated at 3.4 per cent and 2.2 per cent of GDP, respectively. This is already a deviation from the original mandate of the Fiscal Responsibility and Management (FRBM) Act.

Further, growth slowdown means that the tax base is not expanding fast enough. Together with lack of buoyancy, it implies that there is not much scope for increasing the tax and non-tax revenue. Moreover, a number of electoral commitments have constrained the fiscal space available to the government. In the interim budget, for instance, the government announced an ambitious programme of cash transfers to small and marginal farmers whose coverage has been further expanded after the election.

However, the problems don’t stop there. The gross domestic saving rate has declined from around 37 per cent in 2008 to around 30 per cent. Declining domestic savings implies that the pool of resources from which the government can borrow is very limited. Any slippage on the fiscal front will drive up the yields on government securities and crowd out private investment.

What can the finance minister do to square the fiscal circle? Some of the ideas which can be implemented are as follows.

Focus on disinvestment. Continued direct/indirect budgetary support to entities such as Air India is against both the objectives of equity and efficiency. The government should bite the bullet on the disinvestment front. In addition to bringing much-needed money, it will also drive up foreign investment.

Excludable public services/utilities should always be priced. Economists define pure public goods and services which satisfy the twin conditions of being non-excludable and non-rivalrous. There are many infrastructure projects which are excludable, however. Such quasi-public goods — think of metros — should always be priced, irrespective of populist pressures.

Tax economic rent. Economics distinguishes between profit and rent. While the former is a reward for risk-taking, the latter is a payment for owning means of production which are in short supply. House property rent is one example, there are many others.

Equally important would be resisting the temptation to kill the goose that lays golden eggs. Certain ‘bad’ taxes should be avoided at all cost. For example, take the transaction tax. It is a bit like throwing sand in a well-oiled machine, which creates friction and slows down value-creating transactions. Such taxes should be avoided when the growth is already slowing down.

Further, the tax on entrepreneurship. Angel taxes were in the news in recent years. Despite being billed as a tax evasion measure, this had the unintended consequence of taxing the risk capital with enormous long-term implications. Also, taxes on savings and long-term investment should not be contemplated. As the saving rate is already decreasing, any new tax on savings will only disincentivise thrift further.

The focus should be on rationalising government expenditure. The feasibility of mass cash transfers has already been demonstrated. There is a case for a body such as the Expenditure Commission to examine the feasibility of moving different welfare schemes through the more efficient cash transfer mode.

Getting out of the slowdown without jeopardising fiscal rectitude and economic stability calls for a macro stimulus with micro efficiency. It requires combining smart economic ideas with political heft. As she prepares her maiden budget speech, the finance minister has her task cut out.

Avinash M Tripathi is an associate research fellow (economics) at Takshashila Institution. Views are personal.