Often, it is said that only a very small minority of Indians pays tax. That is only true for income-tax (I-T). Almost everyone pays indirect tax when they spend on consumption. In India, two-thirds of total tax collection comes from the indirect side. Every Indian must, therefore, care about the budget, the upcoming one being particularly important.
It is the first budget in independent India that follows such a sharp contraction in growth. The last time India registered negative annual growth was in 1979, when the economy was a fraction of the size it is today and the decline not as sharp. In the circumstances, conventional Keynesian economic wisdom would demand a fiscal expansion. But while the economy has recovered well from the shock of the first two quarters, growth will only be marginally positive in the last two quarters. India needs to grow fast, at over 8% in 2021-22, just to return to the place it was before Covid-19 struck.
Economic growth runs on four engines: consumption, investment, government expenditure and exports.
Despite the larger-than-life role of government, the share of its spending in GDP at around 13% makes it the least weighty of the four. (Consumption is by far the largest at over 55% of GDP.) Can the smallest, and arguably least efficient, engine be the prime driver of speedy growth?
In the first two quarters, when the lockdown was in force in varying degrees, and confidence at rock bottom in the face of an unknown virus, the answer would have been an unambiguous yes. In the circumstances that prevailed at that time, the other three engines of growth were unlikely to fire.
A physical lockdown depressed private consumption, the global nature of the Covid-19 pandemic and cross-border controls squeezed exports, and complete uncertainty took a toll on private investment with firms and people tightening belts for difficult times. Only GoI could loosen its belt and spend more to prevent a total collapse.
In India, the government gave a greater emphasis to liquidity support to struggling firms and individuals than to spending, unlike in many other countries. If GoI did not splurge then, what is the probability it would do so now? The difference is that at that time, government revenues had also dried up, which dissuaded additional spending.
But they have now recovered since the rebound in the economy. The temptation to do a fiscal stimulus by spending more is higher this time. However, there are two ways to do a fiscal stimulus. Either GoI spends more, or it earns/spends less leaving more money to households and firms to spend/invest. The budget must focus on the latter. This is not the time for GoI to increase its spending by taking a bigger share from taxpayers.
On the contrary, it should cut taxes on individuals and firms and allow them to play a bigger part in the revival story. Confidence is back. An effective stimulus could address over-the-top taxation, such as cesses, which can be removed. It could also involve cash transfers to the poorer sections of the population, which will spend immediately.
These will immediately boost investment and consumption, thereby stimulating a supply response creating a virtuous cycle for growth. To the extent that GoI wishes to spend more, on infrastructure, for example, it should avoid additional taxation. Because of India’s legacy of a State-led economy, GoI has its own sources of wealth and revenue — public sector undertakings (PSUs) and land assets. One option it has is to direct PSUs to undertake investment expenditure.
But given the fragile state of finances of most PSUs and the inefficiencies in their operations (like government, they too are bound by lengthy processes), the superior option is to divest PSUs. The demand for assets driven by plentiful cheap liquidity, as evidenced by the booming stock markets, is very high. This applies to assets other than PSUs as well, like airports, ports and highways, as well as tracts of unused land owned by the Indian Railways, defence services and other agencies. Revenue from the monetisation of these assets may be used to finance additional government investment expenditure, without burdening taxpayers.
The finance minister has promised the best budget in 100 years. If GoI can engineer a stimulus while reducing the taxpayers’ burden, indeed it will be.
The author is chief economist, Vedanta