OCTOBER 29, 2014

By TIOL Edit Team

THE role of fiscal policy and expenditure choices as two engines of economic growth has lately come under fresh scrutiny of experts. The outcome of such analysis should prove handy to the NDA Government in transforming the forthcoming budget as a multi-facet instrument of inclusive growth and jobs creation.

The Finance Minister Arun Jaitley might like to mull over such analysis and frame the 2015-16 Budget accordingly. Such an exercise is important because different lobbies pull strings for their own agenda and thus vitiate the budgetary process.    

Mr. Jaitley is indeed in an enviable position to make synergetic changes in the composition of taxes and public expenditure as economic situation has stabilized over the last six months. The decline in prices of crude oil and other major commodities such as urea provides a perfect backdrop for launch of imaginative fiscal and budgetary initiatives to strive for sustained high growth with modest inflation.

Mr. Jaitley’s budget formulation team should factor in the observations and conclusions drawn by Asian Development Bank (ADB’s) working paper ‘Fiscal Policy and Growth in Developing Asia’ released on 27th October.

The Paper concluded: "In developing Asia, the composition of taxes and government spending matters for economic growth. In theory, different types of taxes and public spending have different effects on growth. In line with theory, we find that in developing Asia, property taxes are more conducive for growth than personal and corporate income taxes. Therefore, when the region improves fiscal revenue mobilization efforts across all revenue categories to expand its relatively limited revenue base, governments would do well to pursue a mix of taxes and other fiscal revenues that minimize adverse growth effects."

The paper has estimated the impact of changes on tax composition on per capita gross domestic product (GDP) growth. It shows that in countries like India reducing the proportion of their income taxes to OECD levels may raise GDP per capita growth on average by about 1.0 percentage point in the long run.

It observes: "Results indicate that reducing the proportion of corporate income tax while raising that of consumption and other taxes can raise long run GDP per capita growth by 0.9 percentage points."

The analysis also shows that "the impact of raising shares of property taxes to OECD levels considering the negative relationship between property taxes and growth. This was done for seven economies with India having the largest gains at more than 3 percentage point rise in long-term GDP per capita growth."

The Paper explains that property taxes are preferred over income taxes since they can help shift investment from housing into activities with higher returns, and thus increase the rate of growth.

The broad lesson to be drawn by Indian authorities from this paper is that the composition of taxes and relative changes in rates should be decided with a focus on growth.

As for indirect taxes, Mr. Jaitley should take decisive step in the Budget for roll-out of goods and service tax (GST), which must cover petroleum products.

The World Bank, in its latest ‘India Development Update’ has aptly observed that "The GST offers a unique opportunity to rationalize and re-engineer logistics networks in India, given the inherent inefficiencies with taxes based on the crossing of administrative boundaries."

Mr. Jaitley should also correct the bias for import duty cuts as compared to excise duty cuts exhibited by successive budgets since the start of economic reforms in mid-1991. This bias is one of the major reasons for erosion of the competitiveness of the manufacturing sector and stagnation of its share in the country’s GDP.

We hope the budget would also herald the revival of the mining sector, on which hinges the competitiveness and growth of the manufacturing sector.

As for shuffling the basket of public expenditure, the ADB paper has pertinently noted that "the composition of government spending also has a significant effect on economic growth."

It says: "More specifically, our analysis indicates that shifting public spending to education will yield a sizable growth dividend."

The forthcoming budget should thus provide for handsome increase in allocation for both education and healthcare, apart from improving the regulatory environment for enhanced private participation in these areas.  

Yet another area that deserves enhanced policy and investment intervention is the infrastructure sector, which serves as the ‘pull factor’ for the manufacturing sector.

The Budget team should thus give serious consideration to the recommendations made by the High Level Committee (HLC) on Financing of Infrastructure chaired by Deepak Parekh, HDFC Chairman.

In its recently submitted 2nd report, HLC has rightly pointed out that "the objective of inclusive growth averaging 7-9 per cent per year can be achieved only if this infrastructure deficit is overcome and adequate investment takes place in support of higher growth for an improved quality of life, both for urban as well as rural communities."

The report says: "the enabling environment for private participation in infrastructure needs to be improved significantly in order to mobilise the requisite levels of investment. Cross sectoral impediments such as delays in land acquisition and environmental clearances, taxation related issues and regulatory uncertainties need to be addressed urgently. The proposal to introduce regulatory reforms through an over-arching legislation also needs to be implemented."

The toughest challenge the Budget should address is roll-out of strategies to prevent subsidy leakages and improve significantly the efficiency of public spending including the funds given to States under Centrally sponsored schemes.

We hope Mr. Jaitley would receive in time the reports of Expenditure Management Commission and Finance Commission to reflect their recommendations in the Budget.

The efficient use of public money and the resultant savings can serve as icing in the cake for the jobs market.

IMF, in its latest Fiscal Monitor, has aptly pointed out that job creation is at the top of the policy agenda across the globe. It says:"High and persistent levels of unemployment call for a broad policy response, generally encompassing labour market reform and other economic policies."

The Indian public expects Mr. Jaitley to utilize the Budget to the hilt to unleash forces of growth and jobs creation.