Since the global financial crisis, standard bearers of fiscal rectitude have thrown caution to the wind and are resorting to unbridled fiscal expansion. Countries with large fiscal imbalances are increasing their deficits. Greece, Iceland, Ireland, Portugal and Spain have become or are becoming basket cases and the comity of nations is concerned about a domino effect and global opinion is veering to bail-outs.

Unfortunately, internationally renowned experts, like Professor Robert J Shiller of Yale University, argue that to take advantage of rock-bottom real rates of interest, the present time is opportune for governments to step up borrowing, rather than striving for fiscal consolidation.

Indian Macroeconomic Outlook

There is a considerable euphoria in the context of the government’s Mid-Year Analysis for 2010-11 released on 7th December. The report leads to the conclusion that the economy is firing on all cylinders despite an uncertain global outlook and the official estimate of real GDP growth in 2010-11 has been revised from 8.5 per cent to 8.75 per cent which, eventually, could turn out to be 9.0 per cent. Moreover, with the distinct recovery of agriculture, growth is more balanced. Inflation, based on the year-on-year Wholesale Price Index, shows a slowdown from the much-dreaded double digits to 8.5 per cent and official expectations are that it would come down to 6.0 per cent by the end of March 2011. Investments and consumption are both picking up. The balance of payments current account deficit in 2009-10 was a little less than 3 per cent. Outside analysts expect that with the widening of the trade balance, the deficit in 2010-11 could well be close to 4.0 per cent; nonetheless it is felt that this would be entirely financed by foreign direct investment and external commercial borrowings while non-resident Indian deposits and strong portfolios would provide a cushion. The Chief Economic Adviser (CEA), Dr. Kaushik Basu, recognises that there could be excessive capital inflows and his pecking order of preference for managing the capital account is first, intervention in the forex market, secondly, tax-based intervention and lastly, quantitative intervention. According to the CEA, the faster growth of the economy does not signal overheating. But the Mid-Year Analysis rightly stresses that, although the economy is on the roll, fiscal deficit and the domestic debt-GDP ratio are of concern.

Roadmap for Fiscal Consolidation

While the roadmap set out under the Fiscal Responsibility and Budget Management Act has been scrapped, the government, in its recent report on Government Debt – Status and Road Ahead, has set a revised roadmap of medium-term consolidation. The Centre’s gross fiscal deficit-GDP ratio is expected to come down from 6.6 per cent in 2009-10 to 3.0 per cent in 2014-15 and the Centre’s debt and liabilities from 50.5 per cent to 43 per cent of GDP. The overall debt-GDP ratio is planned to be reduced from 73 per cent in 2009-10 to 65 per cent in 2014-15. A noteworthy feature is that the Centre’s external debt is less than 4 per cent of GDP and, as such, the chances of an externally-generated crisis are minimal. The internal debt is, however, a silent killer. The government recognises that the fiscal consolidation should come essentially from moderation of expenditure and not increased taxation. A cause of concern is that in fiscal consolidation the vulnerable sections bear the brunt of adjustment. The government has done well to stress that the adjustment should not be at the cost of reducing social sector expenditures, such as, education, health and food security.

Issues for Budget 2011-12

At the outset, it is necessary to evaluate the performance of various programmes and recast those which are performing poorly; the overall support for these programmes should not be curtailed. Increased efficiency and reduction of leakages are desirable but this is easier said than done. The government should set up an Independent Evaluation Office for Special Programmes. Attention should be given to steps to bring about an improvement in the poorly performing programmes so that they reach out to the target group.

According to the Mid-Year Analysis, the faster growth of the economy does not signal overheating, adding that although the economy is on the roll, fiscal deficit and the domestic debt-GDP ratio remain areas of concern

The Ministry of Rural Development has sanctioned nine projects for Promoting Urban Amenities in Rural Areas (PURA). There are three important innovations in these projects. First, instead of concentrating on a single village (or a single family), the objective is to develop a cluster of villages. Second, instead of small projects of less than a million rupees, the scale is raised to Rs 10 million. Three, instead of using only NGOs, the PURA is a public-private partnership, with the government contributing 30 per cent and the private sector the remainder. It is also meant to be a co-operative enterprise supported by the local Panchayats. Dr P V Inderesan, former Director, IIT Chennai, argues that urban development, in its very nature, generates slums. PURA can partly alleviate the problem by reversing the rural-urban migration. According to the 80-20 rule, the top half of the population commands 80 per cent of the resources. Of the remaining half, the top quarter commands 15 per cent of the resources while the bottom quarter receives only 5 per cent of the total. Indiresan recommends that the population should be divided into three categories: the top half should bear the full cost of services, the next quarter bear the marginal cost while the bottom quarter should get these services virtually free. In the PPP model, the government’s contribution could be to make up the loss of private enterprises. The PURA model, if successfully, replicated could be a win-win situation wherein urban slums are reduced and there is a reversal of the rural-urban migration.

Sale of Family Silver

The Mid-Term Analysis makes an important point that the disinvestment proceeds should be earmarked to a dedicated fund which will allow a build up of the fund when there are cyclical gains downturns. Alternatively, the sale of family silver should be exclusively earmarked to a Consolidated Sinking Fund to redeem government debt. This implies avoiding the soft option of showing a reduction in fiscal deficit in the immediate ensuing period rather than using the sale of assets to ensure smooth debt repayment in the medium-term.

Rationalisation of Direct Tax Regime

There are a number of creases in the proposed Direct Tax Code (DTC) which are best ironed out well before the new Code comes into effect. It is unconscionable to hurt the vulnerable sections while providing for blatant giveaways for the better-off. It would be best to consider at least a partial correction of some of the anomalies in the Budget for 2011-12.

• (a) Standard Deduction for Salaried Employees: In the case of non-salaried income tax payers, there are a plethora of exemptions which enable individuals with large incomes to show very low taxable incomes. In contrast, salaried earners do not enjoy such benefits. It would only be fair to restore the standard deduction, setting it at a fixed amount rather than a percentage of salary income subject to a ceiling. Under the erstwhile standard deduction, recipients of pensions and annuities were also eligible for standard deduction; Senior citizens, who do not have pensions or annuities, should also be eligible for the standard deduction.
• (b) Basic Exemption Limit: At present, the basic exemption limit is Rs 160,000 for individuals and Hindu Undivided Families, Rs 190,000 for women below the age of 65 and Rs 2,40,000 for Senior Citizens. The DTC envisages that this concession to women should be withdrawn At a time when it is widely recognised that the gender bias should be corrected, it would be best to give a strong signal in the Budget for 2011-12 by giving women below the age of 65 years, the same benefit as that accrues to senior citizens and the proposal in the DTC should be rescinded.
• (c) Deduction of Savings Under Section 80C: Under the extant regulations, there is a deduction from income for specified savings up to Rs 100,000 and a further Rs 20,000 for investments in infrastructure bonds. There is, however, an anomaly in that while salaried earners can have access to both employee provident funds as also the Public Provident Fund (PPF) self employed persons are provided the option of only the PPF. As such the limit for PPF should be made equivalent to the 80C concession; this is important as the Direct Tax Code envisages a significant increase in the 80C deduction.
• (d) Special Consideration for Senior Citizens: The way the 80 C concession works discriminates against senior citizens. Senior citizens cannot be expected to enhance their savings and as such it would be only appropriate if there is a quantum jump in the basic exemption for senior citizens. At present, senior citizens enjoy a basic exemption limit which is Rs 80,000 higher than for other tax payers. Once the 80C exemption is raised to as much as Rs 300,000 as proposed in the DTC, the anomaly becomes glaring and there is a strong case for enhancing the basic exemption for senior citizens to a level which is Rs 300,000 above that for tax payers below the age of 65 years (in such an event, the senior citizens should not be given a double benefit of also getting the 80C benefit). The real challenge is to actually reach out these deprived segments of society rather than commitments which remain on paper.
• (e) Restoration of the 80L Deduction: It is unconscionable to withdraw the 80L deduction for bank deposits and other debt securities, and at the same time grant a blanket exemption for income derived by way of dividends from companies and mutual funds. If the government is unwilling or unable to withdraw the dividend exemption, it is only fair that income from bank deposits and securities should be made eligible for a similar exemption. An equitable approach would be to provide an overall limit for deductions for bank deposits, securities and dividends from companies and mutual funds.
• (f) Revisiting Inheritance Tax and Gift Tax: The present Indian regime of unlimited exemption of gifts and the total absence of an inheritance tax is glaring in comparison with most countries. In this respect the Indian tax regime is a virtual tax haven. While not reverting to the erstwhile confiscatory tax regime it would be worthwhile if a High Powered Committee is empowered to review the experience of other countries and India in relation to inheritance tax and gift tax. There can be reasonable exemption limits but beyond that there should be taxes for gifts and inheritance. Warren Buffer has recently argued that the rich should be taxed more as the rich have had it better than they have ever had- this is even more applicable to India.

There are a number of creases in the proposed Direct Tax Code, which are best ironed out well before the new Code comes into effect. It is unconscionable to hurt the vulnerable sections while providing for blatant giveaways for the better-off

Conclusion

While fiscal consolidation is vital and the government has set out a credible path of adjustment, it is essential to ensure that in the process of consolidation the weaker segments are protected. At the same time, the poverty alleviation programmes need to be subject to review by an Independent Evaluation Office and there can be significant gains in constructive improvement in various schemes. It is not fully appreciated that the quest for growth inevitably implies that the tolerance level for inflation is being made very elastic. Such an approach in a country with large tracts of poverty is a standing invitation for explosive social tensions. This thought should be upper-most while formulating the Union Budget for 2011-12.