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Minimum government, maximum risks

Tough decisions made by Modi in Year 1 will pay off handsomely in Year 5.

Written by Jaithirth Rao | Updated: June 10, 2014 12:57:50 am
Acknowledging and owning up to financial reality may paradoxically result in a positive response from the much-feared rating agencies. Reuters Acknowledging and owning up to financial reality may paradoxically result in a positive response from the much-feared rating agencies. Reuters

Tough decisions made by Modi in Year 1 will pay off handsomely in Year 5.

Conventional wisdom is that the new government should focus on reducing the fiscal deficit. This writer would like to take a contrarian view. Ronald Reagan ignored the deficit hawks . He went for bold tax cuts and increased fiscal deficits. Reagan’s gamble paid off. The American economy acquired vigour. Growth became the new story, albeit with a time lag. At the end of four years, Reagan was re-elected. The Modi government should perhaps imitate the Reagan administration.

The thing to remember is that voters are swayed by inflation and growth in the period just before an election. The new government should focus not on inflationary risks now, but on the likely inflation and growth rates five years from now. Taking risks in the first couple of years may turn out to be worthwhile as a solid growth engine for the economy is set in motion.

On tax revenues, the government can take bold steps: First, there is no need for miserliness with the states in terms of giving them so-called compensation to persuade them to sign up for the GST. A few tens of thousands of crores in payment to states to cover estimates of losses through the GST, as well as generously settling earlier VAT and sales tax claims, would be a masterstroke. The previous government nickel-and-dimed the states to the detriment of the speedy implementation of the GST. States are likely to use these funds to cover up their battered balance sheets; the combined fiscal deficit of the Central and state governments is unlikely to explode. Second, the government can announce that it will fundamentally change the present incentive systems in the tax departments by not prescribing any targets to officers or teams for tax collection. Government officials must be seen as duty-bound to implement the law fairly via-a-vis all tax-paying citizens. It should not be the job of government officials to hound citizens for taxes. This measure will be criticised on the grounds that this will lower  tax collections.

Au contraire, as the venerable Todar Mal (the revenue minister of Sher Shah and Akbar) would have told us, a fair, non-rapacious tax system will in the long run lead to revenue maximisation. Short-term losses, if any, will seem insignificant. Third, the government should make a one sentence announcement that the notorious “Vodafone” amendment will be made a prospective one. This will again be criticised for the implied loss of tax revenue.

Gore Vidal observed that in Mauryan India, the state knew how to extract revenues from citizens gently, painlessly and seemingly effortlessly. Kautilya knew that the goose that lays the golden eggs must not be killed. It should be kept healthy and fat! Fourth, the government should set up a settlements commission to resolve speedily and decisively a host of legal wrangles that have accumulated under previous dispensations. This would include matters like transfer pricing claims, onsite-offshore revenue splits and other issues that have bedevilled our tax administration and made it hostile to business and entrepreneurship. Last, the government should announce that if it loses a case at the level of a tribunal, it will not appeal further. We need not curtail the citizen’s right to appeal if she loses, as that might be unconstitutional. In its announcements, the government claims that “reviving the investment climate” is one of its priorities. This one decision of forbearance in litigation can single-handedly unleash the animal spirits of investments like no other. Lawyers who lose some appeals work may complain. We as a country can afford to live with their complaining!

On expenditure, one of the byproducts of our national obsession with “containing” the fiscal deficit in order to keep the Big Brother rating agencies happy, has been the pernicious habit of postponing government payments. State governments, municipalities, oil companies and fertiliser companies that are asked to wait for payments in turn delay making payments to their supply chain; literally thousands of suppliers and vendors to the government face endless delays in getting legitimate payments. This has several perverse effects on the economy. Many firms, especially smaller ones, go under; banks that have financed the so-called “risk-free” government receivables get stuck with bad loans. The overall effect of such capricious delays is to paralyse an economy that is anyway in a gridlock mode. Making a set of large one-time payments to once and for all eliminate these arrears will definitely blow up the fiscal deficit. But this is a risk that must be taken.

Acknowledging and owning up to financial reality may paradoxically result in a positive response from the much-feared rating agencies. After all, it was the lack of integrity in accounting that did Greece in. In the corporate world, it is an established practice for a new CEO to book all the accounting “bad news” in her very first quarter so that the blame rests with the predecessor CEO and future upsides, if any, accrue to the new one. Our government could do well to imitate such CEOs.

In recent years, concern for fiscal rectitude has forced the government to go in for public-private partnerships in the area of infrastructure. Many PPP projects are stuck in legal quagmires; it will take time for a new and hopefully fair and transparent system to emerge. In the meantime, infrastructure should not wait. The government should go ahead with state-funded infrastructure delivered by a competent and autonomous set of state institutions. This is based on the hope, perhaps optimistic, that the new government can pull off such an effort competently. This may be bad for the fiscal deficit. But if it eases physical bottlenecks, it may end up being anti-inflationary from the supply side.

Net-net: Let us take some risks a la Reagan with a larger fiscal deficit on paper. Even if these risks create troubles , let us remember that it is not Year 1, but Year 5 that counts for a re-election. Hopefully, by that time, the risks would have paid off and India will be in double-digit growth mode.

The writer is a Mumbai-based entrepreneur

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