Today’s Union Budget will be the last full budget before next year’s general election. In such a situation, in any democracy, there is an incentive for the government to announce populist policies, especially those that yield quick political returns. Economic reforms are generally given low priority in pre-election budgets.
Given that rural India constitutes two-thirds of the country’s population, it won’t be surprising to see the agricultural sector being generously rewarded. We know that agricultural income is not taxed in India, a feature of the Indian tax system not expected to change soon. In addition, there are agricultural subsidies for seeds, fertilisers, power, credit, etc., and minimum support prices. All of these are expected to stay in place. While I really don’t expect that these support prices and subsidies will be raised (given the pressure from various quarters not to raise the fiscal deficit), this should not be completely ruled out in this pre-election year.
However, the government has an opportunity to kill two birds with one stone, that is, win the support of the rural population and at the same time do something in the long-run interest of the country. Both these goals could be accomplished by increasing investment in rural roads, schools, clinics, irrigation facilities, etc. These initiatives can be politically as effective as subsidies, but, in contrast, not at all economically wasteful, in that their long-run economic benefits will outweigh costs. In fact, these investments should be part of the government’s overall efforts at expanding and improving the quality of public health, education and infrastructure across the nation. Going by the interviews of NITI Aayog’s vice-chairman, I expect these items to figure prominently in the budget speech. Another item, going by those interviews, would be incentives to switch farmers from foodgrains to higher valued cash crops and agricultural products to boost agricultural incomes — a step in the right direction.
A recent reform has been FDI liberalisation in single-brand retail, construction development and real-estate brokerage, where the automatic approval route has been allowed for 100 per cent foreign investment. Forty-nine per cent investment by foreign airlines in Air India has also been allowed. However, just allowing FDI does not mean it will actually flow in. India needs to be attractive to foreign investors. This is certainly not the case with India’s current corporate tax rate of 30 per cent, which is much higher than in most OECD countries as well as emerging economies trying to attract FDI. Besides, multinationals who have entered then have the incentive to transfer some of their incomes to their respective home countries by manipulating their books, a method popularly known as “transfer pricing”. The budget needs to announce a modest reduction in this corporate tax to about 27 per cent, as part of longer-term gradual reforms. In a pre-election year, it would be unrealistic to expect anything more major that would have the optics of being pro-rich. Ultimately, a lot here depends on the government’s ability to sell this policy to the electorate as job-creating.
The last couple of quarters have seen a considerable decline in growth, with the projected growth rate for the current fiscal year being 6.5 per cent. One could view this growth deceleration as a temporary impact of demonetisation as well as problems with the implementation of GST. While demonetisation was an ill-conceived shock to the economy, I view GST as a good policy reform, whose implementation and structure will need some adjustment, in addition to the fine tuning that has already taken place. I hope that, in today’s budget, the current multiple rates are reduced to just a couple, with the ultimate goal of rolling them into one, and the filing process is simplified, making GST a truly “good and simple tax”, as the prime minister likes to call it. It is not unreasonable to expect revenues to go up through such simplifications, which will also go a long way in enhancing the “ease of doing business” and the formalisation of the economy.
Moving to income tax, the maximum tax-exempt threshold should be raised from Rs 2.5 lakh per year to Rs 3-3.5 lakh. While this is clearly good politics, it is also good economics when growth has declined. The propensity to consume for people in these lowest tax brackets is very high and giving them extra disposable income will provide a stimulus to the economy and job creation. In fact, some tax breaks for people in slightly higher income brackets (say, up to incomes of Rs 20 lakh per annum) will also help in this regard. A slight increase in the tax rates on the highest income brackets will get these revenues back, without negatively affecting this stimulus. Of course, economic growth itself will help with revenue generation. Moreover, these changes to the tax schedule will reduce the inequality of disposable income.
I had argued in an earlier article that recent hikes in electronics import duties don’t help at all with job creation and add relatively little to revenues. They also strengthen protectionist forces, spreading them to the rest of the economy. Given our pre-1991 experience with import protection, at the very least, increases in duties on imported inputs (LCD/LED screens used in domestic TV manufactures) need to be rolled back. Exports of labour-intensive manufactures, especially textiles and apparel and domestically assembled electronics, certainly need promotion through duty-free imports of inputs and other indirect tax exemptions. The much-needed FDI in these sectors will then be encouraged. Even if the corporate tax rate cannot be lowered across the board, the government should consider reducing it for labour-intensive manufacturing.
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