Off-Budget Reforms Needed

I’ve long argued that Union Budgets should be simple but clear statements of the government’s annual accounts. The plethora of schemes that feature in every Budget can be published in a pre-Budget document, allowing the Finance Minister to focus on key numbers on tax revenue, expenditure and borrowing.

Nirmala Sitharaman, realising that her 2020-21 Union Budget left much to be desired, said recently that several off-Budget measures will follow. The Reserve Bank of India (RBI) kicked off a key reform to boost bank liquidity by introducing long-term repo operations (LTRO). Banks will now be able to lend to industry at lower rates of interest. The RBI also announced a limited time waiver on CRR which will soften interest rates further.

Since the principal issues of the 2020-21 Union Budget have been decoded and debated at length, consider now the economic agenda beyond this year’s Budget. The key concern obviously is spurring demand and, collaterally, creating jobs. The cuts in personal income tax will put an estimated Rs. 40,000 crore in the hands of urban middle-class professionals. Not quite enough to spike consumption growth, but a good start. However, the removal of exemptions will moderate those gains. The government says over 90 per cent of taxpayers avail of less than Rs. 2 lakh in exemptions. The gains in their hands, it argues, will therefore still be significant. The proof of this particular pudding will lie in accounting. 

More significantly, the abolition of dividend distribution tax (DDT) for companies will encourage fresh private sector and foreign investment. Dividends were taxed at just over 20 per cent (inclusive of cess and surcharge). Following the removal of DDT, companies will make major savings. Along with the earlier cut in corporate tax to 22 per cent (15 per cent for new manufacturing companies – now extended to power generation firms), companies will have more elbow room to invest, expand and recruit. 

However, what the right hand gives, the left-hand takes away. Dividends will now be taxed in the hands of shareholders at their marginal rate. For wealthy shareholders, that’s anything between 30 per cent and 42 per cent. This will lead to more work for chartered accountants as rich shareholders transfer their holdings to Limited Liability Partnerships (LLPs) where the taxation rate is lower. For a small revenue gain to the treasury, the finance minister has increased paperwork for large shareholders and complicated their tax compliance.

The second key concern is to revive the rural economy. The Budget’s focus on agriculture reform went some way towards addressing this. Clearly though, more off-Budget schemes are needed to alleviate rural distress. As in the past, this could come over the next few months. For example, the additional allocation of Rs. 64,000 crore on investment in infrastructure must match intent with implementation. The increase in defence spending by just over Rs. 3,000 crore seems disappointing, given the hostile external environment. The finance minister, however, indicated that additional funds will be found for weaponry on a need-to-buy basis.

India’s economic policymaking has long been held hostage to vested interests. During the UPA government between 2004 and 2014, “phone banking” gave rise to the non-performing asset (NPA) banking crisis. It has taken over five years for the Narendra Modi government to come to grips with toxic bank NPAs. For the first time in a decade, these are now declining. The large fraudulent loans granted by complicit bankers to DHFL, HDIL, IL&FS, Bhushan Steel and several other companies have nearly crippled the financial sector. The vast majority of these loans were approved in the boom period after 2004.

Along with such malfeasance, misstatements by economists within and outside the government have painted a false picture of the sanctity of the country’s statistics. A report in Business Standard placed the issue in stark perspective: “The 2020-21 Economic Survey found no evidence of miscalculation of India’s gross domestic product (GDP) growth by the new methodology, as alleged by critics. ‘This chapter finds no evidence of mis-estimation of India’s GDP growth,’ said the survey in the chapter titled ‘Is India’s GDP Growth Overstated? No!’ The issue assumes importance since many critics, including Arvind Subramanian, the predecessor of Chief Economic Adviser Krishnamurthy Subramanian, author of this Survey, found loopholes in the current methodology that used value additional method and the new base year of 2011-12. 

“Arvind had said in his research paper that a variety of evidence – within India and across countries – suggested that India’s GDP growth had been overstated by about 2.5 percentage points per year in the post-2011 period. The Survey, however, said that models that incorrectly over-estimate GDP growth for India post-2011 also mis-estimate GDP growth over the same period for 51 other countries by anywhere between 4 per cent and minus 4.6 per cent. These mis-estimates include wrong calculation of the UK’s GDP by 1.6 per cent, Germany by 1 per cent, Singapore by minus 2.3 per cent, South Africa by minus 1.2 per cent and Belgium by minus 1.3 per cent. 

“In the paper published at Harvard University, Arvind noted that the one sector where mis-measurement is particularly high was manufacturing. He said pre-2011, manufacturing value-added in national accounts tended to be tightly correlated with the manufacturing component of the index of industrial production and manufacturing exports. But thereafter, a key methodological change affected the measurement of the formal manufacturing sector, he said.” 

When a former CEA is called out by the current CEA one day before the Union Budget on an issue that had the potential to discredit Indian GDP statistics, it is clear that the government must pay more attention to the quality of economic advice it receives. 

In future too, Ms Sitharaman could restrict her Budget speech to a crisp 90 minutes with specific figures on key areas: defence spending, the break-up of revenue receipts and total borrowing. That would provide a clearer picture of the government’s finances. There is a broader lesson in all of this. No one misses the Railway Budget which has been compressed into the Union Budget since 2014-15.  Future Union Budgets should deal with the year’s key accounts. While brevity is the soul of wit, clarity surely is the soul of a good Budget.