A stimulative dose certainly. The challenge lies in implementation
Devashish Mitra | 04 Mar, 2015
When a new government comes to power, the Union Budget is much more than an accounting statement. It lays down the new Government’s vision and is a ‘roadmap’ for where the economy is headed. This year’s was the first full-fledged Budget the new BJP Government was presenting, and expectations were high, in fact unrealistically high in a country with such a complex polity. While the BJP won the recent General Election with a solid majority, analysts often forget that the party and its allies do not have a majority in the Rajya Sabha. As a result, big changes in economic policy are difficult, if not impossible, to have both Houses of Parliament pass, unless, of course, major concessions are made in the non-economic sphere to opposition parties. Therefore, the expectations of real ‘big-bang reforms’ were unrealistic to begin with, and it would be unfair to evaluate this Budget on the basis of such expectations that do not factor in these political realities or the rural-urban (and the rich-poor) divide. Subject to these constraints, what the Finance Minister has been able to do in the Budget needs to be commended.
While India, on paper, always has had a federal structure, there has always been a fair amount of fiscal centralisation. This Budget represents a break from the past in that it implements the recommendations of the 14th Finance Commission to devolve 42 per cent of tax revenues to the states, an increase of 10 percentage points from last year’s share. Thus, this represents a move towards true fiscal federalism and a recognition of the need to do away with one-size-fits-all policies across diverse Indian states. This way, each state has more control over its own development path, keeping in mind its own specific needs. Some commentators have rightly pointed out that there has been no mention in the Budget speech of the role of local governments, namely the Panchayats, and the need to empower them. Hopefully, the NITI Aayog, which is supposed to advise the states on their expenditures (according to a recent article by its vice chairman, Arvind Panagariya), will impress upon them the important role of Panchayats in economic development for which sizeable funds would need to be allocated to their budgets.
The Union Budget has not been too rigid about fiscal targets. To say that the quality of the entire Budget can be summarised in one number, namely the size of the fiscal deficit as a percentage of GDP, is insulting to the massive effort that goes into putting together a budget of this size for a country of 1.2 billion people. The actual composition of expenditures and revenues is very important. The most impressive thing about the expenditure part of this Budget is the emphasis on infrastructure and social spending. This allocation will include financing of the completion of 100,000 km of roads currently under construction and starting the construction of another 100,000 km soon thereafter. In addition, there is an equal expansion of expenditure on railway infrastructure. The infrastructure allocation will also cover rural electrification, solar energy generation, the setting up of new ‘ultra mega power projects’, expansion of irrigation facilities, etcetera. The Finance Minister also announced the commissioning of another unit of a nuclear power station in 2015- 16. Overall, there is going to be an increase of Rs 1,25,000 crore in public investment over and above what was allocated to it in last fiscal year’s Budget, of which Rs 70,000 crore is earmarked for investment in infrastructure. This is the biggest growth and productivity boosting measure in the Budget, especially given the poor state of India’s infrastructure. Also, the resulting increase in growth will mean greater revenues for the Government in the future, which in turn will lead to rapid paying off of its debts and at the same time greater social spending on health, education and poverty alleviation.
In his speech, Finance Minister Arun Jaitley also announced the expansion and improvement of education at all levels, including the opening of new junior, middle and high schools as well as a few IITs, IIMs and AIIMSs. The expenditure on primary and secondary education is certainly long overdue. In the case of tertiary education, adding a few more elite engineering and medical institutions (and a couple of institutions in other fields) is not good enough. A large number of vocational training institutes are needed and something more concrete should have been said in this regard beyond the Finance Minister’s statement that the Government has “created a ministry for skill development that is about to launch a massive programme’. Along with a greater number of engineers, India needs more electricians, mechanics and carpenters. And along with more doctors, India needs more nurses, physiotherapists, respiratory therapists, speech therapists, mental health counsellors, occupational therapists, etcetera, to expand medical care and improve its quality. Introducing in India the concept of fully trained nurse practitioners—who might be able to perform some of the functions of physicians as is common in the US—is absolutely essential given India’s massive population size and the limited number of quality doctors relative to that population. Moreover, there is also a need for high-quality universities providing education in the basic sciences, social sciences and the humanities. For development to take place, the Government needs to come out of the old mindset that there is very little that is useful outside of engineering and medicine. Like in most developed countries, students should have all possible options and choose their specialisation unconstrained by any kind of hierarchy of fields created by society and reinforced by the Government. Doing away with this hierarchy will lead to more efficient matching between people and their areas of specialisation and expertise. The Government may not have the funds to expand institutions in all fields, but it certainly should think hard about incentives for domestic and foreign private institutions to enter.
To address the issue of open defecat- ion, Jaitley has rightly announced the goal of moving beyond the 5 million toilets already constructed over the last fiscal year and of ultimately constructing 60 million toilets over the next few years. This is important both from the point of view of health and sanitation as well as the safety of women and girls. The Government has mentioned this in the context of the Swachh Bharat campaign started by the Prime Minister. However, I have not heard anything so far about more investment in garbage disposal, better drainage facilities, training and protective gear for garbage and sewage handlers, garbage cans on streets, recycling facilities, and so on. More employment is needed in these areas. And if the Government has limited capacity here, it needs to bring in the private sector, as is done in many developed countries. More investment also needs to go into pollution control as well as monitoring of emission in factories and from automobiles. There is some mention of pollution control in general terms in the Budget, but more specifics would have been useful.
And then the Finance Minister has announced the Government’s long-term goal of universal social security along with extending health, accidental and life insurance coverage throughout the population at very low premiums. While universal social security is an excellent and very progressive objective, there is inadequate information in the Budget on how the country will move towards it.
The opposition has been quick to point out that social spending, especially on the poor and the underprivileged, has actually fallen relative to the last fiscal year. The Finance Minister has clearly explained how this is an obvious consequence of the increase in the share of the states in the overall budget. For the right comparison to these expenditures by the Centre, it would make sense to add the social spending by the states.
I have written elsewhere that MGNREGA should not be shrunk unless we have an expanding system of univer- sal or targeted cash transfers in place. MIT economist Abhijit Banerjee points to work by World Bank researchers show- ing how universal cash transfers guaranteeing a minimum income will be more effective in helping the poor than MGNREGA. However, Banerjee also points out that despite its high administrative costs, leakages and low productivity, it has resulted in some benefits for the poor. The Government has adopted the policy of not shrinking MGNREGA (and, in fact, is expanding it). However, contrary to expectation, it is somewhat disappointing not to see much movement towards more efficient forms of redistribution, such as cash transfers. One can hope that once what the Economic Survey calls the ‘JAM Trinity’ (Jan Dhan, Aadhaar and Mobile) has expanded, we will see greater movement on this.
The revenue side of the Budget is where I think the Government has been the most innovative and creative. Starting with direct taxes, the Budget has raised the total basic exemption, or what is called ‘benefit’, considerably to Rs 4,44,200 for an individual taxpayer. In addition, deductions related to education, health, transport and contribution to pension funds have gone up considerably. While the wealth tax has been eliminated, there is a new 2 per cent surcharge on individuals with annual income of over Rs 1 crore, thereby more than making up for lost revenues due to the abolition of the wealth tax. Thus the effective tax schedule has become more progressive. Over the next four years, the rate of taxation of corporate profits will go down from 30 to 25 per cent. However, all exemptions in the case of corporate profits will be done away with. Getting rid of exemptions, which amounts to closing loopholes, will increase the effective collection rate from 23 to 25 per cent. At the same time, the lower corporate tax rate can have the effect of attracting foreign investment and making sure domestic investors do not go outside the country. Overall, the combined effect of all the changes in direct taxes will lead to a revenue loss of Rs 8,000 crore, which will be more than offset by the indirect tax proposals which will lead to a revenue gain of Rs 23,000 crore. Thus all taxes, direct and indirect, together will lead to a net gain in revenues worth Rs 15,000 crore.
Before I list the major indirect tax measures, it is important to point out another source of funds for the development of infrastructure mentioned in the Budget. The Government wants to have a system in place to issue infrastructure bonds and develop India’s bond market to catch up with the country’s well-developed equity market. The Budget’s indirect tax measures include establishment of a state-of-the-art GST by 2016, increase in the service tax from 12 to 14 per cent and expansion of the coverage of services that would be covered by this tax. Also, while the import tariff rates on many inputs and raw materials will go down to reduce the cost of production of domestic producers to support the ‘Make in India’ campaign, the import tariffs on iron and steel and iron-and-steel products will increase from 10 to 15 per cent. Also, import tariffs on commercial vehicles will go up from 10 to 40 per cent, which is a huge increase. This in my view represents protectionism that seems to be creeping back into the system. Increase in the import tariff on iron and steel will hurt all industries that use it as an input, and primarily construction and automobiles. Thus, while the higher tariff could create a few jobs in the capital- intensive iron and steel industry, it could at the same time destroy a much greater number of jobs in the labour-intensive construction industry. While India’s import tariffs on manufactured goods are quite low, tariffs on agricultural imports remain high. This biases India’s structural composition in favour of agriculture and against manufacturing and services where wages and product- ivity are much higher.
It is disappointing that the Government seems to have no plans to reduce agri- cultural import tariffs. While India has given its commitment to the Trade Facilitation Agreement at the WTO, there seems to be hardly any investment expenditure on significant trade facilitation measures in this Budget.
Another major disappointment is that there is no real leadership being shown in the area of labour reforms by the Centre, putting the burden largely on the states. Rajasthan has shown a lot of progress in this regard, recently. As I have argued in many of my writings, the labour laws currently in place in India are outdated. Due to these laws, the cost of employing regular workers in the formal sector is very high, making Indian manufacturing very unattractive for investors. In response to these regulations, within each industry, firms end up choosing relatively capital-intensive production techniques or product types and use contract workers who have little incentive to learn on the job. Also, firms are not interested in investing in their skills. Furthermore, since these laws apply beyond some threshold levels of employment, they induce a small and inefficient scale of production at the firm level in labour-intensive industries, relative to competitors in the rest of the world. Since labour laws make firing of workers very difficult, firms are reluctant to hire in the first place. The reassignment of workers across tasks in response to demand fluctuations requires government approval, preventing firms from nimbly adjusting to changing business environ- ments. Thus, unless there are labour reforms in the near future, the ‘Make in India’ campaign will face serious obstacles.
The other constraint to the expansion of manufacturing is the shortage of land. The land ordinance issued recently by the Government needs to be passed by both Houses of Parliament. It is currently facing problems in the Rajya Sabha, where the BJP does not have a majority. Some compromises with the opposition, especially on non-economic issues, will be needed for this ordinance to be passed. This will be a serious test of the Govern- ment’s commitment to reforms. While this ordinance aims to cut red tape in land acquisition for areas such as national defence, housing (especially for the poor), industrial corridors and so on, the compensation that needs to be provided to landowners remains prohibitively high at around 2-4 times the market value.
Even though labour reforms and further trade reforms are not on the Government’s radar screen, I will still end this discussion on a positive note. Firms in India have always faced serious exit barriers, making them reluctant to enter the Indian market in the first place. “Bankruptcy law reform” to bring about “legal certainty and speed”, according to the Finance Minister’s Budget speech, is a top priority, so that the ease of doing business can be improved. The Finance Minister indicated his commitment to designing a modern Bankruptcy Code for India during this upcoming fiscal year. This is a very welcome development and, if done right, will provide a definite boost to the ‘Make in India’ campaign. The ease of doing business in India will be further strengthened by the recent launching of the e-Biz portal, which integrates 14 regulatory permissions on a single platform. This is as close as we can get to a single-window clearance under the current regulations.
In conclusion, this Budget provides a clear vision for the next few years. It is full of innovative and creative ideas about various types of expenditures needed to stimulate the economy and about different ways of raising revenues. There is emphasis on infrastructure building, which is key to greater investment, employment and growth. The big disappointments are the lack of leadership shown by the Centre in the area of labour reforms, no further progress with trade reforms (and, in fact, some slippage into protectionism) and the lack of big investments in trade facilitation, notwithstanding the mention of ports and airports as investment possibilities in the Budget speech. Given the very ambitious nature of the Budget in the presence of limited state capacity in India, I believe there is considerable uncertainty about its successful implementation. While it is a job fairly well done as far as the articulation of vision goes and is good on intent, I would wait to see its implementation before I give my final verdict on this Budget.