Union Budget: Recession, taxation and the way forward

Updated: Jul 7 2014, 22:17pm hrs
The problem of course is not that US & European debt crisis have jolted the economic structure across the globe, but how and when will this be over And the more pertinent question is to understand its relevance for a country such as India.

Interestingly, Governments across the globe dont implement the most obvious and common solutions to an otherwise impossible situation. The US is the only country in the world whose currency, the USD, is as "good as gold" and therefore printing currency by increasing fiscal deficit by the Federal Reserve would not give rise to a "flight of capital" as most of world's reserves are in USD denominated bonds itself (which is why I still think that US credit cannot have anything but AAA rating). However, it is important to understand that during the first recessionary period in FY2008, fiscal stimulus was induced in manufacturing and other sectors, with a view to providing "External Prop" for growth, which never happened. All of us did see the anaemic growth for consecutive years, but jobless recovery seems a thing of the past!

The US government decided not to remove the tax cuts imposed during the Bush era, and continue with the present system thereby causing the wealthy to get wealthier and the poor continues to suffer more. A quick solution would be to introduce VAT (the only developed country that does not impose VAT), tax the rich more, and continue aids for the social sector. Unfortunately, CLASS WARS is running at its best in US politics, and even a supposedly "left-oriented" Obama administration was forced to adopt a "Right-wing" policy once in power - nobody would be surprised given the kind of donations his campaign received from the corporate sector. So then the thought process stuck to raising the debt ceiling, which has now crossed the 100% of GDP mark, and to top that by not raising tax rates for corporate and the rich!

The US economy thus has little ways of raising its own revenues and is suffering a fatal economic malaise. Perhaps the only way now is to allow the USD to depreciate to eventually lead to an export-led recovery. But an export led recovery for US is bad news for India and China. India's service sector is largely dependent for its exports on the US. The deprecation of USD is therefore going to hit exports even with all possible sanitisation and currency hedging by RBI and the companies respectively. The economic situation in US is compelling service-importers to cut IT budgets and therefore the pie is shrinking by the quarter. A decline in IT exports means lesser hiring, lower growth, possible decline in the topline and bottomline of companies, and consequently lower tax revenues for the government. For the consumer states such as Bihar, Tamil Nadu, Andhra Pradesh etc. this is yet another bad news. Consumption, in most cases, lie low down the value chain and is particularly susceptible to elastic responses from consumer surplus generated from the service sector, which is higher up the value chain. As a result, and particularly for states that are linked with exports, there is bad news in the offing.

An assessment of the coupling-coefficient between state's own revenues and exports would provide a better picture of the situation. But every state needs to gear up for a better policy to meet this impending situation or else tax revenues for most states may see a major dip in coming quarters, because the contagion is here to stay for a while. The need of the hour is therefore to manage risk arising out of the long period of poor global growth and use taxation policies as tools for stimulating growth.

Yateen Suman, Indian School of Business

NOTE: The views expressed are those of the author