Expectations abound for a naya daur. There are several loose ends on the macro side that need to
be sorted out. More than the bureaucracy, the thinking is
entrenched in very old boxes. Modi has promised change; the delivery time is now.
A new relationship must evolve between the PM, Ministry of Finance and RBI. There are several small steps involved. Recognise that RBI is independent of the Ministry of Finance (MoF) in name and blame. Recognise that the incumbent Raghuram Rajan has the ability to be not only the finest RBI governor we have ever had but also, potentially, to be one of the finest in the world. Thus, comments like we will change the governor, or he will toe our line, or interest rates must be lowered because the MoF thinks so do not belong to a new India. Nowadays, such comments should be considered trash and deleted from the recycle bin.
So, what actions will constitute the writing of a nayee kahani Monetary policy is to be made by RBI, and true independence accorded. Interest rates will be determined by RBI, as it sees fit. In exchange, the RBI governor will make twice-a-year appearances before a joint session of Parliament, where he will be grilled, questioned and if need be cooked over his/her policies. There is no direct or indirect linkage between the RBI governor and the finance minister, but the two should hold at least once-a-month meetings to discuss monetary and fiscal matters facing the country. The meetings, and stature, should be one of equals.
Taxes and expenditures
Fiscal policy: A lot of work has already been done with regard to indirect taxes, and it is encouraging to note that implementation of the GST has been accorded top priority. But a lot remains. The prime focus temporarily will shift to the presentation of the Union Budget in early July. It should be a vision document, but must contain the following features. Most importantly, that taxation is not a morality play, not a conscience-keeper for the left-liberals or for bureaucrats/economists weaned on Nehruvian economics. The thinking that hey, I gave my moral dues at the community temple by asking for increases in dividend tax, capital gains tax, corporate tax, and income tax is so day-before-yesterday. The excuse that
the government did not collect money because people did not comply with your morality will not wash away any
The prime purpose of fiscal policy is to maximise revenue and minimise expenditure. The former involves the plugging of loopholes as does the latter. Corruption is present in the loopholes. So how does one maximise tax revenue By maximising growth and minimising tax rates. Obviously, the minimum tax rate should not be zero! So, what is to be done A new tax policyzero dividend tax, all capital gains tax at 7.5% (short-term, long-term, property), and zero securities transaction taxis needed. One needs to do a complete rethink in order to achieve a Jupiter-style velocity into the new world. Did you know that the government does not publish, or allow publication, of data pertaining to income tax returnswhich income group paid how much tax These data were published, albeit in limited form, a few years back. Until the UPA-II disallowed or prohibited the practice. It is time to make such data freely available so one can actually witness the fact that the rich have the highest compliance rate.
Personal income tax: A complete overhaul of the tax system with only two tax rates10% and 20%. This will increase compliance and substantially increase revenue.
Corporate taxes should be restructured according to best practices in the world (which most emphatically rules out the US) and with two goals in mindmaximisation of revenue and global competitiveness. At present, Indian corporates are among the highest effective tax rate payers in the world where effective is defined as the ratio of taxes paid over income made. This effective tax rate is at present around 25%; it should be closer to 18%.
Essentially, what needs to be done is a lowering of tax rates and an increase in efficiency of tax collection. An increase in tax compliance that will accompany lower tax
rates will also mean substantially lower corruption.
Expenditure policy: Try surgery. The broad statistics on fiscal deficit are as followsand it is surprising how many tax experts and policy economists and especially market economists are unaware of the empirical magnitudes of this identity. The consolidated Centre-plus-state fiscal deficit is around 8% of the GDP; 5% for the Centre and 3% for the states. Expenditure (state-plus-Centre) is around 30% of the GDP. So, revenue is 22%, of which non-tax revenue is 4% of the GDP. Implementation of the GST should allow extra revenue of 1-2% of the GDP; a substantial reduction in welfare or in-the-name-of-the-poor subsidies to only 2% of the GDP will save another 2 percentage points. Linking the subsidies to cash-transfers and Aadhaar will mean that the bottom third of the population will get nearly five times the money they presently receive via the misguided Nehru-Gandhi socialist programmes like PDS and MGNREGA.
A rationalisation of welfare expenditures will allow for substantial increases in expenditures on infrastructure and public health, especially on water and sanitation (including cleaning of the Ganga and other rivers). This will allow the central fiscal deficit to be less than 3% in two years and less than 2% in three. That is the nayee kahani, and we have not even begun to talk about the positive effects that will occur from increased GDP growth.
This new tax and expenditure policy is win-win, stupid. You will only recognise it to be such if you leave your pretentious morals at home.
PS: There is some disturbing news. If reports are to be believed, the BJP government (or old Nehru-Gandhi bureaucrats out to stump Modi) has stated that they cannot act now on the draconian retrospective tax legislation until they hold widespread consultation with the stakeholders. Is Modis BJP the new Congress So soon The ink on the oath is not even dry yet.
The author is chairman, Oxus Investments, an emerging market
advisory firm, and a senior advisor to Zyfin, a leading financial information company. Twitter: @surjitbhalla