The debt overhang at the banks, if allowed to continue, could hobble growth for years
Budget 2017 will be presented on February 1, earlier than in the past, and one can hope for some positive signs of a reform agenda that alleviate the chaos of demonetisation. The Budget has statements of plans or expectations for revenues and expenditures, and it can contain policy decisions that affect these plans, as well as affect the economy without necessarily having major impacts on government’s inflows and outflows. What is the state of play?
There are two significant changes to look forward to in the upcoming budget, finally modernising and rationalising decades of past practice. The first is the integration of the Railway Budget with the overall Budget, which allows for more rational planning. The second is the jettisoning of the relatively meaningless plan/non-plan categorisation of expenditures and replacing it with the more economically meaningful distinction between capital and revenue expenditure. These are both good steps, but much more is needed.An important stylised fact about India is that its tax-GDP ratio is below what its income level would predict, according to cross-country data. GST will represent an important step forward in trying to fix this, and the Budget may be in a position to guess as to the impact of its introduction during the coming fiscal year, although only after it is in place will we have a firm sense of its effects. The GST broadens the base of indirect taxes, and improves the mechanisms of tax collection, both of which can enhance revenue. Another important change that appears to be in the works is a plan to broaden the direct tax base—this may not increase revenue much in the short run, but can have large positive medium-term impacts. Besides, it increases the connection of voters to government, by making more of them direct taxpayers.
On the tax side, the government also needs to do more to incentivise new business creation, investment by existing and especially growing businesses, and exporters. Again, there seem to be some policy moves in the works. These so-called “tax-expenditures” can sacrifice revenue in the short run, but enhance growth and recoup those lost taxes in the long run. Designing such tax policies efficiently—to provide the greatest incentives at the lowest revenue sacrifice, takes some careful analysis by specialists who understand the corporate tax code as well as how economic incentives come into play. Good tax policy and administration for all firms (not just large corporates) will also do more than demonetisation to bring more enterprises into the formal sector. Another important effort by the Union government on the tax side would be to build the capacity of city governments to design and enforce more effective property tax systems. This has to respect state governments’ authority over local governments, but that should not be too difficult given the pressure on the states’ own finances.
On the expenditure side, two priorities come to mind for the Union government. The first is investing in a major build-up of infrastructure, including digital infrastructure. The latter is a complicated task, which, in my view, has been relatively neglected in all the rhetoric about financial inclusion and a cashless economy. Physical infrastructure also needs heavy investments, including the railways, but also ports and airports. Clearly, given the scale of the needs, there has to be strategic prioritisation, as well as more attention to sophisticated financing models that allocate risks appropriately. The second expenditure priority is recapitalising the public sector banks. A debt overhang can affect growth adversely for many years, and a quick clean-up of bank balance sheets requires a large but necessary expense. This is something only the Union government can handle.
Many of the traditionally salient features of the Budget should really be handled at the level of the states, which now, after the 14th Finance Commission, have less excuse than ever before for delivering health, education and sanitation to their constituents. The states are the appropriate level of government for a push in providing quality basic public services to everyone. One exception is in higher education, where the Centre has to continue its plans to build more world-class universities. Unfortunately, to do this effectively, there is going to have to be major institutional reform, which allows for more internationally competitive salaries to be paid (something China recognised several years ago) to attract the best and brightest faculty to conduct research and train the next generation of scholars and researchers.
What is surprising, in a way, is how few things really matter for government to support a high growth path. India’s policymaking problems have been with lack of prioritisation, over-centralisation, spreading attention too thinly, trying to please too many constituencies at once, and poor implementation. Demonetisation showed that this government is capable of strategic prioritisation, focus, and managing political fallout, even if it is still prey to poor implementation and centralisation. It will be welcome if the Union budget brings the positive characteristics of policymaking to what really matters for India’s future economic growth.
The author is professor of economics University of California, Santa Cruz