Budget and the economy: What can we expect after this Budget?

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Published: February 12, 2020 4:00 AM

Union Budget 2020 India: India needs to create many more formal sector jobs than it is doing now, and that means creating many more firms, and growing existing firms more effectively. The Budget did not jettison the long-term capital gains tax, but it does seek to make risk-taking more attractive for start-ups. On balance, this Budget is positive in its potential impacts on India’s economy. But there is a new urgency, and one hopes the government can actually deliver what is needed.

Budget 2020-21: To some extent, all levels of government in India resort to off-budget borrowing, and stratagems such as slowing down payments.

Budget 2020 India: We all know that this year’s Union Budget came at a difficult time for India’s economy. There have been economic challenges in the past, but those memories had receded. However, instead of improving, the situation worsened after the last general elections and the Budget that followed it. What can we expect after this Budget? It is important to remember that the direct economic weight of the Union government is relatively small. After allocating the states’ share of tax revenues and other devolution recommended by the last Finance Commission, the net revenue of the Union government was just 9.45% of GDP, based on 2019-20 Revised Estimates.

Its expenditure was only 13.2% of GDP. The difference is the fiscal deficit, of 3.75% of GDP. This means that the Centre’s revenue is just about 70% of its expenditure. This reminds us of the fragility of the Centre’s revenue-raising capacity, and its limited ability to influence the economy directly through its expenditures, especially with legislative constraints on the fiscal deficit and global monitoring of India’s macroeconomic stability.

But the need was for a fiscal stimulus, and the growth slowdown allowed the Budget to use an escape clause for a planned deficit above the legislated target. To some extent, all levels of government in India resort to off-budget borrowing, and stratagems such as slowing down payments. In hard times, this phenomenon gets worse, but can shift its contractionary effects from where they are apparent and possibly better managed, to places (lower level governments and enterprises) where the effects might be hidden or worse. In the end, it is difficult to tell whether the government’s stimulus hit the right spot. After the Budget, the Reserve Bank of India (RBI) tried to make it easier and more attractive for banks to provide credit. Again, it is difficult to say how it will all add up, but the stock market and foreign exchange market have not cast a negative vote.

On the revenue side, almost all Indians pay indirect taxes, since they buy goods and services, where the goods and services tax (GST) comes into play. The Budget continues a much-needed process of improving the design and implementation of the GST, by streamlining and simplifying. In the long run, the GST will help improve India’s relatively low tax-to-GDP ratio, and bring more of the economy into the formal sector, but it may still be a bumpy road ahead.

Watch Video: What is Union Budget of India?

Very few Indians pay direct taxes, in the form of income taxes. The Budget attempts to simplify the income tax structure, lowering rates in the middle tiers, tying that to giving up various exemptions or deductions, but leaving the old structure as a choice as well. Aside from a small stimulus, simplifying tax preparation and filing could have long-run benefits of encouraging people to file returns. But truly broadening the tax base needs structural reforms that promote formal sector jobs.

The two biggest question marks and challenges on the revenue side are the projected revenues from spectrum auctions and disinvestment of public enterprises. Auctions are good for revenue-raising, but not necessarily for building a telecommunications infrastructure that provides broad access, through affordability, and sustainable competition amongst providers. This remains a tough challenge. Disinvestment has never delivered as promised, because it is often designed poorly and timidly. Political opposition is a perennial problem, and making it work will remain difficult.

Finally, customs duties are no longer a major revenue source, but are tending to be used for protecting certain industries or types of firms. There is over-reliance on such measures, when more direct ways of supporting particular types of firms or sectors, especially through infrastructure investments, would be more efficient.

On the expenditure side, the Union government remains locked into a complicated mix of schemes and discretionary transfers, meant to achieve a wide range of economic policy goals. Their complexity, lack of coordination and deficiencies in implementation capacity make expenditure efficiency a perennial issue. For example, it seems that every Finance Commission, including the latest, calls for simplification of centrally-sponsored schemes. On the plus side, these expenditures do provide safety nets that are quite good for what is still a relatively poor country. The current Union Budget has no significant new schemes, and it is always difficult to assess the aggregate or distributional impacts of adjustments in spending plans (less for employment guarantees, more for payments to farmers, etc).

Ultimately, policy proposals that can influence the future course of the economy are not a core part of the revenue-expenditure-borrowing accounting of the Budget. The Budget, like its predecessors, has many specific proposals, typically needing to be fleshed out, and implemented effectively. There remains a tendency to substitute moralising for designing incentive-compatible economic policies. India needs to create many more formal sector jobs than it is doing now, and that means creating many more firms, and growing existing firms more effectively. The Budget did not jettison the long-term capital gains tax, but it does seek to make risk-taking more attractive for start-ups. But Make in India, and now, Assemble in India, have to be made effective through targeted infrastructure investments and integration in regional production networks. Three decades of economic reform have not achieved this.
On balance, the latest Union Budget is positive in its potential impacts on India’s economy. But there is a new urgency, and one hopes the government can actually deliver what is needed.

(The author is professor of Economics, University of California, Santa Cruz. Views expressed are his own.)

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