The relaxing of the fiscal consolidation target hasn’t added much to public investment
The much-awaited Budget, as a harbinger of change, has finally arrived. Immediate reactions to the Budget proposals have been positive. On the Budget day, the Sensex, after a roller-coaster ride, ended up 141 points higher than the previous day’s closing. The offshore investors were pleased that the GAAR has been deferred for two years, they don’t have to pay MAT and they can make investments in private equity funds or the alternative investment funds. The domestic investors got enthused by the promise of large infrastructure investments in roads, railways, ultra-mega power projects and green energy projects, the promise of reduction in the corporate tax and the promise of GST. The financial sector gets some muscle in the implementation of some of the recommendations of the Financial Sector Legislative Reforms Commission (FSLRC). Indeed, these were instant reactions and it will take some time to absorb the proposals.
Admittedly, the finance minister had a difficult balancing act to perform, between achieving fiscal consolidation and enhancing public investment. The report of the 14th Finance Commission added to his woes by increasing tax devolution to the states from the divisible pool by ten percentage points. What was missed in most of the commentaries was that the Commission, unlike the past Commission, was not asked to confine itself to non-Plan revenue accounts, and therefore made recommendations to cover the entire revenue expenditure requirements of the states. Furthermore, unlike the past Commissions, it abstained itself from recommending grants for various sectors such as judiciary, education, healthcare, upgradation, environment and other discretionary grants. Instead, it preferred to give block transfers by way of higher tax devolution. Any comparison with the past, therefore, should add block/discretionary grants given by the Planning Commission and the sectoral grants given by the past Finance Commissions to the tax devolution made by earlier Commissions. Indeed, increasing the block transfers is in the nature of empowering the state governments. Given the constraints on fiscal space, the Union government could also have used the opportunity to transfer many of the centrally-sponsored schemes to the States.
A close reading of the Budget allocation shows that the Union government has cut the block grants given by the Planning Commission. In FY15, this amounted to R58,355 crore, equivalent to 5.5% of divisible pool. In addition, the various sectoral grants (education, and environment, upgradation, judiciary and other discretionary grants) given by the 13th Finance Commission (excluding local body and disaster relief grant) for FY15 works out to about R15,000 crore, which is about 1.5% of the divisible pool. Thus, the grant subsumed in the higher devolution is about 7% of the pool which means the additional devolution works out to just about 3 percentage points. At the same time, this provides an opportunity for the Union government to rationalise the centrally-sponsored schemes. In the current Budget, for example, the allocation to various schemes in agriculture has been reduced by R5,000 crore, national rural drinking water programme by R6,700 crore, elementary education by about R9,500 crore, ICDS by R8,300 crore and together, these constitute to another 2.8% of divisible pool. Thus, there has not been much of a change in total transfers to the states. What is important is that, the states have greater flexibility to make allocations now. As the relative shares of the states in these transfers are different from the shares in tax devolution, any inference on the gains and losses of individual states by comparing the devolution shares of 13th Commission with that of the 14th Commission would be misleading.
Now that the din and buzz about the Budget has subsided, it would be useful to make a reality check on its contribution to fiscal consolidation and enhancing public investment. The favourable environment for fiscal consolidation was created by the low oil prices and the postponement of the fiscal consolidation target by one year is bound to be looked at with scepticism by the rating agencies. Furthermore, a closer look at the numbers shows that the relaxation in the fiscal target has not added much to investment expenditures. The capital expenditure of the government is at the same level as was budgeted for FY15, at 1.7%. One can also question the wisdom of adding to the existing subsidies and transfers for schemes which are in the state list such as “housing for all”, 24-hour supply of power and water, rural connectivity, electrification, good health and education and enhancing agricultural productivity. The government would do well to focus on efficient delivery of public services in the Union and concurrent lists. While the prevailing low oil price has helped to contain subsidies and the direct benefit transfer is a reform for the future, the occasion was propitious to contain fertiliser subsides by increasing the price of urea, if not decontrol it completely for the sake of balanced consumption of nutrients.
On the tax side, the reforms are disappointing. We seem to continue with the regime of giving exemptions and concessions, including declaring yoga as a charitable activity; this would only give rise to special interests asking for more. The decision to allow additional investment allowance and depreciation allowance for the new units set up in the notified areas of Andhra Pradesh and Telangana will result in the flight of capital from the neighbouring states of Karnataka, Maharashtra and Tamil Nadu, besides eroding the revenue base. The decision to extend the levying of a lower custom duty rates on inputs than that on the finished goods results in very high effective rate of protection to the finished goods.
Furthermore, it would be unwise to have a duty structure based on the end-use of the commodity. There is no attempt to unify the tax rates by converting the specific rates into ad valorem and increasing the rates of excise from the lower category (6%) to the higher category (12%).
Cement, for example, continues to be taxed at specific rate. In a value-added tax regime, levying tax rates at lower rates on items identified as inputs will only provide incentive to evade the tax. The government would have demonstrated its seriousness of introducing GST if it reduced the number of rates to two and unified the rate of excise duty and service tax. In effect, that would have resulted in the extension of GST at the manufacturing/production point by the Union government and this could have given a lot of confidence to the states in embracing the reform.
While the Union government continues to declare that full-fledged GST will be implemented in April 2016, the work involved at the state-level is enormous and one only hopes that the states will be ready to bite the bullet. Interestingly, the government has increased the surcharges on excise duties—and increasing the service tax rates, mainly by increasing cesses and surcharges, implies that the revenues from these additional measures do not have to be shared with the states.
All in all, in my view, the euphoria about the Budget reviving the economy is slightly misplaced. Of course, reforms are a process, and not an event, that can be carried throughout the year and there is plenty the government can do in the coming days.
The author is emeritus professor, NIPFP, and member, 14th Finance Commission