The Budget has been extra-careful and conservative about the impact of DeMo on the economy. It is very likely that GDP growth for FY17 will close in on a number above 7%. It is probably the most brilliant economic and political document since the path-breaking 1991 Budget.
A detached, unhurried reading of Budget 2017 does lead one to conclude that it was not a run of the mill Budget. It was different, both in what it did, and what it did not do. It was a state-of-the-art workmanlike Budget with one flaw—it hesitated to go the full, logical distance in tax reforms. Why? Likely because it is waiting for a near-optimal political and economic moment February next year.
In several articles preceding this Budget, and ever since the demonetisation (DeMo) policy announced on November 8, I have argued that the key post-DeMo goal of the government should be to create a political and economic environment conducive to considerably less creation of black money. I had identified three key areas for policy. First, individual income tax compliance must be made to increase, and as jointly argued with Arvind Virmani, this would not happen unless incentives (carrots) were given to taxpayers for them to come into the tax net and for them to declare a larger fraction of their income. Second, the real estate sector needed to be cleaned up, for it was a major sink for black money. Third, election-funding policies needed to be urgently reformed—this politician-dominated sector is one of the largest black sinks.
On the latter two policy objectives, the Budget has been extraordinarily innovative—especially on election funding.
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In addition to black money, the other problem plaguing the Indian economy has been the low rate of growth of capital formation (investment) by the private sector. This, I had emphasised, was very likely due to the extraordinarily high rates of taxation of profits in India. The corporate sector, in aggregate, was paying more than 60% of its profits as taxes to the government (corporate tax, dividend tax, pension payments, insurance payments, indirect taxes, surcharges, cesses—need one go on?). FM Jaitley has decided to fire the first salvo in cutting tax rates of a bygone socialist era in which profits were considered “evil” and something bhadralok shunned with pride.
For 96% of firms (all those with turnover less than R50 crore), the corporate tax rate has been reduced by 5 percentage points—from 30% to 25%. This is just not enough, and possibly a major clean-up will be presented in next year’s Budget when (hopefully) a no-exemption corporate tax rate of 18-20% will be implemented for all firms, big and small.
Personal income tax (PIT) rates: Modi-Jaitley have taken a significant step forward by halving the tax rate (from 10% to 5%) for the lower middle-class of taxpayers (earning between R2.5 lakh and R5 lakh). Even taxpayers earning between R5 lakh and R50 lakh will have their tax outgo reduced by R12,500. For those earning between R50 lakh and R1 crore there is a tax surcharge of 10%, and the surcharge for incomes above R1 crore is retained at 15%.
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There are important state elections (especially UP) days after the Budget presentation on February 1. It is well recognised (and perhaps, inevitably, should be) that a Budget is both an economic and a political document. Jaitley goes to considerable length in the Budget to emphasise that we are not a PIT compliant society. To coin a phrase, when it comes to PIT, Indians are pits. This was also emphasised by PM Modi on December 31, and this is a very welcome innovation for leading policymakers to publicly, and loudly, admit to the plague of tax non-compliance.
Comparing the tax compliance data offered by Jaitley on page 28 of the Budget speech and our synthetic or estimated income distribution for 2011 to 2016/17 (the one used by Virmani and myself), one gets the following result: For 2015-16, those earning between R10 lakh and R50 lakh (individuals with no tax surcharge), only 13% of individuals paid taxes, while for those with incomes above R50 lakh, tax compliance is 26%, i.e., the super-rich who are paying a 10-15% surcharge are twice as tax compliant as the near-rich! So, the policy of not cutting taxes for all is an opportunity missed; next year, maybe?
However, in the main, the Budget is workmanlike, and brilliant, in being focused on the Big Picture, and ignoring all advice to do the wrong things—e.g., instituting long-term capital gains tax, or bringing in inheritance tax, or providing doles instead of infrastructure, rejecting universal basic income, and indirectly hinting (through the Economic Survey) that the days of cash transfers for the poor were near (bye-bye, PDS). The best commentary on NREGA was by the FM when he declared that this favourite of Sonia Gandhi and the Congress-Left had received the maximum ever allocation of R48,000 crore. What Jaitley did not emphasise was that this was the lowest in real terms since the programme was initiated in 2008-09; the real allocation to NREGA is now less than two-thirds of the R37,400 made available in 2008-09. Further, and more importantly, NREGA has been converted into a programme for providing infrastructure for irrigation.
The Budget has been extra-careful and conservative about the impact of DeMo on the economy. It is very likely that GDP growth for FY17 will close in on a number above 7%. Somewhat surprisingly, DeMo has not had that big a negative impact on the economy. The jury is still out, but all (conservative) official estimates peg GDP growth at no less than 6.7%. This is obtained with a GDP for agriculture at 4.1%. Kharif acreage, unaffected by DeMo, had an expansion of 3.5%. Add a minuscule productivity growth of 0.6%, and one obtains the CSO estimate of 4.1% agricultural growth for FY17.
The CSO was honest about not extrapolating beyond October 2016. But the rabi acreage, advertised by many anti-DeMo experts as doomed, has expanded by at least 5.9% (all data as of January 13, 2016, Economic Survey, pg. 156); wheat acreage is up by 7.1%. This implies that a minimum level of agricultural growth for FY17 will likely be close to 5.5%, and the likely level being 6-7%. Assuming agricultural growth of 6.5% (versus the 4.1% CSO estimate) yields a GDP growth level of 7.1%, well above that of the (deliberately conservative) ministry of finance and near identical to the estimates of both CSO and RBI.
The BJP, especially PM Modi, is a long-distance runner, a Test player, rather than gimmicky T20s (or even less gimmicky ODI). This longer vision has been apparent for some time, and I believe comes out strongly in the Budget in its estimate of the fiscal deficit for FY18. Remember, the Budget is (ultimately) about fiscal-ism, revenues and expenditures, i.e., the fiscal deficit.
The Budget has not only under-estimated GDP growth, but also the addition to tax revenue this year, and in the future, from increased PIT tax compliance. The fiscal deficit for next year is very likely to be less than 3.2% target for FY18, and likely less than 3%. If both tax revenues and GDP growth are understated, the fiscal deficit is doubly overstated! What a great idea, Sirji.
Large state elections are only in November 2018; and 2019 are the national elections. Flush with higher than expected tax revenue and GDP growth, the Modi government will likely complete tax reform for individuals, and corporates, in February next year. What exquisite timing—set a conservative base this year, so you can be radical next year.
The author is contributing editor, The Financial Express, and senior India analyst at Observatory Group, a New York-based macro policy advisory group
Views are personal