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Not in deficit's name
Surjit S Bhalla | February 22, 2003
We must reduce the fiscal deficit in the name of the poor. We must raise taxes. We must not cut expenditure. Round up the usual suspects. But does anybody bother to at least check if the numbers add up, if the logic is sensible, if the reasoning is consistent?
No, and why not? The TV glitterati have an easy answer -- it is all so complicated really. But we must cut the deficit. Tune in again next year, same time.
What is the problem? To the best of my understanding, it is that the country is spending beyond its means, to the tune of 10 percent of its income, or about Rs 200,000 crore (Rs 2,000 billion).
Given our federal set up, it is convenient that the Centre and the states share equally in the annual loot from the taxpayer. Fully, a third of India's GDP is accounted for by the expenditures of the state and Centre, so yearly tax revenues are about a fifth.
If the deficit were to be even maintained at its current level, it would be a major achievement.
A reduction in the deficit rate involves either expenditures to grow less fast, or tax revenues to grow faster or the growth rate to accelerate. All have been commented upon in the name of the reduced deficit.
Some of the good suggestions are analysed below for their effectiveness, or consistency, towards reaching the all-desirable goal. Let us see if the recommended policies pass the 'smell test' -- if it smells like garbage, it can't be French perfume.
Some choose the path of 'higher savings leads to higher growth leads to lower deficits'. These people tend to be relatively clueless about economics or global capital, but their heart is in the right place.
The more sophisticated want higher public investment to deliver higher growth and lament the demise of state entrepreneurship, state 'leadership'. Their heart is in the right place, but their pockets are not.
The really sophisticated want more infrastructure investments to facilitate the growth of the private sector. The really really politically and economically correct define infrastructure as both physical and human capital, and believe there should be more spending by the state on education and health. These people live on belief, hope, and NGOs.
All of the above also believe that simultaneously with increased expenditure, the deficit should be brought down. Should any expenditure be cut? Not really, because we have, by all accounts, low infrastructure, and the state essentially provides 'infrastructure'; indeed, the state should be spending more.
What about privatisation of state firms? Yes, that is a clever idea, but you should sell the loss making units first, and earmark the funds of such units for 'infrastructure'. The Congress party is the leading apologist for this smelly view.
If expenditure control is a goal, then policies which can control expenditure without cutting jobs should be given the highest priority. A large part of the deficit (almost 100 per cent) is composed of interest payments on the borrowings to finance the past deficits.
What if interest costs are cut by Rs 3000 crore (Rs 30 billion) annually? Great idea, but watch what you are smoking. But hang on -- is there really nothing that can be done about interest rates, and therefore interest payments?
Something can be done, for the simple reason that a large part of the interest rate structure is administered, and right now interest rate on small savings deposits (hereafter referred to as scam savings) are mandated to be at 9 per cent, while non scam savings borrowings of the government are at 6 per cent.
How much do scam savings deposits collect a year -- about Rs 100,000 crore (Rs 1,000 billion), or half of the total deficit, or more than the entire deficit of the state governments. This is not a coincidence because there is a smelly Say's law in operation here.
All of scam savings accrue to state governments who gleefully spend it on the 'infrastructure' projects so loved by the state apologists.
But should the government not want to reduce its cost of borrowing? On what basis should the government pay you 6 per cent if you buy government bonds, and 9 per cent if you place that money with the bank in its scam savings box?
Precisely to avoid this absurdity, the government itself had rightfully concluded, a year ago, that the return on the two instruments should be the same starting April 1, 2003.
For reasons entirely unclear, the technocratic committee that reached this correct decision also mandated that scam savings should return 0.5 per cent more than government bonds, but that mental incorrectness pales in comparison with what others are recommending i.e. that the government should not reduce scam returns at all.
Why not -- because such returns are needed to boost our savings rate! The smelly folks argue that if we reduce the return, not only scam savings, but total savings will go down, and we need more savings to generate higher growth.
So why does the government not increase scam returns to 12 per cent and non-scam returns to 9 per cent? This way the real cost of capital would increase to 12 to 15 per cent , and India would surely be on the path of 8 per cent growth.
If consistency is an ass's virtue, then an ass is divine, and the inconsistent -- asinine. It is okay for cocktail induced glitterati to be so inconsistent -- the only danger is that good policies can be made to smell by such experts.
Since expenditure cannot be cut, indeed should be raised, the tiredly inconsistent recommend an increase in tax revenue to help reduce the deficit (the power of motherhood economics — both the Left and Right agree on the need to cut the deficit and little else).
Tax revenue can be theoretically increased either by raising tax rates and preventing compliance from declining, or by decreasing tax rates and increasing compliance.
Prior to the 1997 reduction in tax rates, less than fifteen per cent of those eligible to pay taxes filed returns i.e. the compliance ratio was 15 per cent.
Today, after partial tax reform, compliance has increased to 26 per cent i.e. compared to every 10 people who filed taxes before, there are 17 people today. Revenue from direct personal taxes has also doubled in the last five years — thus contributing more towards reduction of the deficit than any other policy in the last decade...
The Kelkar report on direct taxes goes considerably further than the very incomplete 1997 tax reforms. It brings about a reduction in the effective tax rate for every tax category. The only people who will lose from its implementation are the dishonest and the corrupt.Acceptance of Kelkar, and reduction of returns on scam savings will go a long way towards making the FM smell like a rose on Budget day.