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Will this Budget lower income tax?

By Shankar Acharya
December 18, 2020 15:00 IST
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The Budget-making exercise offers golden opportunities despite challenges, observes Shankar Acharya, former chief economic adviser to the Government of India.

Illustration: Dominic Xavier/

The Union Budget for 2021-2022 will be presented in a few weeks from today.

The context in which this Budget is being prepared is one of the most difficult faced by the country and any finance minister in independent India.

The economy is still reeling from the Covid pandemic and the associated strict lockdowns of the first quarter.

The pandemic continues to rage, with officially recorded Covid cases above 9.9 million.

According to official estimates, GDP collapsed by an unprecedented 24 per cent (y-o-y) in Q1 and, despite a smart recovery, was still down by 7.5 per cent in Q2.

Retail inflation has been tracking above 6 per cent for several months.

The total employment rate (that is, employment as a percentage of working age population) was still below 38 per cent in Q2, having recovered from its nadir of 31 per cent in Q1, but still well below the 43 per cent of 2016-17 (that means about 50 million fewer people employed!).

The Centre's fiscal deficit, properly accounted, is likely to be around 8 per cent of GDP and the combined (Centre plus states) deficit around 12-13 per cent, mainly because of the collapse in revenues in the first half of the year.

Merchandise export growth is still in negative territory and monthly dollar levels are below those of 2011-2012. The current account in the balance of payments is in surplus only because of depressed imports and low oil prices.

Furthermore, the uncertainty about the trajectory of the key macroeconomic aggregates (such as real GDP and inflation) in the second half of fiscal 2020-2021 and 2021-2022 remains huge, making responsible budget-making extremely challenging.

Both the finance ministry and the Reserve Bank of India expect the ongoing economic recovery to yield real GDP growth (y-o-y) in Q3 and Q4, with the RBI projecting 0.1 per cent in Q3 and 0.7 per cent in Q4.

Both these institutions have been guilty of making unduly optimistic short-term growth projections in 2019-2020 and, in the case of the ministry, in the first half of the current year (the RBI maintained a judicious silence). Such projections were confounded by subsequent official data.

In my view, the recovery in the level of GDP will continue in the second half of the current year, but growth in Q3 and Q4 is still likely to remain in negative territory.

Putting it simply, while the RBI expects GDP growth in the second half of 2020-2021 to be positive 0.4 per cent, I still anticipate a negative growth of 2-4 per cent.

This means that while the RBI projects the full year decline in real GDP in 2020-2021 to be 7.5 per cent, I expect it to be 9-10 per cent.

This would make a difference to the level of base year GDP assumed in the budget exercise.

Of course, the recovery rebound (from a low base) in 2021-2022 is likely to be strong, yielding real growth in the order 10-11 per cent and nominal (inflation included) expansion of 15-16 per cent, if one accepts the RBI's inflation projections.

Aside from the numerical uncertainties of budget-making, what are some of the key challenges and opportunities? First, this Budget provides a golden opportunity to bring Budget numbers in line with standard accounting practices.

Fudging Budget numbers has become a serious problem in recent years.

Properly accounted, the Centre's fiscal deficit was around 5 per cent of GDP in 2017-2018, 2018-2019 and 20192020.

FM Nirmala Sitharaman made a significant advance towards greater transparency in the last Budget by providing some details on off-Budget expenditures and their financing, but refrained from including them in the deficit.

This is the Budget to clean it all up. Precisely because everyone expects a huge deficit this year, it is the best time to come clean with full accounting of the deficit, even if the resulting number is 8 per cent of GDP or higher.

Second, a combined deficit of 12-13 per cent of GDP is obviously impossible to sustain beyond this year, which may end with the government debt to GDP ratio at an unprecedented 85-90 per cent.

With GDP and revenues now recovering robustly, 2021-2022 provides the best opportunity for making a serious down payment on the inevitable fiscal consolidation that will have to be done in the years ahead.

With nominal GDP expansion of 15-16 per cent or so next year, the associated revenue increases should permit a shrinkage of the Centre's deficit to around 5 per cent of GDP, as long as the expenditure to GDP ratio is held roughly equal to last year's.

This will allow reduction of the borrowing programme to reasonable levels and an associated reduction in the current high level of indirect deficit financing by the RBI.

Without such compression, inflation could flare out of control and the government debt to GDP ratio could rise to really dangerous levels, undermining basic financial stability.

Third, it is possible that because of pressing realities, the expenditure ratio may have to increase a little above the 2019-2020 level next year to accommodate necessary spending increases on public health and defence.

In that case, to hold the 5 per cent of GDP line on the deficit, the following least disruptive measures may be considered:
a. A significant reduction in the personal income tax exemption limit;
b. A one-time-one-year surcharge on corporate taxes, though this will damage the credibility of the FM's company tax rate cuts of September 2019;
c. A systematic effort to raise government fees and user charges across all ministries and thus reverse the declining trend in the non-tax revenues to GDP ratio;
d. A major programme to conduct sales of surplus government land.

Fourth, import duty rates should not be increased. Indeed, if we want to gain from an expansion of export demand through greater participation in global and regional value chains in East and South-East Asia (the most dynamic geography in today's world) then import duty rates need to be rolled back to 2017 levels, with a significant down payment being made in the forthcoming Budget.

Participation in the Regional Comprehensive Economic Partnership would help greatly, but the potent combination of our politics with some influential protectionist producer lobbies may render that a bridge too far.

Shankar Acharya is honorary professor at ICRIER and former chief economic adviser to the Government of India. Views are personal

Feature Presentation: Rajesh Alva/

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