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Indian Fiscal Budget 1997-98: Analysis


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An Analysis on the Budget 1997-98:
Largesse for the rich, phrases for the poor

Jayati Ghosh

Media celebrations in the past week of Finance Minister Chidambaram's second Budget have typically used two adjectives : "bold" and "innovative". Bold it certainly is, to the point of effrontery. But even the most enthusiastic supporters, if they have just a casual knowledge of public finance, would be hard put to find anything genuinely innovative in the measures proposed in this Budget. The major proposals relate to very significant across-the board tax cuts, especially on direct taxes. This is a route which has been traversed many times, most prominently in the United States under Ronald Reagan in the 1980s, but even quite recently in India by Manmohan Singh's 1992-93 Budget. In other matters, especially in expenditure, the Budget simply continues with several unfortunate tendencies of the past. The real innovation, if it can so be described, lies in the manipulation of the numbers, and the sheer cheekiness of the Finance Minister in presenting estimates of revenue which have no apparent justification given the reduction in tax rates.

The supposed economic rationale which has been invoked by the Finance Ministry, for the massive reduction in tax rates, is the "Laffer Curve", which posits a relationship between tax rates and total revenue collection such that as tax rates rise, the tax collected rises up to some critical point, after which further rises in the rate actually cause tax revenue to decline. In the 1980s, both Reaganite "supply-side economics" in the US and Thatcherite economic policies in the UK adopted this argument to enforce significant cuts in marginal rates of income taxation, on the grounds that this would generate income growth which would more than compensate for the declining rates. The result, in both countries, was actually very substantial declines in tax revenues relative to national income, as well as ballooning government deficits. Perhaps even more significant than the fiscal consequence was the distributional one : in both countries, the period was marked by dramatic increases of inequality in the distribution of income and wealth, which are still having negative social repercussions.

Outside India, at the moment there are few respectable economists anywhere in the world who would support this version of the "Laffer Curve" argument. Within India, the most prevalent version of the argument is that declining tax rates reduce the incentive to avoid tax payment, and therefore bring about improved "compliance" on the part of tax payers. This is expected to provide the "buoyancy" in revenue collection upon which the Budget's revenue estimates crucially depend. The obvious problem with such an argument is that the extent of compliance of taxpayers also depends crucially upon the costs, or punishment, associated with non-compliance along with the likelihood of being found out. The failure in the past of the tax cuts and several "amnesties" which successive Finance Ministers in India have declared, has rested precisely on the understanding that tax evaders have had, that finally the system is not going to come down heavily on them. Ultimately, that is why tax evasion remains pervasive. This suggests that a far more effective way of enforcing compliance and a minimum degree of economic discipline upon the wealthier citizens, is simply to be more energetic in uncovering tax evasion and more stringent in punishing it. Providing the carrot of tax cuts without any corresponding stick of more credible systems of identification and punishment of tax evaders, is likely to have very little effect on compliance.

In the present Indian context therefore, it is clear that direct tax cuts amount to no more than a give-away from the public exchequer to the small proportion of the population that actually pays income taxes in any form. In addition, the Finance Minister has also reduced a range of import and excise duties. The size of the give-away is enormous, and has been estimated at more than Rs. 12,500 crore given the official national income projections for 1997-98. [C.P. Chandrasekhar and Abhijit Sen, Macroscan, Businessline March 4, 1997] Thus, the Central Government is likely to have given up at least Rs. 4,000 crore in corporation taxes, Rs. 6,000 crore in income taxes, Rs. 2,500 crore in customs duties.

Consider what this means in terms of budgetary alternatives. If the Government had retained this tax income, instead of gratuitously providing a free lunch to the already better off groups, there is a range of expenditures it could have made with very different social consequences. For example, with this amount of resources, not only could the Central Government have financed the entire increased allocation necessary for adopting the Pay Commission recommendations, it would still have had enough money left to triple the budgetary allocation made for planned investment in the power sector. Alternatively, it could have allowed public spending on health and education to increase by a full one per cent of GDP. Or else, it could have increased the food subsidy allocation by more than one and a half times, allowing for a genuine spread of a public distribution system for food to the poorer sections. Or it could have tripled the proposed outlay for rural employment schemes, thereby contributing not only to poverty alleviation but also to the creation of rural infrastructure. It could have multiplied several-fold the budgetary support for planned investment by public sector enterprises, creating the conditions for genuine economic viability of all PSUs and greater external competitiveness of the more dynamic and profitable ones. It could have provided more loans to state governments for urgently required infrastructure projects which are being squeezed for lack of resources. The list of possible alternatives goes on and on.

What this makes very evident, of course, is that these tax cuts cannot be assessed independently of the alternatives in terms of either giving up some resources or increasing particular expenditures, and that these choices have very clear distributional implications. The Finance Minister has chosen largesse to the rich, in the form of substantial reductions in the rates of taxation, in preference to expenditures which could directly benefit the majority of the population in various ways. This choice is not a departure from the past but rather a continuation of the trends established in each successive Budget of the previous government, and it is not accidental. It reflects the basic philosophy which has guided the economic liberalization policies since 1991, which is implicitly that distributional inequity and persistent pampering of the rich, are necessary prices to pay for higher economic growth. That this belief (which is indeed simply a belief, rather than an argument based on any hard-headed economic reasoning) persists despite clear electoral evidence that such a strategy is not socially and politically sustainable in a country like India, is a comment on the enhanced power of large capital in determining the decisions of policy makers.

The distributional bias is evident not only in what the Finance Minister has given away, but what he has chosen to withhold even in relation to existing expenditures. It is certainly worth noting that for a government led by a "humble farmer", with self-proclaimed intentions to be concerned with "the poorest of the poor", the Budget as a whole is singularly lacking in any worthwhile schemes to improve the lot of the bottom forty per cent in terms of income. It is true that the total budgetary allocation for social services and rural development shows some increase (just under 15 per cent) of the previous year's budget estimates. Yet these intentions need not translate into reality, for under these very heads the data reveal that in 1996-97, despite a budgeted increase of 11 per cent, there was a 7 per cent shortfall in actual expenditure, which amounts to a fall in real terms in such spending. It is difficult to imagine how or why there should be a shortfall in such spending in the Indian context in which these are definite priority areas. And even if the entire budgeted outlay for 1997-98 is actually spent, this means that such spending will remain at only 1.6 per cent of projected GDP, which is less than the 1.7 per cent of GDP spent in 1995-96, and very significantly less than the proportions of such spending in comparable Asian countries.

Another major gap relates to the food subsidy. The much-publicized targeted public distribution system for the poor (estimated at 320 million people) is due to begin from June 1, 1997. The Food Ministry has announced the expected cost in the financial year to be Rs. 8,283 crore, even apart from the costs involved in identifying and monitoring the target poor population. When the scheme was first announced in Parliament in February, an official booklet estimated the annual cost at Rs. 12,500 crore. In addition, the extant PDS for those above the poverty line is supposed to continue. Yet the food subsidy provided for in the Budget for 1997-98 is only Rs. 7,500 crore, which includes Rs. 500 crore as sugar subsidy. Where is the additional requirement of resources to come from ? Or is the Finance Minister declaring that his Ministry at least is not taking seriously the commitment this government has already made to Parliament ?

These are only some of the manifold ways in which this Budget reveals its clear bias in favor of better-off groups relative to the masses of the country. A closer examination of the fine print is likely to bring out many more examples of the distributional inequalities which this set of budgetary policies will generate. Yet there is a deeper sense in which this Budget is fundamentally inegalitarian in its approach. It is commonsensical to suggest that the risks involved in particular economic strategies should be borne by those who are likely to be the beneficiaries. This particular budgetary strategy - of reducing tax rates and still expecting a significantly higher tax collection, and basing overall fiscal deficit figures in such a calculation - is a highly risky one, which is what makes it so very "bold". Yet in this case, the beneficiaries of these policies - the rich who will profit from the tax cuts - are not those who will have to pay the costs of the strategy fails. Rather, the burden of adjustment in the event of failure will be borne (once again) by the people of India, who will pay for it in terms of higher inflation, a greater burden of public debt, and reduced availability of already inadequate public goods and services. This amounts to much more than a betrayal of the electoral mandate, for there can be no greater disservice done to the citizenry by a government.


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Jayati Ghosh Associate Professor Center Economic Studies & Planning,JNU,Delhi

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