Union Budget and the worrying fiscal position

With less than two weeks left for the Union Budget to be presented by Finance Minister Nirmala Sitharaman, the Indian economy is battling a triple crisis shock. This is surfacing from: a pandemic, an economic meltdown and a deep erosion in social and public trust, articulated in a long-drawn-out protest by farmers against the new farm laws. This continues to paint a grim picture.

The government’s own fiscal position is as worrying as anything else. As the government revenues have dwindled over the past few years, the government debt to GDP has soared rapidly and there is now even lesser (fiscal) room for the Central government spending to rise. Given all this, the FM and her team have a lot of homework to do for this Budget and in planning towards a more comprehensive fiscal plan.

To ensure that the economic recovery is robust, resilient, and more importantly, sustainable, Union Budget 2021 needs to focus on creating a solid medium-to-long term fiscal framework aimed at employment generation across organised-sectors, an upward household income mobility through higher wages, and in boosting domestic private industrial investment. The last focal point will be critical in driving the first two forward (employment growth and higher wage mobility).

India’s own private industrial performance, in terms of production of both capital and consumer goods, is now perhaps at its worst ever. Productivity levels were low even during the pre-pandemic time and have worsened since the pandemic-induced lockdown. It seems many vital corporate groups have almost stopped investing in building new capacities within existing businesses due to a fall in consumption demand (this was seen even before FY 2020).

What did previous budgets do in this regard? Not much. In terms of a few steps taken, the finance ministry’s decision to cut corporate tax rates didn’t yield positive effect on increasing overall industrial production. The government’s response, even then, remained entirely on addressing a demand-side structural problem from purely a supply-side perspective.

Even now, most sectors like construction and real estate - one of the largest worker-employing segments (particularly for migrating workers) - have most firms choked with higher tranches of debt, banks sitting on more NPAs and most companies remain unwilling to invest long-term capital in new capacity generation due to lower consumer spending.

This structural flaw in our policy ecosystem, to address the weakening consumer demand, or inject greater fiscal support during the last year, is only going to make the economic situation worse in months to come.

So, what can the FM do on February 1, 2021? Well, for a start, acknowledge where the problem is. Till the time the government doesn’t understand (or even admit) how structurally weak the economy is on the (consumer) demand-side, the composition of growth, if any, will continue to remain asymmetric (as it was before), worsening existing socio-economic inequities.

In terms of a few tangible fiscal measures, say on the tax-side, a reduction in consumer (indirect) taxes and personal (direct) income taxes may help in at least increasing the disposable income of most citizens covered under the tax base. Lower income groups may especially benefit from this. At the same time, to create a fiscal space for greater social (and welfare) spending out from revenue-receipts, a more structural solution must be considered, if the government has the willingness and prudence to execute it.

A Covid consumption cess (tax)?: That would be the introduction of a consumption tax for the top consumption (income) class, say the 5%. Such a measure could even be introduced as a ‘Covid Consumption Cess’ at first justified by the fiscal pressures imposed by the pandemic. The idea in favour of a consumption tax or a ‘cess’ was pushed strongly by economist Kenneth Rogoff in the US back in 2018. A radical proposal like this may have been perceived as a drastic measure in a ‘normal’ time, but in the context of the current crisis, this can be given serious thought.

A consumption tax (or a cess) is a tax imposed on ‘consumption’ as opposed to some other measure of ability to pay, most notably ‘income’. In India, our data on consumption-based surveys (even at household levels) and trends seen within them has been observed as a principal method for understanding and analysing various kinds of inequities, and therefore, can allow policymakers to have a good idea on considering a ‘consumption tax’ that progressively accrues income from higher consumers-producers. Calling it a ‘wealth tax’ may sound more like a cliché and may discourage top income classes from their wealth creation pursuits in a crisis period.

In practice too, ‘consumption’ is much easier to measure than ‘income’, and the dynamic efficiency gained from encouraging savings and investment could be large. The transitional difficulties, often associated in implementing such a system, are more likely in nations where consumption-based data and its sources are weak. In India, a relatively more robust consumption-based household data allows any such transitional costs to be minimised. For a start, in a graded implementation cycle, at least one can consider imposing a marginal consumption or spending tax side-by-side to existing income taxes, which can be phased out over time.

Going beyond this, the government must prioritise on the need to have a three-to-five year fiscal plan say from 2021-2023, that can help outline its own (fiscal) priorities and consequently help businesses, household, external actors (investors), to get more clarity on the government’s action plan for the long-road to economic normalcy.

So far, when it comes to presenting a planned, prudent fiscal action, the government’s scores ‘F’ grade in governance. What is desperately required now - more than ever - is clarity, for inspiring greater confidence in economic agents, through a medium-to-long term fiscal plan that relies on job-creation, ensuring higher wages for workers across sectors, and a push for higher domestic private investment.

(The writer is Associate Professor of Economics and Director, Centre for New Economics Studies, O P Jindal Global University)