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Budgetary Policy in the Context of Inflation

The Union Budget 2007-08 utterly fails to appropriately respond to the social needs of a situation of profit inflation. The situation demanded an increase in government expenditure relative to gross domestic product aimed at putting transfers in the hands of workers and a financing of this through taxes on private profits. It also required taking appropriate steps to remove the basic cause of profit inflation through a revival of agriculture.

Budgetary Policy inthe Context of Inflation


Economic and Political WeeklyApril 7, 20071261in short, may not mean the end of inflationin nominal wages and prices. Let us how-ever, assume for simplicity that it does, ie,that the wage unit remains unchanged allalong. Even so, while profit inflation maycome to an end, i e, prices in terms of thewage unit may cease to increase, that stillwill leave the level of real wages belowwhat it was before profit inflation began.Hence the end of profit inflation does notmean the end of the increased squeeze onthe poor, relative to the initial situation;it only means a stabilisation of the squeezeat a higher level than initially.Protecting the poor against profit infla-tion therefore means much more thansimply the end of profit inflation; it meansnegating its effects on their living stan-dards, by making them regain what theyhave lost through profit inflation. Hence,even if augmentation of supplies throughresorting to imports, as the government isdoing now in the case of foodgrains,succeeds in ending inflation in terms of thewage unit, there is still the need to put inadditional purchasing power in the handsof the poor so that they regain their earlierreal income.This requires an increase in fiscal trans-fers to the poor, financed, ideally (forreasons we shall discuss later) by an in-crease in taxes on the profit earners. Andthe basic problem with the 2007-08 budgetis that it is oblivious of these social de-mands of a situation of profit inflation.IIThe argument underlying the budgetappears to be the following: fiscal recti-tude, in the sense of a reduction in therevenue and fiscal deficits relative to grossdomestic product (GDP), is necessary forcurbing inflation; it has to be achievedhowever not through additional resourcemobilisation but through a restriction ongovernment expenditure relative to GDP,for it is onlythen that the “animal spirits”of the entrepreneurs will not get destroyedby higher taxes, and hence growth will notbe curbed. The right policy therefore is toenforce fiscal rectitude through expendi-ture restraint; and since the sustenance ofgrowth with a curtailed inflation rate is inthe interests of the poor, such a policybenefits them as well.The problem with this argument is thatit misses the specificity of a profit infla-tion, because, in a situation of profit in-flation, even if one concedes for the momentthe need for fiscal rectitude (on this morelater), protecting the poor against inflationrequires not a curtailment but an increasein government expenditure relative to GDP.As we saw above, if the poor are to regainthelosses they incur in a profit inflation, thenanincrease in government expenditure relativeto GDP, aimed at putting transfers in theirhands and financed by increased taxes onprivate profits, becomes necessary.In short, what a situation of profit in-flation requires is both the ensuring ofappropriate supplies through imports, anda transfer of purchasing power from theprofit earners to the workers. Fulfillingonly one of these two requirements is notenough. If imports are augmented to bringto an end the increase in prices in terms ofthe wage unit, then the losses of the workersare not recouped. On the other hand, ifsupplies are not augmented, but onlytrans-fers from profit earners to workerstakeplace through a larger but balanced budget,then the impact on the workers is exactlythe same as if no transfers had taken place.This last proposition may appear odd, butcan be shown as follows:Let us take, for simplicity, an economywith only capitalists and workers, produc-ing a homogeneous commodity. If weassume that a fractions of post-tax profitsis saved, that all taxation is on profits, andthat all post-transfer wages are consumed,then denoting the level of real investmentby I, the level of real profits by P, andconsidering a closed economy with abalanced budget (where taxes equal trans-fers), we must haveI = s(1-t)P…(i)whence it follows thatP = I/s(1-t)…(ii)and capitalists’ consumption is given byP(1-t)(1-s) = I(1-t)(1-s)/s(1-t)…= I(1-s)/s…(iii)Now, the given full capacity output mustbe distributed between investment, capi-talists’ consumption and workers’ con-sumption. Since investment is given, andso is capitalists’ consumption by (iii), theworkers’ consumption is also given, nomatter what the tax rate and the corre-sponding transfer to the workers.While the government has seen the needfor “supply management”, i e, for import-ing certain essential commodities to aug-ment domestic supplies (though in a mannerso thoughtless as to rob the exercise of anymeaning, as we shall see), it has not seenthe need for transfers. This is clear fromthe fact that the budget’s quest for fiscalrectitude takes the form of a curtailmentof expenditure, including transfer payments.Not only is there a remarkable samenessabout the percentage increases providedfor in all major items in the budget, butthese percentage increases are roughly thesame as the percentage increase in thenominal GDP. Thus gross tax revenue issupposed to increase between 2006-07 (RE)and 2007-08 (BE) by 17.2 per cent; taxrevenue net of states’ share by 17 per cent;total receipts and total expenditures by 17per cent; plan expenditure by 18.7 per centand non-plan expenditure by 16.3 per cent.True, budget support for the Central planis supposed to increase by 22.5 per cent,but this is because the magnitude of budgetsupport for states and union territories isto go up by a mere 8.5 per cent. This inshort is a “17 per cent budget”. Consider-ing the fact that the real GDP is currentlyrising at over 9 per cent and prices ataround 7 per cent, this 17 per cent increasein most budget items matches the 16-17per cent increase in the nominal GDP,leaving their proportion to GDP unchanged.Not only is the proportion of expenditurein GDP not slated to increase, but thoseitems of expenditure which can be clas-sified under the rubric of “transfers” to thepoor, are even slated to decline relative toGDP, and often even absolutely in realterms. Thus the outlay on the National RuralEmployment Guarantee Scheme (NREGS)is supposed to rise from Rs 11,300 crore toRs12,000 crore, i e, by a mere 6.2 per centin nominal terms, even less than the inflationrate, notwithstanding the proposed increasein its coverage from 200 to 330 districts.The total expenditure on rural employmentis supposed to rise by only 3.5 per cent;and the aggregate expenditure on NREGS,Sampoorna Gramin Rozgar Yojana (SGRY)and Swarnajayanti Gram SwarozgarYojana (SGSY) is supposed to increase byjust about 7 per cent (The finance ministerhas even skimped on the Sarva ShikshaAbhiyan where he has, against the wishesof all the chief ministers expressed at theNational Development Council meeting,brought down the share of Central fundingto 50 per cent from the previous 75).The amount earmarked for food subsidyis also supposed to rise by a mere 6.2 percent. The fact that in addition to this meagerincrease in food subsidy, the budget doesnot even mention the need for any strength-ening of the Public Distribution System,suggests that the imported foodgrains willnot be distributed through the PDS, butthrough open market sales, where they willno doubt be bought up by grateful specu-lators. The government may have done the

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