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Union Budget for 2010-11 and the UPA's Growth Strategy

The growth strategy underlying Budget 2010 intensifies a recent tendency wherein private consumption expenditure has increasingly substituted for public expenditure in order to induce growth. It also accepts a regressive bias in fiscal policy as part of the strategy. In the Union Budget, the government has restructured the tax system so as to curtail revenue expenditures, while maintaining past direct tax concessions and using a part of its revenues to provide new concessions that are expected to spur demand, sustain and increase corporate savings and encourage corporate investment, all with the intention of "facilitating" growth. The potentially "inequalising" fallout of such an approach is possibly seen as collateral damage in realising a high rate of market-driven (as opposed to state-driven) growth, which needs to be redressed separately - if at all it will be.

BUDGET 2010

Union Budget for 2010-11 and the UPA’s Growth Strategy

C P Chandrasekhar

consciously adopted in response to the slowdown induced by the global crisis. As a result of the unwinding of this stimulus, total expenditures relative to GDP, which rose from 15.7% to 17.3% between 2008-09 and 2009-10, are slated to slip to 16% in 2010-11. The fiscal and revenue deficits too

The growth strategy underlying Budget 2010 intensifies a recent tendency wherein private consumption expenditure has increasingly substituted for public expenditure in order to induce growth. It also accepts a regressive bias in fiscal policy as part of the strategy. In the Union Budget, the government has restructured the tax system so as to curtail revenue expenditures, while maintaining past direct tax concessions and using a part of its revenues to provide new concessions that are expected to spur demand, sustain and increase corporate savings and encourage corporate investment, all with the intention of “facilitating” growth. The potentially “inequalising” fallout of such an approach is possibly seen as collateral damage in realising a high rate of market-driven (as opposed to state-driven) growth, which needs to be redressed separately – if at all it will be.

C P Chandrasekhar (cpchand@gmail.com) is with the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi.

Economic & Political Weekly

EPW
march 27, 2010

B
eing annual in their periodicity, budgets cannot fully reflect the medium- or long-term strategy of growth of a government. They are influenced by immediate political considerations, leading, for example, to the often-discussed political business cycle in which spikes in election-year expenses affect growth patterns. They are also influenced by special circumstances such as the i mplementation of the Sixth Pay Commission’s (SPC) recommendations in India during the last year. And they can be distorted by shocks such as the global crisis of 2008, which required the resort to a stimulus of sorts in Budget 2009-10.

As a result, budgets cannot be the principal, let alone only, basis for deciphering the growth strategy being pursued. However, the ways in which revenues are generated, the extent to which they match expenditures and the kind of expenditures planned and undertaken are bound to reflect the growth strategy that the government favours. Moreover, over the years, budget speeches have become the sites for important economic policy declarations of successive governments, straying into territory that does not belong to an annual statement of realised and planned revenues and expenditures. So, while exercising due caution, an attempt can be made to glean from budget documents the broad contours of the government’s growth strategy.

Seen in that light, the Union Budget for 2010-11 has a few aspects that are worth highlighting. First, the budget does, in more ways than one, make clear that the government would like to unwind the a dditional fiscal stimulus realised during 2009-10, which is reflected in an increase in the ratio of the revenue and fiscal deficits in the central budget relative to GDP. That increase was the result of the expenditures, especially the payment of arrears, associated with the implementation of the SPC’s recommendations, besides the measures

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are to decline from 6.7% and 5.3% respectively in 2009-10 to 5.5% and 4% in 2010-11.

Second, the reduction in expenditures is expected to come largely from a reduction in revenue rather than capital expenditure. In fact, capital expenditures that rose from 1.6% of GDP in 2008-09 to 2% in 2009-10, are budgeted to rise marginally to 2.2% of GDP in 2010-11. On the other hand, revenue expenditures, which rose from 14.1% to 15.4% of GDP b etween 2008-09 and 2009-10, are bud geted to fall sharply to 13.8% of GDP in 2010-11. With the government’s wage and salary bill having risen and interest and amortisation payment commitments on past debt still large, this reduction in revenue expenditures is to be ensured, inter alia, through a cut in subsidies. Subsidies on a universal intermediate like petroleum consumed directly and indirectly by all are budgeted to fall from Rs 14,954 crore in 2009-10 to a paltry Rs 3,108 crore in 2010-11. In addition, food subsidies are budgeted to fall marginally from Rs 56,002 crore to Rs 55,578 crore despite talk of a Food Security Act and expectations that the population Below the Poverty Line (BPL) will be placed at levels much higher than hitherto admitted. F inally, fertiliser subsidies too are expected to be cut by Rs 3,000 crore from their current level of Rs 52,980 crore. Thus, an important thrust of the budget is a huge cutback in subsidies compared to the levels they would have otherwise touched, in keeping with the perception that subsidies are an inappropriate way to achieve whatever inclusion the system delivers.

Major Tax Concessions

Third, while the budget sees subsidies as unwarranted giveaways, it has chosen to provide huge tax concessions to the upper middle classes falling in different taxable income brackets, by widening these brackets even while keeping the entry level income for income taxation constant. Even

BUDGET 2010

though the number of income taxpayers are a small proportion of the population, the government has decided to offer a completely unexpected bonanza through a widening of the income tax slabs. In the event, an individual earning a taxable income of Rs 8 lakh or more a year, who would definitely constitute a member of the economic creamy layer, will benefit to the tune of Rs 50,000 in terms of tax concessions. According to an official estimate, this alone would result in a revenue loss of around Rs 21,000 crore in 2010-11.

Given the fact that public sector employees have only recently been rewarded with generous salary increases and that those in regular private employment have also seen their salary rise quite significantly, these sections were neither demanding nor expecting this huge bonanza. And since this concession is part of a budget which seeks to curtail expenditure in order to reduce the fiscal and revenue deficits, and plans to cut subsidies on food, diesel, petrol and fertiliser to realise this goal, the largesse in favour of the u pper middle classes is indeed surprising. One way it could be explained is that the measure was designed to spur spending amongst this section of the population in the form of enhanced housing investments, automobile purchases and consumption, financed if necessary with credit. Since such spending may expand domestic markets and drive GDP growth, it could be interpreted as a tax-related measure that is explicitly designed as an element of a growth strategy based on enhancing consumption. In a comparative sense, fiscal concessions financed by the exchequer are expected to play a role similar to the “wealth effect” delivered by equity and housing price increases in the developed countries.

A fourth noteworthy aspect of the budget is that direct taxation of corporations has been eased, though the Minimum Alternate Tax (MAT) rate has been marginally hiked. The surcharge on corporate tax has been reduced from 10% to 7.5%. It has been argued that this has been partly n eutralised by raising the MAT from 15 to 18%. However, what such an argument i gnores is the fact that any firm paying a MAT rate of 15%, is being subjected to an effective tax rate much lower than the normal rate of corporate tax of more than 33% and is therefore only being d eprived of a part of the concessions afforded to it. There is no actual increase in tax here, but merely a small cut in tax exemptions and giveaways delivered in the past. Combine these changes with the concessions in income tax, and it is not surprising that the finance minister expects to have lost as much as Rs 26,000 crore as a result of the direct tax concessions provided in this budget.

Push to Corporate Profits

The light touch seen in the corporate tax area can also be interpreted as being linked to the growth strategy of the government. Simple arithmetic tells us that for a given level of the incremental output-capital ratio, the rate of growth of GDP is given by the rate of investment. Investment has been high in recent years because corporations have seen a substantial improvement in profitability, aided not just by buoyant demand from an enriched upper middle class but also by the benefits of lower interest rates and lower rates of taxation. Not surprisingly, much of the sharp increase in savings and investment in the Indian economy after 2003 is on a ccount of an increase in private corporate savings and investment. The measures with respect to the corporate sector in Budget 2010 appear to be aimed at keeping this process going, so that the e nhanced demand stemming from income tax concessions can be exploited by a corporate sector gaining from profit inflation.

A fifth feature of the budget is that, while coming down heavily on explicit subsidy payments, the government has done little to do away with the implicit subsidies offered to direct taxpayers (both corporations and individuals) through exemptions of various kinds, which resulted in large estimates of “revenues foregone” in earlier years. The government estimates that the effective tax rate on private companies was just 21.56% in 2008-09, as compared with 27.14% in the case of public sector companies and the official corporate tax rate of 33.99%. It also estimates that the revenue foregone taking into account the benefits that accrue to a sample of companies consisting of 90% of all companies in the corporate sector was Rs 79,554 crore in 2009-10. The revenue foregone on account of concessions given to individual income taxpayers was another Rs 36,186 crore. These concessions, too, are in keeping with the larger agenda of sustaining private consumption expenditure and incentivising corporate savings and investment.

Adverse Impact on Poor

Finally, by combining these direct tax concessions with a steep rise in (regressive) indirect taxes the current budget has r eversed the “progressive” tendency in recent years towards relying more on direct rather than indirect taxation. This it does in two ways:

(i) by increasing the median ad valorem rate of excise duty from 8% to 10%, which amounts to a reversal of a part of the “stimulus” through a wide-ranging increase in excise duty; and (ii) by restoring the basic customs duty of 5% on crude petroleum, by increasing customs duties on petrol and diesel to 7.5% from 2.5% and by imposing a specific excise duty on non-branded (normal) petrol and diesel of Re 1 per litre. In the process it has mobilised additional resources to the tune of Rs 40,000 crore. The duties on petroleum and petroleum products alone are expected to yield Rs 26,000 crore. By resorting to these measures and expanding taxes on services, Union Finance Minister Pranab Kumar Mukherjee expects to garner a t otal of around Rs 70,000 crore of indirect tax revenue. For a government that claims to be concerned about inflation, especially food price inflation that affects the poor more, this is indeed surprising. Indirect taxes are both inflationary and regressive and would hurt precisely those who are not benefiting from the recovery in terms of jobs or incomes, but are being adversely affected by the rise in food prices. Apply those on universal intermediates like petroleum and petroleum products, price increases in which would have cascading effects on the costs of various commodities, and the impact is likely to be even more severe.

Private Consumption at the Centre

The net result of these changes is that the government has restructured the tax system so as to simultaneously curtail revenue expenditures by cutting subsidies, while maintaining past direct tax concessions and using a part of its revenues to provide new concessions that are expected to spur demand, sustain and increase corporate savings and encourage corporate investment, all with the

march 27, 2010 vol xlv no 13

EPW
Economic & Political Weekly

BUDGET 2010

intention of “facilitating” growth. There are two implications implicit in a strategy of this kind. The first is that it seeks to intensify a recent tendency wherein private consumption expenditure increasingly substitutes for public expenditure to induce growth. The second is that it accepts a regressive bias in fiscal policy as part of the strategy of growth it pursues. It would be churlish to argue that the government, consisting of trained and experienced economists as leaders and advisers, does not know what it is doing. The conclusion to be derived must be that this potentially “inequalising” fallout of its policies is seen as the collateral damage of realising a high rate of market-driven (as opposed to state-driven) growth, which needs to be redressed separately, if at all.

How does this tally with the view e xpressed in the Economic Survey 2009-10 and the budget speech for 2010-11 that the government’s role is to provide an “enabling environment” for growth, by not intervening whenever the efficacy of any interventionist measure is in doubt, even while adopting measures to include those who may be left out of or marginalised by this growth process? It is unclear whether withdrawing the stimulus and offering tax concessions to encourage private consumption and investment as drivers of growth is to merely “enable” as opposed to actually engineer growth. And even if the effort is to engineer growth, it is also unclear whether this would work. Would the attempt to stimulate consumption generate additional demand adequate to neutralise the exit from the stimulus through a reduction in aggregate expenditures? Possibly not. If there is uncertainty as to whether these measures would work, the “when in doubt refrain” principle would require the government not to adopt them. Moreover, since the “enabling” strategy is to be accompanied by a return to fiscal conservatism, the support to private consumption and investment necessitates a parallel reduction in expenditures on the marginalised or those who will potentially be marginalised by the growth strategy. The strategy would then exclude rather than include the less well endowed and the disadvantaged and d iscriminated.

This the strategy does by slashing subsidies, which, even allowing for leakages, affect the poor. It also does so by cutting expenditures of the kind that put a human

Economic & Political Weekly

EPW
march 27, 2010

face on an otherwise inequalising strategy of growth. The finance minister has sought to conceal the regressive features of his budget behind statements claiming substantial relative (even if not always absolute) increases in social sector expenditures. In nominal terms, the total expenditure on health and family welfare is to rise by 16.3%, that on school education and literacy by 31% and that on higher education by 16%. But these are exceptions. In most cases nominal increases have been unimpressive and even in some areas with high increases, the expenditure does not make up for past inadequacies. If we take some “flagship” programmes, for example, the picture is disconcerting. The 2010-11 allocations for what is to be a much expanded National Rural Employment Guarantee Scheme is budgeted at Rs 40,100 crore as compared with Rs 39,100 crore in 2009-10; that on the Sarva Shiksha Abhiyan at Rs 15,000 crore as compared with Rs 13,100 crore in each of the previous two years; that on the National Rural Health Mission at Rs 15,440 crore as compared with Rs 14,127 crore in 2009-10; and that on the Integrated Child Development Services programme, which is yet to be universalised, at Rs 8,700 crore as compared with Rs 6,705 crore in 2009

10. These are by no means adequate, implying that whatever increases have occurred and been highlighted are selective.

Behind the Reduction

The point is that this combination of measures does not even guarantee the realisation of the finance minister’s claim that he has (correctly or otherwise) r emained within the bounds of fiscal p rudence. The budget expects a reduction in the revenue deficit from 5.3% to 4% of GDP and the fiscal deficit from 6.7% to 5.5% of GDP. There are three dubious sources of finance that are crucial to realising these goals. To start with, an unusual feature of the budget is the fact that an item called “other non-tax revenue” is slated to rise from Rs 36,845 crore to Rs 74,571 crore between the revised estimates for 2009-10 and the budget estimates for 2010-11. This huge revenue windfall is to come largely from receipts from “Other Communication Services”, which consist of licence fees from telecom operators and receipts on account of spectrum usage charges. There is reason to believe

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that what are being included are receipts from the auction of spectrum. If this is the case, it would be wrong to treat this as a revenue receipt. If it is not, the revenue and fiscal deficits would go up substantially.

Further, corporation tax revenues in 2010-11 are projected to rise by as much as Rs 46,255 crore, despite the reduction in the surcharge on corporate taxes from 10% to 7.5%. The budget clearly assumes that corporate profits would display strong buoyancy in the aftermath of the recovery.

Finally, the budget provides for “miscellaneous capital receipts” of Rs 40,000 crore in 2010-11, which refer to receipts from disinvestment and privatisation. This head is reported to have yielded Rs 26,000 crore in 2009-10. If not for this sale of public wealth, the borrowing required to finance the government’s expenditures would have been much more, necessitating higher commitments for interest and amortisation payments in future. That would have made it difficult for the finance minister to claim that he was not merely delivering inclusive growth, but d oing so while remaining fiscally “prudent”.

In sum, the fiscal prudence that Budget 2010 ostensibly embodies appears to be the result of a combination of revenue

o ptimism and reliance on privatisation r eceipts, besides inflationary taxation. Yet the budget does not manage also to e xpand expenditures to spur growth. This explains the strategy of growth underlying the budget. As argued above, the huge direct tax concessions for the upper middle class suggest that the government wants to push a consumption-led growth strategy, the kind the country experienced after 2003. It expects private consumption to substitute for public expenditure as the driver of growth, by encouraging the u pper middle class to spend, especially by resorting to debt-financed investment in housing and credit-financed purchases of automobiles, consumer durables and sundry goods and services. This is what the policy seeks to “enable”. Clearly the dangers i nherent in this trajectory, which were brought home by the recent crisis in the developed countries, are being ignored. So are the inequalising features of a b udget that threatens to accelerate inflation, at a time when food prices are already at distressingly high levels and still rising sharply.

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