When
that happens, by the Act that the government has just
notified, it will then be required to cut back on
expenditure. This means that even the low and inadequate
provisions for employment, education and other goals
listed in the National Common Minimum Programme will
be further cut, and may not even increase at all.
Much of the opposition to the expenditures projected
in the Budget has focussed on the low additional outlays
for critical and socially necessary areas, which has
been seen as a betrayal of the people’s mandate. The
total budgeted for these is only Rs. 10,000 crores,
but imagine the situation if even this small additional
outlay is not actually provided, because of the constraint
posed by the FRBM Act!
There may be even worse to come. The fearsome combination
of heavy floods and severe drought that is affecting
different parts of the country is bound to involve
lower incomes and thus lower tax collections, as already
stated. But it should also require much larger outlays
to provide even the most minimal relief to the affected
people who are spread across India. Even such critical
relief and rehabilitation – including in the form
of rural employment and other physical assistance
– may be under threat from the absurdly rigid fiscal
discipline imposed by the Act.
The problems with such fiscal responsibility legislation
across the world are now becoming more and more evident.
The Gramm-Rudman-Hollings legislation in the US, which
was the international front runner in this regard,
is now really honoured only in the breach, through
shifting many expenditures of the US federal government
to off-budget heads. In the European Union, the Growth
and Stability Pact which provides similar constraints
is coming under severe pressure, and France and Germany
are already seeking ways to make it effectively meaningless
and inapplicable to actual fiscal policy.
However, we in India seem to be blissfully unaware
of the potential problems in store. The Task Force
appointed by the earlier government, on Implementation
of the Fiscal Responsibility and Budget Management
Act (hereafter Kelkar Task Force) has just submitted
its report in late July 2004. This Report is much
more optimistic about meeting the targets defined
by the FRBM.
The Report correctly argues that fiscal consolidation
should be revenue-led, rather than requiring cuts
in expenditure, and even suggests that capital expenditure
should be enhanced, in order to balance the contractionary
effects of fiscal consolidation. And some of its suggestions
for tax reform, such as widening the tax base, enhancing
the equity of the system, establishing an effective
compliance system, and simplifying the system by removing
rebates, are well-known and basically desirable.
However, the Kelkar Tax Force’s basic perception appears
to be that fewer and lower rates of taxation will
lead to much greater compliance and generate a lot
of tax buoyancy. This Laffer Curve-type argument has
been repeatedly disproved in its country of origin
(the US) and there is absolutely no reason to believe
that lower rates will generate higher revenues without
major changes in tax enforcement.
Nevertheless, the optimistic projections in the Report
are based on precisely such an argument. Chart 1 shows
the valiant projections of increasing tax revenues
over the next four years, which are apparently going
to be achieved through lower and fewer rates and reform
of the tax administration by introducing VAT for all
central and state government goods and services taxes.
Apparently, the reduction in tax rates will not only
encourage better voluntary compliance, but will also
generate much higher rates of economic growth, which
will obviously then mean more government revenues
as well.
Chart
1 >>
The largest increase is projected
for services taxes (which are projected to increase
by more than Rs. 45,000 crore from next year to more
than Rs. 85,000 crore by 2008-09), and the most significant
decline is for customs duties (which are slated to
decline progressively, starting from Rs. 8300 crore
next year to more than Rs. 16,000 crore in 2008-09).
All this creates the astounding figure of an additional
Rs. 134,062 crore of tax revenues just four years
hence.
Associated with this, there are naturally very optimistic
projections regarding tax buoyancy. Table 2 indicates
the extent of buoyancy which is predicted, compared
to the estimated buoyancy rates of the past five years.
Customs duties are the only category for which buoyancy
is projected to come down, largely because the Task
Force proposes very dramatic declines in such duties.
For all other categories of taxes, there are substantial
increases projected for buoyancy, mostly without adequate
justification. The biggest such increase is for services
tax, which is apparently assumed to be relatively
easy to collect (a strong assumption in India where
unorganised services dominate).
Table
2 >>
In general, such an optimistic
scenario appears to reflect the triumph of hope over
experience. It is certainly true that such increases
in tax revenues (and indeed even larger increases)
can be achieved – but this will require not just reduction
of rates and simplification of the tax system, but
a much more aggressive attitude towards enforcement
and punishment of tax evaders.
What
has prevented this in the past is not practical difficulty
but the absence of political will. There is little
to indicate that the political economy of the ruling
classes has changed so dramatically in the recent
past that such enforcement will be likely. And until
that happens, the unfortunate reality is that the
burden of fiscal adjustment will continue to be borne
by the poor of the country, through reductions in
much-needed public expenditure.
