Friday, April 10, 2015

On Contractionary Union Budget of 2015-16

Surajit Das


In the first budget of the newly elected NDA government, the total expenditure of the central government has been restricted to 12.6% (a decline of 1.6 percentage points) of expected GDP during 2015-16. For 2014-15, it was budgeted to be 14.2% of GDP by the previous UPA government and as far as the actual spending by the present NDA government is concerned, it is (revised) estimated to be 13.3% of GDP.What does this mean? It simply means that the presence of central government in total national income has already shrunk than what was budgeted during the last fiscal year and it is being planned, according to the budget 2015-16, to bring it down further in this financial year starting from April, 2015.

The official excuse for the smaller government is that the centre is apparently being compelled to transfer more resources this time to the States following the recommendations of the 14th Finance Commission. True, the Finance Commission has recommended that 42% of centre’s tax revenue has to be devolved to the States. As a result, the State’s share in central taxes as percentage of GDP is expected to go up from 3% in 2014-15 (budget estimate) to 3.7% of GDP in 2015-16.However, the claim that the centre’s fiscal space has shrunk because of larger transfer to States is a claim, which is partially true because of the fact that the devolution has gone up by 0.7 percentage points of GDP as compared to the decline in the centre’s expenditure by 1.6 percentage points.How to explainthe 0.9 percentage points of additional decline in the centre’s expenditure as proportion of GDP?

Well, firstly, the fiscal space has been contracted by (estimated) decline in the estimated gross revenue receipts of the central government (including States’ share) as percentage of GDP from 12.5% in 2014-15 to 11.8% in 2015-16 i.e. 0.7 percentage points reduction. Since, the estimated tax devolution to states is gone up by 0.7 percentage points in 2015-16, the centre’s net revenue receipts have come down by 1.4 percentage points. Secondly, it is shrunk by 0.2 more percentage points due to the reduction in the fiscal deficit from 4.1% in 2014-15 to 3.9% of GDP in 2015-16. These two together curbed the fiscal space of the central government by 1.6 percentage points of GDP in 2015-16.

The tax devolution has been estimated to increase by Rs.1.4 lakh crore this year as compared to the budget estimate of last year and the total central assistance for State & UT plans is being cut down by Rs.1.3 lakh crore. The non-plan revenue grants to State and U.T. governments is budgeted to go up by around Rs.0.4 lakh crore. However, the total transfer of resources from centre to States (including the tax devolution, assistance for State plans and non-plan revenue grants) as percentage of GDP during 2015-16 has been estimated to be 5.9% as compared to that being 6.2% during last year (See Mitra 2015, www.macroscan.org).

Therefore, the states’ fiscal space is not going to expand due to larger tax devolution simply because of the fact that the total transfer of centre to states as proportion of GDP is actually coming down. The centre’s expenditure is coming down by 1.6 percentage points. As far as the combined government expenditure of centre and states are concerned, clearly, it is likely to decline by more than 1.6 percentage points provided states’ own tax revenue or states’ fiscal deficit do not go up as percentage of GDP. If that is the case, then the excuse of ‘cooperative federalism’ for reduction in central government expenditure as proportion of GDP can’t stand logical scrutiny! From the states’ point of view, they receive less transfer from the centre than before (as percentage of GDP) and, on top of that, the centre reduces its own expenditure. As a result, the combined expenditures of the central and the state governments would come down as proportion of GDP in general.

The gross revenue receipts of the Central government are estimated to come down mainly due to shortfall in tax revenue. Centres’ gross tax revenue has been estimated to come down by 0.5 percentage points during 2015-16. This implies that the underlying assumption about the tax buoyancy (elasticity: both because of change in the tax rates and that in the tax base) of the central government must have been less than one i.e. if the national income rises by 1%, the tax revenue would rise by less than 1%.Even if the tax rates remain the same, without any extra tax effort and efficiency on the part of the government, with increase in GDP, the gross tax revenue is expected to increase at least proportionately. Assumption of less than unitytax buoyancy simply means that the government is planning to cut down either the tax rates or the tax effort or both. Therefore, the broad policy direction of the present government is that there would be tax-cuts as proportion of GDP and (due to reduction in the fiscal deficit to GDP ratio) there would be expenditure cuts at a more than proportionate rate.

It is important to discuss the current growth scenario of Indian economy to understand the specific context of Indian economy in which this budget has been announced. According to the new GDP series of Central Statistical Organisation (CSO), the growth rates (of GDP at constant 2011-12 basic prices) for the years 2013-14 and 2014-15 have been 6.9% and 7.4% respectively. There are four components of GDP (from the demand side)viz. private consumption, private investment, government expenditure and net exports of goods and services. As compared to 2012-13, the share of private and government consumption expenditures (taken together) in GDP remained more or less the same during the last two years. The investment (gross fixed capital formation) rate in the economy,including government and private investment, has come down by more than 2 percentage points of GDP. The change in stocks (CIS) and valuables (taken together) as proportion of GDP has also come down by more than 2 percentage points. Therefore, the growth in the level of investment including change in stocks and valuables must have been much less than the growth in GDP. As far as the exports of goods and services are concerned, its share in GDP has come down by 1.5 percentage points in 2014-15 due to poor export growth rate of less than 1%. What is then the source of 7% or more growthrate in the economy?

Apart from the private and government final consumption expenditure, the other major contributor to 7% or more growth is neither the private investment nor the investment by the non-departmental government enterprises nor the export but it is interestingly the reduction in the import. The import growth rates have been negative during 2013-14 and 2014-15 and its share in GDP has come down substantially from 31% in 2012-13 to 24.6% in 2014-15. The import bill has come down mainly due to reduction in international crude oil prices and also due to some checks in the gold imports. Since, it is the net export (i.e. export minus import), which enters into the GDP calculations, this reduction in imports have contributed enormously in GDP growth of last two years through reduction in current account deficits (from 6.4% of GDP in 2012-13 to 1.4% in 2014-15 at constant 2011-12 prices: see the table below).
CSO Advanced Estimates of Components of GDP: New Series

Growth Rates

Share in GDP

2012-13
2013-14
2014-15

2012-13
2013-14
2014-15
pfce
5.5
6.2
7.1
pfce
57.9
57.5
57.3
gfce
1.7
8.2
10
gfce
10.8
10.9
11.2
gfcf
-0.3
3
4.1
gfcf
31.9
30.7
29.8
cis
-6.2
-21.4
3.9
cis
2.2
1.6
1.5
Valuables
3.3
-48.7
28.2
Valuables
2.8
1.4
1.6
Export
6.7
7.3
0.9
Export
24.6
24.7
23.2
Import
6
-8.4
-0.5
Import
31
26.6
24.6
Disc



Disc
0.8
-0.3
-0.1
GDP
5.1
6.9
7.4
gdp
100
100
100
Source: CSO Press Release dated 9th February, 2015.
Notes: PFCE is private final consumption expenditure, GFCE is government final consumption expenditure, GFCF is gross fixed capital formation, CIS is change in stocks, Disc is discrepancies and GDP is gross domestic product.

In the context of a demand constrained economy characterised by large scale involuntary unemployment and widespread unutilized capacity, the domestic private final consumption expenditure in real terms cannot keep increasing unless the purchasing power increases in the hands of the people. The real purchasing power (given the tax rates) would not increase unless people earn more income in terms of wages, rents and other factor incomes. Again, extra income cannot accrue unless the government spends or the private investors invest.The private investors would not invest unless their expected risk-adjusted rate of profit is higher than the cost of credit and also unless they are confident that they would be able to sell their products in the market in order to realise the profit. If people don’t have enough purchasing power, then, in absence of enough export demands, the investors would not invest due to lack of demand for their products in the market.

One way to come out of this vicious circle could be, as suggested by John Maynard Keynes in 1936 (in General Theory of Employment, Interest and Money), by enhancing the government expenditure without increasing the tax revenue or, in other words, by increasing the fiscal deficit. If the government taxes more, then also the aggregate demand comes down through reduction in disposable income of the people. But, if the government increases its spending, it gives rise to an increase in the aggregate demand through greater income and purchasing power of people. Given the ongoing fiscal conservatism and rule based budgeting, we have closed down that option, too. The international price of crude oil cannot fall continuously every year, neither the gold import, for that matter, can substantially fall every year over the previous year. The export demand is largely exogenously determined in the sense that it depends,to a great extent,on the demand from our major export destinations. Private investment demand is also falling as proportion of GDP. In this particular macroeconomic context, the union budget of 2015-16 proposes to cut down both the fiscal deficit as well as the aggregate government expenditure as proportion of GDP.

In this budget, the underlying assumption must have been that the larger fiscal deficit to GDP ratio would necessarily cause crowding-out of private investment through rise in interest rate and as a result of that, the private investment demand would come down further. We all know that the RBI can always control the interest rate and hence crowding-out is obviously not inevitable. If invested strategically, the government investment may crowed-in a lot of private investments as well. But, the capital expenditure (net of disinvestment receipts) is, in fact, budgeted to come down this time as percentage of GDP. There is no plan to increase the investment of public sector enterprises either (See Patnaik 2015, Peoples’ Democracy). Therefore, thegovernment is entirely banking upon the private sector investment for growth and (given the state of technology) for aggregate employment generation, the rate of which is on the decline at the moment.

The government intends to boost private investment rate by reducing the profit tax rate from 30% to 25% i.e. by giving 5 percentage points tax incentive on corporate profit for next four years. However, mere reduction in the profit tax rate alone would not be able to excite the investors because of the following reasons. Firstly, as mentioned above, the investors would not increase their level of investment unless they are sure about enough demand for their products in the market. If they cannot sell their products, the profit would not be realised at the first place and the question of 5 percentage point tax incentive comes later.The investors would not mind paying Rs.30 as tax if their realised profit be Rs.100 rather than paying a tax at a rate of 25% when their profit squeezes to Rs.80 due to lack of demand. In the previous case, the net profit after tax would be Rs.70 as compared to that of Rs.60 in the latter case.Moreover, if the effective profit tax rate actually increases on an average, as has been claimed in the budget, then the investment rate is likely to come down given any level of profitability.

Presumably, the government economists think that the reduction in profit tax rate would encourage more saving out of profit, which in turn, gets reinvested. But, the investment demand is not coming down because of lack of saving rather, it is coming down because of lack of aggregate demand. The empirical proof is that the commercial banks are holding around 30% of their liability (NDTL) worth of government securities as compared to the SLR requirement of only 21.5%. If there is enough demand for credit (by the ‘good borrowers’) in the market, the commercial banks can easily meet the extra credit demand. If the aggregate income rises at a slower rate, being a positive function of income, the aggregate saving would also rise at a slower rate, given the distribution of income. If the income distribution shifts in favour of the industrialists and against the wage earners, then of course the aggregate saving rate would increase because usually more proportion of profit and less proportion of wages are saved. Even if the saving rate rises, there is no necessity that the investment rate would also rise proportionately irrespective of the state of aggregate demand in the economy.

If the private investment rate does not go up automatically, in absence of an increase in public sector investment, the rate of growth of output and employment would come down almost certainly if the current account deficit does not keep improving continuously. However, the current account deficit is, at the first place, beyond our control and it is also unlikely that the current account deficit to GDP ratio would continuously improve, which is already less than 1.5% of GDP. The government expenditure to GDP ratio is also being planned to be brought down to continuewith the ongoing neo-liberal agenda of fiscal conservativeness.

This budget would definitely have a contractionary effect on the growth of aggregate level of activity and employment, which would curb the average real purchasing power of common people further. Alternatively, instead of cutting down the tax-GDP ratio and fiscal deficit to GDP ratio and hence reducing both revenue and capital expenditure as proportion of GDP in this budget, the central government could have increased the expenditure-GDP ratio by increasing both tax-GDP ratio and the fiscal deficit to GDP ratio. India has one of the lowest tax-GDP ratios in the world and also 1 or 2 percentage point increase in the fiscal deficit to GDP ratio would not have caused any harm to the economy necessarily. Under a situation of reduced export growth and falling investment rate, the need of the hour was an expansionary fiscal stance rather than a demand contractionary fiscal policy in the context of a demand constrained economy like India. However, the government is doing just the opposite.

References:

Central Statistical Organisation (CSO) Press Release Dated 9th February, 2015 available at http://mospi.nic.in/Mospi_New/upload/Presss_note_for_Q3_AE_2014-15.pdf

Government of India (2015) – “Union Budget 2015-16”, available at http://indiabudget.nic.in/

Mitra, Sona (2015) – “The Myth of Increased Resources for States”, www.macroscan.org, Special Feature, March 12 (http://www.macroscan.org/spfea/mar15/pdf/Myth.pdf).

Patnaik, Prabhat (2015) – “Budget 2015-16: Bonanza for the Corporates”, Peoples’ Democracy, Vol.XXXIX, No.10, Economic Notes, March 08 edition (http://peoplesdemocracy.in/2015/0308_pd/budget-2015-16-bonanza-corporates)

 

The author is Assistant Professor at JNU

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