Budget 2015: Strengthening the fiscal foundation

Having produced his first budget in the conventional mould, Finance Minister Arun Jaitley would be under pressure to present a path-breaking budget, especially as Achhe Din are still eluding! We will have to wait for Jaitley’s magic, if any, to unravel preemptions of debt servicing, redistribution priorities and defence on the one hand, and low growth on the other. It would not be surprising if the Union Budget 2015 remains in conventional mould, tinkering with tax rates, exemption limits and token provisions for all kinds of pet schemes of the Prime Minister. If so, it would add to long-term structural fiscal and economic damage through underfunded and unfinished projects as well as huge time and cost overruns. This article presents ideas if the finance minister wants to act 'differently' this time.
Boost investments

I believe that key priority of the finance minister should be to help growth acceleration without creating inflationary pressures. First green shoots of improvement in investment climate and domestic demand are visible. Under these circumstances, in my view, the best course would be not to tinker with tax rates, limits, capital gains tax, wealth tax or impose inheritance tax as advised by some. Negative noise of these would far outweigh small revenue gain. He should also avoid temptation to reintroduce failed taxes like Fringe Benefit Tax or Cash Transactions Tax as suggested by Tax Administration and Reform Commission (TARC, Report III). Risk of recovery being nipped in the bud is quite high through adverse impact on sentiment. What can finance minister do in these circumstances? I believe he must go to the basics role of the government as a service provider, aiming the high socio-economic benefit cost ratio.

Promote transparency

Actionable goals should be stopping revenue leakages, enhancing operational efficiency of tax administration and public expenditure. While this may not be a glamorous exercise but if executed efficiently, it would maximize socio-economic return on taxpayers' money, be fair to honest taxpayers and raiseadditional resources on a recurring basis. This will lay robust foundation for automatic revenue buoyancy. Tax administration reform is not a new idea. Governments all over the world, including the Obama administration, have pursued administrative reforms and saved large amounts. TARC has a long list of unimplemented sensible recommendations! Failure is not of conviction but one of tardy action, and all one has to understand is ‘why is it so?’.

Do away with feudalistic style

Clearly any reform is bound to be unpalatable to entrenched vested interests, be it tax collectors, middlemen, renters or politicians. Collusion between all these and more for ill-gotten money and gross inefficiency has flourished because of feudal style of functioning of political democracy and misconceived notions about role of elected politicians, who ought to be safeguarding public interest instead of behaving as renters benefiting from the government's privilege to allocate scarce resources. (For example, Indian politicians are often seen using terms like ‘I did it’ or ‘I will do it’ as if they are managing private fiefdoms!)

No comprehensive administrative reform is possible without political will. And Finance Minister Arun Jaitley would need all his courage and ingenuity to bring the change.

Beside this, the penetration of information technology and resultant information availability, post Kelkar report, has overwhelmed inadequately trained staff. On top of that, the 2014 CAG report pointed out several addressable issues like fake tax audit certificates, tax collectors not using tax audit information, wasting time in chasing non-existent, closed down and BIFR companies, senior officers not being posted in key positions.

These are all the symptoms of a dysfunctional organisation. Unless this government, which professes to be different and transparent, undertakes this task, domestic black money generation will continue to grow. According to TARC, non-compliance is vividly reflected in only 3.3% of Indian population paying income tax against 39 to 42% in some developed countries. However, one may argue that these comparisons are invalid because of low per capita income and should not be taken at face value. If one uses crude proxies such as number of luxury cars purchased, foreign travel, purchase of gold and ornaments, costs of lavish weddings, expensive residences and huge expenses in elections, there is enough corroborative evidence that a huge population of Indians are not paying taxes.

Focused approach is the key
For a holistic approach to reforms, it is important to understand the asics of fiscal foundation. Talking about tax rates is good, but clearly revenue from taxes and user tariffs is a function of policies and rates on the one hand, and mundane but important variable, execution efficiency on the other. Likewise, benefit cost ratio of public expenditure is a function of design of a program and efficiency of execution. There is massive empirical evidence that suggests simple tax system and efficient execution have helped natural growth of revenue world over. The finance minister can adopt a structured and focused approach and act with courage to break unholy nexus between bureaucrats, middlemen and politicians.

About the author: This article has been contributed by public finance expert Narendra Jhaveri.