The price of reform

India's return to the phase of higher indirect tax revenues will impose disproportionately larger burdens on the poorer sections.

IN a Budget speech that was tiresome to the point of being boring and sought to conceal far more than it revealed, Finance Minister Pranab Mukherjee has paved the way for an acceleration of inflation. By hiking indirect taxes that would be passed on to buyers and slashing subsidies that would raise the prices of petroleum products and fertilizers, the Finance Minister has exposed a nation already reeling under the effects of a prolonged price rise to another bout of cost push inflation. In a country where, for the last two years or more, inflation has been among the most pressing economic problems, this tendency to engineer inflation is shocking, to say the least.

The magnitudes involved here are by no means small. Consider, for example, the across-the-board hike in Union excise duties on non-petroleum goods, involving a two percentage points increase in the standard rate (from 12 to 14 per cent) and a one percentage point increase in merit rates. As a result of these changes, revenues from Central excise duties are projected to rise from Rs.1,50,075 crore to Rs.1,93,729 crore or by close to 30 per cent in a single year. To augment the gains derived from these indirect taxes, the Finance Minister has decided to slash expenditures on non-food subsidies, especially those on fertilizer and petroleum products. The fertilizer subsidy bill, which stood at Rs.67,199 crore as per the revised estimates for the financial year 2011-12, is expected to fall significantly to Rs.60,974 crore in 2012-13, implying a significant increase in the price paid by the farmer for fertilizer. Simultaneously, the petroleum subsidy is projected to fall from Rs.68,481 crore in 2011-12 to Rs.43,580 crore in 2012-13. Since this is to occur at a time when global petroleum prices are on the rise and political uncertainty in West Asia and elsewhere is threatening to take oil prices to an all-time high, the large reduction in subsidies implies that the prices of petroleum products paid by the consumer will rise sharply. These are intermediates, and petroleum products are universal intermediates at that. A more generalised rise in prices that affects adversely the average citizen is, therefore, inevitable.

Squeeze on farmers' margins

The fertilizer subsidy cut also needs to be seen in the context of the claim that the Budget is coming to terms with the long-term neglect of agriculture. It promises, for example, to raise some allocations, such as to productivity-enhancing investments in agriculture in eastern India, and to enhance the flow of credit to the agricultural sector. However, the actual allocation to previously neglected sectors such as irrigation and extension services that could raise productivity remains woefully inadequate even after the projected increase. On the other hand, costs would rise because of the cut in fertilizer subsidies and the imposition of higher charges for other inputs, squeezing the margins accruing to farmers even further. This is particularly damaging because the problem in agriculture today is that the viability of crop production is under challenge, since costs are rising faster than prices received by farmers. In that context, to squeeze the net returns garnered by farmers while promising them more credit makes no sense. It could trap them in debt with consequences that experience has shown can be tragic.

The Finance Minister justifies this trend to place huge burdens on poorer citizens as the cost of his principled allegiance to reform above all else. There are, as often expressed, two components to such reform. The first is to continue with stalled liberalisation in areas varying from multi-brand retail to the financial sector. The second is to ensure fiscal contraction through a reduction in the fiscal deficit to gross domestic product (GDP) ratio. Referring to the latter as fiscal consolidation, Mukherjee explains that it calls for efforts both to raise the tax-GDP ratio and to lower the expenditure. However, reading the Budget it is clear that imposing direct taxes on the rich is not considered a way of raising the tax-to-GDP ratio, which stands at a pathetic 10.5 per cent. In fact, given the ethos of liberalisation promoted by the United Progressive Alliance (UPA), even his effort to collect taxes he thinks are rightfully due to the government is under challenge. The government has attempted to respond to the Supreme Court's verdict that the capital gains tax imposed on the beneficiaries of the Vodafone-Hutchison deal was not legally sustainable. That verdict not only implied a loss of revenues in this instance but potential losses of taxes imposed on similar deals in the past. Hence the Finance Minister has promised a retrospective clarification of government intent. To his surprise he has come under attack from sections of the media that scream at the mention of a subsidy for the poor.

Minor sops to middle class & more burden on the poor

The corporate sector is also upset that the Finance Minister has not been able to offer it much more by way of tax concession than the continuation of previously granted benefits. On the direct tax side, he has provided minor sops to the middle class by raising the exemption limit and widening the income slabs. This is combined with some concessions to other direct tax paying sections, resulting in a revenue loss of Rs.4,800 crore. He hopes this will win him middle-class support. But, he has possibly angered the new, upper middle class by increasing service tax rates and widening the service tax base to more than neutralise this loss. Overall, the reliance on means other than direct taxation implies that India is returning to a phase when indirect tax revenues constitute a rising proportion of total taxes. This amounts to imposing a disproportionately larger burden on poorer sections of the population and makes the tax regime pushed by this Budget regressive from the point of view of income distribution.

Has the Finance Minister done this in order to finance schemes that would benefit the really poor? Consider the two flagship schemes that are supposed to be directed at making growth more inclusive: the subsidised food distribution programme that is supposed to reach affordable food to the poor and the Mahatma Gandhi National Rural Employment Guarantee Programme (MGNREGP) that is geared to providing employment and putting purchasing power in the hands of the really poor.

The government has been debating and is in the process of legislating and implementing a major food security programme, which is being presented as the first of its kind in a large and poor developing country. So it is surprising that as compared to an expenditure of close to Rs.73,000 crore in 2011-12, the Budget for 2012-13 provides for just Rs.75,000 crore for covering the subsidy on food. Clearly, the government is either not planning to expand the food security programme substantially or it hopes that its new effort at targeting subsidies would help rein in expenditures and reduce real outlays. Similarly, there has been much hype about the MGNREGP under the Ministry of Rural Development. However, assistance for the scheme, which fell from Rs.35,841 crore in 2010-11 to Rs.31,000 crore in 2011-12, is budgeted to increase to only Rs.33,000 crore in 2012-13. Since this was a period of high inflation, the allocation in real terms might have declined and we would possibly see a substantial decline in allocations. The MGNREGP is increasingly all about much talk and little action.

Serving finance capital

Does this mean that the Budget is only concerned with fiscal consolidation and, therefore, does not provide benefits to any section? That is clearly not true. Consider for example finance capital, particularly foreign finance. To start with, the government has decided to slash by 20 per cent (from 0.125 per cent to 0.1 per cent) the already low tax it puts on transactions in stock markets. That tax was designed not just to obtain revenue but also to discourage speculation through repeated transactions in the market. Further, in the name of promoting investment in infrastructure the Budget proposes to reduce the rate of withholding tax on interest payments on foreign borrowings in select sectors from 20 per cent to 5 per cent for three years. Finally, to activate the sluggish stock markets, the government is encouraging middle class investors to move savings into those markets so that big investors can profit. To that end, a new Rajiv Gandhi Equity Savings Scheme is offering tax deduction to middle class investors with an annual income less than Rs.10 lakh; those investing up to Rs.50,000 in equities are eligible for an income tax deduction of 50 per cent of that amount. Middle class investors are thus being enticed into the market to serve the interests of big capital. Finally, individual foreign investors (or Qualified Foreign Investors), who recently have been permitted to invest in the stock market, can now access the Indian corporate bond market and benefit from the higher interest rates in the country.

Thus, external reform in the form of concessions to attract the foreign investor is very much a part of the Minister's conception of reform and this Budget. But this has been to an extent balanced by higher budgeted (though not necessarily realisable) allocations for sectors such as rural development, health and education. But, the additional tax revenues expected to be garnered are inadequate to fund these projected increases. So, the Budget relies on other measures, such as the continuation of the hitherto largely unsuccessful disinvestment programme. In 2011-12, as compared with a budgeted target of Rs.40,000 crore, the government garnered just Rs.14,000 crore. Ignoring the implied signal, Budget 2012-13 provides for a target of Rs.30,000 crore as receipts from disinvestment. Clearly, the Minister needs this sum to prove that after all his inflationary financing efforts he has managed to enhance expenditures to spur inclusive growth. But even after accounting for such receipts, he has to allow himself optimistic assumptions on revenue buoyancy to ensure that the numerical value of the fiscal deficit to GDP ratio does not cross acceptable boundaries.

Despite all this, the Finance Minister can hardly claim that he has done much to revive a slowing economy, and realise the projected 7.6 per cent growth of GDP in 2012-13. Total expenditure, which fell from 15.7 per cent of GDP in 2010-11 to 14.9 per cent of GDP in 2011-12, is budgeted to be marginally lower at 14.8 per cent of GDP in 2012-13. And capital expenditure, which fell from 2.1 to 1.8 per cent of GDP between 2010-11 and 2011-12, is budgeted to rise to only 2 per cent of GDP in 2012-13.

Fiscal deficit

However, the Finance Minister claims that he has paid the price for necessary fiscal consolidation. Whether such consolidation is good or not is another matter. But, in practice, despite huge revenues from spectrum sale and reined-in expenditures on many fronts, the fiscal deficit to GDP ratio in 2011-12 stood at 5.9 per cent compared with a target of 4.6 per cent set in the Budget for that year. And in 2012-13, despite the resource mobilisation planned and optimistic assumptions about revenue generation, the fiscal deficit is projected at 5.1 per cent. The Minister is not successful even in terms of his own objectives.

Of course, Mukherjee prides himself on contributing (through these measures) to the implementation of economic reform in a country which he claims sits at the same high table as policymakers from the developed countries. That position, he says, puts new responsibilities on India's shoulders. But a reading of the Budget seems to suggest that the responsibility merely lies in speaking of economic reforms, such as inviting foreign investment into multi-brand retail, giving special concessions to foreign investors, and bailing out the industrialists who ran aground some of the leading private airlines. It does not seem to involve the responsibility to improve the economic conditions of India's marginalised majority that is poor.