The Budget was placed in the midst of an unprecedented economic downturn. There are at least three reasons why the present phase of the Indian economy stands in contrast to previous episodes of economic downturn.
The first pertains to the magnitude of the economic shock, the intensity of which surpasses all previous episodes of recession in the post-Independence India. The projected -7.7 per cent gross domestic product (GDP) growth rate in 2020-21 makes this magnitude of contraction the worst in the last seven decades. As compared to its peers in G20 countries, the average rate of growth of industrial output between March-October 2020 was much lower in India.
The second reason relates to the timing of the present crisis. The COVID-19 pandemic gripped the Indian economy when it was already going through the most prolonged slowdown in the post-liberalisation period. While expectations regarding investment decisions were already weak, the pandemic struck a further blow to corporate expectations, with adverse implications for the rate of private corporate investment.
The third reason, which makes the present crisis distinct from any other previous episode of downturn, relates to the drastic change in income distribution in Indian society, strikingly against the bottom deciles of income classes and in favour of those at the top rung of the wealth ladder. The sharp reduction in the output growth rate during the pandemic has been associated with a rise in precarious employment, with the bottom deciles registering lower income growth rate as compared to the top deciles. In contrast, as noted in the recent Reserve Bank of India (RBI) bulletin, the profits of the non-financial corporate sector registered a sharp increase. Despite a reduction in sales and output, the phenomenon of higher profits in the corporate sector was on account of a more-than-proportionate fall in their expenditure, of which labour costs are a constituent.
In the backdrop of the specificity of the present crisis, there were at least two challenges which the Budget was expected to address. The first was to initiate a recovery process in terms of GDP growth rates, which has otherwise registered a steady decline since the fourth quarter of 2017-18. The second challenge was to provide adequate fiscal support to the bottom deciles, who have registered a sharp squeeze in their income, particularly since the pandemic.
The Budget simply ignores the existence of the second challenge, while relying primarily on the spontaneous adjustment mechanisms of the economy in order to address the first. Ignoring the first challenge unambiguously jeopardises the livelihood of those in the bottom deciles, whereas policies undertaken on the assumptions of automatic adjustment mechanisms make the prospects for a sustained recovery look grim.
The distinguishing feature of the macroeconomic framework of the Union Budget was that it chose to pursue a conservative fiscal policy in the midst of the crisis. Indicating lower borrowing targets for 2021-22, the Budget estimate of primary deficit-GDP ratio is set to fall in 2021-22 to 3.1 per cent from 5.9 per cent in 2020-21. This is in accordance with government’s objective of fiscal consolidation, which was also reflected by sharp reduction in the targeted fiscal deficit ratio in 2021-22 to 6.8 per cent from 9.5 per cent in 2020-21.
Of course, a reduced deficit can be attained either by increasing receipts or by reducing expenditure. But the reduced deficit targets are set to be achieved in the present Budget by keeping the revenue receipts more or less at the existing level. For both 2020-21 and 2021-22 Budget estimates, the share of revenue receipts in GDP remained at around 8 per cent. One of the primary reasons why the targeted collection of revenue receipts as proportion to GDP is kept at a similar level as the pandemic year, is because of the continuation of the policy of providing corporate tax concessions.
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The corporation tax-GDP ratio, which registered more or less a steady decline throughout the last decade, barring a few years in the interim, fell sharply in 2019-20 and nosedived during the pandemic year 2020-21 (See Figure 1). What the Budget estimate for corporation tax in 2021-22 indicates is the government’s policy of continuing with the low corporate tax regime.
The largest corporate houses have been the beneficiaries of such tax cuts in the recent period. The firms are categorised into different percentiles depending on their asset sizes. The bars describe the difference in corporation tax-income ratios between 2020 and 2019. What the figure shows is that sharpest reduction in corporation tax-income ratio has been registered by the largest corporate houses. Although the tax concessions have failed to spark off higher corporate investments—the purported objective of the tax cuts—the government’s own balance sheet has taken a hit because of the lower receipts. Needless to say, these have limited its ability to finance necessary and additional expenditures in the time of a pandemic.
Despite the government’s attempt to raise receipts through the disinvestment channel, and its increasing reliance on indirect taxes for generating revenues, the Budget’s estimate of receipts (sum of revenue receipts and non-debt capital receipts) appears to be inadequate. With the reduced deficit targets and more or less unchanged non-debt receipts, it is the primary expenditure which has had to bear the main burden of adjustment to accommodate the policy of fiscal consolidation.
This is illustrated in Figure 2, which shows different components of the primary deficit-GDP ratio for 2020-21 and 2021-22. While primary expenditure is equal to the sum of primary deficit and receipts, primary expenditures can be further divided into capital and non-capital primary expenditures. With the reduced deficit targets for the Budget estimate and inadequate rise in receipts, Figure 2 shows the sharp fall in the Budget estimate of primary expenditure as compared to the present level.
While the Budget estimates of capital expenditure remain more or less unchanged, the reduction in primary expenditure is owing to the fall in the allocation for non-capital primary expenditure. Such expenditure typically includes spending on employment guarantee schemes and constitute the bulk of social sector expenditures.
Figure 3 shows some of the major components of primary expenditures, the allocation of which was reduced for the present financial year. While a part of food subsidy expenditures incurred in 2020-21 has been included explicitly in the amount—which were earlier moved off-Budget—it needs to be stressed that the allocation of food subsidy has been drastically reduced in 2021-22. Other expenditures which registered lower allocation were rural development, agriculture and allied activities, fertilizer subsidy and health. That this is happening in a situation in which the economy as well as society is still coping with the effects of the pandemic, emphasises the priorities of the government.
Other things remaining unchanged, such a reduction in primary expenditure along with a fiscal contraction indicates a withdrawal of fiscal support in the midst of the present crisis. Obviously, this would adversely affect the income of the bottom deciles. Moreover, the withdrawal of fiscal support restricts the scope for a sustained recovery of constraining aggregate demand in the economy. The specific fiscal strategy adopted in the midst of the present crisis raises the question: what is the binding constraint for raising government expenditure? And what are the preconditions for adopting an alternative fiscal strategy that adequately addresses the two challenges facing the Indian economy?
Constraints and alternatives
One of the central concerns posed against increasing government expenditure in the recent period pertains to the issue of debt-sustainability. There are two distinct ways in which the issue of debt sustainability is perceived. The first approach targets the debt-GDP ratio on the premise that high levels of debt reduce the creditor’s faith on the government’s ability to repay loans. In this reading of a solution, the question of solvency is paramount. The key flaw in this approach is that it regards the government like an individual or a household, abjuring any role for the government through the implementation of policies that are financed via its own expenditures.
In the second approach, debt-sustainability is defined as stabilisation of debt-GDP ratio over time. However, even if the objective of ensuring a stable debt-GDP ratio is perceived as a policy target, government expenditure in India can be increased to the required level without jeopardising the debt stability condition. The mechanism through which it can be achieved is the following:
Since higher expenditure at the level of given receipts would positively affect both debt and output, the impact of higher expenditures on debt-GDP ratio would depend on the relative strength of these two forces. More precisely, the impact of higher government expenditures on debt-GDP ratio depends on the composition and multiplier value of expenditures. At high multiplier values, higher expenditures can be associated with unchanged or even lower debt-GDP ratio, more bang for the buck, if you will.
Using the RBI’s estimated expenditure multipliers, an Azim Premji University working paper by this author showed that that any targeted level of non-capital primary expenditure can be financed while keeping the debt-GDP ratio unchanged, if the capital and non-capital primary expenditures are increased in a specific proportion. By implication, the objectives of attaining higher output growth rate and providing additional fiscal support can be achieved by simultaneously increasing capital and non-capital primary expenditures in a specific proportion. Since expenditures are perceived to be increased at a given level of receipts, such fiscal strategy would be characterised by higher primary and fiscal deficits.
Instead of debt-sustainability, however, the level of expenditures has been constrained by the obsession of reducing deficits; this has been compounded by the inability or the unwillingness to increase the direct tax-GDP ratio. The objective of fiscal consolidation has been typically based on the consideration of prolonging stock market booms by maintaining “investor confidence”. Although such a stock market boom, as witnessed in the recent period, has hardly been associated with the recovery of the real economy, it has nonetheless led to higher incomes for the rentier class, including foreign and domestic institutional investors. Justified on similar grounds—of maintaining investor interest and confidence—the corporate tax concessions have imposed constraints on the ability to increase the direct tax-ratio.
Since raising indirect taxes beyond a threshold value may be constrained by political considerations, India’s fiscal policy has been de facto associated with an impossible trilemma in the recent period. The impossible trilemma would imply that the government had to drop at least any one of the following objectives: providing additional fiscal support, pursuing fiscal conservatism and continuing with the low corporate tax regime. In what constituted a political choice, the Budget resolved this trilemma by dropping the objective of providing fiscal support and stimulus.
In contrast, the objective of higher government expenditures can be attained either by increasing deficits or increasing the corporation tax-GDP ratio. To illustrate, if the ratio is increased to a level it attained during 2011-12, an additional expenditure of Rs.3.7 lakh crore could be financed at the given level of deficit and debt-ratios without any adverse outcome. Similarly, any additional non-capital primary expenditures can be financed at a given corporation tax rate if capital expenditures are increased in a specific proportion and the deficit ratios are allowed to increase in accordance.
However, meeting the dual objective of initiating an effective recovery process and providing fiscal support may itself require imposing capital controls, going beyond the rules set by international finance, and fundamentally change the macroeconomic structure that has existed in the post-liberalisation period. The policy choice between compensating the income loss of the bottom deciles and changing the existing growth regime essentially involves a political question of choosing which class ought to bear the primary burden of adjustment in the aftermath of crisis. The Budget, in that sense, reflects the choice made by the government.
Zico Dasgupta is Assistant Professor of Economics at Azim Premji University.