Tightrope walk for the finance minister

The finance minister faces a formidable challenge of providing additional fiscal stimulus while containing the fiscal deficit. The interim budget estimates the fiscal deficit of the Centre at 5.5 per cent of the GDP, but the tax cuts announced after the Budget and proper provisioning for the various schemes would increase the deficit to about 6.5 per cent of GDP.

With the states' deficit exceeding 3 per cent of GDP as they undertake pay revision, the consolidated fiscal deficit in 2009-10 (excluding off-Budget liabilities) could remain at the same level as in 2008-09, at about 9.5 per cent of the GDP, which is worrisome.

Given the continued recessionary climate in OECD countries and the negative growth of the manufacturing sector in the last quarter of 2008-09, the Budget will have to make additional allocation to infrastructure sectors and flagship schemes. Thus, even if the fiscal deficit is pegged at 6.5 per cent of the GDP, the Budget will have to focus on raising additional resources.

There is a lot of expectation that reforms will be initiated on several fronts to give a clear signal to the market. Surely, there will be revival of the 3G spectrum auction plan and fast pacing of the divestment programme.

Even if the government decides to retain strategic control of the Navaratnas, there are a number of profit-making enterprises with more than 85 per cent holdings. Properly implemented, the government can generate an additional 2 per cent of the GDP from these measures.

Other important revenue measures include strengthening and deepening of TIN in the case of direct taxes. On indirect taxes, one reason for the low revenue productivity is the poor information system which will become a binding constraint for GST.

The NIC does not have the capacity to create the system required for GST and the government should entrust the task to a competent information technology company.

On expenditures, reforming the fertiliser subsidy regime should be a priority. The prevailing low feedstock prices provide an opportunity to clean up the subsidy regime.

Even if 200 kg of a balanced mix of fertilisers is given to all the farmers at a subsidised rate to protect the interest of small farmers and the balance is decontrolled, the subsidy bill can be substantially reduced in the coming years. Besides reducing the budgetary burden, it will promote balanced use of fertilisers and encourage investment and technology upgradation in the fertiliser sector.

Similarly, the low price of crude oil and distillates provides an opportunity for the government to dismantle the administered price regime in the petroleum sector.

On the tax reform front, the government can attempt to simplify and rationalise the tax system and this in itself can be a stimulus. Perhaps, the time is opportune for abolishing the fringe benefits tax and securities transaction tax.

The government may also clean up the tax structure by abolishing various cesses so that the tax system is made simple and transparent.

What should the government do to move over to GST in this Budget? Unfortunately, the preparatory work for switching over to full-fledged GST has not been done yet and switching over by April, 2010 does not look likely.

The constitutional changes to empower the central government to levy consumption tax beyond the manufacturing stage and enabling the states to levy the service taxes are yet to be initiated. Also, as the states are supposed to get concurrent powers to levy the service tax, the rules of revenue appropriation should be negotiated and settled for all-India services.

Above all, the information system to administer the state GST, particularly on interstate transactions, will have to be put in place. The central government and the empowered committee should speed up the process to set a clear schedule.

At the central level, however, the Budget may advance the process by taking steps to switch over to the GST at the manufacturing stage.

In 2001-02, the expert group on service tax had recommended that the service tax should be extended to all services excluding a small exempted and negative list. Converting the selective taxation into a general taxation will not only expand the tax base, it will also obviate the need to define each service and avoid scope for litigation. In addition, it will also help to generalise input tax credit for all goods and services.

On the excise duty front, it is necessary to unify the tax rates. In fact, it is easy to move towards a single tax rate for all commodities excluding sumptuary items.

In the next stage, the central government may switch over to GST at the manufacturing stage by unifying the two taxes by having a common threshold and a uniform tax rate.

The government may keep the threshold at Rs 1 crore (Rs 10 million) which is higher that the prevailing threshold for service tax but lower than that of union excise duties. This helps to expand the tax base and to begin with, levying the tax at 7 per cent could be revenue-neutral.

In respect of items such as cigarettes and petroleum products, a separate excise may be levied in addition to the GST.

Although this Budget may not attempt at fiscal consolidation -- for the final blueprint will have to wait for the recommendation of the thirteenth finance commission -- it is important to reflect on it.

The experience of implementing the FRBMA shows that static targets are inappropriate to deal with cyclical changes. Similarly, it may be more appropriate to fix deficit targets as a ratio of expenditure rather than GDP for, firm estimates of the latter take longer. The fiscal responsibility legislation should be followed by a rolling medium-term fiscal framework to specify adjustment targets for both revenues and expenditures.

It is important to note that fiscal discipline is not the function of the finance ministry alone. This would entail the preparation of rolling medium-term expenditure plans by each of the spending departments based on the indicative ceiling of expenditures communicated by the finance ministry. Thus, MTFF as well as MTEP should be initiated as a part of the fiscal responsibility legislation and updated every year.

There is a lot of expectation that the forthcoming Budget will give the right direction and thrust in containing the deficits while continuing to create conditions for accelerating investment and growth in the economy. Hopefully, the finance minister, with his vast knowledge and experience, will present a Budget which will fulfil this promise.