Cut subsidies for non-poor
Return to trade liberalisation. Widen tax base to spend more. Initiate land and labour reforms.
With fiscal year 2014-15 already underway and the interim budget in place, the room for major tax-expenditure adjustments in the first year is limited. Therefore, the new government's focus should be on modest tweaking of the budget, laying out the road map of future fiscal actions and making as much progress towards them as possible.
On the tax front, the revised Budget must focus on completing the Goods and Services Tax (GST) reform by March 31, 2016, and begin action by clearing all central sales tax dues of the states and winning their confidence. The revised Budget should also commit the government to implementing a new Direct Taxes Code (DTC) beginning with the next fiscal year and spend the current year reworking the existing draft and developing consensus on it.
The Budget must reassure investors that the government will not introduce measures such as retrospective taxation that would render investments that were profitable when undertaken turn unprofitable now. Symmetrically, it should warn people that tax evasion will not be tolerated and ensure enforcement will be tightened and speeded up. In terms of immediate reform actions, as a trade economist, I would like the government to return to trade liberalisation, which has remained in hibernation at least since 2007-08. We could begin by reducing the top industrial tariff rate from 10 per cent to 7 per cent.
On the expenditure front, an effort must be made to increase capital expenditures to 2 per cent of the GDP from 1.76 per cent in the interim budget.
The Budget must also commit to time-bound decisions on presidential permissions by the states for amendments of central laws on subjects under the Concurrent List of the Constitution. This would help kick off the process of reforms in areas of land, labour and social legislation in the first year itself.
Control fiscal deficit
Over its five-year term, the government must accomplish significant fiscal consolidation. It must ensure that fiscal deficit in the central Budget remains below 4.5 per cent each year. With growth accelerating, this would help bring the debt-toGDP ratio down.
On the tax side, with the GST and DTC in place, the main issue will be to work towards raising the tax-toGDP ratio, which remains low in India. This would require both broadening the tax base and improving tax administration through creative use of information technology. For instance, non-taxation of all agricultural income contributes to the narrowing of tax base as well as tax evasion.
Efforts must be made to bring at least urban agricultural income into the tax base. Likewise, the base of indirect taxes must be broadened. The tax departments will need to exploit the benefits of informationsharing fully. There needs to be exchange of information between the central and state tax departments and between the Central Board of Direct Taxes and Central Board of Excise and Customs.
On the expenditure side, the government will need to continue shifting towards capital expenditures, raising their share in the GDP minimally to 4 per cent by the fifth year, the level prevailing in 2003-04.
This is going to be essential to ensure that enough revenues are available to eliminate infrastructure deficit, including bringing electricity to a significantly larger proportion of the population. The government will also need to raise health expenditure from the current level of 1.3 per cent of the GDP to 2.5 per cent or more by the fifth year. This will be essential for bringing piped water, proper sanitation and improved public health services to a significantly larger population.
If the objective of fiscal consolidation is to be met simultaneously with these increases in expenditures, the measures to raise the tax-to-GDP ratio will not suffice. The government will also have to cut subsidies. India has many subsidies-on petrol, diesel, kerosene, cooking gas, fertilisers, electricity and water-that undermine efficiency while predominantly benefiting non-poor sections of the society.
Don't waste money
The phase-out of subsidies on petrol and diesel is already underway and should be carried to its logical conclusion. Fertiliser subsidy, which has contributed to the overuse of fertilisers and damaged soil and the environment, must also be phased out. The Atal Bihari Vajpayee government had begun this process but the UPA government reversed it.
Subsidies on both electricity and water have led to wastage of water, especially in agriculture. The subsidies must be ended and drip irrigation and related water-saving irrigation technologies encouraged. It is unlikely, however, that even these measures would suffice to achieve fiscal consolidation while meeting the need for increased expenditure on social sectors and infrastructure.
Therefore, the government will need to return to disinvestment on a larger scale. This too is an efficiency enhancing step and the government must consider outright privatisation of some of the public sector units that have no prospects of being revived.
The distinction between plan and non-plan expenditure must be ended with the bulk of the transfers to the states from the central Budget provided in the form of grants. Assistance under centrally sponsored schemes must be reformed to give states greater flexibility. This can be accomplished by grouping the plethora of schemes- currently 66 in number- under broad heads such as agriculture, health, education and infrastructure and giving states freedom to shift spending across schemes within each group. The eventual goal should be to replace the schemes by block grants with the Central government setting performance standards and monitoring progress.
This fiscal reform agenda may seem ambitious but it is surely not beyond a determined government. Indeed, the P.V. Narasimha Rao and Vajpayee governments had done no less. Moreover, with higher per capita income and savings rate today, there is greater feasibility of progress in this direction. India can ill-afford to miss the opportunity to become a nation that counts yet again.
Arvind Panagariya is an economist and Columbia University professor. Govinda Rao and Joydeep Mukherji made invaluable suggestions.