BackAt what cost fiscal prudence?
Rising share of indirect levies in total collections points to a regressive tax regime
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One achievement for which the government can rightly and fully take credit after a year in power is lowering the fiscal deficit. Numbers for the just-ended fiscal year show that the fiscal deficit is at 4% of the gross domestic product (GDP), beating the target finance minister Arun Jaitley had set in February. However, this achievement is by no means unique and the way it has been brought about is questionable.
First, as data shows, the actual fiscal deficit coming in lower than budget estimates is not a one-off occurrence. Mint has constructed an index of fiscal prudence to map this phenomenon since economic reforms started. The index uses the difference between budget estimates and actual fiscal deficit figures as a percentage of the former. The chart below shows this index as a five-year moving average. It is clear that while fiscal prudence has indeed increased, it was a process that was started in the latter years of the previous UPA government.
Second, this phase of fiscal prudence has come at a cost and we are not talking about just a reduction in capital, or plan expenditure. As the chart below shows, India’s tax regime is becoming regressive. In other words, the share of indirect taxes in total tax revenues is rising. Indirect taxes, such as excise and customs duty, do not differentiate between the rich and the poor as everybody pays the same amount. Direct taxes such as income and corporation tax are considered progressive since they are designed to tax the rich more. During the pre-reform phase, India’s tax regime was considered regressive. This trend reversed itself in the 1990s, and the inflexion point came in 2006-07, when direct taxes gained the larger share in total tax collection. Since 2009-10, however, this trend has reversed once again.
Governments generally harp on increasing growth rates to collect more taxes. But tax collections also depend on the government’s ability to garner more taxes at any given level of income. This is measured by the tax-to-GDP ratio. World Bank data shows that this ratio reversed its increasing trend in the first half of the previous decade to first stagnate and then follow a declining trajectory in India.
Unless there is a revival in India’s tax-GDP ratio, maintaining fiscal deficit targets would necessarily entail a squeeze in government spending. Typically, it is investment and social services expenditure that are the most susceptible to such cuts, which does not bode well for the country’s physical and human resources. With tax reforms such as introduction of goods and services tax and restructuring of corporate tax still to come through, the final verdict on the present government’s fiscal management ability has to be kept on hold.
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