Don't be minimalist

The finance minister and his team are now engaged in formulating the Union Budget for 2007-08. This will be the UPA's government's fourth Budget, and the last one in which it can hope to undertake serious fiscal reform. Next year's Budget will be heavily coloured by pre-election concerns and much of the action will be focused at that time on revenue giveaways and expenditure commitments. If fiscal reform is to be pushed forward by the UPA government, it has to be done now. The temptation could be to take the easy route by saying that if things are going well for the economy, it is best to do as little as possible. This may do little harm, but it will be an opportunity lost. In any case, there is much on the agenda that cries out for action.

If fiscal policy is to be counter-cyclical, as the text-books argue, then the government should rein in its borrowing programme when there is independent momentum in the economy (and this automatically creates the elbow room for pump-priming the system if and when it goes into a slowdown). The finance minister has the opportunity to do this just now because revenue collections this year have been unusually good, and well above Budget estimates. In other words, Mr Chidambaram should aim to show more fiscal correction than he promised in February 2006; indeed, it may even be possible for him to shoot for the original target of bringing down the fiscal deficit to 3 per cent of GDP in 2007-08 (instead of the revised target of 2008-09).

There are other reasons why this should be the chosen course of action. India's public debt to GDP ratio is high, and if interest rates continue to climb, it will raise interest outflow next year. It is also likely that some kind of Pay Commission award will be announced in 2008-09, before the general elections due in May 2009. That too will be a significant drain on the exchequer. If the fiscal deficit targets are not to be dumped at that point, it is as well to create some cushion now, when the times are good""which is the logic of counter-cyclicality.

It must be presumed that the minister will announce a further drop in the peak tariff, from 12 per cent to 10 per cent. He also needs to address the very high tariffs that continue to prevail above that peak, for products like cars and liquor. And the ministry needs to resist pressures from all sides for special treatment for one industry or the other. Any number of arguments for such special treatment can be made in any year, but the logic of consistency and movement to an integrated goods and service tax (GST) argue strongly against any differential treatment. Besides, if a GST is to be introduced by 2010, as has been officially announced, measurable progress has to be demonstrated now. To some extent this is dependent on state governments doing their bit, but there is no visible evidence of the Centre pushing the process along.

The finance minister has been rightly concerned about erosion of the tax base because of geographical exemptions and programmes like the one for special economic zones. He is right to articulate these, and perhaps he should seek to impose sunset clauses for all tax holidays and exemptions.