Now that the Assembly elections in five states are over, with what can only be called a defeat for the Congress, the pressure is on Finance Minister Pranab Mukherjee to help the United Progressive Alliance, in its second term, (UPA-II) out of the hole it’s in. Mr Mukherjee’s job is unenviable: the government has been stuck in policy paralysis for months; political obstructionism among its allies and the Opposition have held up basic reform; and the fiscal space has shrunk. Yet there is a certain minimum of reform that is both politically feasible and economically sensible. If this minimum is accomplished in the next Budget, Mr Mukherjee will have averted disaster.
Most importantly, the Budget must show a credible commitment to halting the explosive growth of the subsidy bill. Subsidies are an unsustainable 2.5 per cent of GDP now, and are likely to exceed budgeted estimates by Rs 90,000 crore. Almost half of the bill is due to fuel and fertiliser subsidies, both of which are pushed up by high global oil prices. Those oil prices are not coming down any time soon. UPA-II has committed itself to a food security Bill which is expected to further increase expenditure, even though the cash drawer is pretty bare already. Meanwhile, the administered price of food has not changed since 2002. In order to restore faith that India will, at some point in the future, return to a path of fiscal prudence, some tough reform will be necessary. In particular, a clear road map on how and when the entitlement regime will be fixed – ideally through an accelerated use of Unique ID-enabled transfers – has moved from being a theoretical possibility to a practical necessity. Credible structural change in the subsidy regime on those lines is essential. If necessary, a legislated cap on subsidies as a proportion of GDP should be proposed and passed. Unless there is movement on this front, this Budget could justifiably be declared a failure, politically and economically.
There are, in addition, three basic steps that should be taken on the expenditure side as a bare minimum. The first is a rollback of the cuts in indirect taxes that were made as a stimulus in the post-financial crisis period. The model central value-added tax, or Cenvat, before the Budget of 2008-09 was 16 per cent. It is now 10 per cent. It should be moved up by at least two per cent. In addition, the goods and services tax, or GST, cannot be anticipated forever by this government. If the states are unwilling to move forward quickly, the Centre should at least mandate a negative list of services, thereby expanding the service tax net. Finally, the last few Budgets inaugurated something of an exemption raj. That trend must be reversed by expanding the base of direct taxes. The minimum alternative tax, or MAT, stands at 18.5 per cent, although the effective rate of corporate income tax is 23 per cent. In his last Budget, Mr Mukherjee raised MAT by half a percentage point. By raising this rate further, he could reduce the gap between MAT and the effective tax rate, increase the direct tax mop-up and make the system more rational. If Mr Mukherjee’s Budget can manage these four things, it will have achieved the bare minimum necessary.