Interim Budget 2024-25: Higher tax-to-GDP ratio needed

The interim Budget by its very nature represents a stopgap Budget, important for the policy direction it sets. Some interim Budgets have been guilty of tax largesse but, refreshingly, this Budget has refrained from any changes in the tax rates, both on the direct and indirect tax side.
 

An important signal that has emerged is that the government will be conservative in its expenditures. 
 

The Finance Minister clearly mentioned that the government will rely less on market borrowings and, thereby, facilitate more credit availability for the private sector from the banking system.
 

The economic assessment of various experts has been that while growth has rebounded after the pandemic, the worrying spots are high levels of unemployment, especially among the young, and lagging private investments. The government has had to compensate for inadequate private investment by increasing its own investment, which has gone into hard infrastructure — namely, roads, railways and power. 
 

The government has committed that it would stick to the promised levels of fiscal deficit of 4.5 per cent of gross domestic product (GDP) by 2025-26. For this year, the fiscal deficit has been estimated at 5.8 per cent (as against the projected 5.9 per cent) and for the next year, 2024-25, at 5.1 per cent. While fiscal rectitude is laudable, the real challenge before the government is to maintain the high level of investments. This critically requires the tax-to-GDP ratio to move to at least 20 per cent in the medium term, compared to the present level of 17 to 18 per cent, which has been stagnant for the last two decades. 

This increase in the tax-to-GDP ratio would require goods and services tax (GST) contributions to move from 6.4 per cent of GDP now to at least 7.5 per cent of GDP, which, in turn, would require the average incidence of GST duty to increase from the present 11.8 per cent to 14.8 per cent that was prevalent in the pre-GST period (representing the revenue neutral rate). This correction would require a rate rationalisation — perhaps an increase in the merit rate of 5 per cent and the peak rate of 28 per cent, along with the phasing out of GST exemptions.

In addition to this, the manufacturing base has to increase as GST collections depend on value addition in manufacturing, which contributes to 65 per cent of the GST collected. The services sector’s contribution is only 35 per cent, despite its preponderant share in the total GDP. This is because the services sector in India largely covers low-value-adding units in the informal sector. The government has realised the importance of GST rate rationalisation and has constituted

 a Committee under the Finance Minister of Uttar Pradesh, which will hopefully make its recommendations to the new government. 
 

The government has identified new sunrise sectors such as  electric vehicles, renewable energy and network electronics, which can contribute to a manufacturing renaissance that can also boost GST collections in the future. The elephant in the room continues to be the high levels of unemployment. Here, perhaps, the government has lost an opportunity to lower the cost for labour-intensive sectors such as apparel, leather and food processing by bringing down the Custom duties on critical raw materials and components going into these sectors. 
 

In the case of network electronics, the government has already reduced the import duties on components going into making mobile phones. The same could have been done in the case of other labour-intensive manufacturing industries. The importance of this can hardly be minimised, considering that the import intensity of manufacturing 

is about 0.30. 
 

It is important that GST, which is a transformational tax reform, needs to be studied intensively. There are conflicting conclusions emerging about how GST revenues have performed compared to the pre-GST period. 
 

A recent study by former chief economic advisor Arvind Subramanian showed that GST revenues crossed the pre-GST levels of 6.1 per cent of GDP only in 2022-2023, reaching a level of 6.3 per cent. This result in no way dilutes the robust design of GST, as this has been achieved despite the pandemic years and a reduction in the revenue neutral rate from 14.8 per cent pre-GST to 11.8 per cent now. Evidence-based studies must be conducted to examine the transformational impact of the introduction of GST on the economy. This would require data from the Goods and Services Tax Network to be shared widely with research organisations. Issues of interest in the study could be: (a) relative buoyancy of revenues between the pre-GST and post-GST period after adjusting for integrated GST refunds on imported inputs; (b) widening of the internal market due to abolition of interstate barriers, (c) objective of fiscal equity — have poorer states gained more? 
 

In conclusion, the interim Budget has refreshingly sent a strong signal that India is moving along the path of fiscal consolidation through a combination of productive investment on the expenditure side and better compliance and the expansion of the tax base on the revenue side.

The writer is a former member of Central Board of Indirect Taxes and Customs (CBIC). The views are personal