Revenue reforms should be the priority: M Govinda Rao

Q&A

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M Govinda Rao took over as Director, National Institute of Public Finance and Policy, on January 1, 2003. An expert on service taxation, Rao's research interests include public finance, taxation, Centre-state financial relations, developmental issues and poverty, sales tax reforms, regional disparities and poverty reduction.

Rao is candid about what can be expected from a coalition government. "One cannot expect aggressive reforms under such circumstances. But the pace of reforms may not be a major shortcoming for the economy to grow," he told Business Standard

in an interview. Excerpts:

Do you predict a slowdown in second-generation reforms?

We are not new to coalition politics. We have had more than five years of experience in coalition politics. The government was able to put together a reform programme, although not too aggressive.

Unlike the 1950s, 1960s, 1970s and 1980s, when the government's own role was important in determining the quantity of production and the prices. The government is gradually withdrawing from various functions of administrative control and quota fixation.

It will be important for the new government to maintain the momentum on infrastructure development, primarily in roads, railways, ports and power. Infrastructure is not very contentious.

Everyone agrees on augmentation of infrastructure. Labour reform is a serious issue. It will proceed at a slow pace. The other contentious issue is disinvestment, which has picked up. But it may not be as fast or as clear as it has been till now.

India's economic decision-making and reform process is slow, unlike China. But China does not believe in dialogue and consensus. This is the cost that we have to pay for our freedom.

But the pace of reforms may not be a major shortcoming for the economy to grow. Having said that, any reform that a new government plans has to be done quickly.

How do you assess the current economic scenario? What will the new government inherit?

The combined fiscal deficit of the Centre and states, at 10 per cent of the gross domestic product (GDP), may not destabilise the economy but it has a very heavy growth cost. Household savings are being used for public consumption and not for investment.

So, we are increasingly depending on foreign investment. Thus, there is potential for the fiscal deficit to spill over to the balance of payments.

Interest rates have started gaining ground following the US Fed's upward revision. This will have a ripple effect everywhere. We may be unable to keep interest rates low for long. The foreign investment that poured in over the past few years, may not come forever.

You can already see it in the stock markets. The foreign institutional investors (FIIs) are not coming. Real investment has to come from private companies in the real sector.

So, fiscal reforms should be top priority for the new government?

Fiscal reform, that too on the revenue side, needs to be high on the agenda. If you look at the fiscal story over the last decade, the revenue-GDP ratio has been static at state level.

At the Centre, it has dropped by two percentage points. Customs has seen a decline of two percentage points, excise a drop of one percentage point and direct taxes (corporate and personal income tax) have witnessed an increase of one percentage point.

What I am trying to say is that the tax/GDP ratio, which is less than 13.5 to 14 per cent now, is abysmal. It is extremely low. Just a decade ago, in 1992-93, it was about 16 per cent.

How do you address the issue of revenue augmentation given the prospects of a fragile government where no finance minister will have the courage to touch tax exemptions?

One of the ways is to push through administrative reform. It may not be very popular and may be rather tough. But it has to be deepened further. Reform in service taxation is another important issue. The committee's report on service taxation, which I headed, is already there with the government.

In the first stage, the committee had recommended a particular sequencing of extending the tax to all services except a few on the negative list.

In the next stage, a merger of service tax with taxes on goods was recommended. When you do this, the service tax rate will go up and the 16 per cent Cenvat will come down. The two will merge at about 13.5 per cent. Then you start giving input tax credit for both goods and service.

If the government does this, my own estimate is that the tax as a percentage of GDP will increase by about three-fourth or one percentage point, which will be a great relief.

Is labour reform crucial for pushing growth and attracting foreign investment? Politically sensitive and successive governments have only paid lip service to reform in this area.

Yes and no. Yes, because any new foreign investor is risk-averse and wants the comfort of taking labour-related decisions freely. And no, because nobody has found it a stumbling block. There are always ingenious ways to get around the hurdles.

Labour reform needs to be addressed in a reasonable manner. Social security, too, requires money and any government will have to find a face-saving formula.

A GDP growth of 8 to 10 per cent figures high on the agenda of both the BJP and the Congress. Do you think such high growth is contingent on the pace of reforms?

It is definitely contingent on the pace of reforms. All said and done, how can growth accelerate? Either through large-scale investment leading to an increase in the capital-output ratio or through massive improvement in productivity leading to a reduction in the capital-output ratio.

And how do you accelerate investment? You need to have low interest rates and a reasonable investment climate including liberal labour laws.

Here, we have a scenario with 10 to 12 per cent of the household savings being taken away for public consumption. There are hardly any savings left for investment. Increasingly, you have to depend on foreign investment.

For productivity change, you need reforms, besides new technology and application of information technology, on a large scale in the industry.

The major problem is that our financial sector is still inefficient. If you have to get dollars, it takes not less than 15 to 20 days. Repatriation still takes a long time. A whole lot of reforms in the financial sector still remain. We need to liberalise on the capital account convertibility front, which implies that fiscal reforms are a must.

Do you think any coalition government will be able to touch exemptions, which reports by various committees have said lead to a huge loss in revenues?

There is something called reform by stealth. The government should not make much noise. A 17 to 18 per cent increase in revenues in 2003-04 did not require any earth-shaking measures. Administrative reforms and computerisation can bring significant revenue.

We must focus on getting information from the banking system, plugging loopholes, computerising the IT infrastructure and strengthening enforcement.

There are practical issues in tax reform. It's no point inviting trouble because then even the reforms that can be pushed through can be hijacked.