Pressure to convert pep talk into real action is prompting more quick-fixes. This time it is the fiscal deficit, the indicator that most interests rating agencies. True action here means sticking to the revised deficit target of 5.3% of gross domestic product (GDP). But these are hard times. Revenue has declined with falling growth while politics precludes discretionary spending cuts. What then is a better way to consolidate than raise taxes?
Quick and foolproof, this may politically be the least costly too, given India’s narrow tax base. As the figure shows, the central government’s tax-GDP ratio has never breached an average 9.8% of GDP mark this millennium, against its long-term average of 9.5%; a spurt from 2002 due to introduction of value-added tax (VAT), a wider services tax net and higher growth notwithstanding. The snapshot profile shows that revenue increases from these developments just financed ever-rising subsidies, which reached 2.4% of GDP last year. Conversely, capital expenditure that is desperately needed to finance infrastructure and boost growth has fallen consistently — below 2% of GDP last year; it has seen better days — in the mid-1980s, about 7% of GDP financed public investments.
Structural reforms to widen the tax base and reorganize public finances — the root of India’s macroeconomic problems — have long been delayed. The country’s tax structure might be more revenue-efficient if policymakers were less wedded to tax preferences, for example. Revenue foregone, according to the government’s own calculations, was a hefty 6% of GDP in 2010-11 and 2011-12. The complex tax system is riddled with room for deductions and loopholes, which a reform like the Direct Taxes Code (DTC) would address by raising tax efficiency and equity besides lowering income tax rates. This is now on the back-burner, along with another seminal reform proposal, viz. the Goods and Services Tax (GST), held up for lack of political agreement, among other reasons. The GST aims to harmonize the indirect tax structure across India to create a common market, a change widely expected to deliver a huge stimulus to revenue and growth: foregone revenues from excise and customs duty exemptions are an astonishing 5% of GDP, by way of example.
Raising tax rates will enable a quick hop over the fiscal river. But it shifts the adjustment burden onto a population already stressed from low growth and high inflation. Bridge-building will take longer but will deliver far better outcomes: higher revenue to release much-needed fiscal space for reorganizing the spending mix, especially where public investment levels are concerned.
Renu Kohli is a New Delhi-based macroeconomist; she is currently Lead Economist, DEA-ICRIER G20 Research Programme and a former staff member of the International Monetary Fund and Reserve Bank of India.