From Business World of 31 January 2005.
Fiscal transparency
The finance minister has completed the consultations
preceding the budget: he has heard agriculturists and industrialists,
economists and trade unionists, Congressmen and backwoodsmen. He has conferred
with his top bureaucrats. He has before him the major proposals and hundreds of
minor ones. The outlines of budget are discernible; now he only has to put his
stamp on it.
The major fiscal reforms were
completed in the 1990s, some of them by him. This year will see what might be
the last of them – the introduction of value added tax (VAT). But it is a
toss-up whether those affected will see it as a reform or a turn of the screw.
Tax authorities in this country are seen as arbitrary and corrupt; will this
perception change? Business taxpayers will have to claim rebates for the tax
paid on the inputs purchased by them; each rebate will give the excise and
sales tax authorities a chance to deny it, to harass taxpayers and ask for
bribes. The scope for oppression under VAT will be much greater than under the
present regime; the success or failure of the experiment will depend on what
safeguards the finance minister introduces against the oppression. The finance
minister should apply his formidable legal brain to them, for they will make
his reputation – or make people want to forget him.
The finance minister takes the commitments he took on
under the Fiscal ResponsibilityAct seriously; he devoted most of the ministry’s
mid-term review to his performance on it, even though it was not such as to bring
him credit. If he wants to leave behind a permanent improvement in the way the
country manages its finances, he should change the fiscal deficit targets:
instead of expressing them as percentages of GDP, he should adopt absolute
targets. The ultimate aim is to reach zero revenue or fiscal deficit; it is the
same whether it is expressed in absolute or relative terms. GDP figures are
known with a lag of a year; the ratios put out by the finance ministry are
based on advance estimates, which are approximate and can be biased. If the
finance minister lays down absolute numerical targets for the next four years,
he will have a precise limit he can use to impose absolute budgetary
constraints on each ministry. It will not only make achievement of the overall
deficit target easier, but it will also tell ministers in no uncertain terms
within what figure they have to get through the year. The finance minister may
leave a figure in the budget for contingencies and for discretionary spending
by the Prime Minister; but at least the scope for arbitrariness would then be
limited to the PMO.
Another reform that is overdue is
to replace the fiscal deficit targets by those for the total borrowings of the
public sector. Spending out of borrowings by public sector enterprises (PSEs)
adds as surely to demand as does spending by ministries; fiscal repairs must
cover them too. Britain has for long framed targets in terms of Public Sector
Borrowing Requirements; this is a concept we should adopt as well. There will
be violent opposition to this; many socialists and pseudo-socialists in the
government will argue that PSEs are
independent entities, and that their borrowings should not be treated as a part
of the central deficit. But the fact is, that if those PSEs default on their
debt, the central government will bale them out. And should they need capital,
they do not have the freedom to go and raise equity in the market. As long as
the guarantee and the restriction on equity issues remain, PSEs are an
inalienable part of the central government.
This point gains added
significance when we come to the states. For the states’ finances have been in
a much more parlous state than the centre’s; and many of them have been
borrowing through their PSEs and spending the money to pay their employees’
salaries. This is a most unhealthy practice; the way to bring it out in the
open is to combine their own and their PSEs’ borrowings.
Finally, the finance minister
should think of creating an internal credit market for the central government.
Money is released to spending ministries on 1 April; the next three months see
a huge excess of expenditure over revenue. Income tax flows in between July and
October when returns become due; at this time, the balance is reversed. Then,
as the end of the year approaches, ministries hasten to spend their budgets,
and the deficit again increases. A mechanism can be conceived by which
ministries would be expected to spend evenly through the year, and deviations
from the pattern would either earn or cost interest. The interest could even be
determined by bargaining between ministries with surplus and deficit funds.
