Finance Minister Arun Jaitley\’s first budget should spell out his vision for the next five years, downplaying projections for the coming year. This vision must include a tough budget this year and another tough one next year, pruning populist excesses and improving tax administration. That will build a sound foundation for fast economic growth in the last three years of the BJP\’s term, ushering the way to reelection in 2019.
The rollback of suburban rail fares has sparked fears that despite tough talk, the BJP funks dispensing bitter fiscal medicine since the party\’s election slogan was \”achche din aane wale hain.\” This slogan has led some voters to believe that Modi can wave a magic wand to instantly tame inflation and crate a million jobs. Sorry, there\’s no magic wand. Modi has inherited an economic mess that will take years to sort out.
Jaitley faces the unenviable but necessary task of explaining that \”achche din\” can come sustainably only with a lag of one or two years. He must pluck low-hanging fruit while being fiscally tough.
Modi\’s victory has sparked a stock market boom, and the resultant wealth effect has already spurred car sales, services PMI and fresh capital issues by corporates. The stock market boom means Jaitley can aim for a whopping Rs 100,000 crore through disinvestments, easing fiscal strains.
Potential disinvestments include sale of residual holdings in Balco and Hindustan Zinc, and of shares held in SUUTI. A more radical breakthrough would be to corporatise the railways and sell part of the new corporation to the public.
Foreign agencies tend to focus on the size of the fiscal deficit. Jaitley should focus instead on the revenue deficit, promising to slash this to zero within three years. P Chidambaram ended with a revenue deficit of 3.3 per cent of GDP, though this should have been zero according to the original budget law.
If Jaitley can abolish the revenue deficit, foreign agencies will happily accept much larger government spending on infrastructure. Jaitley should abandon the Direct Tax Code.
Instead he should announce that India\’s direct tax rates will move within five years towards those of ASEAN, making India internationally competitive. In 1997, Chidambaram announced a long-term vision of reducing import duties in stages to the ASEAN level. This vision was so compelling that it was adopted by all succeeding finance ministers, with success.
The same approach now needs to be adopted for direct taxes. This will mean lower direct tax rates, but with fewer exemptions and exceptions, so that the effective tax rate rises.Jaitley must resist the temptation to reward his middle-class supporters with a big increase in the income tax exemption rate.
At most, this rate must be adjusted only for inflation. Non-merit subsidies have been the bane of the budget for several years and structural change is essential. Small periodic increases in the prices of diesel have gradually raised income without raising a public outcry.
Jaitley should use a similar approach for other petroleum products and fertilizers. This need not be announced in the budget speech: it may be politically convenient to do so later. But the Prime Minister\’s full backing must be obtained now itself, so that the budget projections can reflect this strategy.