What Ails Our Budgets?

Like the faithful waiting eagerly for some recurrent hallowed ritual to commence, the annual budget is a ritual that keeps 10 crore plus tax payers, house-wives along with corporates and capital markets on their toes. The ruling dispensation, in the meantime, brags about the “handsome” outlays for various purposes like capital expenditure and a plethora welfare schemes dressed in politically appealing narrative. But what really ails budget making is that the emphasis is almost entirely is on spending and not on outcomes. Some of the areas of concern regarding budget outcomes are the following.

1. Infrastructure: Although we have a separate ministry with an army of bureaucrats, the data from the Ministry of Statistics and Programme Implementation (MOSPI) come with considerable time lag. The latest data from MOSPI paint a somber picture. As of March 2024, out of 1873 ongoing Union Government projects, each with an outlay of Rs 150 crores or more, 779 are running behind schedule. While these delays, per se, are disturbing in that they hide huge opportunity costs, the magnitude of cost overruns is equally alarming.  The aggregate cost overrun in the above 779 projects exceeds Rs 5 lac crores. It is estimated that cost overruns in the infrastructure sector account for 1.6 per cent of the GDP. The performance gets murkier if the shoddy execution of projects is comprehensively accounted for. To cite only a few examples; in Bihar 13 bridges collapsed in June-July 2024, in less than six months after their opening, the much publicized Atal Setu bridge developed large cracks and terminal-1 of Delhi airport collapsed in June 2024.  
2.  Competitive Populism: A functioning democracy, despite its many challenges, is a precious gift that India has rightly come to cherish.  Ever since Archbishop of Canterbury brought charges against King Edward II in 1327 with the now famous Latin phrase, Vox populi Vox Dei, the same has beendeftly perverted by politiciansof all hues, including aspiring dictators. The perversion has taken many forms including majoritarianism that stifles diversity or, pandering to the minority vote banks. A more insidious perversion of this doctrine is competitive populism.  In their quest to seize power at any cost, political parties across the spectrum have resorted to a race to the bottom of mindless giveaways to garner votes, unmindful of the eventual deleterious economic consequences. With fiscal deficit to GDP ratio at 4.9%, Finance Minister says that the budget is fiscally prudent. But even at this level of deficit, 2024-25 budget, thanks to burgeoning subsidies, seems to be fast hitting the ceiling for productive expenditure, since debt servicing (interest costs of Government Debt) is the single largest expenditure at 19% of the total expenditure (excluding States’ share of taxes and duties). The situation is far worse, when deficits by States are taken into account. For instance, the CAG report of May 24 on Maharashtra, one of the most resource rich States, warns of rising debt burden. Over 60% of the State’s expenditure is committed to debt service, salaries and pensions. The Majhi Ladli Bahin scheme alone is expected to cost the exchequer Rs 63000 crore! With unproductive giveaways such as free electricity, water, travel, etc., outlays for capital formation and public merit goods like health and education, etc., are bound to suffer. Given the compulsions of competitive populism, budgets have failed to differentiate between wasteful freebies and welfarism that boosts economic and social empowerment.
3. Demand Deficit: The last budget had some meaningful outlays and policy initiatives to tackle unemployment, both naked and invisible. One umbrella that has been hiding both open and invisible unemployment has been the amorphous category of self-employed. Successive budgets have made concerted efforts to raise outlays for capital formation so as to generate jobs.  But even at the current elevated level of capital outlay, public sector (including outlays by States) accounts for only about 17% of the total investment in the economy, with corporate and household sectors accounting for 83%. It is in this context, erstwhile Finance Secretary Mr. Somanathan’s statement that government investment is no substitute for investment by private sector, acquires significance. Over the last few years aggregate level of investment in the economy as a percentage of GDP has come down and at present it is at 30% of GDP. If we aspire to shift from current GDP growth of around 6.5% to 7.5%, we need to increase investment level from 30 to 35% given that the incremental capital output ratio is 5. This certainly is a tall task given the twin challenges posed by prevailing interest burden and the demand constraint that the household sector is facing. The investment by the household sector is estimated on a residual basis after accounting for gross fixed capital formation in the public and corporate sectors. Investment by household sector in 2013-14 which was at 42.6% of the total, was down to 39.5% in 2021-22. It is important to note that household sector comprises informal sector covering unregistered small and micro enterprises (SMEs) and proprietary firms. So even as officials keep claiming uptick in investment activity in the listed corporate space, there is pain, albeit hidden, in the informal sector because of loss of employment and income accentuated by inflation. This has adversely affected demand for goods and services of mass consumption which has slowed down capacity expansion in the corporate sector. The affluent sections of the society are able and willing to spend on domestic and imported luxury goods. This can be seen in the spike in demand for luxury houses while that for affordable housing remaining sluggish despite government incentives, or in sale of luxury cars taking off, even as demand for entry level two wheelers remaining flat or declining. So it appears that demand constraint will emerge as a major challenge in budget management going forward.
4. Tax Inequity: Since FY 23, personal income tax collections have exceeded corporate tax collections, with the former being 13.5% higher than the later in FY 24 and accounting for about 54% (Rs 10.45 crores) of the direct tax collections of Rs 19.6 lac crores. The skew has worsened in the first half of this fiscal with 25% growth in personal income tax collections, against 2.3% growth in corporate taxes. The corporates which now enjoy lower tax rates, have been generous with dividend distribution and buybacks but have hardly stepped up their investments, many of them being content with trading in imported goods. This anomaly in the incidence of tax on the corporates and individuals needs to be addressed, if only to give a boost to demand in the economy.

The recent data released by the Central Board of Direct Taxes indicate that the tax burden of those in the Rs 5.5 to 9.5 lac annual income bracket is high, as the total tax payable by those in this category exceeds that of those in the higher income brackets. It is worth considering tax reliefs for this quintessentially middle-class bracket as well as those below it, given their relatively higher marginal propensity to consume. Another disturbing development is the sharp fall in the number income tax return filers with income beyond Rs 1 crore, which suggests that the doubling of taxpayers between FY 15 and FY 24 has happened at the lower end. Apart from suitably raising the tax slabs at the lower end, this calls for measures to increase the tax base (about 10% of the working population) at the higher end.

Any taxation regime that seeks, among other things, to support long-term economic growth, needs to incentivize harnessing of ‘high powered’ risk capital as opposed to bonds or other forms of investment. In the last budget under the guise of rationalization, differentiation between capital gains derived from risk capital and other assets is almost eliminated. While it may be beneficial to disincentivize trading in capital assets, patient long term risk capital needs to duly rewarded. The next budget could consider increasing holding period for equity capital to say 3 years, during which any realization of capital gains could be taxed at 20% and thereafter make the gains tax free. This may even prove to be revenue neutral, since bulk of the transactions to book profits are likely to take place within three years, given the prevailing trading intensity on the recognized bourses.