Economic Highlights

New Delhi, 1 February 2007

Avoid Fiscal Contradictions

Separate Budget from Policy Measures

By Dr. Vinod Mehta

 Just on the eve of the budget, the media is full of speculative news about cut in tax exemptions and subsidies.  Yet when the actual budget comes there is neither reduction in subsidies nor cut in tax exemptions.  The old things continue.

For the last five decades it has been observed that the annual budgets are used to make major policy announcements, which are not conducive to long-term savings and investment decisions. Many a time these policy announcements upset the market expectations and lead  to volatility in the stock market. The time has come to think whether we should continue to make policy announcements during budget presentation or separate policy announcements from budget.

Budgetary exercise is essentially an exercise to balance the revenues and expenditures of the Government and it should be treated as such. It is not the place to make economic policy announcements, which is a much more serious matter than the balancing of receipts and expenditures. Moreover, latching economic policy announcement to budget is leading to contradictions in many areas without in any way providing solutions to serious issues.  

One has been hearing about curtailing tax exemptions and levying taxes on savings at the time of final withdrawal for the past few years.  But when it comes to taking a final decision the Government develops cold feet. So is the case with subsidies.  For the past several years, the nation has been discussing the rationalization of subsidies and every time on the eve of a budget anti-subsidy feelings are taken to new heights to find that the subsidies instead of being cut are in fact raised.

The handling of the question of subsidies and cut in tax exemptions call for a serious holistic approach and cannot be tackled in the annual budgetary exercises.  Admittedly, there are a large number of tax exemptions especially to the corporate sector and that savings are tax free at every stage. For instance, when one puts money in Provident Fund or puts money in specified bonds one gets a rebate up to Rs. one lakh and when the final amount is withdrawn the accumulated interest is also not taxed i.e., the final withdrawal with interest earning is also tax free. So the argument goes why one should get tax exemption twice for the same saving?  Therefore it is argued that at least the accumulated interest on savings be taxed. The Government is convinced of this reasoning but saving public is not pleased.

Again, subsidies are an accepted norm in modern societies and cannot be wished away.  The important thing, however, is for what purpose the subsidies are being given and which group(s) stands to benefit from them and whether there are any bad side effects of these subsidies.  The second aspect of this is that these should be administered in a cost effective manner and that the continuation of a particular subsidy is reviewed periodically.  This is the case in most of the developed countries.  For instance, the public transport system, school level education, primary health care, etc. are subsidized in most of the developed countries and the quantum of subsidy reviewed periodically. 

Therefore, there is nothing wrong in giving subsidies so long as they serve a useful social purpose. Let us take the case of subsidies on fertilizers. This is one single subsidy which everyone knows is only harming the nation, but the vested interests are so strong that  no Finance Minister has been able to garner enough of courage and do away with it in one stroke. 

It is common knowledge that the use of chemical fertilizers beyond a certain point is an environmental hazard.  Its long term-use not only pollutes the soil but also spoils the health of the people who eat the produce of such farms.  By keeping the prices of fertilizers artificially down, we are only encouraging the misuse of fertilizer on a large scale. One fails to understand that in a country of over one billion people and the largest number of cattle in the world can't we have sufficient organic manure to replace the use of fertilizers? 

Since fertilizers have been made so cheap that it is not economically possible to invest funds in improving the quality of organic manure, which is environment friendly as well as health friendly.  Recently the Government approved to clear subsidy on fertilizer to the tune of      Rs. 34,000 crore by March 31 this year.

Stop the subsidy on fertilizer and let the farmer buy it at the market prices.  Its consumption will go down and, importantly the farmer will now make an efficient use of it and many of them would even switch over to organic manure. If the fertilizer companies find it uneconomical to operate without any subsidy then let them close down their shop and invest the money in producing organic manure. 

Therefore, delink the question of subsidy from the budget and let the Government state a policy as to what subsidies will continue and what subsidies will be retained.  It may be better to do away with subsidy on fertilizer in the next few years so that the farmers are mentally prepared to buy their requirement of fertilizer at market prices, have time to switch over to use of organic manure as well as give sufficient time to fertilizer companies to either reduce their production costs or switch over to the production of organic manure or bio-fertilizer.  At the same time the Government should come out with an agricultural policy in its totality including the scientific research so that the country is able to produce more than what it requires in the coming years.

 Similarly, the subsidy on food also needs to be streamlined.  As of today a large part of this subsidy goes to meet the expenditure on FCI.  Firstly, the Government has to borrow heavily from the bank to buy food grain from the farmers to store in FCI godowns.  Secondly, it has to pay the maintenance expenditure to keep these stocks in silos.   On the top of it, it has the whole machinery of rationing staff all over the country to implement this scheme.  If the idea is to provide cheap food grains to the poor then the best way would be to issue them food coupons.  The poor can use these coupons  to buy their food  requirements from the market.  The cost of administration would be much lower than the current food subsidy.

As a principle, the commercial activity should never be subsidized except in exceptional circumstances.  There is no need to subsidize exports. It is high time the Government comes out with a working policy paper on its idea about eliminating/cutting tax exemptions and the extent of desirable subsidies or otherwise for each sector of the economy; let the average citizen and the experts react to it and then the Government should finalize its overall policy towards tax exemptions and subsidies.

With interest rates lower than what they were a few years ago and with the Government pushing the average citizen to equity market/mutual fund the citizen should be able to take right decisions about his savings and investment decisions.  Since these are essentially long term decisions the clear cut policy on tax exemptions will help one to take informed decisions on savings and investments. So is the case with subsidies.  It should come clean on the question of subsidies and end once for all the speculative stories about tax exemptions and subsidies.  It will also end volatility in the capital market, which always follows ad hoc announcements in every budget.

All these are policy issues. They need to be de-linked from the annual budgetary proposals.  There should also be nothing secret about the budgetary proposals.  They should be discussed the whole year round and announced at the appropriate time.  There should be only marginal changes in the tax rates with a view to balancing the receipts and expenditure. ---infa

 (Copyright, India News and Feature Alliance)