Friday, November 17, 2006

>A Better Use For Surplus Revenue

There are reasons to think that the finance minister was serious when he told economic editors that there was scope for “further” tax reductions. For one thing, he is not given to making jokes, especially about his work. For another, he has done it before. After his first budget proved extremely unpopular, he made up for it by reducing taxes in his 1998 budget. There was no call for it; but being unexpected, the tax cut cheered up taxpayers and made up for the previous year’s follies. And finally, if there ever is a good time for reducing taxes, it is now. For revenue is leaping up; despite its spendthrift habits the government is finding it difficult to spend it. No wonder Mr Chidambaram is thinking of how to get rid of unwanted cash. And bearing a heavy tax burden himself, he can sympathise with other taxpayers.

A more self-centred finance minister would have thought of introducing some exemptions and rebates. But Mr Chidambaram is quite against them. He knows that they complicate tax law, turn into avenues of evasion and draw the tax authorities into an endless, tiresome struggle to keep taxpayers straight. Hence, he is thinking of straight tax cuts.

All taxpayers will welcome his frame of mind — even those who do not particularly want a tax cut. But as finance minister, he must not act on impulse. He must carefully consider alternatives. What are the other uses to which he can put the surplus revenue?

His fellow ministers would love to pocket it, and will no doubt give him ideas about how he can pass on the money to their own ministries. But that is not what I have in mind. I believe Rajiv Gandhi was optimistic when he said 20 years ago that only 15 per cent of government expenditure went to the intended beneficiaries. So, I am entirely with Mr Chidambaram if he thinks that government expenditure must not be increased beyond the limits set by the budget.

If it is kept unchanged, a higher revenue than was budgeted will lead to a fall in government deficit. This is the major alternative to a tax cut — a better alternative to my mind. The finance minister should not only collect all the revenue he can, but he should rein in expenditure and maximize the reduction in government deficit. He should aim to eliminate fiscal deficit by 2009-10, the last year he may expect to present a budget — unless he returns as finance minister in the next government.

We have run a fiscal deficit for almost 30 years — so long that we have forgotten the advantages of not running one. For with a fiscal surplus, the government will stop borrowing, and start repaying its debt. Once it does so, it will become unnecessary for the Reserve Bank to force banks to buy government debt. And if banks do not have to buy government bonds, they will make more credit available for financing productive activities. Output and employment will grow faster.

Once the need for the government to borrow is removed, its manipulation of interest rates too can cease. At the moment, the Reserve Bank is torn between two objectives. On the one hand, it wants to keep interest rates down to reduce the cost to the government; on the other hand, it wants to keep up the interest income of banks, which are compelled to hold government debt. So it is obsessed with control of the debt market. Once it ceases to have to find a home for ballooning government debt, it can leave the interest rate to be determined by the market. Interest rates will, on balance, come down, and stimulate the economy.

And finally, once the flood of government debt stops, more money will find its way to the equity market. The supply of risk capital will expand; small companies, in particular, will find it easier to access outside capital. Funds will be distributed and growth will spread more widely than now. With many more companies growing, there will be more competition amongst them, higher productivity growth and lower inflation. That is when India will be able to match China’s growth.

by: ashok v. desai
http://www.businessworld.in/issue/column01.asp

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