Union budget 2016-17: a brief note

March 5, 2016

By Debarshi Das

In a bourgeois democratic set up the budget strategies of a government can be seen from two perspectives. One, the government generates as high a growth of aggregate output as possible. It is hoped that the fruits of high growth would percolate down to the lower strata. Thus distribution concerns would be addressed after this “trickling down” – although the details of the percolation are often in a black box. This strategy has been the mantra of neo-liberal regimes. Second, the government directly addresses the distributional parameters. Simultaneous with less poverty and deprivation, economic growth is encouraged. A robust and ethically defensible growth process is thus generated. This has been the contention of the critics of neo-liberalism, who are mainstream nonetheless.

Development and Growth?

One can examine the union budget 2016-17 from either of these perspectives. Let us take the second one first. Does the budget have a plan to address the deleterious effects of skewed distribution of income and wealth? It is well known that the agricultural sector houses the largest mass of resource-poor people. If media reports are to be believed, the budget has given a high emphasis on agriculture. If this is indeed the case, the government is relying on the second strategy mentioned above.

An examination of data reveals that although the finance minister has mentioned agriculture and farmer welfare several times in the budget speech, the share of rural development expenditure (which includes agriculture) in GDP has remained constant at 1.5%. Compared to the data three years ago, there has been a minor decline of 0.3 percentage points in the allocation share. Similarly, allocation shares of other important heads such as education, health have remained constant at best, compared to the previous year. Over a three year span the shares have gone down mildly. There has been an accounting trick as well which shows high allocation for agriculture. Allocation for agriculture falls drastically once we subtract the interest subsidy on farm loans. This head was previously under the finance ministry purview but has been brought under the ministry of agriculture this year. Most talks of rising allocation in agriculture are therefore empty talk. Data does not support the second hypothesis that the government has plans to directly address poverty, or its cause and effects. This article by Dreze and Khera demonstrates as much.


[Courtesy: The Telegraph, 1st March, 2016]

It is true that there has been some jacking up of expenditure on irrigation and rural infrastructure. If they materialise, that would be beneficial. This is a big “if,” because in the past actual expenditure has been slashed in order to meet fiscal deficit targets. It is also noteworthy that these allocation increases have come about when food and fertilizer subsidies have been cut in nominal terms. This further goes to show that direct redressal of inequity is not a priority.

Development after Growth?

How does the budget proposals fare with respect to the first strategy, that is, achieving high growth? Shall we achieve a high growth rate as promised in the Economic Survey? Let us visit basic macroeconomics to be able to answer this.

Output of an economy is driven by four major sources of demand. These are consumption expenditure, private investment expenditure, government expenditure and trade balance (i.e., exports minus imports). As for the fourth component, given the grim global economic prospects and indifferent performance of Indian exports in recent years, there is little reason to expect that the trade balance would dramatically improve in the coming fiscal year.

Coming to the third component, government expenditure is tethered to the revenue of the government courtesy the FRBM Act (Fiscal Responsibility and Budget Management Act restricts the gap between expenditure and revenue of the government within a range). Such acts limit government’s intervention in the economy. This is because, when the revenue if not growing much due to reluctance to tax the rich, FRBM Act puts an upper bound on how much the government can spend. It is to be noted that the limit imposed by FRBM is arbitrary. These limits have been in vogue in the last few decades in many countries. They demonstrate how enfeebled the national governments have become in front of the might of finance capital. Compared to the UPA II government, which was a great adherent of fiscal conservatism, this budget proposes a near 2 percentage point decline in the share of total expenditure in GDP. Thus the third route of generating demand and stimulating output has limited prospects.

For the first two components of private consumption expenditure and investment expenditure, it is important to take note of the taxes to analyse these factors. A high indirect tax, which is imposed on goods and services, is likely to push up prices and reduce consumption expenditure. On the other hand, a reduction in corporation tax (which is imposed on the income of firms) can encourage private investment and stimulate output demand. It is worthwhile to track how these taxes have been changing over time.


Source: Receipts Budget, 2016-2017

In fig. 1 we have plotted three graphs. The data for 2016-17 is the budget estimates (BE), that of 2015-16 is the revised estimate (RE). Rest of the data points are actual final figures. We have included three major contributors in the Direct Tax revenue: corporation tax, personal income tax and wealth tax. Following observations can be made.

First, since 2009-10 there has been a declining trend in direct tax revenue as a proportion of gross tax revenue. This means that the government has been relying more on indirect taxes as far as collecting tax revenue is concerned. Now, reliance on indirect taxes leads to greater economic inequality. This is because indirect tax targets consumption and consumption propensity of the poor is higher than the rich. Greater degree of inequality is likely to dampen the aggregate consumption demand.

Second, corporation tax revenue as a proportion of gross tax revenue has declined since 2009-10. And thirdly, since 2010-11 proportion of corporation tax revenue of the direct tax revenue has also declined. Both these observations suggest that the governments over this time span have been becoming more corporate-friendly.

For the first two parameters (direct taxes as a ratio of gross tax revenue and corporation taxes as a ratio of gross tax revenue), 2015-16 was a notable break: both these parameters fell by about 4 percentage points in that year. In 2015-16 the NDA government presented its first full-fledged budget. From the data it seems it showed its intentions from the very beginning. The share of corporation tax has continued to decline this year, continuing with the trend since 2009-10. It is therefore misleading to say that the corporate sector has not been given any concession this year. The budget documents further reveal the effective tax rate of large corporations is lower than that of smaller corporations!

So, will consumption expenditure would be boosted? The signs seem discouraging. The burden of indirect taxes is going to hurt consumption demand. There is no sign that employment will pick up either, which could have helped consumption demand. Allocation under Mahatma Gandhi National Rural Employment Guarantee Scheme has increased this year. But from a medium run perspective the allocation has remained stagnant in nominal terms. The allocation this year is in fact less than the allocation of each of three years: 2009-10, 2010-11, 2011-12.

This leaves the second component: private investment. It is perhaps hoped that higher private investment will pull the economy towards more growth. Reduction in the corporation tax burden suggests that the government is trying to incentivise private investment. Concessions have been made to foreign direct investment as well. Instead of business visa, foreign investors would be granted residency status. Upper limit on foreign portfolio investment to buy central public sector enterprises’ shares has been raised from 24% to 49%. The government is hoping that by granting “ease to do business” to domestic and foreign capital private investment would be stimulated (it is thus erroneous to think that the momentum of liberalisation has reversed and government control has increased).

At least two factors can jeopardise these plans. First, when the overall economy is showing no robust momentum it is unlikely that private investment would accelerate on its own. Second, the banking sector is suffering from a pile of “stressed assets” in its balance sheet. Much of this is bad loan advanced to crony capitalists who have connections in the bureaucracy and political circles. Stressed assets amount to as much as 6.7% of the GDP. As long as this is not corrected, investments will have difficulty in finding finance.

Thus, from the neo-liberal perspective of “growth for its own sake” as well the budget will not deliver. But that is the irony of market economy. Being an atomistic, chaotic system, capitalism does not serve the interest of the capitalist class as a whole.