Why the Budget Should Support Development Goals

The width and volume of pre-budget discussions in India are a very visible demonstration of the dance of democracy. It is our money and each of us has views on how it should be used. Many hope to gain and markets hope to benefit by predicting winners. 

But the objective of achieving Viksit Bharat requires following the trifecta that has worked over the past few years. First, simplify taxes and reduce them to apply to a larger base, continue to decrease deficits and debt, while stimulating the economy and raising productivity through a better composition of expenditure. Commitment to a medium-term macroeconomic framework implies greater budgetary predictability.

Some operating principles can help achieve the objectives. First, changes should promote and be consistent with efficiency-increasing reforms. Second, reform should align incentives and institutions to promote compliance in spirit. Third, the budget should respond to current needs, while remaining consistent with the first two principles.

After a brief examination of the rationale, we turn to implications for the budget. Trifecta-induced macroeconomic stability has led to a rating upgrade, which reduces borrowing costs for all. Whatever is working should be continued.

Widen Tax Base
A large-volume low-price strategy is very effective for India given its large population. The latter, rising incomes and technology to reduce evasion are a potent combination to expand the tax base. As revenues rise with growth and better tax design, it becomes possible to lower tax rates, sharing gains with the tax-payer. Simplification of the tax structure improves compliance and promotes the ease of doing business towards Viksit Bharat. Closing loopholes widens the base.

Emerging market sovereigns are forced to borrow at higher rates that cover a risk premium. Falling risk reduces rates. And, together with reduction in debt ratios, may aid reduction of the 25% of central revenue tied up in debt servicing. If there are constraints on borrowing and debt, using each rupee more effectively is the way to stimulate the economy. That is, paying attention to the composition of expenditure.

Current needs include counter-cyclical smoothing of shocks, to sustain demand and keep growth at potential even as reforms raise potential. Then growth volatility is reduced and gives multiple benefits. Rating agencies see smooth high growth as indicating maturity and reduced risks.

The GST simplification and rate reduction provides an example satisfying several of the principles.  It is consistent with reform, with sharing revenue buoyancy and a compositional change that stimulates the economy while preserving overall fiscal consolidation. The budget will extend the simplification to customs duties.

The demand response to GST and income tax cuts showed the 2024 slowdown was cyclical; the K-shaped recovery and inequality story lost credibility. Corporates who had bought into the story are shifting from a value to a volume strategy; corporate investment may strengthen as they expand capacity for volume growth.

Bang for the Buck
There is demand for tax cuts and expenditure allocation to specific sectors. Since geo-economic shocks continue, the decision should be based on what delivers the best bang for the buck in terms of the counter-cyclical stimulus required in the current context as well as productivity gains.

Temporary or conditional tax changes are a way to improve incentives without creating arbitrage or more complexity. Corporates have large profits and cash balances but inadequate physical investment and R&D expenditure. They have to get future ready and helping the country to do so will also help them. A carrot and stick package can incentivise these actions. Since there is demand visibility a push might get them going. 

Firms may be given three options, of which they can choose anyone or a mix:

1. Invest or spend 10% of PBT on R&D
2. Put it in designated infrastructure bonds or funds or
3. Give it as tax to the government to build a platform for ready central/state infrastructure projects.

A time-limited measure will not affect entry or location decisions. New entrants can be exempt from it. By fast tracking their investment decision existing firms can escape the cess—therefore they could be motivated to invest. The initiative could be called corporates for the future.

China’s growth was export-led; India has a better balance between savings and consumption demand. Export growth is required but it is not the only source of demand. Even so, the budget should further support the rising international diversity of our exports—this is the way for robust long-term export growth. Emerging markets now account for more than 50% of global growth; this can be leveraged in many ways.

Not just exports, rising labour productivity and incomes are essential sources of the required demand. AI can help in faster low-level skilling in areas of critical shortages as well as in high-value added innovation.  Productivity is expected to rise about 30%. The budget should support developing relevant AI use cases.

But funds should not be hand-outs; educational and other institutions should have to compete for central funds on the basis of proven capability and plans. This is what sustained the creativity and success of US universities.

State Borrowing
To achieve Viksit Bharat it is necessary for everyone to contribute. Mechanisms for better coordination and convergence with states need to be strengthened. State Development Loans, or SDLs, are now almost 50% of combined government borrowing and are keeping gilt yields high, although the market has grown in size and there are new participants to absorb borrowing. As the Centre moves towards the golden rule of borrowing only for investment, states should also be encouraged to do so, with own tax revenue used for well-targeted local welfare schemes. Untying of central grants can be made conditional on decentralisation and better two- and three-tier governance.

A budget for Viksit Bharat must take the long view, not give in to ad-hoc demands and special interests.